WEBVTT

NOTE 12.11. Binary Intervention: Inflation and Business Cycles

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11. Binary Intervention, Inflation and Business Cycles

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a. Inflation and Credit Expansion

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In Chapter 11 we depicted the workings of the monetary system of a purely free market.

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A free money market adopts specie, either gold or silver, or both parallel,

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Units of Money are simply units of weight of the money stuff.

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The total stock of the money commodity increases with new production, mining, and decreases

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from wear and tear and use in industrial employments.

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Generally there will be a gradual secular rise in the money stock, with effects as analyzed.

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The wealth of some people will increase, and of others will decline, and no social usefulness

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will accrue from an increased supply of money in its monetary use.

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However, an increased stock will raise the social standard of living and well-being by

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further satisfying non-monetary demands for the monetary metal.

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Demand in this money market usually takes the form of issuing pseudo-warehouse receipts

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as money substitutes.

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As we saw in Chapter 11, demand liabilities, such as deposits or paper notes, may come

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into use in a free market, but may equal only the actual value or weight of the specie deposited.

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The demand liabilities are then genuine warehouse receipts, or true money certificates, and

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they pass on the market as representatives of the actual money, that is, as money substitutes.

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Pseudo-warehouse receipts are those issued in excess of the actual weight of specie on

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deposit.

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Naturally, their issue can be a very lucrative business.

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Working like the genuine certificates, they serve also as money substitutes, even though

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not covered by specie.

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They are fraudulent because they promise to redeem in specie at face value, a promise

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that could not possibly be met were all the deposit holders to ask for their own property

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at the same time.

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Only the complacency and ignorance of the public permit the situation to continue.

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Although it has obvious third-person effects, this type of intervention is essentially binary

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because the issuer, or intervener, gains at the expense of individual holders of legitimate

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money.

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The lines of force radiate from the interveners to each of those who suffer losses.

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Broadly, such intervention may be affected either by the government or by private individuals

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Inflation Inflation in this work is explicitly defined

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to exclude increases in the stock of specie.

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While these increases have such similar effects as raising the prices of goods, they also

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differ sharply in other effects.

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A. Simple increases in specie do not constitute an intervention in the free market, penalizing

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one group and subsidizing another.

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And B. They do not lead to the processes of the business cycle.

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A contraction in the money supply outstanding over any period, aside from a possible net

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decrease in specie, may be called deflation.

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Clearly, inflation is the primary event, and the primary purpose of monetary intervention.

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There can be no deflation without an inflation having occurred in some previous period of

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time.

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A priori, almost all intervention will be inflationary.

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For not only must all monetary intervention begin with inflation, the great gain to be

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derived from inflation comes from the issuers putting new money into circulation.

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The profit is practically costless, because while all other people must either sell goods

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The Government or the commercial banks are literally creating money out of thin air.

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They do not have to buy it.

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Any profit from the use of this magical money is clear gain to the issuers.

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As happens when new specie enters the market, the issue of uncovered money substitutes also

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has a diffusion effect.

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The first receivers of the new money gain the most.

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The next gain slightly less, etc., until the midpoint is reached.

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And then each receiver loses more and more as he waits for the new money.

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For the first individuals, selling prices soar while buying prices remain almost the

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same.

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But later, buying prices have risen while selling prices remain unchanged.

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A crucial circumstance, however, differentiates this from the case of increasing specie.

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The new paper or new demand deposits have no social function whatever.

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They do not demonstrably benefit some without injuring others in the market society.

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The increasing money supply is only a social waste and can only advantage some at the expense

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and the benefits and burdens are distributed as just outlined, the early comers gaining at the expense of later comers.

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Certainly the business and consumer borrowers from the bank, its clientele, benefit greatly from the new money, at least in the short run, since they are the ones who first receive it.

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If inflation is any increase in the supply of money not matched by an increase in the gold or silver stock available, the method of inflation just depicted is called credit expansion, the creation of new money substitutes entering the economy on the credit market.

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As will be seen, while credit expansion by a bank seems far more sober and respectable than outright spending of new money, it actually has far graver consequences for the economic system, consequences which most people would find especially undesirable.

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This inflationary credit is called circulating credit, as distinguished from the lending of saved funds, called commodity credit.

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In this book, the term credit expansion will apply only to increases in circulating credit.

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Credit expansion has, of course, the same effect as any sort of inflation.

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The prices tend to rise as the money supply increases.

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Like any inflation, it is a process of redistribution, whereby the inflators and the part of the economy

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selling to them gain at the expense of those who come last in line in the spending process.

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This is the charm of inflation for the beneficiaries and the reason why it has been so popular,

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Particularly since modern banking processes have camouflaged its significance for those

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losers who are far removed from banking operations.

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The gains to the inflators are visible and dramatic.

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The losses to others hidden and unseen, but just as effective for all that.

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Just as half the economy are taxpayers and half tax consumers, so half the economy are

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Most of these gains and losses will be short run or one shot.

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They will occur during the process of inflation but will cease after the new monetary equilibrium

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is reached.

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The inflators make their gains, but after the new money supply has been diffused throughout

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About the economy, the inflationary gains and losses are ended.

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However, as we have seen in Chapter 11, there are also permanent gains and losses resulting

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from inflation.

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For the new monetary equilibrium will not simply be the old one multiplied in all relations

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and quantities by the addition to the money supply.

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This was an assumption that the old quantity theory economists made.

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The valuations of the individuals making temporary gains and losses will differ.

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Therefore, each individual will react differently to his gains and losses and alter his relative

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spending patterns accordingly.

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Moreover, the new money will form a high ratio to the existing cash balance of some and a

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and a low ratio to that of others, and the result will be a variety of changes in spending

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patterns.

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Therefore, all prices will not have increased uniformly in the new equilibrium.

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The purchasing power of the monetary unit has fallen, but not equaproportionally over

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the entire array of exchange values.

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Some prices have risen more than others, therefore, some people will be permanent gainers and some permanent losers from the inflation.

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Particularly hard hit by an inflation, of course, are the relatively fixed income groups, who end their losses only after a long period or not at all.

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Pensioners and annuitants who have contracted for a fixed money income are examples of permanent

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as well as short-run losers.

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Life insurance benefits are permanently slashed.

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Conservative anti-inflationists' complaints about the widows and orphans have often been

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ridiculed, but they are no laughing matter nevertheless, for it is precisely the widows

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Mises and Orphans who bear a main part of the brunt of inflation.

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The avowed goal of Cain's inflationist program was the euthanasia of the rentier.

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Did Cain's realize that he was advocating the not-so-merciful annihilation of some of

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the most unfit for labor groups in the entire population?

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Profits whose marginal value productivity consisted almost exclusively in their savings.

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Also suffering losses are creditors who have already extended their loans and find it too

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late to charge a purchasing power premium on their interest rates.

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Inflation also changes the market's consumption investment ratio.

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Superficially, it seems that credit expansion greatly increases capital, for the new money

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enters the market as equivalent to new savings for lending.

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Since the new bank money is apparently added to the supply of savings on the credit market,

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businesses can now borrow at a lower rate of interest.

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Hence, inflationary credit expansion seems to offer the ideal escape from time preference,

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as well as an inexhaustible fount of added capital.

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Actually, this effect is illusory.

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On the contrary, inflation reduces saving and investment,

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thus lowering society's standard of living.

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It may even cause large-scale capital consumption.

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In the first place, as we have just seen, existing creditors are injured.

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This will tend to discourage lending in the future,

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and thereby discourage saving investment.

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Secondly, as we have seen in Chapter 11, the inflationary process inherently yields a purchasing power profit to the businessman,

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since he purchases factors and sells them at a later time, when all prices are higher.

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The businessman may thus keep abreast of the price increase.

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We are here exempting from variations in price increases, the terms of trade component, neither losing nor gaining from the inflation.

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But business accounting is traditionally geared to a world where the value of the monetary unit is stable.

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Capital goods purchased are entered in the asset column at cost, that is, at the price paid for them.

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When the firm later sells the product, the extra inflationary gain is not really a gain at all, for it must be absorbed in purchasing the replaced capital good at a higher price.

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Inflation, therefore, tricks the businessman. It destroys one of his main signposts and leads him to believe that he has gained extra profits when he is just able to replace capital.

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capital. Hence he will undoubtedly be tempted to consume out of these profits and thereby

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unwittingly consume capital as well. Thus inflation tends at once to repress saving investment and to

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cause consumption of capital. The accounting error stemming from inflation has other economic

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Consequences.

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The firms with the greatest degree of error will be those with capital equipment bought

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more preponderantly when prices were lowest.

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If the inflation has been going on for a while, these will be the firms with the oldest equipment.

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Their seemingly great profits will attract other firms into the field, and there will

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will be a completely unjustified expansion of investment in a seemingly high profit area.

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Conversely, there will be a deficiency of investment elsewhere.

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Thus the error distorts the market system of allocating resources and reduces its effectiveness

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in satisfying the consumer.

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The error will also be greatest in those firms with a greater proportion of capital equipment

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to Product, and similar distorting effects

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will take place through excessive investment

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in heavily capitalized industries,

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offset by under-investment elsewhere.

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B, Credit Expansion and the Business Cycle.

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We have already seen in chapter eight

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what happens when there is net saving investment,

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an increase in the ratio of gross investment

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to Consumption in the Economy

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Consumption expenditures fall,

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and the prices of consumers' goods fall.

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On the other hand, the production structure is lengthened,

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and the prices of original factors,

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specialized in the higher stages, rise.

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The prices of capital goods change like a lever

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being pivoted on a fulcrum at its center.

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The prices of consumers' goods fall most,

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Those of first-order capital goods fall less, those of highest-order capital goods rise

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most and the others less.

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Thus, the price differentials between the stages of production all diminish.

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Prices of original factors fall in the lower stages and rise in the higher stages, and

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the non-specific original factors, mainly labor, shift partly from the lower to the higher

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in the higher stages. Investment tends to be centered in lengthier processes of production.

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The drop in price differentials is, as we have seen, equivalent to a fall in the natural

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rate of interest, which, of course, leads to a corollary drop in the loan rate. After

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a while, the fruit of the more productive techniques arrives, and the real income of

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of Everyone rises.

