A History of Money and Banking in the United States: The Colonial Era to World War II (5 page)

49For examples, see, respectively, George J. Stigler, “The Theory of Economic Regulation,” in
The Citizen and the State: Essays on Regulation
(Chicago: University of Chicago Press, 1975), pp. 114–41; and James M.

Buchanan, “Politics without Romance: A Sketch of Positive Public Choice Theory and Its Normative Implications,” in
The Theory of Public Choice—II,
James M. Buchanan and Robert D. Tollison, eds. (Ann Arbor: University of Michigan Press, 1984), pp. 11–22.

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A History of Money and Banking in the United States:
The Colonial Era to World War II

investigation of the actual motives of those individuals or groups whose actions they are analyzing. Instead, their positivist methodology inclines them to mechanically impute to real actors in concrete historical circumstances a narrowly conceived utility maximization.

James Buchanan, one of the founders of public choice theory, writes, for instance, that economists pursuing this paradigm tend to bring with them models of man that have been found useful within economic theory, models that have been used to develop empirically testable and empirically corroborated hypotheses. These models embody the presumption that persons seek to maximize their own utilities, and their own narrowly defined economic well-being is an important com-ponent of these utilities.50

George Stigler, who pioneered the theory of economic regulation, argues, “There is, in fact, only one theory of human behavior, and that is the utility-maximizing theory.” But for Stigler, unlike Rothbard or Mises, the exact arguments of the utility function of flesh-and-blood actors are not ascertained by the historical method of specific understanding but by the empirical method. Thus, Stigler argues:

The first purpose of the empirical studies [of regulatory policy]

is to identify the purpose of the legislation! The announced goals of a policy are sometimes unrelated or perversely related to its actual effects and the
truly intended effects should
be deduced from the actual effects
. This is not a tautology designed to gloss over a hard problem, but instead a hypothesis on the nature of political life. . . . If an economic policy has been adopted by many communities, or if it is persistently pursued by a society over a long span of time, it is fruitful to assume that the real effects were known and desired.51

50Buchanan, “Politics without Romance,” p. 13.

51Stigler, “Theory of Economic Regulation,” p. 140.

Introduction

33

By thus discounting the effect of erroneous ideas about the appropriate means for achieving preferred goals on the choices made by historical actors, Stigler the positivist seeks to free himself from the task of delving into the murky and unmeasurable phenomenon of motives. Without doubt, if the historical outcome of a policy or action is always what was aimed at by an individual or organization—because, according to Stigler,

“errors are not what men live by or on”—then there is no need to ever address the question of motive. For Stigler, then, there is no reason for the historian to try to subjectively understand the motive for an action because the actor’s goal is objectively revealed by the observed result. Now, Stigler would probably agree that it is absurd to assume that Hitler was aiming at defeat in World War II by doggedly pursuing his disastrous policy on the Eastern front over an extended period of time. But this assumption only appears absurd to us in light of the thymological insight into Hitler’s mind achieved by examining the records of his actions, policies, utterances, and writings, and those of his associates. This insight leads us to an
understanding
, which cannot be reasonably doubted by anyone of normal intelligence, that Hitler was fervently seeking victory in the war.

Rothbard insists that the same method of specific understanding that allows the historian to grasp Hitler’s objectives in directing the German military campaign against the Soviet Union also is appropriate when attempting to discern the motives of those who lobby for a tariff or for the creation of a central bank. Accordingly, the guide that Rothbard originates to direct the economic historian first to a search for evidence of an unspoken economic motive in such instances is only a guide. As such, it can never rule out in advance the possibility that an ideological or altruistic goal may serve as the dominant motivation in a specific case. If his research turns up no evidence of a hidden economic motive, then the historian must explore further for ideological or other noneconomic motives that may be operating. Thus, as Rothbard points out, his approach to economic history, whether it is labeled a “conspiracy theory of history” or not, “is really only praxeology applied to human history, in
34

A History of Money and Banking in the United States:
The Colonial Era to World War II

assuming that men have motives on which they act.”52 This approach also respects what Mises has called “historical individuality” by assuming that “[t]he characteristics of individual men, their ideas and judgments of value as well as the actions guided by those ideas and judgments, cannot be traced back to something of which they would be the derivatives.”53 In sharp contrast, the positivist methods of Stigler and Buchanan attempt to force participants in historical events into the Pro-crustean bed of
homo economicus
, who ever and unerringly seeks for his own economic gain.

