“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.”
—Murray N. Rothbard
This month’s offering is Murray Rothbard’s Economic Depressions: Their Cause and Cure. In it he contrasts Mises’s theory of the business cycle with Keynesian errors, showing that business cycles are not inherent features of the market economy but the result of government intervention in money and credit.
Keynesians think that depressions are caused by “animal spirits.” There’s a sudden decrease in spending that catches everyone off guard. Businesses contract and lay off workers, which aggravates the problem, since lower incomes result in lower demand and further decreases in spending. The answer? Government! Large-scale deficit spending and money printing can rescue the market economy from its irrational and self-reinforcing downturns.
Rothbard tears this theory to shreds. He shows that it doesn’t explain “the peculiar breakdown of the entrepreneurial function at times of economic crisis and depression.” The profit and loss system of the market economy selects for accurate forecasting of consumer demand. Those who are less adept at forecasting incur losses and leave the ranks of business owners. Those especially skilled at forecasting earn profits and see an increase in the scarce factors of production under their control. The market economy, therefore, brings about a healthy, dynamic structure of production aimed at satisfying consumers and eliminating waste.
Rothbard asks, “How is it that, periodically, in times of the onset of recessions and especially in steep depressions, the business world suddenly experiences a massive cluster of severe losses?” The answer, according to Mises and Rothbard, is bank credit expansion, enabled and exacerbated by government intervention. Artificial credit, unbacked by real savings, leads entrepreneurs to take on unsustainable lines of production. Instead of healthy growth, we get malinvestment, overconsumption, stock market bubbles, inflation, and a fragile banking system.
The inevitable bust comes when the errors made in the boom are corrected. Unfortunately, governments respond to economic crises with more spending, more credit expansion, bank bailouts, and other interventions that not only prevent the necessary correction process, but lead to yet another boom-bust cycle.
Rothbard urges us to discard Keynesian errors and wake up to the true cause and cure of the business cycle.
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