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Thus an increase in saving resulting from a fall in time preferences leads to a fall

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in the interest rate and another stable equilibrium situation with a longer and narrower production

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structure.

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What happens, however, when the increase in investment is not due to a change in time

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Is this a magic way of expanding the capital structure easily and costlessly without reducing

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present consumption?

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Suppose that 6 million gold ounces are being invested and 4 million consumed in a certain

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period of time.

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Suppose now that the banks in the economy expand credit and increase the money supply

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by 2 million ounces.

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What are the consequences?

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The new money is loaned to businesses.

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To the extent that the new money is loaned to consumers rather than businesses, the cycle

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effects discussed in this section do not occur.

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These businesses, now able to acquire the money at a lower rate of interest, enter the

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Capital Goods and Original Factors Market to bid resources away from the other firms.

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At any given time, the stock of goods is fixed, and the 2 million new ounces are therefore

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employed in raising the prices of producers' goods.

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The rise in prices of capital goods will be imputed to rises in original factors.

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The credit expansion reduces the market rate of interest.

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This means that price differentials are lowered, and as we have seen in Chapter 8, lower price

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differentials raise prices in the highest stages of production, shifting resources to

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these stages and also increasing the number of stages.

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As a result, the production structure is lengthened.

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The borrowing firms are led to believe that enough funds are available to permit them

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to embark on projects formerly unprofitable.

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On the free market, investment will always take place first in those projects that satisfy

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the most urgent wants of the consumers, then the next most urgent wants are satisfied,

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etc.

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The interest rate regulates the temporal order of choice of projects in accordance with their

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urgency.

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A lower rate of interest on the market is a signal that more projects can be undertaken

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profitably.

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Increased saving on the free market leads to a stable equilibrium of production at a

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lower rate of interest, but not so with credit expansion, for the original factors now receive

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In the free market example, total money incomes remained the same.

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The increased expenditure on higher stages was offset by decreased expenditure in the lower stages.

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The increased length of the production structure was compensated by the reduced width.

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But credit expansion pumps new money into the production structure.

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Aggregate money incomes increase instead of remaining the same.

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The production structure has lengthened, but it has also remained as wide,

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without contraction of consumption expenditure.

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The owners of the original factors, with their increased money income,

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naturally hasten to spend their new money.

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They allocate this spending between consumption and investment in accordance with their time preferences.

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Let us assume that the time preference schedules of the people remain unchanged.

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This is a proper assumption, since there is no reason to assume that they have changed because of the inflation.

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Production now no longer reflects voluntary time preferences.

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Advances. Business has been led by credit expansion to invest in higher stages as if

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more savings were available. Since they are not, business has over-invested in the higher

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stages and under-invested in the lower. Consumers act promptly to re-establish their time preferences,

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Their Preferred Investment Consumption Proportions and Price Differentials

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The differentials will be re-established at the old, higher amount, that is, the rate

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of interest will return to its free market magnitude.

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As a result, the prices at the higher stages of production will fall drastically, the prices

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Those at the lower stages will rise again, and the entire new investment at the higher

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stages will have to be abandoned or sacrificed.

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Altering our oversimplified example, which has treated only two stages, we see that the

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highest stages, believed profitable, have proved to be unprofitable.

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The pure rate of interest, reflecting consumer desires, is shown to have really been higher

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all along.

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The bank's credit expansion had tampered with that indispensable signal, the interest

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rate, that tells businessmen how much savings are available and what length of projects

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will be profitable.

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In the free market, the interest rate is an indispensable guide in the time dimension

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to the urgency of consumer wants, but bank intervention in the market disrupts this free price

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and renders entrepreneurs unable to satisfy consumer desires properly or to estimate the

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most beneficial time structure of production. As soon as the consumers are able, that is,

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as soon as the increased money enters their hands, they take the opportunity to reestablish

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Overinvestment in the highest stages and underinvestment in the lower stages are now revealed in all

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their starkness.

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The situation is analogous to that of a contractor misled into believing that he has more building

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Banking material than he really has and then awakening to find that he has used up all

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his material on a capacious foundation, the higher stages, with no material left to complete

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the house.

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Clearly, bank credit expansion cannot increase capital investment by one iota.

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Investment can still come only from savings.

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It should not be surprising that the market tends to revert to its preferred ratios.

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The same process, as we have seen, takes place in all prices after a change in the money

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stock.

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Increased money always begins in one area of the economy, raising prices there, and

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filters and diffuses eventually over the whole economy, which then roughly returns to an

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an equilibrium pattern conforming to the value of the money.

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If the market then tends to return to its preferred price ratios after a change in the

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money supply, it should be evident that this includes a return to its preferred saving

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investment ratio, reflecting social time preferences.

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It is true, of course, that time preferences may alter in the interim, either for each

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individual or as a result of the redistribution during the change.

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The gainers may save more or less than the losers would have done.

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Therefore, the market will not return precisely to the old free market interest rate and investment

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Consumption Ratio just as it will not return to its precise pattern of prices.

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It will revert to whatever the free market interest rate is now as determined by current

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time preferences.

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Some advocates of coercing the market into saving and investing more than it wishes have

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have hailed credit expansion as leading to forced saving, thereby increasing the capital

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goods structure.

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But this can happen not as a direct consequence of credit expansion, but only because effective

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time preferences have changed in that direction.

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That is, time preference schedules have shifted, or relatively more money is now in the hands

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of those with low time preferences.

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Credit expansion may well lead to the opposite effect.

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The gainers may have higher time preferences, in which case the free market interest rate

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will be higher than before.

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Because these effects of credit expansion are completely uncertain and depend on the

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concrete data of each particular case, it is clearly far more cogent for advocates of

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of Forced Saving to use the taxation process to make their redistribution.

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The market, therefore, reacts to a distortion of the free market interest rate by proceeding

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to revert to that very rate.

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The distortion caused by credit expansion deceives businessmen into believing that more

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Our savings are available and causes them to malinvest, to invest in projects that will

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turn out to be unprofitable when consumers have a chance to reassert their true preferences.

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This reassertion takes place fairly quickly, as soon as owners of factors receive their

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increased incomes and spend them.

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This theory permits us to resolve an age-old controversy among economists, whether an increase

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in the money supply can lower the market rate of interest.

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To the mercantilists and to the Keynesians, it was obvious that an increased money stock

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permanently lowered the rate of interest, given the demand for money.

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To the classicists, it was obvious that changes in the money stock could affect only the value

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The answer is that an increase in the supply of money does lower the rate of interest when it enters the market as credit expansion, but only temporarily.

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In the long run, and this long run is not very long, the market re-establishes the free market time preference interest rate and eliminates the change.

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Change

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In the long run, a change in the money stock affects only the value of the monetary unit.

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This process, by which the market reverts to its preferred interest rate and eliminates

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the distortion caused by credit expansion, is, moreover, the business cycle.

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Our analysis, therefore, permits the solution not only of the theoretical problem of the

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The Relation Between Money and Interest, but also of the problem that has plagued society

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for the last century and a half and more, the dread business cycle.

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And furthermore, the theory of the business cycle can now be explained as a subdivision

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of our general theory of the economy.

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Note the hallmarks of this distortion-reversion process.

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First, the money supply increases through credit expansion.

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Then, businesses are tempted to malinvest, overinvesting in higher stage and durable

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production processes.

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Next, the prices and incomes of original factors increase, and consumption increases, and businesses

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realize that the higher stage investments have been wasteful and unprofitable.

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The first stage is the chief landmark of the boom.

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The second stage, the discovery of the wasteful malinvestments, is the crisis.

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The depression is the next stage, during which malinvested businesses become bankrupt, and

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original factors must suddenly shift back to the lower stages of production.

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The liquidation of unsound businesses, the idle capacity of the malinvested plant, and

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the frictional unemployment of original factors that must suddenly and en masse shift to lower

316
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stages of production, these are the chief hallmarks of the depression stage.

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We have seen in Chapter 11 that the major unexplained features of the business cycle

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are the mass of error and the concentration of error and disturbance in the capital goods industries.

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Our theory of the business cycle solves both of these problems.

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The cluster of error suddenly revealed by entrepreneurs is due to the interventionary distortion of a key market signal, the interest rate.

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00:32:04.580 --> 00:32:10.980
The concentration of disturbance in the capital goods industries is explained by the spur to

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unprofitable higher order investments in the boom period. And we have just seen that other

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characteristics of the business cycle are explained by this theory. One point should be stressed.

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The depression phase is actually the recovery phase. Most people would be happy to keep the

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The boom period, where the inflationary gains are visible and the losses hidden and obscure.

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This boom euphoria is heightened by the capital consumption that inflation promotes through

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illusory accounting profits.

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The stages that people complain about are the crisis and depression.

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But the latter periods, it should be clear, do not cause the trouble.

330
00:33:00.360 --> 00:33:06.880
The trouble occurs during the boom, when malinvestments and distortions take place.

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The crisis depression phase is the curative period, after people have been forced to recognize

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the malinvestments that have occurred.

333
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The depression period, therefore, is the necessary recovery period.

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It is the time when bad investments are liquidated and mistaken entrepreneurs leave the market.

335
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The time when consumer sovereignty and the free market reassert themselves and establish

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once again an economy that benefits every participant to the maximum degree.

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The depression period ends when the free market equilibrium has been restored and expansionary

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distortion eliminated.

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It should be clear that any governmental interference with the depression process can only prolong

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it, thus making things worse from almost everyone's point of view.

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Since the depression process is the recovery process, any halting or slowing down of the

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process impedes the advent of recovery.

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The depression readjustments must work themselves out before recovery can be complete.

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The more these readjustments are delayed, the longer the depression will have to last,

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and the longer complete recovery is postponed.

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For example, if the government keeps wage rates up, it brings about permanent unemployment.

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If it keeps prices up, it brings about unsold surplus, and if it spurs credit expansion

348
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again, then new malinvestment and later depressions are spawned.

