Credit, Boom, and Collapse: The Austrian Business Cycle and the Great Depression

The Great Depression was not just another downturn; it was a defining economic catastrophe of the twentieth century. Scholars still debate its causes, offering explanations that range from monetary contraction to structural weaknesses in banking and trade. Monetary economists stress the Federal Reserve’s contraction of the money supply in the early 1930s. Keynesians point to weak aggregate demand and call for government spending as the remedy. Still others highlight agricultural distress, global instability, or the policy shifts of the New Deal. Each perspective captures part of the story. Yet the Austrian Business Cycle Theory (ABCT) offers a particularly sharp lens: it insists that the very prosperity of the 1920s, built on easy credit and speculative booms, carried within it the seeds of collapse.

Understanding the Austrian Business Cycle Theory

At its core, ABCT is disarmingly simple. When central banks expand credit and suppress interest rates, they distort the natural signals of the market. Entrepreneurs, seeing cheap borrowing costs, rush into projects that appear profitable but are not sustainable in the long run. Friedrich Hayek and Ludwig von Mises labeled these projects “malinvestments.” They flourish while credit is abundant but crumble when rates rise or demand falters. The cycle ends not with a soft landing but with collapse.

Fred Foldvary observes that ABCT theorists often neglected land in their early models. Yet land, he argues, is the clearest stage on which this drama plays out. Cheap credit inflates land prices, encourages borrowing for real estate development, and sparks waves of construction. Eventually, prices climb so high that returns vanish. Builders slow, defaults rise, and the bubble bursts—pulling banks, households, and entire communities down with it.¹

The Roaring Twenties: A Prelude to Collapse

The United States in the 1920s embodied this cycle. Murray Rothbard calculated that the money supply rose by 62 percent during the decade, propelled by Federal Reserve policies that kept credit artificially cheap.² That tidal wave of liquidity did not simply raise incomes; it poured into speculation.

Florida became the poster child for this phenomenon. Paul George recounts the surreal pace of Miami’s boom: on opening day, the East Shenandoah subdivision sold $3 million in property, while nearby Sylvania Heights sold $2.1 million.³ Newspapers swelled with real estate ads, and in 1925 Miami issued nearly $60 million in building permits—ninth in the nation for construction.⁴ Skyscrapers and hotels sprouted overnight. For a moment, Miami looked like the future. But supply bottlenecks soon appeared: a railroad embargo trapped freight cars, the harbor clogged with ships, and in 1926 a hurricane smashed subdivisions flat. By the end of the decade, Coral Gables was drowning in $35 million of creditor claims.⁵ What had looked like boundless growth turned out to be built on sand.

The Agricultural Crisis: A Parallel Narrative

Agriculture told the same story, though in less flamboyant form. Raghuram Rajan and Rodney Ramcharan show how cheap credit and high commodity prices after World War I drove farmers to buy land and machinery on a massive scale. Counties with the most banks experienced the steepest rises in land prices—and the sharpest collapses.⁶ Debt per acre soared. When prices for crops fell back to earth, farmers could not service their loans. Nearly 5,000 banks failed in the 1920s, many tied directly to farm defaults.⁷ The wounds were not temporary: land prices in high-credit counties stayed depressed for decades, and their banking systems never fully recovered.⁸

The Inevitable Downturn

The ABCT lens reframes the Depression not as a sudden shock but as the logical endpoint of the 1920s boom. Construction, the classic “higher-order” industry, slowed sharply by 1927. Alvin Hansen later described the 1928 downturn in building as “catastrophic.”⁹ In Chicago, office space nearly doubled between 1923 and 1929, but once built, demand evaporated, leaving buildings half-empty for years.¹⁰

Foreclosures ticked upward even before 1929. Real estate analyst Homer Hoyt called them a “barometer of approaching financial storms.”¹¹ The signals were clear: speculative excess, overleveraged households, and fragile banks were straining. The stock market crash did not create the Depression so much as light the match in a room already filled with fumes.

The Path to Liquidation

If credit inflation created the mess, ABCT argued, the only cure was liquidation. Let failed enterprises fail. Let prices adjust. Painful, yes—but necessary to clear away malinvestment and allow genuine growth. They pointed to the 1920–1921 depression as evidence. That slump was brutal—industrial production dropped nearly 30 percent—but because government largely stood aside, the contraction ended quickly and set the stage for the roaring decade that followed.¹²

This conviction shaped their long-term recommendations as well. Hayek and Mises distrusted central banking altogether. They favored free banking systems where competition—and a tie to real money like gold—restrained reckless credit creation. Whether through gold or some other hard standard, their message was consistent: detach credit from politics or face recurring cycles of boom and bust.

