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How Recessions Become Depressions

This talk was delivered at the Mises Institutes 2003 Supporters Summit in Auburn, Alabama, on October 25, 2003.

As all Austrians should be aware, recessions themselves only come about as a reaction to the unsustainable tempo of the preceding Boom. They also know that, at root, the Boom itself always has its genesis in an unwarranted expansion of the means of payment.

When the central bank proactively encourages - or retroactively endorses - a credit expansion, the subtle interconnections between supply and demand; investment and saving; consumption and production; and - a uniquely Austrian insight this - impatience and postponement - that is to say, demands today and requirements tomorrow - all become disrupted.

In the end, after a seeming period of extraordinary vitality, the economy is seen to be suffering from a cancer, or perhaps an auto-immune disease: one where the costs of resources no longer correspond to the prices realized from their use in a manner which sufficiently rewards entrepreneurs and their backers, so that they will - or even can - maintain and extend their stock of useful capital equipment, and continue to support an equal or greater payroll outlay (whether in numerical or remunerative terms) and so perform their vital role of driving the community onward up the slopes of advancing material progress.

In short, though in a truly free market, even the largest business concerns would be like Kipling's Cities and Thrones and Powers, which 'Stand in Time's eye, Almost as long as flowers, Which daily die', others would constantly be rising to take their place and, in a progressive, increasingly capitalistic, classically liberal society, the profits made by the foresighted and the fortunate would, on balance, outweigh the losses made by the foolish and foredoomed, and would thus provide the seedcorn for future progress.

The music of commerce would thus be harmonious and evenly paced, its dynamics restrained; there would be no swelling crescendo of the Boom, no cacophonous accelerando to the climax and no minor key diminuendo thereafter into the Bust.

But, once the government takes over from the free market as musical director - and certainly after it appoints the central bank to conduct the orchestra - things are never quite so euphonious.

Too many brass players are hired, while there are empty seats left in the woodwind section. The timpani play too fast, the strings too slowly. The piano fails to arrive in time for the performance, since the instrument maker has been too busy churning out penny whistles, and ultimately, what the band plays, the public no longer wants to hear - certainly not at the ticket prices being charged.

At last, then, the reaction sets in.

Investment projects are revealed as hopelessly optimistic, or plain wrongly conceived. Wages turn out to be too high for the ultimate value the workers can generate. Certain vital inputs become too scarce and hence too costly to use to complete entrained production processes and to bring goods profitably to market.

Denied those current or prospective profits, capital investment dries up, unemployment rises and general business expenditures are reduced, intensifying the squeeze on the sub-marginal and the overstretched - as well as revealing many of the deceits and defalcations which have been hidden during the Boom's suspension of critical faculties, and which have been cultivated amid that erosion of personal morality and professional integrity which always accompanies the fever of the seemingly instant prosperity of inflation.

At this point, the clamour goes up for a cure - a cry all the more plaintive because so many have been rudely disabused of the mirage to which they have all succumbed.

Fearing for their jobs, seeing their pensions and college funds slashed in value as inflated asset prices come into closer coincidence with the much lesser real wealth to which these ultimately lay claim; feeling at first rueful, then vengeful, that they have been gullible enough to participate in the madness, people everywhere awaken to the shocking truth - even if they do not consciously articulate it this way - that the Boom has not enriched them, but impoverished them instead, as Mises himself pointed out.

So, having imbibed too much at the previous night's wild Bacchanalia, what is the prescription which should now be followed in order to relieve the distress of this thunderous hangover most swiftly?

Actually, we need do nothing more than to follow the advice of the tactful, but mildly skeptical doctor who tells us to 'Take two aspirin and call me in the morning'.

We need no deficit spending, no unfinanced tax cuts, no protectionism, no lowered interest rates or expanded credit, no vendettas against short sellers or 'speculators', no extra unemployment benefits or increased minimum wages. Nothing. Nil. Nada.

True, if an earthquake in the unsound credit structure threatens to topple too many of our intrinsically insolvent banks at once - and so risks burying more innocents in the rubble than is necessary - emergency finance might, in extremis, be temporarily provided to the most urgent supplicants, but only at such a swingeing cost that it makes this particular avenue unattractive to all but the truly desperate, as the eminent British Victorian Bagehot famously prescribed.

Moreover, once this liquidity crisis abates, this recourse must categorically not be perpetuated as a support mechanism for the living dead, no matter how illustrious their pedigree, or how many presidents, prime ministers, princes and pontiffs they have owned in the past.