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Many 19th century economists referred to the business cycle in a biological metaphor, likening

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the depression to a painful but necessary curative of the alcoholic or narcotic jag

351
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which is the boom and asserting that any tampering with the depression delays recovery.

352
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They have been widely ridiculed by present-day economists.

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The ridicule is misdirected, however, for the biological analogy is, in this case, correct.

354
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One obvious conclusion from our analysis is the absurdity of the under-consumptionist

355
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Most Remedies for Depression The idea that the crisis is caused by under-consumption

356
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and that the way to cure the depression is to stimulate consumption expenditures.

357
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The reverse is clearly the truth.

358
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What has brought about the crisis is precisely the fact that entrepreneurial investment erroneously

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anticipated greater savings and that this error is revealed by consumers re-establishing

360
00:36:05.440 --> 00:36:16.180
Overconsumption or undersaving has brought about the crisis, although it is hardly fair

361
00:36:16.180 --> 00:36:22.580
to pin the guilt on the consumer, who is simply trying to restore his preferences after the

362
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market has been distorted by bank credit.

363
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The only way to hasten the curative process of the depression is for people to save and

364
00:36:32.720 --> 00:36:40.920
and invest more and consume less, thereby finally justifying some of the malinvestments

365
00:36:40.920 --> 00:36:45.760
and mitigating the adjustments that have to be made.

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One problem has been left unexplained.

367
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We have seen that the reversion period is short and that factor incomes increase rather

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quickly and start restoring the free market consumption-saving ratios.

369
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But why do booms historically continue for several years?

370
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What delays the reversion process?

371
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The answer is that as the boom begins to peter out from an injection of credit expansion,

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the banks inject a further dose.

373
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In short, the only way to avert the onset of the depression adjustment process is to

374
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continue inflating money and credit.

375
00:37:30.200 --> 00:37:37.120
For only continual doses of new money on the credit market will keep the boom going and

376
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the new stages profitable.

377
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Furthermore, only ever-increasing doses can step up the boom, can lower interest rates

378
00:37:47.160 --> 00:37:50.920
further and expand the production structure.

379
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For as the prices rise, more and more money will be needed to perform the same amount

380
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of work.

381
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Once the credit expansion stops, the market ratios are reestablished and the seemingly

382
00:38:04.920 --> 00:38:13.000
glorious new investments turn out to be malinvestments, built on a foundation of sand.

383
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How long booms can be kept up?

384
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What limits there are to booms in different circumstances will be discussed later.

385
00:38:21.680 --> 00:38:28.080
But it is clear that prolonging the boom by ever larger doses of credit expansion will

386
00:38:28.080 --> 00:38:36.440
will have only one result, to make the inevitably ensuing depression longer and more grueling.

387
00:38:36.440 --> 00:38:42.300
The larger the scope of malinvestment and error in the boom, the greater and longer

388
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the task of readjustment in the depression.

389
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The way to prevent a depression, then, is simple, avoid starting a boom.

390
00:38:52.520 --> 00:38:58.840
And to avoid starting a boom, all that is necessary is to pursue a truly free market

391
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policy in money, that is, a policy of 100% specie reserves for banks and governments.

392
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Credit expansion always generates the business cycle process, even when other tendencies

393
00:39:15.160 --> 00:39:16.960
cloak its workings.

394
00:39:16.960 --> 00:39:26.960
Thus many people believe that all is well if prices do not rise or if the actually recorded interest rate does not fall.

395
00:39:26.960 --> 00:39:37.960
But prices may well not rise because of some counteracting force, such as an increase in the supply of goods or a rise in the demand for money.

396
00:39:37.960 --> 00:39:42.960
But this does not mean that the boom-depression cycle fails to occur.

397
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The essential processes of the boom, distorted interest rates, malinvestments, bankruptcies, etc., continue unchecked.

398
00:39:52.960 --> 00:40:04.960
This is one of the reasons why those who approach business cycles from a statistical point of view and try in that way to arrive at a theory are in hopeless error.

399
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Any historical statistical fact is a complex resultant of many causal influences, and cannot be used as a simple element with which to construct a causal theory.

400
00:40:18.460 --> 00:40:29.960
The point is that credit expansion raises prices beyond what they would have been in the free market, and thereby creates the business cycle.

401
00:40:29.960 --> 00:40:38.960
Similarly, credit expansion does not necessarily lower the interest rate below the rate previously recorded.

402
00:40:38.960 --> 00:40:47.960
It lowers the rate below what it would have been in the free market, and thus creates distortion and malinvestment.

403
00:40:47.960 --> 00:40:57.960
Recorded interest rates in the boom will generally rise, in fact, because of the purchasing power component in the market interest rate.

404
00:40:57.960 --> 00:41:11.960
An increase in prices, as we have seen, generates a positive purchasing power component in the natural interest rate, that is, the rate of return earned by businessmen on the market.

405
00:41:11.960 --> 00:41:21.960
In the free market, this would quickly be reflected in the loan rate, which, as we have seen, is completely dependent on the natural rate.

406
00:41:21.960 --> 00:41:35.960
natural rate, but a continual influx of circulating credit prevents the loan rate from catching up with the natural rate, and thereby generates the business cycle process.

407
00:41:35.960 --> 00:41:47.960
Since Knut Wichsel is one of the fathers of this business cycle approach, it is important to stress that our usage of natural rate differs from his.

408
00:41:47.960 --> 00:41:52.760
Excel's natural rate was akin to our free market rate.

409
00:41:52.760 --> 00:42:00.200
Our natural rate is the rate of return earned by businesses on the existing market without

410
00:42:00.200 --> 00:42:02.720
considering loan interest.

411
00:42:02.720 --> 00:42:09.720
It corresponds to what has been misleadingly called the normal profit rate, but is actually

412
00:42:09.720 --> 00:42:12.760
the basic rate of interest.

413
00:42:12.760 --> 00:42:20.160
A further corollary of this bank-created discrepancy between the loan rate and the natural rate

414
00:42:20.160 --> 00:42:26.400
is that creditors on the loan market suffer losses for the benefit of their debtors, the

415
00:42:26.400 --> 00:42:31.740
capitalists on the stock market or those who own their own businesses.

416
00:42:31.740 --> 00:42:38.400
The latter gain during the boom by the differential between the loan rate and the natural rate,

417
00:42:38.400 --> 00:42:46.400
While the creditors, apart from banks, which create their own money, lose to the same extent.

418
00:42:46.400 --> 00:42:51.640
After the boom period is over, what is to be done with the malinvestments?

419
00:42:51.640 --> 00:42:57.880
The answer depends on their profitability for further use, that is, on the degree of

420
00:42:57.880 --> 00:43:00.400
error that was committed.

421
00:43:00.400 --> 00:43:05.760
Some malinvestments will have to be abandoned, since their earnings from consumer demand

422
00:43:05.760 --> 00:43:12.960
will not even cover the current costs of their operation, others, though monuments of failure,

423
00:43:12.960 --> 00:43:20.080
will be able to yield a profit over current costs, although it will not pay to replace them as they

424
00:43:20.080 --> 00:43:27.520
wear out. Temporarily working them fulfills the economic principle of always making the best

425
00:43:27.520 --> 00:43:30.800
of Even a Bad Bargain.

426
00:43:30.800 --> 00:43:37.920
Because of the malinvestments, however, the boom always leads to general impoverishment,

427
00:43:37.920 --> 00:43:44.200
that is, reduces the standard of living below what it would have been in the absence of

428
00:43:44.200 --> 00:43:45.600
the boom.

429
00:43:45.600 --> 00:43:52.660
For the credit expansion has caused the squandering of scarce resources and scarce capital.

430
00:43:52.660 --> 00:43:58.460
Some resources have been completely wasted, and even those malinvestments that continue

431
00:43:58.460 --> 00:44:06.740
in use will satisfy consumers less than would have been the case without the credit expansion.

432
00:44:06.740 --> 00:44:12.780
c. Secondary developments of the business cycle

433
00:44:12.780 --> 00:44:18.220
In the previous section we have presented the basic process of the business cycle.

434
00:44:18.220 --> 00:44:25.740
This process is often accentuated by other or secondary developments induced by the cycle.

435
00:44:25.740 --> 00:44:32.460
Thus, the expanding money supply and rising prices are likely to lower the demand for

436
00:44:32.460 --> 00:44:33.460
money.

437
00:44:33.460 --> 00:44:39.500
Many people begin to anticipate higher prices and will therefore disord.

438
00:44:39.500 --> 00:44:43.820
The lowered demand for money raises prices further.

439
00:44:43.820 --> 00:44:49.900
Since the impetus to expansion comes first in expenditure on capital goods, and later

440
00:44:49.900 --> 00:44:56.940
in consumption, this secondary effect of a lower demand for money may take hold first

441
00:44:56.940 --> 00:44:59.740
in producers' goods industries.

442
00:44:59.740 --> 00:45:05.940
This lowers the price and profit differentials further, and hence widens the distance that

443
00:45:05.940 --> 00:45:11.500
the rate of interest will fall below the free market rate during the boom.

444
00:45:11.500 --> 00:45:16.900
The effect is to aggravate the need for readjustment during the depression.

445
00:45:16.900 --> 00:45:22.920
The adjustment would cause some fall in the prices of producers' goods anyway, since

446
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the essence of the adjustment is to raise price differentials.

447
00:45:27.500 --> 00:45:34.060
The extra distortion requires a steeper fall in the prices of producers' goods before

448
00:45:34.060 --> 00:45:36.980
recovery is completed.

449
00:45:36.980 --> 00:45:44.020
As a matter of fact, the demand for money generally rises at the beginning of an inflation.

450
00:45:44.020 --> 00:45:50.500
People are accustomed to thinking of the value of the monetary unit as inviolate and of prices

451
00:45:50.500 --> 00:45:53.780
as remaining at some customary level.

452
00:45:53.780 --> 00:46:00.260
Hence, when prices first begin to rise, most people believe this to be a purely temporary

453
00:46:00.260 --> 00:46:04.620
development, with prices soon due to recede.

454
00:46:04.620 --> 00:46:09.380
This belief mitigates the extent of the price rise for a time.

