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Advancing Austrian Economics, Liberty, and Peace

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Making Economic Sense
by Murray Rothbard
(Contents by Publication Date)

Chapter 70
Lessons of The Recession

It's official! Long after everyone in America knew that we were in a severe recession, the private but semi-official and incredibly venerated National Bureau of Economic Research has finally made its long-awaited pronouncement: we've been in a recession ever since last summer. Well! Here is an instructive example of the reason why the economics profession, once revered as a seer and scientific guide to wealth prosperity, has been sinking rapidly in the esteem of the American public. It couldn't have happened to a more deserving group. The current recession, indeed, has already brought us several valuable lessons:

Lesson # 1: You don't need an economist . . . . One of the favorite slogans of the 1960s New Left was: "You don't need a weatherman to tell you how the wind is blowing." Similarly, it is all too clear that you don't need an economist to tell you whether you've been in a recession. So how is it that the macro-mavens not only can't forecast what will happen next, they can't even tell us where we are, and can barely tell us where we've been? To give them their due, I am pretty sure that Professors Hall, Zarnowitz, and the other distinguished solons of the famed Dating Committee of the National Bureau have known we've been in a recession for quite a while, maybe even since the knowledge percolated to the general public.

The problem is that the Bureau is trapped in its own methodology, the very methodology of Baconian empiricism, meticulous data-gathering and pseudo-science that has brought it inordinate prestige from the economics profession.

For the Bureau's entire approach to business cycles for the past five decades has depended on dating the precise month of each cyclical turning point, peak and trough. It was therefore not enough to say, last fall, that "we entered a recession this summer." That would have been enough for common-sense, or for Austrians, but even one month off the precise date would have done irrepa rable damage to the plethora of statistical manipulations--the averages, reference points, leads, lags, and indicators--that constitute the analytic machinery, and hence the "science," of the National Bureau. If you want to know whether we're in a recession, the last people to approach is the organized economics profession.

Of course, the general public might be good at spotting where we are at, but they are considerably poorer at causal analysis, or at figuring out how to get out of economic trouble. But then again, the economics profession is not so great at that either. 

Lesson #2: There ain't no such thing as a "new era." Every time there is a long boom, by the final years of that boom, the press, the economics profession, and financial writers are rife with the pronouncement that recessions are a thing of the past, and that deep structural changes in the economy, or in knowledge among economists, have brought about a "new era." The bad old days of recessions are over. We heard that first in the 1920s, and the culmination of that first new era was 1929; we heard it again in the 1960s, which led to the first major inflationary recession of the early 1970s; and we heard it most recently in the later 1980s. In fact, the best leading indicator of imminent deep recession is not the indices of the National Bureau; it is the burgeoning of the idea that recessions are a thing of the past.

More precisely, recessions will be around to plague us so long as there are bouts of inflationary credit expansion which bring them into being.

Lesson #3: You don't need an inventory boom to have a recession. For months into the current recession, numerous pundits proclaimed that we couldn't be in a recession because business had not piled up excessive inventories. Sorry. It made no difference, since malinvestments brought about by inflationary bank credit don't necessarily have to take place in inventory form. As often happens in economic theory, a contingent symptom was mislabeled as an essential cause.

Unlike the above, other lessons of the current recession are not nearly as obvious. One is:

Lesson #4: Debt is not the crucial problem. Heavy private debt was a conspicuous feature of the boom of the 1980s, with much of the publicity focused on the floating of high-yield ("junk") bonds for buyouts and takeovers. Debt per se, however, is not a grave economic problem.

When I purchase a corporate bond I am channeling savings into investment much the same way as when I purchase stock equity. Neither way is particularly unsound. If a firm or corporation floats too much debt as compared to equity, that is a miscalculation of its existing owners or managers, and not a problem for the economy at large. The worst that can happen is that, if indebtedness is too great, the creditors will take over from existing management and install a more efficient set of managers. Creditors, as well as stockholders, in short, are entrepreneurs.

The problem, therefore, is not debt but credit, and not all credit but bank credit financed by inflationary expansion of bank money rather than by the genuine savings of either share holders or creditors. The problem in other words, is not debt but loans generated by fractional-reserve banking.

Lesson #5: Don't worry about the Fed "pushing on a string." Hard-money adherents are a tiny fraction in the economics profession; but there are a large number of them in the investment newsletter business. For decades, these writers have been split into two warring camps: the "inflationists" versus the "deflationists." These terms are used not in the sense of advocating policy, but in predicting future events.

"Inflationists," of whom the present writer is one, have been maintaining that the Fed, having been freed of all restraints of the gold standard and committed to not allowing the supposed horrors of deflation, will pump enough money into the banking system to prevent money and price deflation from ever taking place.

"Deflationists," on the other hand, claim that because of excessive credit and debt, the Fed has reached the point where it cannot control the money supply, where Fed additions to bank reserves cannot lead to banks expanding credit and the money supply. In common financial parlance, the Fed would be "pushing on a string." Therefore, say the deflationists, we are in for an imminent, massive, and inevitable deflation of debt, money, and prices.

One would think that three decades of making such predictions that have never come true would faze the deflationists somewhat, but no, at the first sign of trouble, especially of a recession, the deflationists are invariably back, predicting imminent deflationary doom. For the last part of 1990, the money supply was flat, and the deflationists were sure that their day had come at last. Credit had been so excessive, they claimed, that businesses could no longer be induced to borrow, no matter how low the interest rate is pushed.

What deflationists always overlook is that, even i