EconomicDepressions:Their Cause and Cure
EconomicDepressions:Their Cause and CureMurray N. Rothbard
2009 by the Ludwig von Mises Instituteand published under the Creative CommonsAttribution License wig von Mises Institute518 West Magnolia AvenueAuburn, Alabama 36832www.mises.orgISBN: 978-1-933550-50-3
.banks would never be able toexpand credit in concert were it not forthe intervention and encouragementof government.— Murray N. Rothbard
EconomicDepressions:Economic Depressions: Their Cause and Cure7Their Cause and CureWE LIVE in a world of euphemism. Undertakers havebecome “morticians,” pressagents are now “public relations counsellors” and janitors have allbeen transformed into “superintendents.”In every walk of life, plain facts havebeen wrapped in cloudy camouflage.No less has this been true of economics. In the old days, we used to sufferThis essay was originally published as a minibookby the Constitutional Alliance of Lansing, Michigan, 1969. It is also included in The Austrian Theory of the Trade Cycle and Other Essays, RichardM. Ebeling, ed. (Auburn, Ala.: Ludwig von MisesInstitute, 2006).7
8Economic Depressions: Their Cause and Curenearly periodic economic crises, the sudden onset of which was called a “panic,”and the lingering trough period after thepanic was called “depression.”The most famous depression in moderntimes, of course, was the one that began ina typical financial panic in 1929 and lasteduntil the advent of World War II. After thedisaster of 1929, economists and politicians resolved that this must never happenagain. The easiest way of succeeding atthis resolve was, simply to define “depressions” out of existence. From that point on,America was to suffer no further depressions. For when the next sharp depressioncame along, in 1937–38, the economistssimply refused to use the dread name, andcame up with a new, much softer-sounding word: “recession.” From that point on,we have been through quite a few recessions, but not a single depression.But pretty soon the word “recession”also became too harsh for the delicatesensibilities of the American public. Itnow seems that we had our last recessionin 1957–58. For since then, we have only
Economic Depressions: Their Cause and Cure9had “downturns,” or, even better, “slowdowns,” or “sidewise movements.” So beof good cheer; from now on, depressionsand even recessions have been outlawedby the semantic fiat of economists; fromnow on, the worst that can possibly happen to us are “slowdowns.” Such are thewonders of the “New Economics.”For 30 years, our nation’s economistshave adopted the view of the businesscycle held by the late British economist,John Maynard Keynes, who created theKeynesian, or the “New,” Economics inhis book, The General Theory of Employment, Interest, and Money, published in1936. Beneath their diagrams, mathematics, and inchoate jargon, the attitudeof Keynesians toward booms and bust issimplicity, even naivete, itself. If there isinflation, then the cause is supposed to be“excessive spending” on the part of thepublic; the alleged cure is for the government, the self-appointed stabilizer andregulator of the nation’s economy, to stepin and force people to spend less, “sopping up their excess purchasing power”
10Economic Depressions: Their Cause and Curethrough increased taxation. If there is arecession, on the other hand, this has beencaused by insufficient private spending,and the cure now is for the governmentto increase its own spending, preferablythrough deficits, thereby adding to thenation’s aggregate spending stream.The idea that increased governmentspending or easy money is “good forbusiness” and that budget cuts or hardermoney is “bad” permeates even the mostconservative newspapers and magazines.These journals will also take for grantedthat it is the sacred task of the federal government to steer the economic system onthe narrow road between the abysses ofdepression on the one hand and inflationon the other, for the free-market economyis supposed to be ever liable to succumbto one of these evils.All current schools of economists havethe same attitude. Note, for example, theviewpoint of Dr. Paul W. McCracken, theincoming chairman of President Nixon’sCouncil of Economic Advisers. In aninterview with the New York Times shortly
Economic Depressions: Their Cause and Cure11after taking office (January 24, 1969),Dr. McCracken asserted that one of themajor economic problems facing the newadministration is “how you cool downthis inflationary economy without at thesame time tripping off unacceptably highlevels of unemployment. In other words,if the only thing we want to do is cool offthe inflation, it could be done. But oursocial tolerances on unemployment arenarrow.” And again: “I think we have tofeel our way along here. We don’t reallyhave much experience in trying to cool aneconomy in orderly fashion. We slammedon the brakes in 1957, but, of course, wegot substantial slack in the economy.”Note the fundamental attitude of Dr.McCracken toward the economy—remarkable only in that it is shared byalmost all economists of the present day.The economy is treated as a potentiallyworkable, but always troublesome andrecalcitrant patient, with a continual tendency to hive off into greater inflation orunemployment. The function of the government is to be the wise old manager