455
00:46:09.380 --> 00:46:16.260
Eventually, however, people realize that credit expansion has continued and undoubtedly will

456
00:46:16.260 --> 00:46:24.260
continue, and their demand for money dwindles, becoming lower than the original level.

457
00:46:24.260 --> 00:46:30.380
After the crisis arrives and the depression begins, various secondary developments often

458
00:46:30.380 --> 00:46:31.500
occur.

459
00:46:31.500 --> 00:46:37.860
In particular, for reasons that will be discussed further, the crisis is often marked not only

460
00:46:37.860 --> 00:46:45.820
by a halt to credit expansion, but by an actual deflation, a contraction in the supply of

461
00:46:45.820 --> 00:46:46.820
money.

462
00:46:46.820 --> 00:46:51.060
The deflation causes a further decline in prices.

463
00:46:51.060 --> 00:46:57.220
Any increase in the demand for money will speed up adjustment to the lower prices.

464
00:46:57.220 --> 00:47:04.300
Furthermore, when deflation takes place first on the loan market, that is, as credit contraction

465
00:47:04.300 --> 00:47:10.620
by the banks, and this is almost always the case, this will have the beneficial effect

466
00:47:10.620 --> 00:47:15.060
of speeding up the depression adjustment process.

467
00:47:15.060 --> 00:47:21.880
For credit contraction creates higher price differentials, and the essence of the required

468
00:47:21.880 --> 00:47:30.580
Adjustment is to return to higher price differentials, that is, a higher natural rate of interest.

469
00:47:30.580 --> 00:47:36.960
Furthermore, deflation will hasten adjustment in yet another way, for the accounting error

470
00:47:36.960 --> 00:47:44.040
of inflation is here reversed, and businessmen will think their losses are more, and profits

471
00:47:44.040 --> 00:47:49.880
less than they really are, hence they will save more than they would have with correct

472
00:47:49.880 --> 00:47:56.440
Accounting and the Increased Saving will speed adjustment by supplying some of the needed

473
00:47:56.440 --> 00:47:59.440
deficiency of savings.

474
00:47:59.440 --> 00:48:06.180
It may well be true that the deflationary process will overshoot the free market equilibrium

475
00:48:06.180 --> 00:48:11.880
point and raise price differentials and the interest rate above it.

476
00:48:11.880 --> 00:48:19.620
But if so, no harm will be done, since a credit contraction can create no malinvestments and

477
00:48:19.620 --> 00:48:24.580
therefore does not generate another boom bust cycle.

478
00:48:24.580 --> 00:48:30.700
If some readers are tempted to ask why credit contraction will not lead to the opposite

479
00:48:30.700 --> 00:48:37.580
type of malinvestment to that of the boom, overinvestment in lower order capital goods

480
00:48:37.580 --> 00:48:44.780
and underinvestment in higher order goods, the answer is that there is no arbitrary choice

481
00:48:44.780 --> 00:48:50.580
Open of Investing in Higher-Order or Lower-Order Goods.

482
00:48:50.580 --> 00:48:58.380
Increased investment must be made in the higher-order goods, in lengthening the structure of production.

483
00:48:58.380 --> 00:49:04.980
A decreased amount of investment simply cuts down on higher-order investment.

484
00:49:04.980 --> 00:49:11.000
There will thus be no excess of investment in the lower orders, but simply a shorter

485
00:49:11.000 --> 00:49:14.480
are structured than would otherwise be the case.

486
00:49:14.480 --> 00:49:17.360
Contraction, unlike expansion,

487
00:49:17.360 --> 00:49:21.440
does not create positive malinvestments.

488
00:49:21.440 --> 00:49:25.280
And the market will correct the error rapidly.

489
00:49:25.280 --> 00:49:28.280
When there is such excessive contraction

490
00:49:28.280 --> 00:49:32.100
and consumption is too high in relation to savings,

491
00:49:32.100 --> 00:49:35.480
the money income of businessmen is reduced

492
00:49:35.480 --> 00:49:38.480
and their spending on factors declines,

493
00:49:38.480 --> 00:49:41.220
especially in the higher orders.

494
00:49:41.220 --> 00:49:45.280
Owners of original factors, receiving lower incomes,

495
00:49:45.280 --> 00:49:48.040
will spend less on consumption.

496
00:49:48.040 --> 00:49:50.640
Price differentials and the interest rate

497
00:49:50.640 --> 00:49:52.440
will again be lowered,

498
00:49:52.440 --> 00:49:56.640
and the free market consumption investment ratios

499
00:49:56.640 --> 00:49:58.700
will be speedily restored.

500
00:49:59.600 --> 00:50:02.640
Just as inflation is generally popular

501
00:50:02.640 --> 00:50:04.600
for its narcotic effect,

502
00:50:04.600 --> 00:50:09.800
Deflation is always highly unpopular for the opposite reason.

503
00:50:09.800 --> 00:50:12.520
The contraction of money is visible.

504
00:50:12.520 --> 00:50:19.240
The benefits to those whose buying prices fall first and who lose money last remain

505
00:50:19.240 --> 00:50:20.240
hidden.

506
00:50:20.240 --> 00:50:26.280
And the illusory accounting losses of deflation make businesses believe that their losses

507
00:50:26.280 --> 00:50:31.240
are greater, or profits smaller, than they actually are.

508
00:50:31.240 --> 00:50:34.800
and this will aggravate business pessimism.

509
00:50:34.800 --> 00:50:41.680
It is true that deflation takes from one group and gives to another, as does inflation, yet

510
00:50:41.680 --> 00:50:49.480
not only does credit contraction speed recovery and counteract the distortions of the boom,

511
00:50:49.480 --> 00:50:56.300
but it also, in a broad sense, takes away from the original coercive gainers and benefits

512
00:50:56.300 --> 00:50:59.560
the original coerced losers.

513
00:50:59.560 --> 00:51:03.520
Now this will certainly not be true in every case.

514
00:51:03.520 --> 00:51:10.760
In the broad sense, much the same groups will benefit and lose, but in reverse order from

515
00:51:10.760 --> 00:51:15.760
that of the redistributive effects of credit expansion.

516
00:51:15.760 --> 00:51:22.360
Fixed income groups, widows and orphans will gain, and businesses and owners of original

517
00:51:22.360 --> 00:51:27.880
factors previously reaping gains from inflation will lose.

518
00:51:27.880 --> 00:51:33.660
The longer the inflation has continued, of course, the less the same individuals will

519
00:51:33.660 --> 00:51:35.740
be compensated.

520
00:51:35.740 --> 00:51:41.960
If the economy is on a gold or silver standard, then many advocates of a free market will

521
00:51:41.960 --> 00:51:46.960
argue for credit contraction for the following additional reasons.

522
00:51:46.960 --> 00:51:53.080
A. To preserve the principle of paying one's contractual obligations.

523
00:51:53.080 --> 00:52:01.400
be, to punish the banks for their expansion and force them back toward a 100% specie reserve

524
00:52:01.400 --> 00:52:03.640
policy.

525
00:52:03.640 --> 00:52:07.680
Some may object that deflation causes unemployment.

526
00:52:07.680 --> 00:52:15.560
However, as we have seen, deflation can lead to continuing unemployment only if the government

527
00:52:15.560 --> 00:52:22.880
or the unions keep wage rates above the discounted marginal value products of labor.

528
00:52:22.880 --> 00:52:30.000
If wage rates are allowed to fall freely, no continuing unemployment will occur.

529
00:52:30.000 --> 00:52:37.160
Finally, deflationary credit contraction is necessarily severely limited.

530
00:52:37.160 --> 00:52:44.280
Whereas credit can expand, barring various economic limits to be discussed later, virtually

531
00:52:44.280 --> 00:52:52.480
to infinity, circulating credit can contract only as far down as the total amount of specie

532
00:52:52.480 --> 00:53:00.720
in Circulation. In short, its maximum possible limit is the eradication of all previous credit

533
00:53:00.720 --> 00:53:08.320
expansion. The business cycle analysis set forth here has essentially been that of the Austrian

534
00:53:08.320 --> 00:53:14.960
School, originated and developed by Ludwig von Mises and some of his students. A prominent

535
00:53:14.960 --> 00:53:22.240
criticism of this theory is that it assumes the existence of full employment or that its analysis

536
00:53:22.240 --> 00:53:27.140
This holds only after full employment has been attained.

537
00:53:27.140 --> 00:53:33.420
Before that point, say the critics, credit expansion will beneficently put these factors

538
00:53:33.420 --> 00:53:38.520
to work and not generate further malinvestments or cycles.

539
00:53:38.520 --> 00:53:44.520
But in the first place, inflation will put no unemployed factors to work unless their

540
00:53:44.520 --> 00:53:51.180
owners, though holding out for a money price higher than their marginal value product,

541
00:53:51.180 --> 00:53:58.740
are blindly content to accept the necessarily lower real price when it is camouflaged as

542
00:53:58.740 --> 00:54:06.300
a rise in the cost of living, and credit expansion generates further cycles whether or not there

543
00:54:06.300 --> 00:54:08.540
are unemployed factors.

544
00:54:08.540 --> 00:54:15.820
It creates more distortions and malinvestments, delays indefinitely the process of recovery

545
00:54:15.820 --> 00:54:22.680
from the previous boom and makes necessary an eventually far more grueling recovery to

546
00:54:22.680 --> 00:54:27.600
adjust to the new malinvestments as well as to the old.

547
00:54:27.600 --> 00:54:34.580
If idle capital goods are now set to work, this idle capacity is the hangover effect

548
00:54:34.580 --> 00:54:41.980
of previous wasteful malinvestments and hence is really sub-marginal and not worth bringing

549
00:54:41.980 --> 00:54:43.660
into production.

550
00:54:43.660 --> 00:54:49.860
Putting the capital to work again will only redouble the distortions.

551
00:54:49.860 --> 00:54:54.460
D. The Limits of Credit Expansion.

552
00:54:54.460 --> 00:55:01.500
Having investigated the consequences of credit expansion, we must discuss the important question,

553
00:55:01.500 --> 00:55:08.300
if fractional reserve banking is legal, are there any natural limits to credit expansion

554
00:55:08.300 --> 00:55:10.020
by the banks?

