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The Force Is With Us

December 2, 2008

Tags The FedFree MarketsEntrepreneurship

It is a marvelous thing to see the market work, in good times and bad. Just look at the way that marvelous, unplanned barometer of wise resource use — the price system — has reacted in response to the human reality of economic downturn.

As we prepare for the future with the holidays upon us, consumers are wondering whether it is a wise thing to take on too many new financial burdens. They are cutting back and still somewhat indecisive about the economic climate. For most people, the only real evidence of downturn they see is the devastation that has been wrought on their retirement accounts. This causes quite a psychological hesitation to buy.

What consumers need to spend is a solid inducement, one that coordinates financial responsibility with their material needs. And the retailers are there to provide it. Thus are prices being chopped from one end of the country to the other. Earrings that were $700 are now $250, purses that were $1000 are now $250, large-screen televisions that were $2000 are now $1,200, and suits that were $900 are going for $400. Deals are everywhere, from laptops to cell phones to cars. The street wisdom is that now is the time to buy.

Imagine if these prices were fixed by a central committee. The response would be slow in coming if it happened at all. The committee would likely stick by some cost-plus pricing rule that wedded present realities to past expense. But in the free market, there is only one reality and that is the present problem of balancing consumer demand with economic viability.

The price mechanism provides a means of coordinating consumer demands with producer realities. Retailers are wildly overstocked with goods now, having made their purchases for Christmas back in the spring or summer. (We should never forget that sellers have to buy goods before they sell them, and that this is always a speculative enterprise.)

The downturn hit hard and suddenly, and its impact has been felt up and down the structure of production. Retailers find themselves with a serious problem of overstuffed inventory, a declining cash flow, and a financial sector that is risk-averse. The solution is to disgorge, and this accords precisely with the demand of consumers. So in this one signal of the price we see a remarkable coordination taking place.

When you put all these price cuts together — and they are pervasive — you end up with a macroeconomic setting that is a great relief to consumers in troubled times. Wouldn't you know that the press would find this to be a cause to bellyache about the supposed dangers of "deflation." And in a crazy, upside-down way, we find politicians, financial managers, and economists quoted all over the place who have deduced that the real problem with the economy is falling prices.

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They are confusing cause and effect. The cause of the downturn is that the bubble burst, and the effect is downward pressure on prices. The interests of producers and consumers are being coordinated here. For central planners to interrupt this process will only end up punishing everyone, so that consumers will not be able to save money on good deals and businesses will end up carrying more inventory than they can afford. We will be robbed of the blessing of lower prices, which are, contrary to what some people say, wholly compatible with economic growth.

Also, the less that consumers spend now means that the more they have left over to save for the future, which also seems to be a wise choice today.

Not only that: falling prices are an important means for flushing economic error out of a system that is rife with malinvestments generated during boom times. I won't go into this point further but rather point you to the mind-opening work of Guido Hülsmann: Deflation and Liberty.

Those who posit a disharmony of interests between consumers who want falling prices and overall economic health are showing an attachment to Keynesian-style thinking, which at its most fundamental level asserts that prices don't work to coordinate supply and demand. In fact, we see them working ever day. The market, if left alone, is the means by which harmony among all market actors is achieved.

Many people have wondered how it is possible that the Federal Reserve would be engaging in such a massive expansionary trend, creating money without limit, even as prices tend to fall. The answer can be found in the balance sheets of the banking system. The reserves are there but they are finding few willing borrowers. We often hear about the credit crunch, but the real source of the supposed problem here is a borrowing crunch. Borrowers are not in any position to expand and invest for the future. This is why, despite the Fed's effort to expand, the money supply today is actually shrinking.

The Fed is pushing a variety of workarounds that would inject trillions in new money into the economy while bypassing the banking system altogether. Time will tell whether or not this will succeed. Meanwhile, a serious danger lurks around the corner. Once the recession is over, the lending will start again. With fractional-reserve banking and limitless supplies of cash on hand, we will likely see the overall price trends reversed, from deflation to inflation to possible hyperinflation. The timing and the extent entirely depend on many unknowns, but it is something worth thinking about today.

The urgency of price declines today, then, becomes all the more apparent. Now is the time to cut prices as low as possible. Yes, this means growing business failures, unemployment, and much worse, but this is precisely what is needed. As the Austrians have long said, the recession is a necessary phase. It is not an economic blight but a tonic that heals. If we let the market work without trying to interfere with its operations, we will see that the recession will bottom out and the economy prepare for future of growth.

There is nothing that the government can do today — apart from repealing laws and regulations — that will make an improvement on the workings of the market. As Mises wrote in Profit and Loss, the price system is our guide to both success and failure under conditions of freedom. We need to be as tolerant toward one tendency as the other.

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