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The Curative Power of Economic Busts

Mises Daily: Friday, October 19, 2001 by

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The salutary nature of an economic bust is how it sifts out the misallocations of capital made during the preceding boom. It thereby leaves a stronger mix of businesses better fitted to meet the needs and wants of consumers. 

The misallocations induced by a credit-inspired boom are built on the sandy foundations of expansive monetary policy and government intervention (in the form of regulations, tax incentives, and other manipulative tools).  All serve to distort the pattern of production into something it otherwise would not be.  

These distortions do not come without cost, as Austrian business cycle theory asserts. For there will come a day of reckoning, a time when projects begun under the illusory veil of easy money are no longer promising. At this point, the sifting process will begin.

In our own day, this sifting process has already begun with the liquidation and reorganization of businesses that can no longer survive in the current environment.  These casualties include not only the profitless new-economy companies that were seemingly so full of promise, but also old-economy stalwarts, such as Xerox and Bethlehem Steel.  

Bethlehem Steel

In the case of Bethlehem Steel, the venerable steel outfit has been unable, despite all the help from Uncle Sam over the years, to beat its cheaper foreign rivals.  Bethlehem Steel recently filed for Chapter 11 bankruptcy.  Since mid-1998, the company has bled over $500 million worth of operating losses, and revenues have declined $1.3 billion.  The company is wallowing in $4.5 billion in debt-more than the book value of its assets.  

Bethlehem will not go down without a fight-or, rather, it will not go down without at least trying to get something for nothing from much-abused American taxpayers in an effort to prop up its failing business a while longer.  

In their campaign to snow fellow Americans, the steel interests will surely point out how important steel is to the U.S. economy and to U.S. interests, such as national defense.  After all, Bethlehem was the largest shipbuilder during World War II, and it built the first aircraft carrier.  The steel interest will also surely bring out the old bromide about how unfair it is that some Japanese or Korean or eastern European manufacturer actually charges lower prices for the same steel.  

The great Frederic Bastiat, if he were here today, would surely point out that it is not so important whether or not a steel manufacturer is located in the U.S., but rather whether or not Americans can purchase the steel that they can pay for.  Every argument has two sides, and while low steel prices push American steel manufacturers to the brink of extinction, these same low steel prices are a great boon for American purchasers of steel, such as General Motors or Caterpillar.  Moreover, the capital freed from the steel industry could be put to more economical use in other industries.

As to fairness, perhaps the steel interests should consider how unfair it is for the rest of us Americans to have to pay more for our steel than we would otherwise.  

The fight to alter the verdict of markets is costly and futile.  Like irrepressible death itself, the market always gets its man.  This time, the scythe swings for Bethlehem Steel.  

Creative Destruction

Businesses are created, and they are destroyed.  Like empires and men, their fortunes ebb and flow.  Some thrive; some are crushed.  Consumers are harsh masters.  In free markets, you make what they want, or you perish.  

And so the market turns, with old industries and businesses sometimes being replaced with newer ones that are in turn replaced yet again-in an endless cycle.  At each turn, more efficient means replace less efficient ones.

In the twentieth century, America successfully made the transition from an economy dominated by agricultural production to one that became increasingly dominated by manufacturing.  As recently as 1900, agricultural workers made up over 40 percent of the U.S. workforce, employing twice as many workers as the manufacturing sector.  Compare that with the less than 3 percent of the population  involved in production agriculture today.  

The transition away from manufacturing has also elicited kicking and screaming from politicians and other dolts (manufacturing accounts for less than 20 percent of GDP today).  So too, the shift away from an agricultural economy brought forth many paeans to the simpler life of farming and a call to help the American family farmer.  Yet all the efforts to help the American farmer over the decades did not prevent the virtual extinction of the once-dominant family farm, as it yielded to more efficient and cheaper producers.

Farming is certainly not the only industry that has left the spotlight on the stage of the U.S. economy.  Most people could readily identify others, like the railroad industry.

Such historical evidence of the powerful evolutionary nature of the market and its relentless capacity for overcoming obstacles-like the irresistible roots of a great oak that, over time, crack and rip through seemingly impenetrable concrete-does not prevent meddlers from attempting to stop it.