555
00:55:10.020 --> 00:55:16.060
The one basic limit, of course, is the necessity of the banks to redeem their money substitutes

556
00:55:16.060 --> 00:55:17.720
on demand.

557
00:55:17.720 --> 00:55:22.700
Under a gold or silver standard, they must redeem in specie.

558
00:55:22.700 --> 00:55:29.040
Under a government fiat paper standard, the banks have to redeem in government paper.

559
00:55:29.040 --> 00:55:34.900
In any case, they must redeem in standard money or its virtual equivalent.

560
00:55:34.900 --> 00:55:42.820
Therefore, every fractional reserve bank depends for its very existence on persuading the public,

561
00:55:42.820 --> 00:55:49.780
specifically its clients, that all is well, and that it will be able to redeem its notes

562
00:55:49.780 --> 00:55:57.060
or deposits whenever the clients demand. Since this is palpably not the case, the continuance

563
00:55:57.060 --> 00:56:03.140
of confidence in the banks is something of a psychological marvel. Perhaps one reason for

564
00:56:03.140 --> 00:56:09.060
For continuing confidence in the banking system is that people generally believe that fraud

565
00:56:09.060 --> 00:56:17.880
is prosecuted by the government and that therefore any practice not so prosecuted must be sound.

566
00:56:17.880 --> 00:56:23.180
Governments indeed always go out of their way to bolster the banking system.

567
00:56:23.180 --> 00:56:29.320
It is certain at any rate that a wider knowledge of praxeology among the public would greatly

568
00:56:29.320 --> 00:56:42.840
Let just a few of their clients lose confidence and begin to call on the banks for redemption,

569
00:56:42.840 --> 00:56:49.400
and this will precipitate a scramble by other clients to make sure that they get their money

570
00:56:49.400 --> 00:56:52.560
while the bank's doors are still open.

571
00:56:52.560 --> 00:57:00.020
The obvious and justifiable panic of the banks, should any sort of run develop, encourages

572
00:57:00.020 --> 00:57:05.060
other clients to do the same, and aggravates the run still further.

573
00:57:05.060 --> 00:57:12.380
At any rate, runs on banks can wreak havoc, and of course, if pursued consistently, could

574
00:57:12.380 --> 00:57:16.780
close every bank in the country in a few days.

575
00:57:16.780 --> 00:57:23.520
All this, of course, assumes no further government intervention in banking than permitting fractional

576
00:57:23.520 --> 00:57:25.380
reserve banking.

577
00:57:25.380 --> 00:57:32.420
Since the advent of deposit insurance during the New Deal, for example, the bank run limitation

578
00:57:32.420 --> 00:57:37.660
has been virtually eliminated by this act of special privilege.

579
00:57:37.660 --> 00:57:44.140
Runs, therefore, and the constant underlying threat of their occurrence, are one of the

580
00:57:44.140 --> 00:57:47.140
The Prime Limits to Credit Expansion

581
00:57:47.140 --> 00:57:55.140
Runs often develop during a business cycle crisis, when debts are being defaulted and failures become manifest.

582
00:57:55.140 --> 00:58:02.140
Runs and the fear of runs help to precipitate deflationary credit contraction.

583
00:58:02.140 --> 00:58:09.140
Runs may be an ever-present threat, but as effective limitations they are not generally active.

584
00:58:09.140 --> 00:58:13.140
When they do occur, they usually wreck the banks.

585
00:58:13.140 --> 00:58:19.140
The fact that a bank is in existence at all signifies that a run has not developed.

586
00:58:19.140 --> 00:58:27.140
A more active, everyday limitation is the relatively narrow range of a bank's clientele.

587
00:58:27.140 --> 00:58:34.140
The clientele of a bank consists of those people willing to hold its deposits or notes,

588
00:58:34.140 --> 00:58:38.140
its money substitutes, in lieu of money proper.

589
00:58:38.140 --> 00:58:53.140
It is an empirical fact in almost all cases that one bank does not have the patronage of all people in the market society, or even of all those who prefer to use bank money rather than specie.

590
00:58:53.140 --> 00:59:01.140
It is obvious that the more banks exist, the more restricted will be the clientele of any one bank.

591
00:59:01.140 --> 00:59:05.340
People decide which bank to use on many grounds.

592
00:59:05.340 --> 00:59:14.840
Reputation for integrity, friendliness of service, price of service, and convenience of location may all play a part.

593
00:59:14.840 --> 00:59:22.140
How does the narrow range of a bank's clientele limit its potentiality for credit expansion?

594
00:59:22.140 --> 00:59:28.340
The newly issued money substitutes are, of course, loaned to a bank's clients.

595
00:59:28.340 --> 00:59:32.740
The client then spends the new money on goods and services.

596
00:59:32.740 --> 00:59:37.340
The new money begins to be diffused throughout the society.

597
00:59:37.340 --> 00:59:45.640
Eventually, usually very quickly, it is spent on the goods or services of people who use a different bank.

598
00:59:45.640 --> 00:59:49.440
Suppose that the Star Bank has expanded credit.

599
00:59:49.440 --> 00:59:58.240
The newly issued Star Bank's notes or deposits find their way into the hands of Mr. Jones, who uses the Citibank.

600
00:59:58.240 --> 01:00:04.240
Two alternatives may occur, either of which has the same economic effect.

601
01:00:04.240 --> 01:00:11.240
A. Jones accepts the Star Bank's notes or deposits and deposits them in the Citibank,

602
01:00:11.240 --> 01:00:15.240
which calls on the Star Bank for redemption.

603
01:00:15.240 --> 01:00:22.240
Or B. Jones refuses to accept the Star Bank's notes and insists that the star client,

604
01:00:22.240 --> 01:00:32.240
Say, Mr. Smith, who bought something from Jones, redeemed the note himself and paid Jones in acceptable standard money.

605
01:00:32.240 --> 01:00:43.240
Thus, while gold or silver is acceptable throughout the market, a bank's money substitutes are acceptable only to its own clientele.

606
01:00:43.240 --> 01:01:02.240
Clearly, a single bank's credit expansion is limited, and this limitation is stronger a. the narrower the range of its clientele, and b. the greater its issue of money substitutes in relation to that of competing banks.

607
01:01:02.240 --> 01:01:08.840
In illustration of the first point, let us assume that each bank has only one client.

608
01:01:08.840 --> 01:01:13.800
Then it is obvious that there will be very little room for credit expansion.

609
01:01:13.800 --> 01:01:20.040
At the opposite extreme, if one bank is used by everybody in the economy, there will be

610
01:01:20.040 --> 01:01:26.740
no demands for redemption resulting from its clients purchasing from non-clients.

611
01:01:26.740 --> 01:01:34.060
It is obvious that Ceteris Paribus, a numerically smaller clientele, is more restrictive of

612
01:01:34.060 --> 01:01:36.460
credit expansion.

613
01:01:36.460 --> 01:01:42.700
As regards the second point, the greater the degree of relative credit expansion by any

614
01:01:42.700 --> 01:01:49.660
one bank, the sooner will the day of redemption and potential bankruptcy be at hand.

615
01:01:49.660 --> 01:01:55.860
Suppose that the star bank expands credit while none of the competing banks do.

616
01:01:55.860 --> 01:02:02.320
This means that the Star Bank's clientele have added considerably to their cash balances.

617
01:02:02.320 --> 01:02:09.300
As a result, the marginal utility to them of each unit of money to hold declines, and

618
01:02:09.300 --> 01:02:13.820
they are impelled to spend a great proportion of the new money.

619
01:02:13.820 --> 01:02:19.100
Some of this increased spending will be on one another's goods and services, but it

620
01:02:19.100 --> 01:02:24.740
is clear that the greater the credit expansion, the greater will be the tendency for their

621
01:02:24.740 --> 01:02:50.340
In the meantime, the prices of the goods sold by non-clients remain the same.

622
01:02:50.340 --> 01:02:56.820
As a consequence, clients are impelled to buy more from non-clients and less from one

623
01:02:56.820 --> 01:03:03.140
another, while non-clients buy less from clients and more from one another.

624
01:03:03.140 --> 01:03:09.920
The result is an unfavorable balance of trade from clients to non-clients.

625
01:03:09.920 --> 01:03:17.260
In the consolidated balance of payments of the clients, money income from sales to non-clients,

626
01:03:17.260 --> 01:03:26.260
The exports will decline and money expenditures on the goods and services of non-clients, imports, will increase.

627
01:03:26.260 --> 01:03:32.260
The excess cash balances of the clients are transferred to non-clients.

628
01:03:32.260 --> 01:03:40.260
It is clear that this tendency of money to seek a uniform level of exchange value throughout the entire market

629
01:03:40.260 --> 01:03:50.260
is an example of the process by which new money, in this case new money substitutes, is diffused through the market.

630
01:03:50.260 --> 01:04:03.260
The greater the relative credit expansion by the bank then, the greater and more rapid will be the drain and consequent pressure on an expanding bank for redemption.

631
01:04:03.260 --> 01:04:13.260
The purpose of banks keeping any specie reserves in their vaults, assuming no legal reserve requirements, now becomes manifest.

632
01:04:13.260 --> 01:04:21.260
It is not to meet bank runs, since no fractional reserve bank can be equipped to withstand a run.

633
01:04:21.260 --> 01:04:28.260
It is to meet the demands for redemption, which will inevitably come from non-clients.

634
01:04:28.260 --> 01:04:42.260
Mises has brilliantly shown that a subdivision of this process was discovered by the British currency school and by the classical international trade theorists of the 19th century.

635
01:04:42.260 --> 01:04:50.260
These older economists assumed that all the banks in a certain region or country expanded credit together.

636
01:04:50.260 --> 01:04:55.260
The result was a rise in the prices of goods produced in that country.

637
01:04:55.260 --> 01:05:03.100
A further result was an unfavorable balance of trade, that is, an outflow of standard

638
01:05:03.100 --> 01:05:05.900
specie to other countries.

