A Better Century?
This talk
was delivered at the 2013 Jeremy Davis Mises Circle in Houston,
Texas.
In December
it will be 100 years since Congress authorized the creation of the
Federal Reserve System. Throughout that century the Fed has enjoyed
broad bipartisan support. That’s another way of saying the Fed never
appeared on the political radar until Ron Paul broke the rules by
actually campaigning against it in 2007.
The Fed was
supposed to provide stability to the financial sector and the economy
at large. We are supposed to believe it has been a wonderful success.
A glance at the headlines over the past five years renders an unkind
verdict on this rarely examined assumption.
Last year we
observed another important centenary – the 100-year anniversary
of the publication of Ludwig von Mises’s pathbreaking book, The
Theory of Money and Credit, written when the great economist
was just 31. The end of an era was approaching as that book reached
the public. A century of sound money, albeit with exceptions here
and there, was drawing to a close. It had likewise been a century
of peace, or at least without a continent-wide war, since the Congress
of Vienna. Both of these happy trends came to an abrupt end for
the same reason: the outbreak in 1914 of World War I, the great
cataclysm of Western civilization.
It was as though
Mises had one eye to the past, speaking of the merits of a monetary
system which – while not perfectly laissez-faire – had served the
world so well for so long, and another eye to the future, as he
warned of the consequences of tampering with or abandoning that
system. Mises carefully dismantled the inflationist doctrines that
were to ravage much of the world during the twentieth century.
That book covered
the whole expanse of monetary theory, including money and its origins,
interest rates, time preference, banking, credit, inflation, deflation,
exchange rates, and business cycles.
Most important
for our topic today was Mises’s warning to the world’s monetary
authorities not to suppress the market rate of interest in the name
of creating prosperity. The failure to heed Mises’s advice, indeed
the full-fledged ignorance or outright defiance of that advice,
is the monetary story of the twentieth century.
The single
most arresting economic event of the Fed’s century was surely the
Great Depression. This was supposed to have discredited laissez-faire
and the free economy for good. Wild speculation was said to have
created a stock market bubble, and the bust in 1929 was what the
unregulated market had allegedly wrought. Other critics said the
problem had been the free market’s unfair distribution of wealth:
the impoverished masses simply couldn’t afford to buy what the stores
had for sale. In later years, even so-called free-marketeers would
blame the Depression on too little intervention into the market
by the Federal Reserve. (With friends like these, who needs enemies?)
Ludwig von
Mises offered a different explanation, as did F.A. Hayek, Lionel
Robbins, and other scholars working in the Austrian tradition in
those days. Murray N. Rothbard, in turn, would devote his 1962 book
America’s
Great Depression to an Austrian analysis of this misunderstood
episode.
The study of
business cycles differs from the study of economic hard times. Economic
conditions can be poor because of war, a natural disaster, or some
other calamity that disrupts the normal functioning of the market.
Business cycle research is not interested in those kinds of conditions.
It seeks to understand economic boom and bust when none of these
obvious factors are present.
Mises referred
to his own approach as the Circulation Credit theory of the business
cycle. For our purposes, we can describe it in brief.
On the free
market, when people increase their saving, that increased saving
has two important consequences. First, it lowers interest rates.
These lower interest rates, in turn, make it possible for entrepreneurs
to pursue a range of long-term investment projects profitably, thanks
to the lower cost of financing. Second, the act of saving and thus
abstaining from spending on consumer goods, releases resources that
these entrepreneurs can use to complete their new projects. If consumer-goods
industries no longer need quite so many resources, since (as we
stipulated at the start) people are buying fewer consumer goods,
those released resources provide the physical wherewithal to carry
out the long-term production projects that the lower interest rates
encouraged entrepreneurs to initiate.
Note that it
is decisions and actions by the public that provide the means for
this capital expansion. “If the public does not provide these
means,” Mises explains, “they cannot be conjured up by
the magic of banking tricks.”
But “banking
tricks” are precisely how the Fed tries to stimulate the economy.
The Fed lowers interest rates artificially, without an increase
in saving on the part of the public, and without a corresponding
release of resources. The public has not made available the additional
means of production necessary to make the array of long-term production
projects profitable. The boom will therefore be abortive, and the
bust becomes inevitable.
In short, interest
rates on a free market reflect people’s willingness to abstain from
immediate consumption and thereby make resources available for business
expansion. They give the entrepreneur an idea of how far and in
what ways he may expand. Market interest rates help entrepreneurs
distinguish between projects that are appropriate to the current
state of resource availability, and projects that are not, projects
that the public is willing to sustain by its saving and projects
that they are not.
