WEBVTT NOTE Economic Depressions: Their Cause and Cure 1 00:00:00.000 --> 00:00:06.000 Economic Depressions, Their Cause and Cure, by Murray N. Rothbard 2 00:00:06.000 --> 00:00:20.000 We live in a world of euphemism. Undertakers have become morticians, press agents are now public relations counselors, and janitors have all been transformed into superintendents. 3 00:00:20.000 --> 00:00:29.000 In every walk of life, plain facts have been wrapped in cloudy camouflage. No less has this been true of economics. 4 00:00:29.000 --> 00:00:41.000 In the old days, we used to suffer nearly periodic economic crises, the sudden onset of which was called a panic, and the lingering trough period after the panic was called depression. 5 00:00:41.000 --> 00:00:46.640 Depression. The most famous depression, in modern times of course, was the one that began 6 00:00:46.640 --> 00:00:54.160 in a typical financial panic in 1929 and lasted until the advent of World War II. After the 7 00:00:54.160 --> 00:01:01.480 disaster of 1929, economists and politicians resolved that this must never happen again. 8 00:01:01.480 --> 00:01:07.400 The easiest way of succeeding at this resolve was simply to define depressions out of existence. 9 00:01:07.400 --> 00:01:12.560 From that point on, America was to suffer no further depressions, for when the next 10 00:01:12.560 --> 00:01:19.560 sharp depression came along in 1937-38, the economists simply refused to use the dread 11 00:01:19.560 --> 00:01:25.280 name, and came up with a new, much softer sounding word, recession. From that point 12 00:01:25.280 --> 00:01:31.760 on, we have been through quite a few recessions, but not a single depression. But pretty soon, 13 00:01:31.760 --> 00:01:37.200 The word recession also became too harsh for the delicate sensibilities of the American 14 00:01:37.200 --> 00:01:46.000 public. It now seems that we had our last recession in 1957-58. For since then, we have 15 00:01:46.000 --> 00:01:54.200 only had downturns, or even better slowdowns, or sidewise movements. So be of good cheer. 16 00:01:54.200 --> 00:01:59.160 From now on, depressions and even recessions have been outlawed by the semantic fiat of 17 00:01:59.160 --> 00:02:06.200 of Economists. From now on, the worst that can possibly happen to us are slowdowns. Such 18 00:02:06.200 --> 00:02:12.840 are the wonders of the new economics. For 30 years, our nation's economists have adopted 19 00:02:12.840 --> 00:02:18.000 the view of the business cycle held by the late British economist John Maynard Keynes, 20 00:02:18.000 --> 00:02:24.280 who created the Keynesian, or the new, economics in his book The General Theory of Employment, 21 00:02:24.280 --> 00:02:28.120 Interest and Money, published in 1936. 22 00:02:28.120 --> 00:02:34.600 Beneath their diagrams, mathematics, and inchoate jargon, the attitude of Keynesians toward booms 23 00:02:34.600 --> 00:02:38.760 and bust is simplicity, even naivete itself. 24 00:02:38.760 --> 00:02:43.440 If there is inflation, then the cause is supposed to be excessive spending on the part of the 25 00:02:43.440 --> 00:02:44.440 public. 26 00:02:44.440 --> 00:02:49.280 The alleged cure is for the government, the self-appointed stabilizer and regulator of 27 00:02:49.280 --> 00:02:54.880 of the Nation's Economy to step in and force people to spend less, sopping up their excess 28 00:02:54.880 --> 00:03:00.320 purchasing power through increased taxation. If there is a recession on the other hand, 29 00:03:00.320 --> 00:03:05.440 this has been caused by insufficient private spending, and the cure now is for the government 30 00:03:05.440 --> 00:03:11.280 to increase its own spending, preferably through deficits, thereby adding to the nation's aggregate 31 00:03:11.280 --> 00:03:19.200 spending stream. The idea that increased government spending, or easy money, is good for business, 32 00:03:19.200 --> 00:03:24.600 and that budget cuts, or harder money, is bad, permeates even the most conservative 33 00:03:24.600 --> 00:03:30.400 newspapers and magazines. These journals will also take for granted that it is the sacred 34 00:03:30.400 --> 00:03:35.600 task of the federal government to steer the economic system on the narrow road between 35 00:03:35.600 --> 00:03:40.360 the abysses of depression on the one hand and inflation on the other, for the free market 36 00:03:40.360 --> 00:03:45.920 economy is supposed to be ever liable to succumb to one of these evils. All current schools 37 00:03:45.920 --> 00:03:56.920 Note, for example, the viewpoint of Dr. Paul W. McCracken, the incoming chairman of President Nixon's Council of Economic Advisers. 38 00:03:56.920 --> 00:04:03.920 In an interview with the New York Times shortly after taking office, January 24th, 1969, 39 00:04:03.920 --> 00:04:09.920 Dr. McCracken asserted that one of the major economic problems facing the new administration is 40 00:04:09.920 --> 00:04:13.920 How you cool down this inflationary economy without at the same time 41 00:04:13.920 --> 00:04:17.360 tripping off unacceptably high levels of unemployment. 42 00:04:17.360 --> 00:04:21.600 In other words, if the only thing we want to do is cool off the inflation, 43 00:04:21.600 --> 00:04:24.800 it could be done. But our social tolerances on 44 00:04:24.800 --> 00:04:30.480 unemployment are narrow. And again, I think we have to feel our way along here. 45 00:04:30.480 --> 00:04:33.920 We don't really have much experience in trying to cool an economy 46 00:04:33.920 --> 00:04:37.840 in orderly fashion. We slammed on the brakes in 1957, 47 00:04:37.840 --> 00:04:51.840 Note the fundamental attitude of Dr. McCracken toward the economy, remarkable only in that it is shared by almost all economists of the present day. 48 00:04:51.840 --> 00:05:02.840 The economy is treated as a potentially workable but always troublesome and recalcitrant patient, with a continual tendency to hive off into greater inflation or unemployment. 49 00:05:02.840 --> 00:05:12.840 The function of the government is to be the wise old manager and physician, ever watchful, ever tinkering, to keep the economic patient in good working order. 50 00:05:12.840 --> 00:05:20.840 In any case, here the economic patient is clearly supposed to be the subject, and the government as physician the master. 51 00:05:20.840 --> 00:05:28.840 It was not so long ago that this kind of attitude and policy was called socialism, but we live in a world of euphemism. 