639
01:05:05.900 --> 01:05:11.380
Since other countries did not patronize the expanding countries' banks, the consequence

640
01:05:11.380 --> 01:05:19.020
was a specie drain from the expanding country and increased pressure for redemption on its

641
01:05:19.020 --> 01:05:20.380
banks.

642
01:05:20.380 --> 01:05:27.620
Like all parts of the overstressed and over-elaborated theory of international trade, this analysis

643
01:05:27.620 --> 01:05:35.300
is simply a special subdivision of general economic theory, and cataloguing it as international

644
01:05:35.300 --> 01:05:42.060
trade theory, as Mises has shown, underestimates its true significance.

645
01:05:42.060 --> 01:05:49.700
Older economists also distinguished an internal drain as well as the external drain, but included

646
01:05:49.700 --> 01:05:57.460
in the former only the drain from bank users to those who insist on standard money.

647
01:05:57.460 --> 01:06:03.500
Thus the more freely competitive and numerous are the banks, the less they will be able

648
01:06:03.500 --> 01:06:09.240
to expand fiduciary media, even if they are left free to do so.

649
01:06:09.240 --> 01:06:14.920
As we noted in Chapter 11, such a system is known as free banking.

650
01:06:14.920 --> 01:06:21.960
A major objection to this analysis of free banking has been the problem of bank cartels.

651
01:06:21.960 --> 01:06:28.200
If banks get together and agree to expand their credit simultaneously, the clientele

652
01:06:28.200 --> 01:06:35.080
limitation vis-à-vis competing banks will be removed, and the clientele of each bank

653
01:06:35.080 --> 01:06:40.240
will, in effect, increase to include all bank users.

654
01:06:40.240 --> 01:06:45.920
Mises points out, however, that the sounder banks with higher fractional reserves will

655
01:06:45.920 --> 01:06:52.640
not wish to lose the goodwill of their own clients and risk bank runs by entering into

656
01:06:52.640 --> 01:06:56.160
collusive agreements with weaker banks.

657
01:06:56.160 --> 01:07:03.120
This consideration, while placing limits on such agreements, does not rule them out altogether,

658
01:07:03.120 --> 01:07:09.700
for after all, no fractional reserve banks are really sound, and if the public can be

659
01:07:09.700 --> 01:07:15.700
The theory led to believe that, say, an 80% specie reserve is sound.

660
01:07:15.700 --> 01:07:21.380
It can believe the same about 60% or even 10% reserve banks.

661
01:07:21.380 --> 01:07:28.500
Indeed, the fact that the weaker banks are allowed by the public to exist at all demonstrates

662
01:07:28.500 --> 01:07:36.260
that the more conservative banks may not lose much goodwill by agreeing to expand with them.

663
01:07:36.260 --> 01:07:42.060
As Mises has demonstrated, there is no question that from the point of view of opponents of

664
01:07:42.060 --> 01:07:49.640
inflation and credit expansion, free banking is superior to a central banking system.

665
01:07:49.640 --> 01:07:55.860
But as Amasa Walker stated, much has been said at different times of the desirableness

666
01:07:55.860 --> 01:08:02.920
of free banking, of the propriety and rightfulness of allowing any person who chooses to carry

667
01:08:02.920 --> 01:08:09.980
on Banking, as freely as farming or any other branch of business, there can be no doubt.

668
01:08:09.980 --> 01:08:16.500
But while banking, as at present, means the issuing of inconvertible paper, the more it

669
01:08:16.500 --> 01:08:19.920
is guarded and restricted, the better.

670
01:08:19.920 --> 01:08:26.600
But when such issues are entirely forbidden, and only notes equivalent to certificates

671
01:08:26.600 --> 01:08:32.300
of so much coin are issued, banking may be as free as brokerage.

672
01:08:32.300 --> 01:08:40.300
The only thing to be secured would be that no issues should be made except upon specie in hand.

673
01:08:41.300 --> 01:08:46.300
E. The Government as Promoter of Credit Expansion

674
01:08:47.300 --> 01:08:53.300
Historically, governments have fostered and encouraged credit expansion to a great degree.

675
01:08:53.300 --> 01:09:00.300
They have done so by weakening the limitations that the market places on bank credit expansion.

676
01:09:00.300 --> 01:09:06.700
One way of weakening it is to anesthetize the bank against the threat of bank runs.

677
01:09:06.700 --> 01:09:13.500
In 19th century America, the government permitted banks, when they got into trouble in a business crisis,

678
01:09:13.500 --> 01:09:18.300
to suspend specie payment while continuing in operation.

679
01:09:18.300 --> 01:09:24.300
They were temporarily freed from their contractual obligation of paying their debts,

680
01:09:24.300 --> 01:09:47.300
While they could continue lending and even force their debtors to repay in their own banknotes, this is a powerful way to eradicate limitations on credit expansion, since the banks know that if they overreach themselves, the government will permit them blithely to avoid payment of their contractual obligations.

681
01:09:47.300 --> 01:10:02.300
Under a fiat money standard, governments, or their central banks, may obligate themselves to bail out, with increased issues of standard money, any bank, or any major bank, in distress.

682
01:10:02.300 --> 01:10:15.300
In the late 19th century, the principle became accepted that the central bank must act as the lender of last resort, which will lend money freely to banks threatened with failure.

683
01:10:15.300 --> 01:10:31.300
Another recent American device to abolish the confidence limitation on bank credit is deposit insurance, whereby the government guarantees to furnish paper money to redeem the bank's demand liabilities.

684
01:10:31.300 --> 01:10:37.300
These and similar devices remove the market breaks on rampant credit expansion.

685
01:10:37.300 --> 01:10:44.740
A second device, now so legitimized that any country lacking it is considered hopelessly

686
01:10:44.740 --> 01:10:47.760
backward, is the central bank.

687
01:10:47.760 --> 01:10:54.940
The central bank, while often nominally owned by private individuals or banks, is run directly

688
01:10:54.940 --> 01:10:57.220
by the national government.

689
01:10:57.220 --> 01:11:03.580
Its purpose, not always stated explicitly, is to remove the competitive check on bank

690
01:11:03.580 --> 01:11:07.580
provided by a multiplicity of independent banks.

691
01:11:07.580 --> 01:11:12.580
Its aim is to make sure that all the banks in the country are coordinated

692
01:11:12.580 --> 01:11:18.580
and will therefore expand or contract together, at the will of the government.

693
01:11:18.580 --> 01:11:25.580
And we have seen that coordination of expansion greatly weakens the market's limits.

694
01:11:25.580 --> 01:11:30.580
The crucial way in which governments have established central bank control

695
01:11:30.580 --> 01:11:36.460
control over the commercial banking system is by granting the bank a monopoly of the

696
01:11:36.460 --> 01:11:39.180
note issue in the country.

697
01:11:39.180 --> 01:11:45.820
As we have seen, money substitutes may be issued in the form of notes or book deposits.

698
01:11:45.820 --> 01:11:49.340
Economically, the two forms are identical.

699
01:11:49.340 --> 01:11:55.260
The state has found it convenient, however, to distinguish between the two and to outlaw

700
01:11:55.260 --> 01:11:58.760
all note issue by private banks.

701
01:11:58.760 --> 01:12:04.840
Such nationalizing of the note-issue business forces the commercial banks to go to the central

702
01:12:04.840 --> 01:12:12.040
bank whenever their customers desire to exchange demand deposits for paper notes.

703
01:12:12.040 --> 01:12:17.720
To obtain notes to furnish their clients, commercial banks must buy them from the central

704
01:12:17.720 --> 01:12:18.920
bank.

705
01:12:18.920 --> 01:12:25.680
Such purchases can be made only by selling their gold coin or other standard money or

706
01:12:25.680 --> 01:12:31.320
Or by Drawing on the Bank's Deposit Accounts with the Central Bank

707
01:12:31.320 --> 01:12:37.320
Since the public always wishes to hold some of its money in the form of notes and some

708
01:12:37.320 --> 01:12:43.560
in demand deposits, the banks must establish a continuing relationship with the central

709
01:12:43.560 --> 01:12:47.000
bank to be assured a supply of notes.

710
01:12:47.000 --> 01:12:53.480
Their most convenient procedure is to establish demand deposit accounts with the central bank,

711
01:12:53.480 --> 01:12:57.080
which thereby becomes the banker's bank.

712
01:12:57.080 --> 01:13:04.320
These demand deposits added to the gold in their vaults become the reserves of the banks.

713
01:13:04.320 --> 01:13:12.720
The central bank can also more freely create demand liabilities not backed 100% by gold,

714
01:13:12.720 --> 01:13:19.520
and these increased liabilities add to the reserves and demand deposits held by banks

715
01:13:19.520 --> 01:13:23.840
or else increase central bank notes outstanding.

716
01:13:23.840 --> 01:13:30.240
The rise in reserves of banks throughout the country will spur them to expand credit, while

717
01:13:30.240 --> 01:13:36.860
any decrease in these reserves will induce a general contraction in credit.

718
01:13:36.860 --> 01:13:42.200
The central bank can increase the reserves of a country's banks in three ways.

719
01:13:42.200 --> 01:13:50.060
a. by simply lending them reserves, b. by purchasing their assets, thereby adding directly

720
01:13:50.060 --> 01:13:57.480
to the bank's deposit accounts with the central bank, or c. by purchasing the IOUs of the

721
01:13:57.480 --> 01:14:03.640
public, which will then deposit the drafts on the central bank in the various banks that

722
01:14:03.640 --> 01:14:09.840
serve the public directly, thereby enabling them to use the credits on the central bank

723
01:14:09.840 --> 01:14:12.440
to add to their own reserves.

724
01:14:12.440 --> 01:14:19.320
The second process is known as discounting, the latter as open market purchase.

725
01:14:19.320 --> 01:14:27.320
A lapse in discounts as the loans mature will lower reserves, as will open market sales.