Rather, we must hold unflinchingly to the practice of financial triage, realizing that if the monetary value of our liabilities has grown disproportionately large in relation to the income and real assets which should underpin it, it is much better, far more equitable, and vastly less threatening to liberty, to bring the debts down to the assets through bankruptcy and write-downs, than to engineer the converse upward matching of assets to the debt through the insidious mechanism of inflation.

Further, if, as might well happen in the throes of the Boom, the nation has become drastically uncompetitive on the world stage, a one-off devaluation might just be seen as a more politically certain address than a protracted domestic deflation, but any resort made to this lesser evil should be sternly reinforced with credit restriction at home, so that the need for it will not shortly recur, to the disruption of world trade and to the detriment of that international division of labour which so enriches us all.

Above all, recognizing that much capital has been lost and that our wealth has been greatly diminished, all sectors of society - householders, corporations and, above all, governments, should tighten their belts and attempt to live within their sadly reduced circumstances.

Saving - not newly elevated spending - will be what ultimately rebuilds peoples' fortunes in such a pass and the sooner it is grasped that there are no shortcuts by which the penitents may recover the grace from which they have fallen, the more readily the right course of action will be followed.

After all, if Robinson Crusoe loses the roof off his hut and sees his maize crop flattened, his goat herds scattered, by a passing hurricane, the last thing he should do is to pour all his remaining food stocks into his cooking pot, to use what's left of his thatch and his stockades to set a fire under it and to sit back and smoke a pipe while this last great feast is simmering.

For though this is exactly the equivalent of what the powers-that-be are recommending to us today - in the vain hope that, once Crusoe has consumed his goods and chattels and has expressed a wish to have some more, the necessary replacements will magically reappear at his whim - such a course will clearly serve only to jeopardize his chances of further survival.

No, if Crusoe doesn't want to starve, he needs to ration his residual provisions as closely as possible to see him through while he sets to work, with redoubled effort, in order to make repairs and to replenish what has been lost, paying particular attention to the timeliest possible replacement of his capital assets.

Nor is there any fallacy of composition at play here: what works for Crusoe on his island will also work for us out in the big, scary global economy.

But all this common sense and sound reasoning, so painstakingly laid out upon the foundations of the Classical economists by four generations of Austrian masters, has still to penetrate through the mental miasma that is the Keynesian-fixated mainstream.

What we need, they cry, is for 'purchasing power' to be maintained - as if this comes about by the issue of paper shopping coupons in isolation from the corresponding production of value.

We need to stimulate 'effective demand', they contend - rather than accepting the price adjustments required to bring about appropriate supply: appropriate, that is, in terms of both its composition, as well as its price (and as if 'demand' - in other words, the sum of human wants - ever truly wanes, in any case).

If no one is buying because prices are too high, rather than sellers yielding in their (now outdated) estimations of value to the worthy buyers, who should be sovereign in all economic transactions, both the Keynesians' and the Monetarists' central banks must be induced to ensure that enough new credit floods in so that even the most undesirable goods gain in attractiveness relative to the now more abundant money.

In other words, the thrifty must be assailed, and the improvident deluded, through the trickery of inflation.

If those who don't earn the right to buy through first selling their own wares, and thus cannot otherwise maintain a lifestyle which requires an income clearly beyond their productive capacities; well, the reserve bank must enable them to consume capital instead, through borrowing for the purpose - if need be, against the collateral of their homes; something which can be more than adequately inflated for the purpose by the very same credit infusions at work elsewhere in the system.

If companies will not invest, the government must borrow to squander people's savings - and ideally be financed in good part by the banks, in order to help push up prices even more - as if replacing entrepreneurs' inhibiting fears of a low return on a project by the state's actual delivery of one is the route to renewed well-being.

If companies will not hire, the government must commandeer private property in order to pay the masses to undertake such tasks as it deems fit - building bridges to nowhere, or - worse - bombing bridges nowhere it should be interfering.

If there are more jobseekers than jobs - which implies, as with all uncleared markets, that those offering the good (in this instance their labour) are pricing it too high - the state must otherwise subsidize this withholding of services by increasing the dole for unemployment: all the while helping enforce it through minimum wages, mandatory benefits, and maximum hours rules.

If capital is emigrating to hire cheaper and more marginally productive workers abroad, rather than at home, vote-hungry Congressmen must not make the local environment more conducive to retaining and nurturing that capital, but must rather seek an Outgroup to vilify as an excuse for the inability of their constituents to make a living.

If businesses complain all manner of costs are too high to justify maintaining production in the homeland, those costs must never be cut - for that would imply a shrinkage of the role and patronage of the state - but instead the costs must be equalized upwards across the whole economy, through the application of tariffs on imports and subsidies on exports.

