Mises Wire

To Prevent Future Busts, Rothbard’s America’s Great Depression Must Be Reckoned With


In the midst of an economic downturn caused by central banks interfering with the economy, economists and politicians have proposed a variety of proposed causes and remedies to these business cycles, many hoping to have their plans followed so as to achieve fame and government privilege. Though some are close to the mark as to what causes business cycles, with a few inadvertently stumbling upon the correct way to prevent them, the vast majority of these “antidotes,” in spite of being done by men with PhDs from top universities and receiving funding from various D.C. based think-tanks, fail to truly grasp business cycle theory.

Rothbard’s 1963 work, The Great Depression, despite being written over 60 years ago, is ever relevant today for its stunning analysis of business cycles-how it is caused, cured, and made worse. From the beginning of the book, Rothbard explains business cycles in exquisite detail, including their description and how they are caused. He notes that during all periods in which there was a boom and a bust, certain trends typically occurred in all of them. Some of the occurring trends spotted by Rothbard include a general expansion of capital goods industries within the economy during the boom phase of the boom-bust cycle, a major increase in the money supply, and an increase in prices. For the bust phase of the boom-bust cycle, Rothbard notes a major decrease in the number of capital goods industries in the economy, a major decrease in the money supply, a lowering of prices, and most importantly of all, the fact that all of these businesses fail at about the same time.

With the above in mind, Rothbard then sets out the foundations for the Austrian theory of the business cycle. Starting with banks expanding their money supply, interest rates decrease due to the increased supply of funds made available, followed by a concomitant increase in loans taken out by businesses seeking to grow. This increase in loans being taken out means that more resources are now spent on producing capital goods relative to consumer goods; thus, industries producing capital goods end up expanding.

Normally, when interest rates are naturally lowered due to individuals willingly saving more, which expands the amount of loanable funds available to entrepreneurs, this process would simply indicate consumer preferences towards increasing demand for this type of production. However, because interest rates are artificially lowered due to bank credit expansion in the money supply, this lengthening in the structure of production is just as artificial. As money spent by these various business owners on capital goods eventually works its way through the rest of the economy, it inevitably gets into the hands of consumers. As the new money spreads throughout the rest of the economy, prices rise as consumers increase their demands for goods from the increased money supply made possible from the bank credit expansion. With this new money, consumers reassert their preferences for consumer goods over capital goods.

As these companies, having built their businesses on the idea on false signals that consumers would have a higher preference for capital goods, start to receive less money than would have been expected, they are left with three choices: 1) try to scrap their losses and attempt to get the most they possibly can out of the various malinvestments they made; 2) go out of business for having made misinformed decisions via an artificial interest rate based on perceived consumer preferences; or 3) appeal to the government to have interest rates be artificially lowered so as to prop up their businesses with more borrowed money.

Assuming that only the first two choices are followed, market tendencies themselves do the job as resources are now allocated where consumers actually want them while price inflation declines due to the decreased money supply and banks contracting credit. However, if the third choice is followed, then the cycle continues on as more and more resources are further malinvested into areas that consumers do not want, causing the inevitable bust that is sure to occur to be even worse than had bank credit expansion just stopped after its first foray into the economy.

By laying out the tendencies of the boom-bust cycle and then precisely explaining why and how they occur, Rothbard not only explains why our current system of easy money harms the economy but refutes all other theories of the business cycle used to advocate for government economic intervention. If business cycles are apparently caused by the inherent flaws and instability of capitalism, then how come the bust only happens after the money supply is increased? If all of these business cycles occur because of over-speculation, then why do they heavily target the capital goods sectors of the economy? No matter what explanation is used, the only one that makes logical sense is Rothbard’s Austrian theory of the business cycle.

Another point in favor of Rothbard’s Austrian business cycle theory is the logical chain of reasoning he uses to reach theoretical conclusions rather relying on statistics to inductively ascertain the causes and cures of business cycles. As Rothbard states, “There are always many causal factors impinging on each other to form historical facts. Only causal theories a priori to these facts can be used to isolate and identify the causal strands.” (Rothbard 2000 xxxix)

Rothbard’s prioritization of a priori reasoning rather than empirical testing to reach his conclusion means that unlike other theories of the business cycle, which rely primarily on statistics to conclude what allegedly causes a business cycle, Rothbard’s Austrian explanation can be used in all timeframes if the conditions of bank credit expansion are satisfied. This does not mean that such booms and busts and their impacts can be quantified, since Rothbard’s theory is purely qualitative. Rather it helps to make the case that the inevitable outcome of all cases of monetary intervention in the economy result in a worsening of overall economic conditions.

Not only does the book do a thorough job of describing the causes of recessions, including discussing at considerable length how policies furthering the amount of easy credit in a society end up leading to the boom-bust cycle, it also explains the various remedies for an economy that is currently in a recession as well as governmental policies that will make a recession even worse. Rothbard lucidly describes the quickest way for government to get an economy out of a depression:

If government wishes to alleviate, rather than aggravate, a depression, its only valid course is laissez faire-to leave the economy alone. Only if there is no interference, direct or threatened, with prices, wage rates, and business liquidation will the necessary adjustment proceed with smooth dispatch” (Rothbard 2000 185).

By allowing market processes to work, resources will naturally shift towards actual consumer choice, fixing the maladjustments caused during the boom period. In contrast, however, if the government attempts to intervene instead of keeping its hands off of the private sector and reducing its functions, the bust will only be lengthened. As Rothbard describes:

 …any propping up of shaky positions postpones liquidation and aggravates unsound conditions. Propping up wage rates creates mass unemployment, and bolstering prices perpetuates and creates unsold surpluses” (Rothbard 2000 185).

Rothbard’s explanation of how government attempts to “fix” the economy through intervention make the situation worse is relevant in the current economy of the United States as it teeters closer and closer to economic ruin. With the Federal Reserve’s recent meeting only increasing the federal funds rate by twenty-five percentage points, combined with predictions of future federal funds rate increases either remaining as low as it currently is or possibly decreasing again, it is apparent that monetary authorities have not learned Rothbard’s lesson on what to do and what not to do during the bust phase of the boom-bust cycle. The only way the current bust and any future ones can possibly be mitigated is by following Rothbard’s explanation of the Great Depression and taking those lessons to heart, else we will be doomed to repeat the mistakes of the past.

Note: The views expressed on Mises.org are not necessarily those of the Mises Institute.
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