726
01:14:27.320 --> 01:14:33.360
In open market sales, the people will pay the central bank for its assets, purchased

727
01:14:33.360 --> 01:14:39.460
with checks drawn on their accounts at the banks, and the central bank exacts payment

728
01:14:39.460 --> 01:14:46.580
by reducing bank reserves on its books. In most cases, the assets purchased or sold on

729
01:14:46.580 --> 01:14:53.380
the open market are government IOUs. There is a fourth way by which a central bank may

730
01:14:53.380 --> 01:14:59.320
increase bank reserves. In countries such as the United States, where banks must keep

731
01:14:59.320 --> 01:15:06.460
a legally required minimum ratio of reserves to deposits, the bank may simply lower the

732
01:15:06.460 --> 01:15:08.460
and the required ratio.

733
01:15:08.460 --> 01:15:14.460
Thus the banking system becomes coordinated under the aegis of the government.

734
01:15:14.460 --> 01:15:21.460
The central bank is always accorded a great deal of prestige by its creator government.

735
01:15:21.460 --> 01:15:25.460
Often the government makes its notes legal tender.

736
01:15:25.460 --> 01:15:29.460
Under the gold standard, the wide resources which it commands,

737
01:15:29.460 --> 01:15:33.460
added to the fact that the whole country is its clientele,

738
01:15:33.460 --> 01:15:40.260
usually make negligible any trouble the bank may have in redeeming its liabilities in gold.

739
01:15:40.260 --> 01:15:48.460
Furthermore, it is certain that no government will let its own central bank, that is, itself, go bankrupt.

740
01:15:48.460 --> 01:15:55.860
The central bank will always be permitted to suspend specie payment in times of serious difficulty.

741
01:15:55.860 --> 01:16:10.860
It can therefore inflate and expand credit itself through rediscounts and open market purchases and, by adding to bank reserves, spur a multiple bank credit expansion throughout the country.

742
01:16:10.860 --> 01:16:28.860
The effect is multiple because banks will generally keep a certain proportion of reserves to liabilities, based on estimates of non-client redemption, and a general increase in their reserves will induce a multiple expansion of fiduciary media.

743
01:16:28.860 --> 01:16:47.860
In fact, the multiple will even increase, for the knowledge that all the banks are coordinated and expanding together decreases the possibility of non-client redemption, and therefore the proportion of reserves that each bank will wish to keep.

744
01:16:47.860 --> 01:16:57.360
When the government goes off the gold standard, central banknotes then become legal tender, and virtually the standard money.

745
01:16:57.360 --> 01:17:06.360
It then cannot possibly fail. And this, of course, practically eliminates limitations on its credit expansion.

746
01:17:06.360 --> 01:17:17.360
In the present-day United States, for example, the current basically fiat standard, also known as a restricted international gold bullion standard,

747
01:17:17.360 --> 01:17:29.360
virtually eliminates pressure for redemption, while the central bank's ready provision of reserves, as well as deposit insurance, eliminates the threat of bank failure.

748
01:17:29.360 --> 01:17:40.360
Foreign central banks and governments are still permitted to redeem in gold bullion, but this is hardly a consolation for either foreign citizens or Americans.

749
01:17:40.360 --> 01:17:55.360
The result is that gold is still an ultimate balancing item between national governments and therefore a kind of medium of exchange for governments and central banks in international transactions.

750
01:17:55.360 --> 01:18:06.360
In order to ensure centralized control by the government over bank credit, the United States enforces on banks a certain minimum ratio of reserves,

751
01:18:06.360 --> 01:18:26.360
So long as a country is, in any sense, on the gold standard, the central bank and the banking system must worry about an external drain of specie, should the inflation become too great.

752
01:18:26.360 --> 01:18:37.360
Under an unrestricted gold standard, it must also worry about an internal drain, resulting from the demands of those who do not use the banks.

753
01:18:37.360 --> 01:18:46.360
A shift in public taste from deposits to notes will embarrass the commercial banks, though not the central bank.

754
01:18:46.360 --> 01:18:56.360
Asiduous propaganda on the conveniences of banking, however, has reduced the ranks of those not using banks to a few malcontents.

755
01:18:56.360 --> 01:19:02.360
As a result, the only limitation on credit expansion is now external.

756
01:19:02.360 --> 01:19:10.360
Governments, of course, are always anxious to remove all checks on their powers of inducing monetary expansion.

757
01:19:10.360 --> 01:19:17.560
One way of removing the external threat is to foster international cooperation, so that

758
01:19:17.560 --> 01:19:23.820
all governments and central banks expand their money supply at a uniform rate.

759
01:19:23.820 --> 01:19:31.160
The ideal condition for unlimited inflation is, of course, a world fiat paper money, issued

760
01:19:31.160 --> 01:19:35.960
by a world central bank or other governmental authority.

761
01:19:35.960 --> 01:19:41.480
Poor fiat money on a national scale would serve almost as well, but there would then

762
01:19:41.480 --> 01:19:48.840
be the embarrassment of national monies depreciating in terms of other monies, and imports becoming

763
01:19:48.840 --> 01:19:51.160
much more expensive.

764
01:19:51.160 --> 01:19:57.660
The transition from gold to fiat money will be greatly smoothed if the state has previously

765
01:19:57.660 --> 01:20:04.660
The Theory of Money and Credit The Theory of Money and Credit

766
01:20:27.660 --> 01:20:35.660
With its own unique name, it will be far easier for each state to control its own fiat issue, absolutely.

767
01:20:42.660 --> 01:20:47.660
With the establishment of fiat money by a state or by a world state,

768
01:20:47.660 --> 01:20:54.660
it would seem that all limitations on credit expansion or on any inflation are eliminated.

769
01:20:54.660 --> 01:21:04.660
The central bank can issue limitless amounts of nominal units of paper unchecked by any necessity of digging a commodity out of the ground.

770
01:21:04.660 --> 01:21:10.660
They may be supplied to banks to bolster their credit at the pleasure of the government.

771
01:21:10.660 --> 01:21:14.660
No problems of internal or external drain exist.

772
01:21:14.660 --> 01:21:21.360
exist. And if there existed a world state, or a cooperating cartel of states, with a

773
01:21:21.360 --> 01:21:27.740
world bank and world paper money, and gold and silver money were outlawed, could not the

774
01:21:27.740 --> 01:21:34.380
world state then expand the money supply at will, with no foreign exchange or foreign trade

775
01:21:34.380 --> 01:21:40.860
difficulties, permanently redistributing wealth from the market's choice to its own favorites,

776
01:21:40.860 --> 01:21:44.860
from Voluntary Producers to the Ruling Castes?

777
01:21:44.860 --> 01:21:50.860
Many economists and most other people assume that the state could accomplish this goal.

778
01:21:50.860 --> 01:21:56.860
Actually, it could not, for there is an ultimate limit on inflation.

779
01:21:56.860 --> 01:22:03.860
A very wide one, to be sure, but a terrible limit that will, in the end, conquer any inflation.

780
01:22:03.860 --> 01:22:11.860
Paradoxically, this is the phenomenon of runaway inflation, or hyperinflation.

781
01:22:11.860 --> 01:22:19.860
When the government and the banking system begin inflating, the public will usually aid them unwittingly in this task.

782
01:22:19.860 --> 01:22:30.860
The public, not cognizant of the true nature of the process, believes that the rise in prices is transient, and that prices will soon return to normal.

783
01:22:30.860 --> 01:22:40.860
As we have noted, people will therefore hoard more money, that is, keep a greater proportion of their income in the form of cash balances.

784
01:22:40.860 --> 01:22:44.860
The social demand for money, in short, increases.

785
01:22:44.860 --> 01:22:52.860
As a result, prices tend to increase less than proportionately to the increase in the quantity of money.

786
01:22:52.860 --> 01:23:03.860
The government obtains more real resources from the public than it had expected, since the public's demand for these resources has declined.

787
01:23:03.860 --> 01:23:08.860
Eventually, the public begins to realize what is taking place.

788
01:23:08.860 --> 01:23:19.860
It seems that the government is attempting to use inflation as a permanent form of taxation, but the public has a weapon to combat this depredation.

789
01:23:19.860 --> 01:23:20.860
Education.

790
01:23:20.860 --> 01:23:27.020
Once people realize that the government will continue to inflate, and therefore that prices

791
01:23:27.020 --> 01:23:33.560
will continue to rise, they will step up their purchases of goods, for they will realize

792
01:23:33.560 --> 01:23:39.940
that they are gaining by buying now instead of waiting until a future date when the value

793
01:23:39.940 --> 01:23:44.680
of the monetary unit will be lower and prices higher.

794
01:23:44.680 --> 01:23:52.080
In other words, the social demand for money falls, and prices now begin to rise more rapidly

795
01:23:52.080 --> 01:23:55.360
than the increase in the supply of money.

796
01:23:55.360 --> 01:24:02.360
When this happens, the confiscation by the government, or the taxation effect of inflation,

797
01:24:02.360 --> 01:24:08.080
will be lower than the government had expected, for the increased money will be reduced in

798
01:24:08.080 --> 01:24:12.360
purchasing power by the greater rise in prices.

799
01:24:12.360 --> 01:24:19.780
This stage of the inflation is the beginning of hyperinflation, of the runaway boom.

800
01:24:19.780 --> 01:24:26.360
The lower demand for money allows fewer resources to be extracted by the government, but the

801
01:24:26.360 --> 01:24:33.280
government can still obtain resources so long as the market continues to use the money.

802
01:24:33.280 --> 01:24:40.000
The accelerated price rise will, in fact, lead to complaints of a scarcity of money

803
01:24:40.000 --> 01:24:47.080
and stimulate the government to greater efforts of inflation, thereby causing even more accelerated

804
01:24:47.080 --> 01:24:49.000
price increases.

805
01:24:49.000 --> 01:24:52.380
This process will not continue long, however.

806
01:24:52.380 --> 01:24:58.600
As the rise in prices continues, the public begins a flight from money, getting rid of

807
01:24:58.600 --> 01:25:06.080
money as soon as possible in order to invest in real goods, almost any real goods, as a

808
01:25:06.080 --> 01:25:08.880
store of value for the future.

809
01:25:08.880 --> 01:25:15.200
This mad scramble away from money, lowering the demand for money to hold practically to

810
01:25:15.200 --> 01:25:21.200
zero, causes prices to rise upward in astronomical proportions.

811
01:25:21.200 --> 01:25:25.880
The value of the monetary unit falls practically to zero.