52 00:05:28.840 --> 00:05:37.840 And now we call it by far less harsh labels such as moderation or enlightened free enterprise. We live and learn. 53 00:05:37.840 --> 00:05:46.840 What then are the causes of periodic depressions? Must we always remain agnostic about the causes of booms and busts? 54 00:05:46.840 --> 00:05:51.840 Is it really true that business cycles are rooted deep within the free market economy, 55 00:05:51.840 --> 00:05:57.300 Economy, and that therefore some form of government planning is needed if we wish to keep the 56 00:05:57.300 --> 00:06:03.480 economy within some kind of stable bounds. Do booms and then busts just simply happen, 57 00:06:03.480 --> 00:06:09.800 or does one phase of the cycle flow logically from the other? The current fashionable attitude 58 00:06:09.800 --> 00:06:15.880 toward the business cycle stems actually from Karl Marx. Marx saw that before the Industrial 59 00:06:15.880 --> 00:06:21.640 Revolution in approximately the late 18th century, there were no regularly recurring 60 00:06:21.640 --> 00:06:27.400 booms and depressions. There would be a sudden economic crisis whenever some king made war 61 00:06:27.400 --> 00:06:32.760 or confiscated the property of his subject, but there was no sign of the peculiarly modern 62 00:06:32.760 --> 00:06:39.400 phenomena of general and fairly regular swings in business fortunes, of expansions and contractions. 63 00:06:40.040 --> 00:06:45.400 Since these cycles also appeared on the scene at about the same time as modern industry, 64 00:06:45.400 --> 00:06:51.240 Marx concluded that business cycles were an inherent feature of the capitalist market economy. 65 00:06:51.240 --> 00:06:56.360 All the various current schools of economic thought, regardless of their other differences 66 00:06:56.360 --> 00:07:01.960 and the different causes they attribute to the cycle, agree on this vital point, that these 67 00:07:01.960 --> 00:07:07.720 business cycles originate somewhere deep within the free market economy. The market economy is to 68 00:07:07.720 --> 00:07:13.720 blame. Karl Marx believed that the periodic depressions would get worse and worse until the 69 00:07:13.720 --> 00:07:18.680 All the masses would be moved to revolt and destroy the system, while the modern economists 70 00:07:18.680 --> 00:07:24.040 believe that the government can successfully stabilize depressions and the cycle. 71 00:07:24.040 --> 00:07:28.820 But all parties agree that the fault lies deep within the market economy, and that if 72 00:07:28.820 --> 00:07:34.840 anything can save the day, it must be some form of massive government intervention. 73 00:07:34.840 --> 00:07:40.800 There are, however, some critical problems in the assumption that the market economy 74 00:07:40.800 --> 00:07:42.280 is the culprit. 75 00:07:42.280 --> 00:07:47.720 Therefore, general economic theory teaches us that supply and demand always tend to 76 00:07:47.720 --> 00:07:53.880 be in equilibrium in the market, and that therefore prices of products as well as of 77 00:07:53.880 --> 00:07:58.920 the factors that contribute to production are always tending towards some equilibrium 78 00:07:58.920 --> 00:08:04.540 point. Even though changes of data, which are always taking place, prevent equilibrium 79 00:08:04.540 --> 00:08:09.480 from ever being reached, there is nothing in the general theory of the market system 80 00:08:09.480 --> 00:08:16.240 that would account for regular and recurring boom and bust phases of the business cycle. 81 00:08:16.240 --> 00:08:21.640 Modern economists solved this problem by simply keeping their general price and market theory 82 00:08:21.640 --> 00:08:27.360 and their business cycle theory in separate, tightly sealed compartments, with never the 83 00:08:27.360 --> 00:08:31.600 twain meeting, much less integrated with each other. 84 00:08:31.600 --> 00:08:36.480 Economists unfortunately have forgotten that there is only one economy, and therefore only 85 00:08:36.480 --> 00:08:46.480 There is only one integrated economic theory. Neither economic life nor the structure of theory can or should be in watertight compartments. 86 00:08:46.480 --> 00:08:51.480 Our knowledge of the economy is either one integrated whole or it is nothing. 87 00:08:51.480 --> 00:09:03.480 Yet most economists are content to apply totally separate and indeed mutually exclusive theories for general price analysis and for business cycles. 88 00:09:03.480 --> 00:09:10.180 They cannot be genuine economic scientists, so long as they are content to keep operating 89 00:09:10.180 --> 00:09:12.040 in this primitive way. 90 00:09:12.040 --> 00:09:18.800 But there are still graver problems with the currently fashionable approach. 91 00:09:18.800 --> 00:09:23.180 Economists also do not see one particularly critical problem because they do not bother 92 00:09:23.180 --> 00:09:27.580 to square their business cycle and general price theories. 93 00:09:27.580 --> 00:09:35.420 The Peculiar Breakdown of the Entrepreneurial Function at Times of Economic Crisis and Depression 94 00:09:35.420 --> 00:09:41.860 In the market economy, one of the most vital functions of the businessman is to be an entrepreneur, 95 00:09:41.860 --> 00:09:48.860 a man who invests in productive methods, who buys equipment and hires labor to produce 96 00:09:48.860 --> 00:09:53.580 something which he is not sure will reap him any return. 97 00:09:53.580 --> 00:10:00.780 In short, the entrepreneurial function is the function of forecasting the uncertain future. 98 00:10:00.780 --> 00:10:07.780 Before embarking on any investment or line of production, the entrepreneur or enterpriser 99 00:10:07.780 --> 00:10:14.420 must estimate present and future costs and future revenues, and therefore estimate whether 100 00:10:14.420 --> 00:10:19.460 and how much profits he will earn from the investment. 101 00:10:19.460 --> 00:10:24.780 If he forecasts well, and significantly better than his business competitors, he will reap 102 00:10:24.780 --> 00:10:26.860 profits from his investment. 103 00:10:26.860 --> 00:10:31.100 The better his forecasting, the higher profits he will earn. 104 00:10:31.100 --> 00:10:38.020 If on the other hand, he is a poor forecaster, and overestimates the demand for his product, 105 00:10:38.020 --> 00:10:42.980 he will suffer losses, and pretty soon be forced out of the business. 