by Murray Rothbard
(Contents by Publication Date)
Stocks, Bonds, And Rule by Fools
The economic acumen of establishment politicians, economists, and the financial press, never very high at best, has plunged to new lows in recent years. The state of confusion, self-contradiction, and general feather-brainedness has never been so rampant. Almost any event can now be ascribed to any cause, or to the contradiction of the very cause assigned the previous week.
If the Fed raises short-term interest rates, the same analyst can say at one point that this is sure to raise long-term rates very soon, while stating at another point that it is bound to lower long-term rates: each contradictory pronouncement being made with the same air of certitude and absolute authority. It is a wonder that the public doesn't dismiss the entire guild of economists and financial experts (let alone the politicians) as a bunch of fools and charlatans.
In the past year and a half, the usual geyser of pseudo-economic humbug has accelerated into virtual gibberish by the fervent desire of the largely Clintonian establishment to put a happy face on every possible morsel of economic news. Is unemployment up? But that's good, you see, because it means that inflation will be less of a menace, which means that interest rates will fall, which means that unemployment will soon be falling. And besides, we don't call layoffs "unemployment" any more, we call it "downsizing," and that means the economy will get more productive, soon decreasing unemployment.
In pre-Clinton economics, moreover, it was always considered--by all schools of economic thought--BAD to increase taxes during a recession. But Clinton's huge tax increase during a recession was an economic masterstroke, you see, because this will lower deficits, which in turn will lower interest rates, which in turn will bring us out of the recession.
What, you say that interest rates have gone up, despite the Clintonian budget staking much of its forecasts on the assurance that interest rates will go down? But that's okay, because, you see, higher interest rates will check inflation, bringing interest rates down, so we were right all along! And so down means up, up means down, and round and round she goes, and where she stops nobody knows.
Any sane assessment of the current economic situation is made still more problematic by the National Bureau of Economic Research's self-proclaimed "scientific" methodology of dating business cycles, which has been treated as Holy Writ by the economics profession for the past half-century. In this schema, there is exclusive concentration on finding the allegedly precise monthly date of the peak or trough of the business cycle, to the neglect of what is actually happening between these dates. Once a "trough" was officially proclaimed for some month in 1992, for example, every period since has to be an era of "recovery" by definition, even though the supposed recovery may be only one centimeter less feeble than the previous "recession." In any common sense view, however, the fact that we might be slightly better off now than at the depth of the recession scarcely makes the current period a "recovery".
Let us now try to dispel two of the most common--and most egregious--economic fallacies of our current epoch. First is the Low Interest Rate Fetish. It all reminds me of the Cargo Cult that took root in areas of the South Pacific during World War II. The primitive natives there saw big iron birds come down from the sky and emit U.S. soldiers replete with food, clothing, radios, and other goodies.
After the war, the U.S. Army left the area, and the old flow of abundant goodies disappeared. Whereupon the natives, using high-tech methods of empirical correlation, concluded that if these giant birds could be induced to return, the eagerly-sought goodies would come back with them. The natives then constructed papier-mache replicas of birds that would flap their wings and try to "attract" the large iron birds back to their villages.
In the same way, the British, the French and other countries saw, in the 17th century, that the Dutch were by far the most prosperous country in Europe. In casting around for the alleged cause of Dutch prosperity, the English concluded that the reason must be the lower interest rates that the Dutch enjoyed. Yet, many more plausible causal theories for Dutch prosperity could have been offered: fewer controls, freer markets, and lower taxes.
Low interest rates were merely a symptom of that prosperity, not the cause. But many English theorists, enchanted to have found the alleged causal chain called for creating prosperity by forcing down the rate of interest by government action: either by pushing down the interest rate below the "natural" or free market rate, determined by the rate of time preference. But bringing down the interest rate by government coercion lowers it below the true, "time preference" rate, thereby causing vast dislocations and distortions on the market.
The other point that should be made is the total amnesia of the financial press. In the old days, before World War II, one hallmark of a "recession" was the fact that prices were falling, as well as production and employment. And yet, in every recession since World War II, prices, especially consumer goods prices, have been rising.
In short, in the permanent post-World War II inflation attendant on the shift from a gold standard to fiat paper money, we have suffered through several "inflationary recessions," where we get hit by both inflation and recession at the same time, suffering the worst of both worlds. And yet, while consumer prices, or the "cost of living," has not fallen for a half-century, the overriding fact of inflationary recession has been poured down the Orwellian "memory hole," and everyone duly heaves a sigh of relief when inflation accelerates because "at least we won't have a recession," or when unemployment increases that "at least there is no threat of inflation." And in the meanwhile inflation has become permanent.
And yet everyone still acts as if the Keynesian hokum of the "inflation- unemployment tradeoff" (the so-called "Phillips curve") is a valid and self- evident insight. When will people realize that this "tradeoff" is about as correct as the forecast that the Soviet Union and the United States would have the same gross national product and standard of living by 1984. If we look, for example, at the benighted countries that suffer from the ravages of hyper-inflation (Russia, Brazil, Poland) they, at the same, time suffer from loss of production and unemployment; while, on the other hand, countries with almost zero inflation, such as Switzerland, also enjoy close to zero unemployment.
Finally, to sum up our current macroeconomic situation: During the 1980s, the Federal Reserve embarked on a decade of inflationary bank credit expansion, an expansion fueled by credit inflation of the Savings & Loans. The fact that prices only rose moderately was just as irrelevant as a similar situation during the inflationary boom of the 1920s. At the end of the 1980s, as at the end of the 1920s, the American--and the world--economy paid a heavy price in a lengthy recession that burst the "bubble" of the inflationary boom, that liquidated unsound investments, lowered industrial commodity prices, and, in particular, ravaged the real estate market that had been the major focus of the boom in the United States.
To try to get out of this recession, the Fed inflated bank reserves and pushed down short-term interest rates still further: with resulting bank credit expanding not so much the real industrial economy, which stayed pretty much depressed, but generating instead an artificial boom in the stock and bond markets. The stock and bond price boom of the last year or two has clearly been so out-of-line with current earnings that one of two things had to happen: either a spectacular recovery in the real world of industry to warrant the higher stock prices; or a collapse of the swollen financial markets.
For those of us skeptical about any magical economic recovery in the near future, and critical, too, of the feasibility of any permanent lowering by government manipulation of the rate of interest below the time-preference rate, a sharp stock and bond price decline was, and continues to be, in the cards.