If entrepreneurialism is in decline at home, the state's central planners must renew their homage to the dictatorial Collectivists of the 1930s to compensate for the supposed 'market failures' - in truth, market encumbrances - which are deemed to be in operation.

Never must the Nomenklatura stop to wonder at the plethora of bureaucratic and highly unconstitutional rules and regulations, of licences and quotas, combined with obligatory social insurance charges, unbridled legal vulturism and environmental, gender-related, and ethnic irrationalism, or the rapidly declining educational standards prevalent today.

No. Never must they pause to wonder, might these impediments - all of them ills which these very same Corporatists have done so much to inflict upon us - perhaps have so shackled the country's traders and industrialists that they are no longer able to run in the same race as those less hobbled abroad?

If, as it does, the US trade gap for goods amounts to a whopping 28% of its total cross-border traffic - most graphically represented by the nearly 4 million-a-year, 3:1 inbound-to-outbound container imbalance stacking up at the vast West Coast ports of Long Beach and LA - we must, naturally, hold it to be the fault of the exporting nation's monetary policy, for the beam in our eye does not prevent us from seeing the mote in theirs.

No one must ask just how it comes to be that Americans (as well as Britons and their kin) can continue to buy so much from foreigners, with so little to offer in return, unless credit is too cheap and too plentiful at home; unless it is our criminally lax monetary policy which is culpable: a policy of which the loudest Congressional complainers are also likely to be the most fervent advocates?

If Asian workers have sweated long hard hours to make us goods - earning barely $700 a year in urban China, for example - and if they have also been inveigled into holding onto, rather than spending or selling, the paper promises of goods tomorrow which we gave them in return, and if those pledges, in all their $4 trillion glory, are now too much to contemplate redeeming in full, we must fulminate against these fiendish Orientals for their 'unfair' trade practices and try to force them to accept less than their due recompense by devaluing our currency - and hence the scale of our obligations - while all our other excesses remain unchecked.

Finally, if - as is most probable - none of this succeeds in promoting, rather than preventing, a recovery and so regaining, for whichever jack-in-office it is with whom we happen to be beset, the popularity needed for him and his crew to retain power, we must not be allowed to throw the fellow out summarily and to enjoin his replacement to do it our way henceforward.

No, our leader will first be expected to appeal to the darker side of politics and to sublimate our widespread angst, projecting it onto conveniently identified 'monsters abroad'.

It will be of little comfort to note that the declared national emergency never more seems to call forth a Cincinnatus to return straightaway to his plough after the immediate occasion for his dictatorial powers has passed. Rather what we get is a Caesar, or a Duce, whose hands have to be forcibly prised from the staff of office, once they have first grasped it so tightly.

Sadly, it is also a lesson still to be unlearned by the elite and their court intellectuals that the Second World War did not, in fact, end the Great Depression, and so this is a myth of economic salvation through the Clausewitzian 'continuation of policy by other means': a myth which exerts an ever more dangerous and compelling fascination for the powerful, the longer the recession is protracted by all their other policy misadventures.

So, to sum up: what is the answer to the question implicit in the title of this address?

Pursue inflationism, frustrate the market, extend socialism, adopt protectionism, embrace militarism, extirpate thrift, expropriate the Middle Classes, consume capital - and ignore the Austrians! - that is the way to turn a recession into a depression.

Unfortunately, it is the only way the vast majority of our leaders - of whatever outward political stripe - know how to act.

Thus the avoidance of its effects will entail a hard-headed and rational redisposition of our assets and undertakings - with the preservation of as much valuable capital as we can secure from the tempest an over-riding objective.

Avoiding Depression altogether will require of us Herculean efforts of political activism and economic proselytizing, in the attempt to avoid reaping the whirlwind we have already sown.

If this last seems beyond our means, or if time proves too short, we should still endeavour to reason as clearly as possible about our predicament - fully utilizing the insights of the Austrians; we should seek to explain our thoughts to others, where possible; and to act as consistently and courageously as we are able in implementing the conclusions derived from these thoughts ourselves.

That way, we might emerge from the ordeal we face, the one of restoring a consonance between prices and costs, between earned demand and economically sustainable supply - whether this takes the form of a firestorm of inflation, or a deep tough of deflationary depression - with our capital of the financial variety relatively intact, and that of the intellectual variety significantly enhanced.

Thence, if people were subsequently to look to the successful example we had set, perhaps we might then be able to undo the errors of the Thirties and to further discredit the poisonous legacy of Keynes and the Collectivists, such that the title of this essay might - one glorious day in the not-so-remote future - become nothing more than an historical curiosity.

That would, indeed, be a triumph worthy of our aim.

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