We can more fully appreciate the significance of Rothbard’s methodological innovation by briefly contrasting his explanation of the origins of the Federal Reserve System with the explanation given by Milton Friedman and Anna J. Schwartz in their influential work,
A Monetary History of the United States,
1867–1960
.54 Since its publication in 1963, this book has served as the standard reference work for all subsequent research in U.S. monetary history. While Friedman and Schwartz cannot exactly be classified as new economic historians, their book is written from a strongly positivist viewpoint and its methods are congenial to those pursuing research in this paradigm.55 For example, in the preface to the book, Friedman and Schwartz write that their aim is “to provide a prologue and a background for a statistical analysis of the secular and cyclical behavior of money in the United States, and to exclude any material not relevant to that purpose.” In particular it is not their ambition to write “a full-scale economic and political history that would be 52Murray N. Rothbard, “Only One Heartbeat Away,”
The Libertarian
Forum
6 (September 1974): 5.

53Mises,
Theory and History
, p. 183.

54Milton Friedman and Anna Jacobson Schwartz,
A Monetary History
of the United States, 1867–1960
(Princeton, N.J.: Princeton University Press, 1963).

55See, for example, North,
Growth and Welfare in the American Past,
p. 11, n. 6.

Introduction

35

required to record at all comprehensively the role of money in the United States in the past century.”56 Thus, in effect, the behavior of the unmotivated money supply takes center stage in this tome of 808 pages including appendices. Indeed, the opening sentence of the book reads, “This book is about the stock of money in the United States.”57

Now Friedman and Schwartz certainly do not, and would not, deny that movements in the money supply are caused by the purposeful actions of motivated human beings. Rather, the positivist methodology they espouse constrains them to narrowly focus their historical narrative on the observable outcomes of these actions and never to formally address their motivation. For, according to the positivist philosophy of science, it is only observable and quantifiable phenomena that can be assigned the status of “cause” in a scientific investigation, while human motives are intensive qualities lacking a quantifiable dimension. So, if one is to write a monetary history that is scientific in the strictly positivist sense, the title must be construed quite literally as the chronicling of quantitative variations in a selected monetary aggregate and the measurable effects of these variations on other quantifiable economic variables, such as the price level and real output.

However, even Friedman and Schwartz’s
Monetary History
must occasionally emerge from the bog of statistical analysis and address human motivation in order to explain the economic 56Friedman and Schwartz,
A Monetary History,
p. xxii.

57Ibid., p. 3. As doctrinaire positivists, Friedman and Schwartz consistently refer to the “stock” or “quantity” of money rather than to the “supply” of money, presumably because the former is the observable market outcome of the interaction of the unobservable money supply and money demand curves. However, it is likely that Friedman and Schwartz conceive the money stock as a good empirical proxy for the money supply, because they view the latter as perfectly inelastic with respect to the price level. On this point, compare Peter Temin’s interpretation. Peter Temin,
Did Monetary Forces Cause the Great Depression?
(New York: W.W. Norton, 1976), p. 18.

36

A History of Money and Banking in the United States:
The Colonial Era to World War II

events, intellectual controversies, social conflicts, and political maneuverings that had an undeniable and fundamental impact on the institutional framework of the money supply. Due to the awkward fit of motives into the positivist framework, however, Friedman and Schwartz’s forays into human history tend to be cursory and unilluminating, when not downright misleading.