106 00:10:42.980 --> 00:10:49.140 The market economy, then, is a profit and loss economy, in which the acumen and ability 107 00:10:49.140 --> 00:10:54.820 of Business Entrepreneurs is gauged by the profits and losses they reap. 108 00:10:54.820 --> 00:11:01.260 The market economy, moreover, contains a built-in mechanism, a kind of natural selection, that 109 00:11:01.260 --> 00:11:08.540 ensures the survival and the flourishing of the superior forecaster and the weeding out 110 00:11:08.540 --> 00:11:10.820 of the inferior ones. 111 00:11:10.820 --> 00:11:15.420 For the more profits reaped by the better forecasters, the greater become their business 112 00:11:15.420 --> 00:11:20.380 Business Responsibilities, and the more they will have available to invest in the productive 113 00:11:20.380 --> 00:11:26.460 system. On the other hand, a few years of making losses will drive the poorer forecasters 114 00:11:26.460 --> 00:11:33.460 and entrepreneurs out of business altogether and push them into the ranks of salaried employees. 115 00:11:34.320 --> 00:11:40.200 If then the market economy has a built-in natural selection mechanism for good entrepreneurs, 116 00:11:40.200 --> 00:11:46.400 This means that generally we would expect not many business firms to be making losses, 117 00:11:46.400 --> 00:11:51.680 and in fact if we look around at the economy on an average day or year we will find that 118 00:11:51.680 --> 00:11:54.820 losses are not very widespread. 119 00:11:54.820 --> 00:12:00.840 But in that case the odd fact that needs explaining is this, how is it that periodically in times 120 00:12:00.840 --> 00:12:07.180 of the onset of depressions, and especially in steep depressions, the business world suddenly 121 00:12:07.180 --> 00:12:11.220 only experiences a massive cluster of severe losses. 122 00:12:11.220 --> 00:12:16.220 A moment arrives when business firms, previously highly astute entrepreneurs in their ability 123 00:12:16.220 --> 00:12:22.100 to make profits and avoid losses, suddenly and dismayingly find themselves, almost all 124 00:12:22.100 --> 00:12:26.180 of them, suffering severe and unaccountable losses. 125 00:12:26.180 --> 00:12:27.180 How come? 126 00:12:27.180 --> 00:12:31.740 Here's a momentous fact that any theory of depressions must explain. 127 00:12:31.740 --> 00:12:38.020 An explanation such as underconsumption, a drop in total consumer spending, is not sufficient, 128 00:12:38.020 --> 00:12:43.700 for one thing, because what needs to be explained is why businessmen, able to forecast all manner 129 00:12:43.700 --> 00:12:49.860 of previous economic changes and developments, prove themselves totally and catastrophically 130 00:12:49.860 --> 00:12:54.140 unable to forecast this alleged drop in consumer demand. 131 00:12:54.140 --> 00:12:57.820 Why this sudden failure in forecasting ability? 132 00:12:57.820 --> 00:13:02.820 An adequate theory of depressions, then, must account for the tendency of the economy to 133 00:13:02.820 --> 00:13:09.260 move through successive booms and busts, showing no sign of settling into any sort of smoothly 134 00:13:09.260 --> 00:13:15.420 moving or quietly progressive approximation of an equilibrium situation. 135 00:13:15.420 --> 00:13:20.980 In particular, a theory of depression must account for the mammoth cluster of errors 136 00:13:20.980 --> 00:13:26.380 which appear swiftly and suddenly at a moment of economic crisis and lingers through the 137 00:13:26.380 --> 00:13:56.380 and there is a third universal fact that a theory of the cycle must account for invariably the booms and busts are much more intense and severe in the capital goods industries the industries making machines and equipment the ones producing industrial raw materials or constructing industrial plants than in the industries making consumers goods here is another fact of business cycle life that must be explained 138 00:13:56.380 --> 00:14:02.380 are explained, and obviously can't be explained, by such theories of depression as the popular 139 00:14:02.380 --> 00:14:08.620 under-consumption doctrine, that consumers aren't spending enough on consumer goods. 140 00:14:08.620 --> 00:14:14.300 For if insufficient spending is the culprit, then how is it that retail sales are the last 141 00:14:14.300 --> 00:14:20.480 and least to fall in any depression, and that depression really hits such industries as 142 00:14:20.480 --> 00:14:27.480 has machine tools, capital equipment, construction, and raw materials. Conversely, it is these 143 00:14:27.480 --> 00:14:33.060 industries that really take off in the inflationary boom phases of the business cycle, and not 144 00:14:33.060 --> 00:14:38.040 those businesses serving the consumer. An adequate theory of the business cycle, then, 145 00:14:38.040 --> 00:14:44.160 must also explain the far greater intensity of booms and busts in the non-consumer goods, 146 00:14:44.160 --> 00:14:49.920 or producer's goods, industries. Fortunately, a correct theory of depression and of the 147 00:14:49.920 --> 00:15:19.920 of the Business Cycle does exist 148 00:15:19.920 --> 00:15:25.840 of the century, alongside the industrial system. This was the institution of banking, with 149 00:15:25.840 --> 00:15:31.560 its capacity to expand credit and the money supply, first in the form of paper money or 150 00:15:31.560 --> 00:15:38.020 bank notes, and later in the form of demand deposits or checking accounts that are instantly 151 00:15:38.020 --> 00:15:44.500 redeemable in cash at the banks. It was the operations of these commercial banks which, 152 00:15:44.500 --> 00:15:49.740 these economists saw, held the key to the mysterious recurrent cycles of expansion and 153 00:15:49.740 --> 00:15:56.580 and a contraction of boom and bust that had puzzled observers since the mid-18th century. 