12Economic Depressions: Their Cause and Cureand physician, ever watchful, ever tinkering to keep the economic patient in goodworking order. In any case, here the economic patient is clearly supposed to bethe subject, and the government as “physician” the master.It was not so long ago that this kindof attitude and policy was called “socialism”; but we live in a world of euphemism, and now we call it by far less harshlabels, such as “moderation” or “enlightened free enterprise.” We live and learn.What, then, are the causes of periodicdepressions? Must we always remainagnostic about the causes of booms andbusts? Is it really true that business cyclesare rooted deep within the free-marketeconomy, and that therefore some form ofgovernment planning is needed if we wishto keep the economy within some kind ofstable bounds? Do booms and then bustsjust simply happen, or does one phase ofthe cycle flow logically from the other?The currently fashionable attitudetoward the business cycle stems, actually,
Economic Depressions: Their Cause and Cure13from Karl Marx. Marx saw that, beforethe Industrial Revolution in approximatelythe late eighteenth century, there were noregularly recurring booms and depressions. There would be a sudden economiccrisis whenever some king made war orconfiscated the property of his subject;but there was no sign of the peculiarlymodern phenomena of general and fairlyregular swings in business fortunes, ofexpansions and contractions. Since thesecycles also appeared on the scene at aboutthe same time as modern industry, Marxconcluded that business cycles were aninherent feature of the capitalist marketeconomy. All the various current schoolsof economic thought, regardless of theirother differences and the different causesthat they attribute to the cycle, agree onthis vital point: That these business cyclesoriginate somewhere deep within the freemarket economy. The market economyis to blame. Karl Marx believed that theperiodic depressions would get worse andworse, until the masses would be movedto revolt and destroy the system, whilethe modern economists believe that the
14Economic Depressions: Their Cause and Curegovernment can successfully stabilizedepressions and the cycle. But all parties agree that the fault lies deep withinthe market economy and that if anythingcan save the day, it must be some form ofmassive government intervention.There are, however, some criticalproblems in the assumption that the market economy is the culprit. For “generaleconomic theory” teaches us that supplyand demand always tend to be in equilibrium in the market and that thereforeprices of products as well as of the factorsthat contribute to production are alwaystending toward some equilibrium point.Even though changes of data, which arealways taking place, prevent equilibrium from ever being reached, there isnothing in the general theory of the market system that would account for regular and recurring boom-and-bust phasesof the business cycle. Modern economists “solve” this problem by simplykeeping their general price and markettheory and their business cycle theory inseparate, tightly-sealed compartments,
Economic Depressions: Their Cause and Cure15with never the twain meeting, much lessintegrated with each other. Economists,unfortunately, have forgotten that thereis only one economy and therefore onlyone integrated economic theory. Neithereconomic life nor the structure of theorycan or should be in watertight compartments; our knowledge of the economy iseither one integrated whole or it is nothing. Yet most economists are content toapply totally separate and, indeed, mutually exclusive, theories for general priceanalysis and for business cycles. Theycannot be genuine economic scientists solong as they are content to keep operatingin this primitive way.But there are still graver problemswith the currently fashionable approach.Economists also do not see one particularly critical problem because they do notbother to square their business cycle andgeneral price theories: the peculiar breakdown of the entrepreneurial function attimes of economic crisis and depression.In the market economy, one of the mostvital functions of the businessman is to
16Economic Depressions: Their Cause and Curebe an “entrepreneur,” a man who investsin productive methods, who buys equipment and hires labor to produce something which he is not sure will reap himany return. In short, the entrepreneurialfunction is the function of forecasting theuncertain future. Before embarking onany investment or line of production, theentrepreneur, or “enterpriser,” must estimate present and future costs and futurerevenues and therefore estimate whetherand how much profits he will earn fromthe investment. If he forecasts well andsignificantly better than his business competitors, he will reap profits from hisinvestment. The better his forecasting,the higher the profits he will earn. If, onthe other hand, he is a poor forecaster andoverestimates the demand for his product,he will suffer losses and pretty soon beforced out of the business.The market economy, then, is a profitand-loss economy, in which the acumenand ability of business entrepreneurs isgauged by the profits and losses they reap.The market economy, moreover, contains