Meddling with the Process

Let us count the ways: stimulus packages ranging from $60 billion to $75 billion; $18 billion at least in new spending for defense; a $40-billion recovery package in the wake of September 11; a $15-billion bailout for the airlines; nine Federal Reserve rate cuts (bringing short-term rates to their lowest level in forty years); and more to come.  We have possible support for U.S. steel manufactures, more foreign aid (a $15.6-billion foreign-aid bill!), nationalization of airport security, and we still have the same long-term problems as before that the government will surely find irresistible (i.e., more money for Social Security, education, health care, etc.). 

Efforts to prop up failing businesses and the weakening economic picture should be seen for what they are, not what they try to be.  They are attempts to arrest the curative powers of the bust.  But, they will only delay and prolong the inevitable.  

Japan is a case in point.  Despite having access to all of the best in the meddlers' tool kits (short-term nominal interest rates are practically zero there), the Japanese economy remains mired in a decade-long slump, saddled with a huge public debt and a record postwar unemployment rate.

American politicians are still Keynesians at heart.   They want to spend their way out of this recession.  

In doing so, they prescribe the worst possible medicine for an already-hobbled horse.  With the new packages and bailouts, new misallocations are created.  

The Airlines Bailout

In the absence of an airline bailout, many of America's major airlines would have been pushed into bankruptcy.  Many presume that this would have meant the end of commercial aviation in America.  Not so.  What would have happened?  The airlines would have had to renegotiate their debts; equity holders may have been wiped out, their holding reduced to pennies; the unions would have had to make concessions; and the airlines would have had to come up with a plan, satisfactory to their creditors, that would have led them back to health.  Some of the airlines may have been forced to sell to other carriers or other group of investors at rock-bottom prices.  But in the end, the airlines industry would have emerged stronger for it.  It would have forced a change in the way they do things. 

But now, the airlines are getting a windfall that amounts, by some estimates, to more than three times what they actually lost.  They are getting $5 billion in cash and $10 billion in loan guarantees.   By the industry's own numbers, they lost $1.36 billion for the days they couldn't fly.  That leaves $3.64 billion to compensate them for doing less business through September 30 than they would have otherwise.  Keep in mind that after the bailout, the industry still laid off more than 70,000 workers and canceled hundreds of flights.  

Having dodged a bullet, the airline industry can continue on its way (although UAL is now talking about its demise next year, after having taken the people's pottage.  In fact, some experts are saying that some airlines will have to go bankrupt anyway, taking all that taxpayer money with them).  But what about the travel industry?  What about hotels?  Their businesses, too, suffered from the attacks.  Should we hand them some money for the business that they might have done?

What has the bailout cost America?  Well, for one thing, $15-billion worth of resources that are being used in a manner that they might not otherwise have been used.  What we don't see is what might have been.  Somebody's pocket is leaner because the government took the money and put it in the sinkhole known as the American airline industry.

A Prescription for a Recovery

Any prescription for a recovery must begin with an acknowledgement of the healing process that is the hallmark of the bust.  When you eat a huge meal and then experience indigestion, the remedy is not to eat more food.  Rather, it's to step away from the table.  In a similar way, it is time for the American economy to get off its easy-money binge.

As Murray Rothbard advised:

The first and clearest injunction is: don't interfere with the market's adjustment process.  The more the government intervenes to delay the market's adjustment, the longer and more grueling the depression will be, and more difficult will be the road to recovery.  Government hampering aggravates and perpetuates the depression.

Government is far from the economy's savior.  Rather, it is a parasite, a cancer, that eats away at the wealth of its citizens with its fiat currency, its many billions of dollars of expropriated wealth, and its multitudinous directives.  The incessant interference inhibits the market's drive to satisfy consumers.  It also dulls the corrective process that weeds out poor investments, which then provides a foundation for future growth.


Christopher Mayer is a commercial lender for Provident Bank in the suburbs of Washington, D.C.  Send him MAIL and see his Mises.org Archive.   See also Richard M. Ebeling's Austrian Theory of the Trade Cycle and Other Essays.