154 00:15:56.580 --> 00:16:01.900 The Ricardian analysis of the business cycle went something as follows. The natural monies 155 00:16:01.900 --> 00:16:09.100 emerging as such on the world-free market are useful commodities, generally gold and 156 00:16:09.100 --> 00:16:15.340 silver. If money were confined simply to these commodities, then the economy would work in 157 00:16:15.340 --> 00:16:21.860 Money aggregate as it does in particular markets, a smooth adjustment of supply and demand, 158 00:16:21.860 --> 00:16:25.180 and therefore no cycles of boom and bust. 159 00:16:25.180 --> 00:16:31.940 But the injection of bank credit adds another crucial and disruptive element, for the banks 160 00:16:31.940 --> 00:16:38.260 expand credit and therefore bank money in the form of notes or deposits, which are theoretically 161 00:16:38.260 --> 00:16:43.620 redeemable on demand in gold, but in practice clearly are not. 162 00:16:43.620 --> 00:16:50.040 For example, if a bank has 1000 ounces of gold in its vaults, and it issues instantly 163 00:16:50.040 --> 00:16:57.540 redeemable warehouse receipts for 2500 ounces of gold, then it clearly has issued 1500 ounces 164 00:16:57.540 --> 00:17:00.320 more than it can possibly redeem. 165 00:17:00.320 --> 00:17:06.900 But so long as there is no concerted run on the bank to cash in these receipts, its warehouse 166 00:17:06.900 --> 00:17:12.620 receipts function on the market as equivalent to gold, and therefore the bank has been able 167 00:17:12.620 --> 00:17:42.620 The banks, then, happily begin to expand credit. For the more they expand credit, the greater will be their profits. This results in the expansion of the money supply within a country, say, England. As the supply of paper and bank money in England increases, the money incomes and expenditures of Englishmen rise, and the increased money in England increases. 168 00:17:42.620 --> 00:17:49.620 bids up prices of English goods. The result is inflation and a boom within the country. 169 00:17:49.620 --> 00:17:56.620 But this inflationary boom, while it proceeds on its merry way, sows the seeds of its own demise. 170 00:17:56.620 --> 00:18:03.620 For as English money supply and incomes increase, Englishmen proceed to purchase more goods from abroad. 171 00:18:03.620 --> 00:18:10.620 Furthermore, as English prices goes up, English goods begin to lose their competitiveness 172 00:18:10.620 --> 00:18:15.740 with the products of other countries which have not inflated or have been inflating to 173 00:18:15.740 --> 00:18:17.760 a lesser degree. 174 00:18:17.760 --> 00:18:23.680 Englishmen begin to buy less at home and more abroad, while foreigners buy less in England 175 00:18:23.680 --> 00:18:25.380 and more at home. 176 00:18:25.380 --> 00:18:30.340 The result is a deficit in the English balance of payments, with English exports falling 177 00:18:30.340 --> 00:18:32.760 sharply behind imports. 178 00:18:32.760 --> 00:18:38.460 But if imports exceed exports, this means that money must flow out of England to foreign 179 00:18:38.460 --> 00:18:39.460 countries. 180 00:18:39.460 --> 00:18:45.660 What money will this be? Surely not English banknotes or deposits, for Frenchmen or Germans 181 00:18:45.660 --> 00:18:52.660 or Italians have little or no interest in keeping their funds locked up in English banks. 182 00:18:52.660 --> 00:18:57.920 These foreigners will therefore take their banknotes and deposits and present them to 183 00:18:57.920 --> 00:19:04.200 the English banks for redemption in gold, and gold will be the type of money that will 184 00:19:04.200 --> 00:19:09.040 will tend to flow persistently out of the country as the English inflation proceeds 185 00:19:09.040 --> 00:19:15.380 on its way, but this means that English bank credit money will be more and more pyramiding 186 00:19:15.380 --> 00:19:21.940 on top of a dwindling gold base in the English bank vaults. As the boom proceeds, our hypothetical 187 00:19:21.940 --> 00:19:29.120 bank will expand its warehouse receipts issued from say 2,500 ounces to 4,000 ounces while 188 00:19:29.120 --> 00:19:35.680 While its gold base dwindles to say 800, as this process intensifies, the banks will eventually 189 00:19:35.680 --> 00:19:40.720 become frightened, for the banks, after all, are obligated to redeem their liabilities 190 00:19:40.720 --> 00:19:46.840 in cash, and their cash is flowing out rapidly as their liabilities pile up. 191 00:19:46.840 --> 00:19:52.040 Hence, the banks will eventually lose their nerve, stop their credit expansion, and in 192 00:19:52.040 --> 00:19:57.080 order to save themselves, contract their bank loans outstanding. 193 00:19:57.080 --> 00:20:03.320 Even this retreat is precipitated by bankrupting runs on the banks, touched off by the public, 194 00:20:03.320 --> 00:20:08.760 who had also been getting increasingly nervous about the ever more shaky condition of the 195 00:20:08.760 --> 00:20:10.400 nation's banks. 196 00:20:10.400 --> 00:20:14.440 The bank contraction reverses the economic picture. 197 00:20:14.440 --> 00:20:16.560 Contraction and bust follow boom. 198 00:20:16.560 --> 00:20:22.040 The banks pull in their horns, and businesses suffer as the pressure mounts for debt repayment 199 00:20:22.040 --> 00:20:23.520 and contraction. 200 00:20:23.520 --> 00:20:29.680 The fall in the supply of bank money, in turn, leads to a general fall in English prices. 201 00:20:29.680 --> 00:20:36.560 As money supply and incomes fall and English prices collapse, English goods become relatively 202 00:20:36.560 --> 00:20:42.240 more attractive in terms of foreign products, and the balance of payments reverses itself 203 00:20:42.240 --> 00:20:45.720 with exports exceeding imports. 204 00:20:45.720 --> 00:20:51.260 As gold flows into the country, and as bank money contracts on top of an expanding gold 205 00:20:51.260 --> 00:20:56.260 and the gold base, the condition of the banks becomes much sounder. 206 00:20:56.260 --> 00:21:00.260 This, then, is the meaning of the depression phase of the business cycle. 207 00:21:00.260 --> 00:21:07.260 Note that it is a phase that comes out of, and inevitably comes out of, the preceding expansionary boom. 208 00:21:07.260 --> 00:21:12.260 It is the preceding inflation that makes the depression phase necessary. 209 00:21:12.260 --> 00:21:19.260 We can see, for example, that the depression is the process by which the market economy adjusts, 210 00:21:19.260 --> 00:21:34.260 Why, then, does the next cycle begin? Why do business cycles tend to be recurrent and continuous? Because when the banks have pretty well recovered, and are in a sounder condition, why do business cycles tend to be recurrent and continuous? 