Economic Depressions: Their Cause and Cure17a built-in mechanism, a kind of naturalselection, that ensures the survival and theflourishing of the superior forecaster andthe weeding-out of the inferior ones. Forthe more profits reaped by the better forecasters, the greater become their businessresponsibilities, and the more they willhave available to invest in the productivesystem. On the other hand, a few years ofmaking losses will drive the poorer forecasters and entrepreneurs out of businessaltogether and push them into the ranks ofsalaried employees.If, then, the market economy has abuilt-in natural selection mechanism forgood entrepreneurs, this means that, generally, we would expect not many business firms to be making losses. And, infact, if we look around at the economy onan average day or year, we will find thatlosses are not very widespread. But, inthat case, the odd fact that needs explaining is this: How is it that, periodically, intimes of the onset of recessions and especially in steep depressions, the businessworld suddenly experiences a massive
18Economic Depressions: Their Cause and Curecluster of severe losses? A momentarrives when business firms, previouslyhighly astute entrepreneurs in their ability to make profits and avoid losses, suddenly and dismayingly find themselves,almost all of them, suffering severe andunaccountable losses? How come? Hereis a momentous fact that any theory ofdepressions must explain. An explanationsuch as “underconsumption”—a drop intotal consumer spending—is not sufficient, for one thing, because what needs tobe explained is why businessmen, able toforecast all manner of previous economicchanges and developments, proved themselves totally and catastrophically unableto forecast this alleged drop in consumerdemand. Why this sudden failure in forecasting ability?An adequate theory of depressions,then, must account for the tendency ofthe economy to move through successivebooms and busts, showing no sign of settling into any sort of smoothly moving,or quietly progressive, approximation ofan equilibrium situation. In particular, a
Economic Depressions: Their Cause and Cure19theory of depression must account for themammoth cluster of errors which appearsswiftly and suddenly at a moment ofeconomic crisis, and lingers through thedepression period until recovery. Andthere is a third universal fact that a theory of the cycle must account for. Invariably, the booms and busts are muchmore intense and severe in the “capitalgoods industries”—the industries making machines and equipment, the onesproducing industrial raw materials orconstructing industrial plants—than inthe industries making consumers’ goods.Here is another fact of business cyclelife that must be explained—and obviously can’t be explained by such theoriesof depression as the popular underconsumption doctrine: That consumers aren’tspending enough on consumer goods. Forif insufficient spending is the culprit, thenhow is it that retail sales are the last andthe least to fall in any depression, and thatdepression really hits such industries asmachine tools, capital equipment, construction, and raw materials? Conversely,it is these industries that really take off
20Economic Depressions: Their Cause and Curein the inflationary boom phases of thebusiness cycle, and not those businessesserving the consumer. An adequate theory of the business cycle, then, must alsoexplain the far greater intensity of boomsand busts in the non-consumer goods, or“producers’ goods,” industries.Fortunately, a correct theory of depression and of the business cycle does exist,even though it is universally neglectedin present-day economics. It, too, has along tradition in economic thought. Thistheory began with the eighteenth century Scottish philosopher and economist David Hume, and with the eminentearly nineteenth century English classical economist David Ricardo. Essentially,these theorists saw that another crucialinstitution had developed in the mid-eighteenth century, alongside the industrialsystem. This was the institution of banking, with its capacity to expand credit andthe money supply (first, in the form ofpaper money, or bank notes, and later inthe form of demand deposits, or checkingaccounts, that are instantly redeemable in
Economic Depressions: Their Cause and Cure21cash at the banks). It was the operationsof these commercial banks which, theseeconomists saw, held the key to the mysterious recurrent cycles of expansion andcontraction, of boom and bust, that hadpuzzled observers since the mid-eighteenth century.The Ricardian analysis of the businesscycle went something as follows: Thenatural moneys emerging as such on theworld free market are useful commodities, generally gold and silver. If moneywere confined simply to these commodities, then the economy would work in theaggregate as it does in particular markets: A smooth adjustment of supplyand demand, and therefore no cycles ofboom and bust. But the injection of bankcredit adds another crucial and disruptive element. For the banks expand creditand therefore bank money in the formof notes or deposits which are theoretically redeemable on demand in gold, butin practice clearly are not. For example,if a bank has 1,000 ounces of gold in itsvaults, and it issues instantly redeemable