The central
bank confuses this process when it intervenes in the market to lower
interest rates. As Mises put it:
The policy
of artificially lowering the rate of interest below its potential
market height seduces the entrepreneurs to embark upon certain
projects of which the public does not approve. In the market economy,
each member of society has his share in determining the amount
of additional investment. There is no means of fooling the public
all of the time by tampering with the rate of interest. Sooner
or later, the public’s disapproval of a policy of over-expansion
takes effect. Then the airy structure of the artificial prosperity
collapses.
None of these
cycles will be exactly like any other. Roger Garrison says the artificial
boom will tend to latch on to and distort whatever the big thing
at the time happens to be – tech stocks in the 1990s, for example,
and housing in the most recent boom.
With this theoretical
apparatus as a guide, Mises became convinced as the 1920s wore on
that the seeds of a bust were being sown. This was not a fashionable
position. Irving Fisher, a godfather of modern neoclassical economics
and the man Milton Friedman called the greatest American economist,
could see nothing but continued growth and prosperity in his own
survey of economic conditions at the time. In fact, Fisher’s predictions
in the late 1920s, even in the very midst of the crash, are downright
embarrassing.
On September
5, 1929, Fisher wrote: “There may be a recession in stock prices,
but not anything in the nature of a crash…the possibility of which
I fail to see.”
In mid-October,
Fisher said stocks had reached a “permanently high plateau.”
He expected “to see the stock market a good deal higher than
it is today within a few months.” He did “not feel that
there will soon, if ever, be a fifty- or sixty-point break below
present levels.”
On October
22 Fisher was speaking of “a mild bull market that will gain
momentum next year.” With the stock market crashing and values
plummeting all around him – with declines far more severe than Fisher
had been prepared to admit were even conceivable – Fisher on November
3 insisted that stock prices were “absurdly low.” But
they would go much lower, ultimately losing 90 percent of their
peak value.
What had gone
so horribly wrong? Fisher and his colleagues had been blinded by
their assumptions. They had been looking at the “price level”
and at economic growth figures to determine the health of the economy.
They concluded that the 1920s were a period of solid, sustainable
economic progress, and were taken completely by surprise by the
onset and persistence of the Depression.
Mises, on the
other hand, was not fooled by the 1920s. For Mises and the Austrians,
crude aggregates of the kind Fisher consulted were not suitable
for ascertaining the condition of the economy. To the contrary,
these macro-level measurements concealed the economy-wide micro-level
maladjustments that resulted from the artificial credit expansion.
The misdirection of resources into unsustainable projects, and the
expansion or creation of stages of production that the economy cannot
sustain, do not show up in national income accounting figures. What
matters is that interest rates were pushed lower than they would
otherwise have been, thereby leading the economy into an unsustainable
configuration that had to be reversed in a bust.
Thus Mises
wrote in 1928:
It is clear
that the crisis must come sooner or later. It is also clear that
the crisis must always be caused, primarily and directly, by the
change in the conduct of the banks. If we speak of error on the
part of the banks, however, we must point to the wrong they do
in encouraging the upswing. The fault lies, not with the policy
of raising the interest rate, but only with the fact that it was
raised too late.
Once the crisis
hit, Mises showed how his theory of business cycles accounted for
what was happening. If people could understand how the crash had
come about, Mises hoped, they would be less likely to exacerbate
the problem with counterproductive government policy.
“The Causes
of the Economic Crisis” was the title of an address Ludwig
von Mises delivered in late February 1931 to a group of German industrialists.
It was unknown to English-speaking audiences until 1978, when it
was published as a chapter in a collection of Mises’s essays called
On
the Manipulation of Money and Credit. The Mises Institute
published a new edition of these essays in 2006 under the title
The
Causes of the Economic Crisis: And Other Essays Before and After
the Great Depression.
In that essay
Mises was characteristically blunt in describing the causes of the
Great Depression, as well as in his warnings that such crises would
recur as long as the authorities continued to pursue the same destructive
courses of action.
The crisis
from which we are now suffering is…the outcome of a credit expansion.
The present crisis is the unavoidable sequel to a boom. Such a
crisis necessarily follows every boom generated by the attempt
to reduce the “natural rate of interest” through increasing
the fiduciary media [in other words, through creating credit out
of thin air]….
As we have
seen at this event today, the crisis whose wreckage we see all around
us right now, a crisis that began in 2008, originated from the same
interventions Mises warned against a century ago. Mises would not
have been surprised by the Panic of 2008. In 1931 he warned of a
recurrence of boom-bust cycles if the policy of artificially low
interest rates was not abandoned:
The appearance
of periodically recurring economic crises is the necessary consequence
of repeatedly renewed attempts to reduce the “natural”
rates of interest on the market by means of banking policy. The
crises will never disappear so long as men have not learned to
avoid such pump-priming, because an artificially stimulated boom
must inevitably lead to crisis and depression….All attempts
to emerge from the crisis by new interventionist measures are
completely misguided. There is only one way out of the
crisis…. Give up the pursuit of policies which seek to establish
interest rates, wage rates, and commodity prices different from
those the market indicates.