211 00:21:34.260 --> 00:21:41.820 of the Previous Boom. Why, then, does the next cycle begin? Why do business cycles tend 212 00:21:41.820 --> 00:21:47.340 to be recurrent and continuous? Because when the banks have pretty well recovered, and 213 00:21:47.340 --> 00:21:52.720 are in a sounder condition, they are then in a confident position to proceed to their 214 00:21:52.720 --> 00:21:58.680 natural path of bank credit expansion, and the next boom proceeds on its way, sowing 215 00:21:58.680 --> 00:22:01.680 for the next inevitable bust. 216 00:22:01.680 --> 00:22:04.680 But if banking is the cause of the business cycle, 217 00:22:04.680 --> 00:22:08.680 aren't the banks also a part of the private market economy? 218 00:22:08.680 --> 00:22:12.680 And can't we therefore say that the free market is still the culprit, 219 00:22:12.680 --> 00:22:15.680 if only in the banking segment of that free market? 220 00:22:15.680 --> 00:22:18.680 The answer is no, for the banks, for one thing, 221 00:22:18.680 --> 00:22:21.680 would never be able to expand credit in concert, 222 00:22:21.680 --> 00:22:25.680 were it not for the intervention and encouragement of government. 223 00:22:25.680 --> 00:22:40.680 For if the banks were truly competitive, any expansion of credit by one bank would quickly pile up the debts of that bank in its competitors, and its competitors would quickly call upon the expanding bank for redemption in cash. 224 00:22:40.680 --> 00:22:48.680 In short, a bank's rivals will call upon it for redemption in gold or cash in the same way as do foreigners, 225 00:22:48.680 --> 00:22:56.680 except that the process is much faster and would nip any incipient inflation in the bud before it got started. 226 00:22:56.680 --> 00:23:01.680 Banks can only expand comfortably in unison when a central bank exists, 227 00:23:01.680 --> 00:23:06.680 essentially a governmental bank enjoying a monopoly of government business 228 00:23:06.680 --> 00:23:11.680 and a privileged position imposed by government over the entire banking system. 229 00:23:11.680 --> 00:23:22.680 It is only when central banking got established that the banks were able to expand for any length of time and the familiar business cycle got underway in the modern world. 230 00:23:22.680 --> 00:23:34.680 The central bank acquires its control over the banking system by such governmental measures as making its own liabilities legal tender for all debts and receivable in taxes, 231 00:23:34.680 --> 00:23:40.520 taxes, granting the central bank monopoly of the issue of bank notes, as contrasted 232 00:23:40.520 --> 00:23:46.320 to deposits. In England, the Bank of England, the governmentally established central bank 233 00:23:46.320 --> 00:23:51.500 had a legal monopoly of bank notes in the London area, or through the outright forcing 234 00:23:51.500 --> 00:23:57.480 of banks to use the central bank as their client for keeping their reserves of cash, 235 00:23:57.480 --> 00:24:02.560 as in the United States and its Federal Reserve system. Not that the banks complain about 236 00:24:02.560 --> 00:24:21.560 This Intervention, for it is the establishment of central banking that makes long-term bank credit expansion possible, since the expansion of central bank notes provides added cash reserves for the entire banking system, and permits all the commercial banks to expand their credit together. 237 00:24:21.560 --> 00:24:29.060 Central banking works like a cozy compulsory bank cartel to expand the bank's liabilities, 238 00:24:29.060 --> 00:24:37.060 and the banks are now able to expand on a larger base of cash in the form of central banknotes as well as gold. 239 00:24:37.060 --> 00:24:45.060 So now we see at last that the business cycle is brought about not by any mysterious failings of the free market economy, 240 00:24:45.060 --> 00:24:51.060 but quite the opposite, by systematic intervention by government in the market process. 241 00:24:51.060 --> 00:25:01.060 Government intervention brings about bank expansion and inflation, and, when the inflation comes to an end, the subsequent depression adjustment comes into play. 242 00:25:01.060 --> 00:25:07.060 The Ricardian theory of the business cycle grasped the essentials of a correct cycle theory. 243 00:25:07.060 --> 00:25:17.060 The recurrent nature of the phases of the cycle, depression as adjustment to intervention in the market, rather than from the free market economy. 244 00:25:17.060 --> 00:25:47.060 But two problems were as yet unexplained. Why the sudden cluster of business error, the sudden failure of the entrepreneurial function? And why the vastly greater fluctuations in the producer's goods than in the consumer's goods industries? The Ricardian theory only explained movements in the price level in general business. There was no hint of explanation of the vastly different reactions in the capital and consumer goods industries. 245 00:25:47.060 --> 00:25:58.060 The correct and fully developed theory of the business cycle was finally discovered and set forth by the Austrian economist Ludwig von Mises. 246 00:25:58.060 --> 00:26:11.060 When he was a professor at the University of Vienna, Mises developed hints of his solution to the vital problem of the business cycle in his monumental Theory of Money and Credit, 247 00:26:11.060 --> 00:26:17.860 published in 1912 and still nearly 60 years later, the best book on the theory 248 00:26:17.860 --> 00:26:23.620 of money and banking. Mises developed his cycle theory during the 1920s and it was 249 00:26:23.620 --> 00:26:29.260 brought to the English-speaking world by Mises's leading follower, Friedrich A. von 250 00:26:29.260 --> 00:26:35.060 Hayek, who came from Vienna to teach at the London School of Economics in the 251 00:26:35.060 --> 00:26:50.060 in the early 1930s and who published, in German and in English, two books which applied and elaborated the Mises Cycle Theory, Monetary Theory and the Trade Cycle, and Prices and Production. 252 00:26:50.060 --> 00:27:07.060 Since Mises and Hayek were Austrians, and also, since they were in the tradition of the great 19th century Austrian economists, this theory has become known in the literature as the Austrian, or the monetary overinvestment theory of the business cycle. 253 00:27:07.060 --> 00:27:18.060 Building on the Ricardians, on general Austrian theory, and on his own creative genius, Mises developed the following theory of the business cycle. 254 00:27:18.060 --> 00:27:29.060 Without bank credit expansion, supply and demand tend to be equilibrated through the free-price system, and no cumulative booms or busts can then develop. 255 00:27:29.060 --> 00:27:41.560 But then, government, through its central bank, stimulates bank credit expansion, by expanding central bank liabilities, and therefore, the cash reserves of all the nation's commercial banks. 