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Volume 10, No. 1

January 1992

The Recession Explained

Murray N. Rothbard

I told you so!" may not be considered polite among Recession friends or acquaintances, but in ideological clashes it is important to remind one and all of your successes, since neither the indifferent nor your enemies are likely to do the job for you.

In the case of Austrian business cycle theory, shouldering this task is particularly important. For not only have our ideological and methodological enemies been all too quick to bury Austrian theory as either (a) hopelessly Neanderthal and reactionary, and/or (b) obsolete in today's world, but also many of our erstwhile friends and adherents have been joining the chorus, maintaining that Austrian theory might have been applicable in the 1930s, or, more radically, only in the 19th century, but that it definitely has no application in the modern economy.

Well, to paraphrase the great philosopher Etienne Gilson on natural law, Austrian cycle theory always survives to bury its enemies. In contrast to conventional wisdom, from Keynesian to monetarist to eclectic, Austrian theory has recently triumphed over its host of detractors in the following ways:

1. The perpetual boom of the '80s. As the 1980s went on, the Conventional Wisdom (CW) trumpeted that recessions were a thing of the dead and unlamented past. Here was a new era, of perpetual prosperity. Wise governmental fiscal and monetary policies, combined with structural changes such as the age of the computer and global capital markets, have made sure that we never have a recession again, that 1981-82 was the Last Recession.

I have long asserted that the best "leading indicator" of a recession is when the CW has started proclaiming the end of the business cycle and perpetual prosperity. Sure enough, here we are, and, as Austrians point out, the bigger and the longer the boom, the greater and deeper will tend to be the recession necessary to wash out the distortions and malinvestrnent of the inflationary boom, brought on by bank credit expansion.

2. The end of inflation. During the great boom of the '80s, the CW also proclaimed that inflation was a thing of the past. It was over, licked. Again: wise government monetary and fiscal policies, coupled with structural economic changes, and "efficient markets," insured that inflation was finished. And yet, inflation, which never really disappeared, is back in full force, and is even stronger now, in the depths of recession, than it was during most of the boom--a sure sign that not only is inflation still with us, but that it is going to pose a severe and accelerating problem as soon as recovery occurs.

3. (A corollary of one and two.) They forgot about inflationary recession. Mation has persisted in every post-World War II recession since 1973-74, and indeed really began in the 1957-58 recession, after a couple of years of recovery. Yet everyone--and that means everyone including all wings of Establishment economics, and financial writers and forecasters--forgets all about the new reality of inflationary recession (also called "stagflation"), and writes and talks as if the choice in the coming months is always between inflation or recession.

There is a long-running dispute among Austrian economists on whether market participants can or do learn from experience. Whatever the answer is (and I believe it is "yes"), it becomes increasingly clear that the body of economists and the financial press seem to be incapable of this simple learning experience. Look fellas: every recession is going to be inflationary from now on.

Presumably, the reason for this failure to learn is because it violates the basic theoretical prejudices of both Keynesian and monetarist economists: that either we are experiencing an inflationary boom or we are in a recession, never both. And indeed, no one can truly learn about these matters without a correct theory. But it just so happens that Austrian theory alone predicts and explains why all recessions, precisely in the modern world, will be inflationary. The reason: the scrapping of the gold standard and the shift to fiat money in the 1930s meant that there is no longer any restraint on the government or the Federal Reserve from creating as much money as it wishes--and it always'wishes. This act does not eliminate business cycles; in fact, it makes them worse, by adding inflation and rising costs of living on top of recessions, falling asset values, bankruptcies, and unemployment

4. The average person knows when we're in a recession long before economists do. Establishment economists, mired in their methodology of statistical correlation based on precise dating of cycle peaks and troughs, take a very long time to decide the precise month of the peak--in the current recession, July 1990. It took almost a year after that point before economists deigned to tell us what we already all knew: that we were in a big recession.

5. The average person knows we're in a recession long after the economists have proclaimed "recovery." Here we have a failing among economists far less excusable than methodological error. For hardly were we told, at long last, that we were in a recession, when the Establishment hastened to tell us that recovery was already under way. In a spectacular mistake, Establishment economists, professionally and politically bedded, as any Administration is, to Pollyanna optimism, hastened to assure us that the recession was over by the beginning of the third quarter of 1991.

When it came to forecasting recovery, professional economic caution was sharnefully thrown to the winds. Ever since the middle of 1991, the political and economic establishent has been desperately searching for signs of "recovery." "Well, it's there but it's feeble"; "recoveries always begin weakly"; and on and on. Finally, by November, as most indices were clearly getting worse, economists, reluctant to admit their glaring error of the summer, started muttering about a possible "double-dip recession," about the danger of slipping back into recession," etc. Look, let's face reality, and let the revered Dating Committee of the National Bureau of Economic Research, the semi-official but universally exclaimed gurus of business cycle dating, go hang.

6. Once a recession has taken hold, the government cannot inflate out of it; government can only delay recovery, not hasten it. This is a vital truth of Austrian economics that has been absorbed by virtually no one. Once a recession is underway, Keynesian-monetarist type stimulation: cheap money, accelerating the money supply, etc., can only make things worse. But look at what has happened to such alleged anti-inflation "hawks" as Alan Greenspan and the Cleveland Fed: as soon as the recession took hold, and even though inflation is now worse than it has been in years, they have all thrown over their alleged anti-inflation principles and have been cutting intkest rates like mad, trying rashly and vainly to hype the sick horse with another shot of inflationary stimulus.

7. Tax cuts are good in a recession, or any other time. Students of human folly can only stand in wonder at the Keynesian, one of whose traditional proposals was for tax cuts during recession, suddenly adopting a conservative, monetarist stance. During this recession, Keynesians declare that 'yes, well, tax cuts are good in theory (?) but they won't help us out of recession, because of inevitable lag in the results of fiscal policy." The complaint is that the cuts will only take effect after a recovery (they hope) has already begun. Well, so what?

Tax cuts are good at any time, especially for the long run. Apart from the business cycle, the American economy has been suffering from stagnation for the past twenty years; since 1973, the American standard of living has been level and even slightly declining. This is a highly worrisome feature of the modern American economy. One way to remedy this problem is tax cuts, the deeper the better. Keynesian tax cuts were only designed to stimulate consumer spending in recession; Austrian tax cuts are a means of partially loosening the fetters by which the governmenthas been chaining and binding down the private and productive sector of the economy, a crippling effect that has gotten steadily worse in recent years.

But what about the deficit? The deficit is indeed monstrous and out of control, but the one way it should not and cannot be combatted is by raising taxes or keeping them high. Lower taxes would mean that government spending would have to be cut, and government spending cuts are the only sound way to cure deficits. Indeed, Austrian theory is unique in advocating government spending cuts even in a recession as a way to shift social spending from excessive consumption to much needed saving-and-investment For, contrary to Keynesian myth, government spending is not "investment" at all (a cruel joke), but is wasteful "consumption" spending. The "consumers," in this case, are the politicians and government officials who leech off the productive private sector.

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