812
01:25:25.880 --> 01:25:32.460
The devastation and havoc that the runaway boom causes among the populace is enormous.

813
01:25:32.460 --> 01:25:36.840
The relatively fixed income groups are wiped out.

814
01:25:36.840 --> 01:25:42.700
Human Action declines drastically, sending up prices further, as people lose the incentive

815
01:25:42.700 --> 01:25:47.960
to work, since they must spend much of their time getting rid of money.

816
01:25:47.960 --> 01:25:54.840
The main desideratum becomes getting hold of real goods, whatever they may be, and spending

817
01:25:54.840 --> 01:25:57.680
money as soon as received.

818
01:25:57.680 --> 01:26:04.360
When this runaway stage is reached, the economy, in effect, breaks down, the market is virtually

819
01:26:04.360 --> 01:26:10.360
and Society reverts to a state of virtual barter and complete impoverishment.

820
01:26:10.360 --> 01:26:15.360
Commodities are then slowly built up as media of exchange.

821
01:26:15.360 --> 01:26:21.360
The public has rid itself of the inflation burden by its ultimate weapon,

822
01:26:21.360 --> 01:26:28.360
lowering the demand for money to such an extent that the government's money has become worthless.

823
01:26:28.360 --> 01:26:32.360
When all other limits and forms of persuasion fail,

824
01:26:32.360 --> 01:26:44.360
This is the only way, through chaos and economic breakdown, for the people to force a return to the hard commodity money of the free market.

825
01:26:44.360 --> 01:26:50.360
The most famous runaway inflation was the German experience of 1923.

826
01:26:50.360 --> 01:26:57.360
It is particularly instructive because it took place in one of the world's most advanced industrial countries.

827
01:26:57.360 --> 01:27:09.360
The chaotic events of the German hyperinflation and other accelerated booms, however, are only a pale shadow of what would happen under a world state inflation.

828
01:27:09.360 --> 01:27:25.360
For Germany was able to recover and return to a full monetary market economy quickly, since it could institute a new currency based on exchanges with other pre-existing monies, gold or foreign paper.

829
01:27:25.360 --> 01:27:45.360
As we have seen, however, Mises regression theorem shows that no money can be established on the market except as it can be exchanged for a previously existing money, which in turn must have ultimately related back to a commodity in barter.

830
01:27:45.360 --> 01:27:52.220
If a world state outlaws gold and silver and establishes a unitary fiat money, which it

831
01:27:52.220 --> 01:28:00.320
proceeds to inflate until a runaway boom destroys it, there will be no pre-existing money on

832
01:28:00.320 --> 01:28:01.520
the market.

833
01:28:01.520 --> 01:28:07.600
The task of reconstruction will then be enormously more difficult.

834
01:28:07.600 --> 01:28:14.160
G. Inflation and Compensatory Fiscal Policy

835
01:28:14.160 --> 01:28:19.940
Money in recent years has been generally defined as an increase in prices.

836
01:28:19.940 --> 01:28:23.860
This is a highly unsatisfactory definition.

837
01:28:23.860 --> 01:28:30.200
Prices are highly complex phenomena, activated by many different causal factors.

838
01:28:30.200 --> 01:28:36.540
They may increase or decrease from the goods side, that is, as a result of a change in

839
01:28:36.540 --> 01:28:39.300
the supply of goods on the market.

840
01:28:39.300 --> 01:28:45.940
They may increase or decrease because of a change in the social demand for money to hold,

841
01:28:45.940 --> 01:28:51.060
or they may rise or fall from a change in the supply of money.

842
01:28:51.060 --> 01:28:58.400
To lump all of these causes together is misleading, for it glosses over the separate influences,

843
01:28:58.400 --> 01:29:01.540
the isolation of which is the goal of science.

844
01:29:01.540 --> 01:29:08.060
Thus, the money supply may be increasing, while at the same time the social demand for

845
01:29:08.060 --> 01:29:15.300
Your money is increasing from the goods side, in the form of increased supplies of goods.

846
01:29:15.300 --> 01:29:21.900
Each may offset the other, with no general price changes occurring, yet both processes

847
01:29:21.900 --> 01:29:25.580
perform their work, nevertheless.

848
01:29:25.580 --> 01:29:30.840
Resources will still shift as a result of inflation, and the business cycle caused by

849
01:29:30.840 --> 01:29:34.000
credit expansion will still appear.

850
01:29:34.000 --> 01:29:41.800
It is therefore highly inexpedient to define inflation as a rise in prices.

851
01:29:41.800 --> 01:29:48.080
Movements in the supply of goods and in the demand for money schedules are all the results

852
01:29:48.080 --> 01:29:52.400
of voluntary changes of preferences on the market.

853
01:29:52.400 --> 01:29:59.280
The same is true for increases in the supply of gold or silver, but increases in fiduciary

854
01:29:59.280 --> 01:30:06.300
Voluntary or fiat media are acts of fraudulent intervention in the market, distorting voluntary

855
01:30:06.300 --> 01:30:12.000
preferences and the voluntarily determined pattern of income and wealth.

856
01:30:12.000 --> 01:30:19.120
Therefore, the most expedient definition of inflation is one we have set forth, an increase

857
01:30:19.120 --> 01:30:25.200
in the supply of money beyond any increase in specie.

858
01:30:25.200 --> 01:30:31.920
Inflation is here defined as any increase in the money supply greater than an increase

859
01:30:31.920 --> 01:30:37.080
in specie, not as a big change in that supply.

860
01:30:37.080 --> 01:30:46.260
As here defined, therefore, the terms inflation and deflation are praxeological categories.

861
01:30:46.260 --> 01:30:52.880
The absurdity of the various governmental programs for fighting inflation now becomes

862
01:30:52.880 --> 01:30:53.880
evident.

863
01:30:53.880 --> 01:30:59.960
Most people believe that government officials must constantly pace the ramparts, armed with

864
01:30:59.960 --> 01:31:07.200
a huge variety of control programs designed to combat the inflation enemy.

865
01:31:07.200 --> 01:31:13.320
Yet all that is really necessary is that the government and the banks, nowadays controlled

866
01:31:13.320 --> 01:31:18.080
almost completely by the government, cease inflating.

867
01:31:18.080 --> 01:31:23.800
The absurdity of the term inflationary pressure also becomes clear.

868
01:31:23.800 --> 01:31:28.680
Either the government and banks are inflating or they are not.

869
01:31:28.680 --> 01:31:33.080
There is no such thing as inflationary pressure.

870
01:31:33.080 --> 01:31:39.360
The idea that the government has the duty to tax the public in order to sop up excess

871
01:31:39.360 --> 01:31:43.440
purchasing power is particularly ludicrous.

872
01:31:43.440 --> 01:31:50.440
If inflation has been underway, this excess purchasing power is precisely the result of

873
01:31:50.440 --> 01:31:53.440
previous governmental inflation.

874
01:31:53.440 --> 01:31:59.620
In short, the government is supposed to burden the public twice, once in appropriating the

875
01:31:59.620 --> 01:32:07.160
resources of society by inflating the money supply, and again by taxing back the new money

876
01:32:07.160 --> 01:32:08.720
from the public.

877
01:32:08.720 --> 01:32:15.400
Rather than checking inflationary pressure then, a tax surplus in a boom will simply

878
01:32:15.400 --> 01:32:18.980
place an additional burden upon the public.

879
01:32:18.980 --> 01:32:25.520
If the taxes are used for further government spending, or for repaying debts to the public,

880
01:32:25.520 --> 01:32:28.880
then there is not even a deflationary effect.

881
01:32:28.880 --> 01:32:35.280
If the taxes are used to redeem government debt held by the banks, the deflationary effect

882
01:32:35.280 --> 01:32:41.280
Conflict will not be a credit contraction and therefore will not correct maladjustments

883
01:32:41.280 --> 01:32:44.440
brought about by the previous inflation.

884
01:32:44.440 --> 01:32:51.800
It will, indeed, create further dislocations and distortions of its own.

885
01:32:51.800 --> 01:32:59.160
Keynesian and neo-Keynesian compensatory fiscal policy advocates that government deflate during

886
01:32:59.160 --> 01:33:06.120
Inflating an inflationary period and inflate incur deficits financed by borrowing from the

887
01:33:06.120 --> 01:33:09.060
banks to combat a depression.

888
01:33:09.060 --> 01:33:15.780
It is clear that government inflation can relieve unemployment and unsold stocks only

889
01:33:15.780 --> 01:33:23.560
if the process dupes the owners into accepting lower real prices or wages.

890
01:33:23.560 --> 01:33:30.740
This money illusion relies on the owners being too ignorant to realize when their real incomes

891
01:33:30.740 --> 01:33:35.720
have declined, a slender basis on which to ground a cure.

892
01:33:35.720 --> 01:33:41.620
Furthermore, the inflation will benefit part of the public at the expense of the rest,

893
01:33:41.620 --> 01:33:47.960
and any credit expansion will only set a further boom-bust cycle into motion.

894
01:33:47.960 --> 01:33:54.880
The Keynesians depict the free market's monetary fiscal system as minus a steering wheel so

895
01:33:54.880 --> 01:34:01.640
that the economy, though readily adjustable in other ways, is constantly walking a precarious

896
01:34:01.640 --> 01:34:09.160
tightrope between depression and unemployment on the one side and inflation on the other.

897
01:34:09.160 --> 01:34:15.440
It is then necessary for the government, in its wisdom, to step in and steer the economy

898
01:34:15.440 --> 01:34:17.880
on an even course.

899
01:34:17.880 --> 01:34:23.500
Under our completed analysis of money and business cycles, however, it should be evident

900
01:34:23.500 --> 01:34:27.080
that the true picture is just about the reverse.

901
01:34:27.080 --> 01:34:34.040
The free market, unhampered, would not be in danger of suffering inflation, deflation,

902
01:34:34.040 --> 01:34:40.880
depression or unemployment, but the intervention of government creates the tightrope for the

903
01:34:40.880 --> 01:34:48.880
of the Economy and is constantly, if sometimes unwittingly, pushing the economy into these pitfalls.