256 00:27:41.560 --> 00:27:49.060 The banks then proceed to expand credit, and hence the nation's money supply, in the form of cheque deposits. 257 00:27:49.060 --> 00:27:56.560 As the Ricardians saw, this expansion of bank money drives up the prices of goods, and hence causes inflation. 258 00:27:56.560 --> 00:28:01.560 But Mises showed it does something else and something even more sinister. 259 00:28:01.560 --> 00:28:06.560 Bank credit expansion, by pouring new loan funds into the business world, 260 00:28:06.560 --> 00:28:11.560 artificially lowers the rate of interest in the economy below its free market level. 261 00:28:11.560 --> 00:28:18.560 On the free and unhampered market, the interest rate is determined purely by the time preferences 262 00:28:18.560 --> 00:28:21.560 of all the individuals that make up the market economy, 263 00:28:21.560 --> 00:28:33.560 For the essence of a loan is that a present good, money which can be used at present, is being exchanged for a future good, an IOU which can only be used at some point in the future. 264 00:28:33.560 --> 00:28:45.560 Since people always prefer money right now to the present prospect of getting the same amount of money sometime in the future, the present good always commands a premium in the market over the future. 265 00:28:45.560 --> 00:28:55.560 The premium is the interest rate, and its height will vary according to the degree to which people prefer the present to the future, i.e. the degree of their time preferences. 266 00:28:55.560 --> 00:29:04.560 People's time preferences also determine the extent to which people will save and invest, as compared to how much they will consume. 267 00:29:04.560 --> 00:29:11.560 If people's time preferences should fall, i.e. if their degree of preference for present over future falls, 268 00:29:11.560 --> 00:29:17.080 If money falls, then people will tend to consume less now, and save and invest more, at the 269 00:29:17.080 --> 00:29:23.080 same time, and for the same reason, the rate of interest, the rate of time discount, will 270 00:29:23.080 --> 00:29:30.360 also fall. Economic growth comes about largely as the result of falling rates of time preference, 271 00:29:30.360 --> 00:29:35.720 which lead to an increase in the proportion of saving and investment to consumption, and 272 00:29:35.720 --> 00:29:42.680 also to a falling rate of interest. But what happens when the rate of interest falls, not 273 00:29:42.680 --> 00:29:48.520 because of lower time preferences and higher savings, but from government interference 274 00:29:48.520 --> 00:29:54.680 that promotes the expansion of bank credit? In other words, if the interest rate falls 275 00:29:54.680 --> 00:30:01.520 artificially due to intervention, rather than naturally as a result of changes in the valuations 276 00:30:01.520 --> 00:30:05.040 and Preferences of the Consuming Public. 277 00:30:05.040 --> 00:30:11.120 What happens is trouble, for businessmen seeing the rates of interest fall, react as they 278 00:30:11.120 --> 00:30:15.400 always would and must to such a change of market signals. 279 00:30:15.400 --> 00:30:19.120 They invest more in capital and producers' goods. 280 00:30:19.120 --> 00:30:26.000 Investments, particularly in lengthy and time-consuming projects, which previously looked unprofitable, 281 00:30:26.000 --> 00:30:30.060 now seem profitable, because of the fall of the interest charge. 282 00:30:30.060 --> 00:30:35.180 In short, businessmen react as they would react if savings had genuinely increased. 283 00:30:35.180 --> 00:30:40.780 They expand their investment in durable equipment, in capital goods, in industrial raw material, 284 00:30:40.780 --> 00:30:45.460 in construction, as compared to their direct production of consumer goods. 285 00:30:45.460 --> 00:30:49.860 Businesses in short happily borrow the newly expanded bank money that is coming to them 286 00:30:49.860 --> 00:30:51.300 at cheaper rates. 287 00:30:51.300 --> 00:30:56.460 They use the money to invest in capital goods, and eventually this money gets paid out in 288 00:30:56.460 --> 00:31:02.060 and higher rents to land and higher wages to workers in the capital goods industries. 289 00:31:02.060 --> 00:31:08.020 This increased business demand bids up labor costs, but businesses think they can pay these 290 00:31:08.020 --> 00:31:13.060 higher costs because they have been fooled by the government and bank intervention in 291 00:31:13.060 --> 00:31:18.820 the loan market, and it's decisively important tampering with the interest rate signal of 292 00:31:18.820 --> 00:31:20.540 the marketplace. 293 00:31:20.540 --> 00:31:25.260 The problem comes as soon as the workers and landlords, largely the former, since most 294 00:31:25.260 --> 00:31:30.340 When the most gross business income is paid out in wages, begin to spend the new bank 295 00:31:30.340 --> 00:31:35.180 money that they have received in the form of higher wages. For the time preferences 296 00:31:35.180 --> 00:31:39.560 of the public have not really gotten lower. The public doesn't want to save more than 297 00:31:39.560 --> 00:31:45.140 it has, so the workers set about to consume most of their new income, in short, to reestablish 298 00:31:45.140 --> 00:31:50.480 the old consumer-saving proportions. This means that they redirect the spending back 299 00:31:50.480 --> 00:31:55.400 back to the consumer goods industries, and they don't save and invest enough to buy 300 00:31:55.400 --> 00:32:01.560 the newly produced machines, capital equipment, industrial raw materials, etc. This all reveals 301 00:32:01.560 --> 00:32:08.360 itself as a sudden sharp and continuing depression in the producers goods industries. Once the 302 00:32:08.360 --> 00:32:13.900 consumers reestablish their desired consumption investment proportions, it is thus revealed 303 00:32:13.900 --> 00:32:21.140 that business had invested too much in capital goods and had under-invested in consumer goods. 304 00:32:21.140 --> 00:32:25.860 Business had been seduced by the governmental tampering and artificial lowering of the rate 305 00:32:25.860 --> 00:32:32.540 of interest and acted as if more savings were available to invest than were really there. 