WEBVTT NOTE 11.15. Business Fluctuations 1 00:00:00.000 --> 00:00:04.000 15. Business Fluctuations 2 00:00:04.000 --> 00:00:11.000 In the real world there will be continual changes in the pattern of economic activity, 3 00:00:11.000 --> 00:00:16.000 changes resulting from shifts in the tastes and demands of consumers, 4 00:00:16.000 --> 00:00:21.000 in resources available, technological knowledge, etc. 5 00:00:21.000 --> 00:00:26.000 That prices and outputs fluctuate, therefore, is to be expected, 6 00:00:26.000 --> 00:00:32.040 and absence of fluctuation would be unusual. Particular prices and outputs 7 00:00:32.040 --> 00:00:38.440 will change under the impact of shifts in demand and production conditions. The 8 00:00:38.440 --> 00:00:44.040 general level of production will change according to individual time preferences. 9 00:00:44.040 --> 00:00:49.960 Prices will all tend to move in the same direction instead of shifting in 10 00:00:49.960 --> 00:00:55.440 different directions for different goods whenever there is a change in the money 11 00:00:55.440 --> 00:00:57.520 Money Relation. 12 00:00:57.520 --> 00:01:04.360 Only a change in the supply of or demand for money will transmit its impulses throughout 13 00:01:04.360 --> 00:01:11.800 the entire monetary economy and impel prices in a similar direction, albeit at varying 14 00:01:11.800 --> 00:01:13.920 rates of speed. 15 00:01:13.920 --> 00:01:21.720 General price fluctuations can be understood only by analyzing the money relation. 16 00:01:21.720 --> 00:01:28.600 But simple fluctuations and changes do not suffice to explain that terrible phenomenon 17 00:01:28.600 --> 00:01:34.040 so marked in the last century and a half, the business cycle. 18 00:01:34.040 --> 00:01:39.440 The business cycle has had certain definite features which reveal themselves time and 19 00:01:39.440 --> 00:01:40.440 again. 20 00:01:40.440 --> 00:01:46.520 First, there is a boom period, when prices and productive activity expand. 21 00:01:46.520 --> 00:01:52.440 There is a greater boom in the heavy capital goods and higher order industries, such as 22 00:01:52.440 --> 00:01:59.160 industrial raw materials, machine goods and construction, and in the markets for titles 23 00:01:59.160 --> 00:02:03.880 to these goods, such as the stock market and real estate. 24 00:02:03.880 --> 00:02:10.960 Then suddenly, without warning, there is a crash, a financial panic with runs on banks 25 00:02:10.960 --> 00:02:12.560 ensues. 26 00:02:12.560 --> 00:02:19.720 These fall very sharply, and there is a sudden piling up of unsold inventory, and, particularly, 27 00:02:19.720 --> 00:02:26.200 a revelation of great excess capacity in the higher-order capital goods industries. 28 00:02:26.200 --> 00:02:33.240 A painful period of liquidation and bankruptcy follows, accompanied by heavy unemployment, 29 00:02:33.240 --> 00:02:39.040 until recovery to normal conditions gradually takes place. 30 00:02:39.040 --> 00:02:43.860 This is the empirical pattern of the modern business cycle. 31 00:02:43.860 --> 00:02:50.700 Historical events can be explained by laws of praxeology, which isolate causal connections. 32 00:02:50.700 --> 00:02:54.780 Some of these events can be explained by laws that we have learned. 33 00:02:54.780 --> 00:03:01.020 A general price rise could result from an increase in the supply of money, or from a 34 00:03:01.020 --> 00:03:02.980 fall in demand. 35 00:03:02.980 --> 00:03:09.180 Unemployment from insistence on maintaining wage rates that have suddenly increased in 36 00:03:09.180 --> 00:03:16.720 real value, a reduction in unemployment from a fall in real wage rates, etc. 37 00:03:16.720 --> 00:03:23.520 But one thing cannot be explained by any economics of the free market, and this is the crucial 38 00:03:23.520 --> 00:03:26.080 phenomenon of the crisis. 39 00:03:26.080 --> 00:03:30.480 Why is there a sudden revelation of business error? 40 00:03:30.480 --> 00:03:43.480 Suddenly, all or nearly all businessmen find that their investments and estimates have been in error, that they cannot sell their products for the prices which they had anticipated. 41 00:03:43.480 --> 00:03:53.480 This is the central problem of the business cycle, and this is the problem which any adequate theory of the cycle must explain. 