22Economic Depressions: Their Cause and Curewarehouse receipts for 2,500 ouncesof gold, then it clearly has issued 1,500ounces more than it can possibly redeem.But so long as there is no concerted “run”on the bank to cash in these receipts, itswarehouse-receipts function on the market as equivalent to gold, and thereforethe bank has been able to expand themoney supply of the country by 1,500gold ounces.The banks, then, happily begin toexpand credit, for the more they expandcredit the greater will be their profits. Thisresults in the expansion of the money supply within a country, say England. As thesupply of paper and bank money in England increases, the money incomes andexpenditures of Englishmen rise, and theincreased money bids up prices of Englishgoods. The result is inflation and a boomwithin the country. But this inflationaryboom, while it proceeds on its merry way,sows the seeds of its own demise. Foras English money supply and incomesincrease, Englishmen proceed to purchasemore goods from abroad. Furthermore,
Economic Depressions: Their Cause and Cure23as English prices go up, English goodsbegin to lose their competitiveness withthe products of other countries whichhave not inflated, or have been inflatingto a lesser degree. Englishmen begin tobuy less at home and more abroad, whileforeigners buy less in England and moreat home; the result is a deficit in the English balance of payments, with Englishexports falling sharply behind imports.But if imports exceed exports, this meansthat money must flow out of England toforeign countries. And what money willthis be? Surely not English bank notes ordeposits, for Frenchmen or Germans orItalians have little or no interest in keeping their funds locked up in English banks.These foreigners will therefore take theirbank notes and deposits and present themto the English banks for redemption ingold—and gold will be the type of moneythat will tend to flow persistently out ofthe country as the English inflation proceeds on its way. But this means that English bank credit money will be, more andmore, pyramiding on top of a dwindlinggold base in the English bank vaults. As
24Economic Depressions: Their Cause and Curethe boom proceeds, our hypothetical bankwill expand its warehouse receipts issuedfrom, say 2,500 ounces to 4,000 ounces,while its gold base dwindles to, say, 800.As this process intensifies, the banks willeventually become frightened. For thebanks, after all, are obligated to redeemtheir liabilities in cash, and their cash isflowing out rapidly as their liabilities pileup. Hence, the banks will eventually losetheir nerve, stop their credit expansion,and in order to save themselves, contracttheir bank loans outstanding. Often, thisretreat is precipitated by bankrupting runson the banks touched off by the public,who had also been getting increasinglynervous about the ever more shaky condition of the nation’s banks.The bank contraction reverses the economic picture; contraction and bust followboom. The banks pull in their horns, andbusinesses suffer as the pressure mountsfor debt repayment and contraction. Thefall in the supply of bank money, in turn,leads to a general fall in English prices.As money supply and incomes fall, and
Economic Depressions: Their Cause and Cure25English prices collapse, English goodsbecome relatively more attractive in termsof foreign products, and the balance ofpayments reverses itself, with exportsexceeding imports. As gold flows into thecountry, and as bank money contracts ontop of an expanding gold base, the condition of the banks becomes much sounder.This, then, is the meaning of thedepression phase of the business cycle.Note that it is a phase that comes out of,and inevitably comes out of, the precedingexpansionary boom. It is the precedinginflation that makes the depression phasenecessary. We can see, for example, thatthe depression is the process by whi
10 Economic Depressions: Their Cause and Cure through increased taxation. If there is a recession, on the other hand, this has been caused by insuffi cient private spending, and the cure now is for the government to increase its own spending, preferably through deficits, thereby adding to the nation’s aggregate spending stream.
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Substance-induced depressions may appear identical to major depressive episodes (Schuckit & Smith, 1996) However, individuals with substance-induced depressions did not have . Excessive involvement in activities that have a high potential for painful consequences (e.g., engaging in unrestrained buying sprees,
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