306 00:32:32.540 --> 00:32:38.000 As soon as the new bank money filtered through the system and the consumers re-established 307 00:32:38.000 --> 00:32:43.300 their old proportions, it became clear that there were not enough savings to buy all the 308 00:32:43.300 --> 00:32:55.300 and that business had misinvested the limited savings available. Business had overinvested in capital goods and underinvested in consumer products. 309 00:32:55.300 --> 00:33:00.300 The inflationary boom thus leads to distortions of the pricing and production system. 310 00:33:00.300 --> 00:33:11.300 Prices of labor and raw materials in the capital goods industries had been bid up during the boom too high to be profitable once the consumers reassert their old consumption investment preferences. 311 00:33:11.300 --> 00:33:29.300 The Depression is then seen as the necessary and healthy phase by which the market economy sloughs off and liquidates the unsound, uneconomic investments of the boom and re-establishes those proportions between consumption and investment that are truly desired by the consumers. 312 00:33:29.300 --> 00:33:43.300 The Depression is the painful but necessary process by which the free market sloughs off the excesses and errors of the boom and reestablishes the market economy in its function of efficient service to the mass of consumers. 313 00:33:43.300 --> 00:33:58.300 Since prices of factors of production have been bid too high in the boom, this means that prices of labor and goods in these capital goods industries must be allowed to fall until proper market relations are resumed. 314 00:33:58.300 --> 00:34:05.260 Since the workers receive the increased money in the form of higher wages fairly rapidly, 315 00:34:05.260 --> 00:34:10.760 how is it that Boehm's can go on for years without having their unsound investments revealed, 316 00:34:10.760 --> 00:34:16.440 their errors due to tampering with market signals become evident, and the depression 317 00:34:16.440 --> 00:34:24.960 adjustment process begin its work? The answer is that Boehm's would be very short-lived 318 00:34:24.960 --> 00:34:29.780 If the bank credit expansion and subsequent pushing of the rate of interest below the 319 00:34:29.780 --> 00:34:35.060 free market level were a one-shot affair, but the point is that the credit expansion 320 00:34:35.060 --> 00:34:41.860 is not one-shot, it proceeds on and on, never giving consumers the chance to re-establish 321 00:34:41.860 --> 00:34:48.660 their preferred proportions of consumption and saving, never allowing the rise in costs 322 00:34:48.660 --> 00:34:54.420 in the capital goods industries to catch up to the inflationary rise in prices, like the 323 00:34:54.420 --> 00:35:00.740 As a repeated doping of a horse, the boom is kept on its way and ahead of its inevitable 324 00:35:00.740 --> 00:35:06.300 comeuppance by repeated doses of the stimulant of bank credit. 325 00:35:06.300 --> 00:35:11.140 It is only when bank credit expansion must finally stop, either because the banks are 326 00:35:11.140 --> 00:35:15.700 getting into a shaky condition or because the public begins to balk at the continuing 327 00:35:15.700 --> 00:35:20.180 inflation, that retribution finally catches up with the boom. 328 00:35:20.180 --> 00:35:27.260 As soon as credit expansion stops, then the piper must be paid, and the inevitable readjustments 329 00:35:27.260 --> 00:35:32.340 liquidate the unsound over-investments of the boom with the reassertion of a greater 330 00:35:32.340 --> 00:35:36.260 proportionate emphasis on consumer goods production. 331 00:35:36.260 --> 00:35:42.060 Thus, the Misesian theory of the business cycle accounts for all of our puzzles. 332 00:35:42.060 --> 00:35:48.380 The repeated and recurrent nature of the cycle, the massive cluster of entrepreneurial error, 333 00:35:48.380 --> 00:35:53.580 The Far Greater Intensity of the Boom and Bust in the Producers' Goods Industries 334 00:35:53.580 --> 00:36:00.140 Mises then pinpoints the blame for the cycle on inflationary bank credit expansion propelled 335 00:36:00.140 --> 00:36:03.780 by the intervention of government and its central bank. 336 00:36:03.780 --> 00:36:08.740 What does Mises say should be done, say by government, once the Depression arrives? 337 00:36:08.740 --> 00:36:12.900 What is the governmental role in the cure of depression? 338 00:36:12.900 --> 00:36:19.300 In the first place, government must cease inflating as soon as possible. It is true 339 00:36:19.300 --> 00:36:25.260 that this will inevitably bring the inflationary boom abruptly to an end and commence the inevitable 340 00:36:25.260 --> 00:36:29.940 recession or depression. But the longer the government waits for this, the worse the necessary 341 00:36:29.940 --> 00:36:36.020 adjustments will have to be. The sooner the depression readjustment is gotten over with, 342 00:36:36.020 --> 00:36:41.940 the better. This means also that the government must never try to prop up unsound business 343 00:36:41.940 --> 00:36:46.940 It must never bail out or lend money to business firms in trouble. 344 00:36:46.940 --> 00:36:54.940 Doing this will simply prolong the agony and convert a sharp and quick depression phase into a lingering and chronic disease. 345 00:36:54.940 --> 00:36:59.940 The government must never try to prop up wage rates or prices of producers' goods. 346 00:36:59.940 --> 00:37:07.940 Doing so will prolong and delay indefinitely the completion of the depression adjustment process. 347 00:37:07.940 --> 00:37:15.940 It will cause indefinite and prolonged depression and mass unemployment in the vital capital goods industries. 348 00:37:15.940 --> 00:37:19.940 The government must not try to inflate again in order to get out of the depression. 349 00:37:19.940 --> 00:37:24.940 For even if this reinflation succeeds, it will only sow greater trouble later on. 350 00:37:24.940 --> 00:37:30.940 The government must do nothing to encourage consumption, and it must not increase its own expenditures. 351 00:37:30.940 --> 00:37:35.940 For this will further increase the social consumption investment ratio. 352 00:37:35.940 --> 00:37:48.440 In fact, cutting the government budget will improve the ratio. What the economy needs is not more consumption spending, but more saving, in order to validate some of the excess investments of the boom. 353 00:37:48.440 --> 00:37:55.440 Thus, what the government should do, according to the Misesian analysis of the Depression, is absolutely nothing. 