The Complexity of the Great Depression

ABCT does not explain everything. The depth and duration of the Depression owed much to banking panics, international trade collapse, and policy missteps. Monetarists rightly underscore the Federal Reserve’s contraction after 1929, while Keynesians highlight the failure of aggregate demand. Robert Higgs points to the “ratchet effect” of wartime government expansion.¹³ Each theory adds texture.

But the ABCT account explains something essential: why prosperity in the 1920s was so fragile. Without the speculative bubbles in Florida real estate and Midwestern farmland, fueled by cheap credit, the crash might not have spiraled into catastrophe. Credit created dazzling growth—skyline booms, land rushes, paper fortunes—but it was hollow growth. Once credit dried up, the structure collapsed under its own weight.

The Faces of the Great Depression

The Great Depression has many faces: shuttered banks, empty factories, foreclosed farms, and breadlines stretching for blocks. Each theory of its causes captures part of that tragedy. But the Austrian Business Cycle Theory reminds us of something fundamental. Booms built on credit are not stable; they are mirages. Miami’s skyscrapers and the mortgaged fields of the Midwest looked like symbols of progress, but in truth, they were warning signs. The collapse of the 1930s was not just misfortune—it was the inevitable consequence of choices made in the roaring decade before.

Conclusion: Lessons from the Past

As we reflect on the Great Depression, we must remember the lessons it imparts. The fragility of prosperity built on credit serves as a cautionary tale. The past teaches us that unchecked growth, fueled by easy money, can lead to devastating consequences. By understanding the intricacies of the Austrian Business Cycle Theory, we can better appreciate the delicate balance of our economic systems and the importance of sustainable growth.

Footnotes

1. Fred Foldvary, “The Austrian Theory of the Business Cycle,” American Journal of Economics and Sociology Vol. 71, no. 2 (2012). (288-290)

2. Murray N. Rothbard, America’s Great Depression, Kansas City: Sheed and Ward, 1975. (7–10)

3. Paul S. George, “Brokers, Binders, and Builders: Greater Miami’s Boom of the Mid-1920s,” Florida Historical Quarterly Vol. 65, no. 1 (1986): 42–44.

4. Ibid. (47)

5. Ibid. (49)

6. Raghuram G. Rajan and Rodney Ramcharan, “The Anatomy of a Credit Crisis: The Boom and Bust in Farm Land Prices in the United States in the 1920s,” American Economic Review Vol. 105, no. 4 (2015). (1469)

7. Ibid. (1470)

8. Ibid. (1472–74)

9. Alvin H. Hansen, Business Cycles and National Income (New York: W. W. Norton, 1951). (219)

10. Homer Hoyt, One Hundred Years of Land Values in Chicago, Chicago: University of Chicago Press, 1933. (416–18)

11. Ibid. (265)

12. Rothbard, America’s Great Depression. (45–46)

13. Robert Higgs, “Wartime Prosperity? A Reassessment of the U.S. Economy in the 1940s,” Journal of Economic History Vol. 52, no. 1 (1992). (41–42)

Bibliography

Foldvary, Fred. “The Austrian Theory of the Business Cycle.” American Journal of Economics and Sociology Vol. 71, no. 2 (2012): 288–97.

George, Paul S. “Brokers, Binders, and Builders: Greater Miami’s Boom of the Mid-1920s.” Florida Historical Quarterly Vol. 65, no. 1 (1986): 40–60.

Hansen, Alvin H. Business Cycles and National Income. New York: W. W. Norton, 1951.

Higgs, Robert. “Wartime Prosperity? A Reassessment of the U.S. Economy in the 1940s.” Journal of Economic History Vol. 52, no. 1 (1992): 41–60.

Hoyt, Homer. One Hundred Years of Land Values in Chicago. Chicago: University of Chicago Press, 1933.

Rajan, Raghuram G., and Rodney Ramcharan. “The Anatomy of a Credit Crisis: The Boom and Bust in Farm Land Prices in the United States in the 1920s.” American Economic Review Vol. 105, no. 4 (2015): 1439–77.

Rothbard, Murray N. America’s Great Depression. Kansas City: Sheed and Ward, 1975.