In the 1920s
as now, fashionable opinion could see no major crisis coming. Then
as now, the public was assured that the experts at the Fed were
smoothing out economic fluctuations and deserved credit for bringing
about unprecedented prosperity. And then as now, when the bust came,
the free market took the blame for what the Federal Reserve had
caused.
It is fitting
that a century of the Federal Reserve should come to an end at a
moment of economic crisis and uncertainty, with the central bank’s
leadership confused and in disarray after the economy’s failure
to respond to unprecedented doses of monetary intervention. The
century of the Fed has been a century of depression, recession,
inflation, financial bubbles, and unsound banking, and its legacy
is the precipice on which our economy now precariously rests.
Faced with
a slow-motion train wreck they feel helpless to stop, people often
ask what they can do.
There are no
easy answers, to be sure. But one thing is certain: there will be
no progress without the spread of knowledge.
I hope you’ll
be a part of the crucial and historic moment that lies before us.
Thanks in large
part to Ron Paul, recent years have seen a spectacular revival of
interest in the Austrian School of economics and in particular its
theory of the business cycle. This is a deeply significant and most
welcome development. Until recently, even supporters of the free
market had by and large ignored the Federal Reserve, or even thought
of it as a potentially stabilizing force in a capitalist economy.
The possibility that its interventions into the market may actually
have been destabilizing, and actually have been the cause of the
boom-bust cycle, was hardly to be heard anywhere. Were you to say
such a thing at an ostensibly free-market conference, chances were
slim that you would appear on the following year’s program.
For more than
30 years, however, the Mises Institute has been dedicated to the
pursuit of economic science in the Austrian tradition. We’ve warned
against the economic damage caused by central banking at a time
when that message couldn’t have been less fashionable. You’ve already
seen some of the results of our work here this weekend: three of
our speakers – Peter Klein, Bob Murphy, and Tom Woods – came through
the Institute’s programs during their college years.
But now, with
the vastly increased demand for what we offer, we want to step things
up. Way up.
One of our
primary goals is to carry out what we’re calling Operation Ron Paul.
We want to equip the masses of young people drawn to the Austrian
School by Ron’s heroic work with the skills, resources, and knowledge
they’ll need in order to keep the Austrian School and Ron’s message
vital and growing.
We are also
setting up an Economic Crisis Project, to be ready now and when
the next event hits, with the scholarly and popular explanations
of what happened, and what to do about it.
What is attractive
about the market economy is not simply what it accomplishes materially:
ever-higher standards of living, prosperity for the masses that
the most exalted monarchs of yore could scarcely have imagined for
themselves, and the ability to support far larger populations than
anyone centuries ago could have dreamed. This is all great cause
for celebration, to be sure. But what the beautiful order of the
market shows is the staggering, near-miraculous achievements of
mankind by means of voluntary cooperation, and without state violence
or an exalted leader ordering people around.
Set against
this marvelous spectacle, the government-privileged central bank
is a grotesque anomaly. To say that we need a politically created
monopoly to create money, the commodity that constitutes one-half
of every non-barter transaction, is to say that the market economy
is not really so impressive or effective after all. If we must conjure
a specially privileged monopoly to create this most essential commodity,
and if that monopoly is likewise given the task of managing the
economy to maximize employment and output, then we are in principle
abandoning the whole case for the free market and conceding the
value of central planning.
We
do not need any such monopoly, as the work of the Austrian economists
makes clear, and we do not need any form of central planning. We
need the free market, which is another way of saying we need to
let people make their own decisions, enter into the agreements of
their choice, and be secure in their private property.
The Austrian
School is enjoying its most spectacular surge in growth in its entire
history. A generation of smart young people are reading everything
they can find on Austrian economics. The Austrian diagnosis of the
economic crisis is so widespread that even establishment writers
and economists have been forced to engage with it.
Let’s make
sure this surge doesn’t fizzle out. If we build on these early successes,
if we carry forward the message of the Austrian School relentlessly
and courageously, we can make the next hundred years a Misesian
century of peace, sound money, and liberty. Please
join us.
January
31, 2013
Llewellyn
H. Rockwell, Jr. [send him
mail], former editorial assistant to Ludwig von Mises and congressional
chief of staff to Ron Paul, is founder and chairman of the Mises
Institute, executor for the estate of Murray N. Rothbard, and
editor of LewRockwell.com.
See his
books.
Copyright
© 2013 by LewRockwell.com. Permission to reprint in whole or in
part is gladly granted, provided full credit is given.