354 00:37:55.440 --> 00:38:03.940 It should, from the point of view of economic health and ending the Depression as quickly as possible, maintain a strict hands-off laissez-faire policy. 355 00:38:03.940 --> 00:38:32.940 The Misesian prescription is thus the exact opposite of the Keynesian. It is for the government to keep absolute hands off the economy and to confine itself to stopping its own inflation and to cutting its own budget. 356 00:38:32.940 --> 00:38:55.940 It has today been completely forgotten, even among economists, that the Misesian explanation and analysis of the Depression gained great headway precisely during the Great Depression of the 1930s, the very Depression that has always held up to advocates of the free market economy as the greatest single and catastrophic failure of laissez-faire capitalism. It was no such thing. 357 00:38:55.940 --> 00:39:03.440 1929 was made inevitable by the vast bank credit expansion throughout the Western world during the 1920s, 358 00:39:03.440 --> 00:39:11.440 a policy deliberately adopted by the Western governments, and most importantly, by the Federal Reserve system in the United States. 359 00:39:11.440 --> 00:39:18.440 It was made possible by the failure of the Western world to return to a genuine gold standard after World War I, 360 00:39:18.440 --> 00:39:22.940 and thus allowing more room for inflationary policies by government. 361 00:39:22.940 --> 00:39:29.340 Everyone now thinks of President Coolidge as a believer in laissez-faire and an unhampered market economy. 362 00:39:29.340 --> 00:39:34.540 He was not, and tragically, nowhere less so than in the field of money and credit. 363 00:39:34.540 --> 00:39:41.740 Unfortunately, the sins and errors of the Coolidge intervention were laid to the door of a non-existent free market economy. 364 00:39:41.740 --> 00:39:49.740 If Coolidge made 1929 inevitable, it was President Hoover who prolonged and deepened the Depression, 365 00:39:49.740 --> 00:40:00.740 transforming it from a typically sharp but swiftly disappearing depression into a lingering and near-fatal malady, a malady cured only by the Holocaust of World War II. 366 00:40:00.740 --> 00:40:18.740 Hoover, not Franklin Roosevelt, was the founder of the policy of the New Deal, essentially the massive use of the state to do exactly what Misesian theory would most warn against, to prop up wage rates above their free market levels, prop up prices, inflate credit, and lend money to shaky business positions. 367 00:40:18.740 --> 00:40:24.740 Roosevelt only advanced, to a greater degree, what Hoover had pioneered. 368 00:40:24.740 --> 00:40:32.740 The result for the first time in American history was a nearly perpetual depression and nearly permanent mass unemployment. 369 00:40:32.740 --> 00:40:38.740 The Coolidge Crisis had become the unprecedentedly prolonged Hoover-Roosevelt Depression. 370 00:40:38.740 --> 00:40:43.740 Ludwig von Mises had predicted the depression during the heyday of the great boom of the 1920s, 371 00:40:43.740 --> 00:41:01.740 in the 1920s, a time, just like today, when economists and politicians armed with the new economics of perpetual inflation, and with new tools provided by the Federal Reserve system, proclaimed a perpetual new era of permanent prosperity, guaranteed by our wise economic doctors in Washington. 372 00:41:01.740 --> 00:41:15.240 Ludwig von Mises, alone armed with a correct theory of the business cycle, was one of the very few economists to predict the Great Depression, and hence the economic world was forced to listen to him with respect. 373 00:41:15.240 --> 00:41:33.240 F. A. Hayek spread the word in England, and the younger English economists were all, in the early 1930s, beginning to adopt the Misesian cycle theory for their analysis of the Depression, and also to adopt, of course, the strictly free-market policy prescription that flowed with this theory. 374 00:41:33.240 --> 00:41:45.240 Unfortunately, economists have now adopted the historical notion of Lord Keynes that no classical economists had a theory of the business cycle until Keynes came along in 1936. 375 00:41:45.240 --> 00:42:02.240 There was a theory of the Depression. It was the classical economics tradition. Its prescription was strict hard money and laissez-faire, and it was rapidly being adopted in England and even in the United States as the accepted theory of the business cycle. 376 00:42:02.240 --> 00:42:18.240 A particular irony is that the major Austrian proponent in the United States in the early and mid-1930s was none other than Professor Alvin Hanson, very soon to make his mark as the outstanding Keynesian disciple in this country. 377 00:42:18.240 --> 00:42:32.240 What swamped the growing acceptance of Misesian Cycle Theory was simply the Keynesian Revolution, the amazing sweep that Keynesian Theory made of the economic world shortly after the publication of the General Theory in 1936. 378 00:42:32.240 --> 00:42:41.240 It is not that Misesian Theory was refuted successfully, it was just forgotten in the rush to climb on the suddenly fashionable Keynesian bandwagon. 379 00:42:41.240 --> 00:42:53.240 Some of the leading adherents of the Mises theory, who clearly knew better, succumbed to the newly established winds of doctrine, and won leading American university posts as a consequence. 380 00:42:53.240 --> 00:43:00.240 But now the once arch-Keynesian London economist has recently proclaimed that Keynes is dead. 381 00:43:00.240 --> 00:43:09.240 After over a decade of facing trenchant theoretical critiques and refutation by stubborn economic facts, the Keynesians are now in general and massive retreat. 382 00:43:09.240 --> 00:43:16.240 Once again, the money supply and bank credit are being grudgingly acknowledged to play a leading role in the cycle. 383 00:43:16.240 --> 00:43:21.240 The time is ripe for a rediscovery, a renaissance of the Mises theory of the business cycle. 384 00:43:21.240 --> 00:43:28.240 It can come none too soon. If it ever does, the whole concept of a council of economic advisors would be swept away, 385 00:43:28.240 --> 00:43:32.240 and we would see a massive retreat of government from the economic sphere. 386 00:43:32.240 --> 00:43:46.240 But for all this to happen, the world of economics and the public at large must be made aware of the existence of an explanation of the business cycle that has lain neglected on the shelf for all too many tragic years.