For example, their two chapters dealing with the crucial period from 1879 to 1914 in U.S. monetary history comprise one hundred pages, only 11 of which are devoted to discussing the political and social factors that culminated in the establishment of the Federal Reserve System.58 In these pages, Friedman and Schwartz suggest that the “money ‘issue’” that consumed American politics in the last three decades of the nineteenth century was precipitated by “the crime of 1873” and was almost exclusively driven by the silver interests in league with the inflationist and agrarian Populist Party. This movement, moreover, was partly expressive of the 1890s, a decade which, according to C. Vann Woodward as quoted by the authors, “had rather more than its share of zaniness and crankiness, and that these qualities were manifested in the higher and middling as well as lower orders of American society.”59 In thus trivializing the “money issue,” the authors completely ignore the calculated and covert drive by the Wall Street banks led by the Morgans and Rockefellers for a cartelization of the entire banking industry, with themselves and their political allies at the helm. This movement, which began in earnest in the 1890s, was also in part a reaction to the proposals of the silverite and agrarian inflationists and was aimed at reserving to the banks the gains forthcoming from monetary inflation.

Friedman and Schwartz thus portray the drive toward a central bank as completely unconnected with the money issue and as only getting under way in reaction to the panic of 1907 and the problem with the “inelasticity of the currency” that was 58Friedman and Schwartz,
A Monetary History,
pp. 89–188.

59Ibid., p. 115, n. 40.

Introduction

37

then commonly construed as its cause. The result is that they characterize the Federal Reserve System as the product of a straightforward, disinterested, bipartisan effort to provide a practical solution to a purely technical problem afflicting the monetary system.60 Nowhere in their discussion of the genesis of the Federal Reserve System do Friedman and Schwartz raise the all-important question of precisely which groups benefitted from this “solution.” Nor do they probe deeply into the motives of the proponents of the Federal Reserve Act. After a brief and superficial account of the events leading up to the enactment of the law, they hasten to return to the main task of their “monetary history” which, as Friedman expresses it in another work, is “to add to our tested knowledge.”61

For Friedman and Schwartz, then, the central aim of economic history is the testing of hypotheses suggested by empirical regularities observed in the historical data. Accordingly, Friedman and Schwartz describe their approach to economic history as “conjectural history—the tale of ‘what might have been.’ ”62 In their view, the primary task of the economic historian is to identify the observable set of circumstances that accounts for the emergence of the historical events under investigation by formulating and testing theoretical conjectures about the course of events that would have developed in the absence of these circumstances. This “counterfactual method,” as the new economic historians refer to it, explains the historical events in question and, at the same time, adds to the “tested knowledge” of theoretical relationships to be utilized in future investigations in economic history.63

60Ibid., p. 171.

61Milton Friedman, “The Quantity Theory of Money—A Restatement,” in
Studies in the Quantity Theory of Money
(Chicago: University of Chicago Press, [1956] 1973), p. 18.

62Ibid., p. 168.

63For more on the nature and use of the counterfactual method, see Robert William Fogel, “The New Economic History: Its Findings and Methods,” in
The Reinterpretation of American History,
Robert William
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A History of Money and Banking in the United States:
The Colonial Era to World War II

Friedman and Schwartz exemplify this method in their treatment of the panic of 1907.64 During this episode, banks swiftly restricted cash payments to their depositors within weeks after the financial crisis struck, and there ensued no large-scale failure or even temporary closing of banks. Friedman and Schwartz formulate from this experience the theoretical conjecture that, when a financial crisis strikes, early restrictions on currency payments work to prevent a large-scale disruption of the banking system. They then test this conjecture by reference to the events of 1929–1933. In this case, although the financial crisis began with the crash of the stock market in October 1929, cash payments to bank depositors were not restricted until March 1933. From 1930 to 1933, there occurred a massive wave of bank failures. The theoretical conjecture, or “counterfactual statement,” that a timely restriction of cash payments would have checked the spread of a financial crisis, is therefore empirically validated by this episode because, in the absence of a timely bank restriction, a wave of bank failures did, in fact, occur after 1929.