42 00:03:53.480 --> 00:03:58.480 No businessman in the real world is equipped with perfect foresight. 43 00:03:58.480 --> 00:03:59.480 All make errors. 44 00:03:59.480 --> 00:04:08.480 But the free market process precisely rewards those businessmen who are equipped to make a minimum number of errors. 45 00:04:08.480 --> 00:04:12.480 Why should there suddenly be a cluster of errors? 46 00:04:12.480 --> 00:04:19.480 Furthermore, why should these errors particularly pervade the capital goods industries? 47 00:04:19.480 --> 00:04:35.480 Sometimes sharp changes, such as a sudden burst of hoarding, or a sudden raising of time preferences, and hence a decrease in saving, may arrive unanticipated, with a resulting crisis of error. 48 00:04:35.480 --> 00:04:36.480 Error. 49 00:04:36.480 --> 00:04:43.160 But since the 18th century there has been an almost regular pattern of consistent clusters 50 00:04:43.160 --> 00:04:50.140 of error which always follow a boom and expansion of money and prices. 51 00:04:50.140 --> 00:04:56.720 In the Middle Ages and down to the 17th and 18th centuries, business crises rarely followed 52 00:04:56.720 --> 00:04:59.060 upon booms in this manner. 53 00:04:59.060 --> 00:05:04.940 They took place suddenly, in the midst of normal activity, and as the result of some 54 00:05:04.940 --> 00:05:08.580 obvious and identifiable external event. 55 00:05:08.580 --> 00:05:17.400 Thus, W. R. Scott lists crises in 16th and early 17th century England as irregular, and 56 00:05:17.400 --> 00:05:25.840 caused by some obvious event, famine, plague, seizures of goods in war, bad harvest, crises 57 00:05:25.840 --> 00:05:32.840 is in the cloth trade as a result of royal manipulations, seizure of bullion by the king, 58 00:05:32.840 --> 00:05:33.840 etc. 59 00:05:33.840 --> 00:05:40.600 But in the late 17th, 18th and 19th centuries there developed the aforementioned pattern 60 00:05:40.600 --> 00:05:47.140 of the business cycle, and it became obvious that the crisis and ensuing depression could 61 00:05:47.140 --> 00:05:55.760 no longer be attributed to some single external event or single act of government. 62 00:05:55.760 --> 00:06:02.420 Since no one event could account for the crisis and depression, observers began to theorize 63 00:06:02.420 --> 00:06:09.160 that there must be some deep-seated defect within the free market economy that causes 64 00:06:09.160 --> 00:06:11.760 these crises and cycles. 65 00:06:11.760 --> 00:06:16.480 The blame must rest with the capitalist system itself. 66 00:06:16.480 --> 00:06:22.080 Many ingenious theories have been put forward to explain the business cycle as an outgrowth 67 00:06:22.080 --> 00:06:27.800 Both of the free market economy, but none of them has been able to explain the crucial 68 00:06:27.800 --> 00:06:32.040 point, the cluster of errors after a boom. 69 00:06:32.040 --> 00:06:38.520 In fact, such an explanation can never be found, since no such cluster could appear 70 00:06:38.520 --> 00:06:41.040 on the free market. 71 00:06:41.040 --> 00:06:48.840 The nearest attempt at an explanation stressed general swings of over-optimism and over-pessimism 72 00:06:48.840 --> 00:06:51.000 in the Business Community. 73 00:06:51.000 --> 00:06:56.540 But put in such fashion, the theory looks very much like a deus ex machina. 74 00:06:56.540 --> 00:07:02.500 Why should hard-headed businessmen, schooled in trying to maximize their profits, suddenly 75 00:07:02.500 --> 00:07:06.200 fall victim to such psychological swings? 76 00:07:06.200 --> 00:07:13.580 In fact, the crisis brings bankruptcies regardless of the emotional state of particular entrepreneurs. 77 00:07:13.580 --> 00:07:21.020 We shall see in Chapter 12 that feelings of optimism do play a role, but they are induced 78 00:07:21.020 --> 00:07:24.820 by certain objective economic conditions. 79 00:07:24.820 --> 00:07:32.040 We must search for the objective reasons that cause businessmen to become over-optimistic, 80 00:07:32.040 --> 00:07:35.100 and they cannot be found on the free market. 81 00:07:35.100 --> 00:07:40.780 The positive explanation of the business cycle, therefore, will have to be postponed to the 82 00:07:40.780 --> 00:07:41.780 in the next chapter.