Economic Ups and Downs 66 THE NATIONAL BUREAU AND BUSINESS CYCLES

Not only is there confusion about whether or not a recession is imminent, but some economists think that we’re already in one (1988). Thus, Richard W. Rahn, chief economist for the U.S. Chamber of Commerce, recently declared: “The economic slowdown is not coming: it’s here, and soon it will be gone.” Not knowing whether or not we’re in a recession is not as silly as it sounds. It takes a while for data to come in, and then to figure out if a decline is a mere glitch or if it constitutes a new trend. But the natural confusion is compounded by the thrall in which virtually all economists, statisticians, and financial writers have been held by the National Bureau of Economic Research.

Everyone waits for the National Bureau to speak; when the oracle finally makes its pronouncement, it is accepted without question. Thus, in 1966, the economy slowed down and receded to such an extent that I, for one, concluded that we were in a recession. But no, GNP had not declined quite long enough to meet the Bureau’s definition of a recession, and that, unfortunately, was that. And since we were not in what the Bureau called a “recession,” we by definition continued to be in a “boom.” The reason is that, by the Bureau’s peculiar and arbitrary standards and methods, the economy cannot be just sort of lolling along, in neither a boom nor a recession. It has to be in one or the other.

To say that the Bureau is fallible should go without saying; but instead, its pronouncements are taken as divine writ. Why is that? Precisely because the Bureau was cleverly designed, and so proclaimed, to be an allegedly value-free, purely “scientific” institution.

The Bureau is a private institution, supported by a large group of associations and institutions, business and union groups, banks, foundations, and scholarly associations, which confer upon it an almost painful respectability. Its numerous books and monographs are very long on statistics, short on text or interpretation. Its proclaimed methodology is Baconian: that is, it trumpets the claim that it has no theories, that it collects myriads of facts and statistics, and that its cautiously worded conclusions arise solely, Phoenix-like, out of the data themselves. Hence, its conclusions are accepted as unquestioned holy “scientific” writ.

And yet, despite its proclamations, the National Bureau’s procedures themselves necessarily manipulate the data to arrive at conclusions. And these procedures are not free of theory, indeed they rest on faulty and questionable theoretical assumptions. Hence, the conclusions, far from being strictly “scientific,” are skewed and misshaped to the extent that they are determined by the procedures themselves.

Specifically, the Bureau selects “reference cycles,” of the general economy, and then examines “specific cycles” of particular prices, production, etc. and compares these with the reference cycles. Unfortunately, all depends on the Bureau’s dating theory, that is, it picks out only the trough and peak months, first for the general cycles, and then for each specific cycle. But suppose, as in many cases, the curve is flat, or there are several peaks or troughs close to each other.

In these cases, the Bureau arbitrarily takes the last month of the plateau, or the multi-peak or trough period, and calls that the peak or trough month. There is no earthly economic reason for this; why not take the whole period as a peak or trough period, or average the data, or whatever? Instead, the Bureau takes only the last month and calls that the peak or trough, and then compounds that error by arbitrarily squeezing the distance between the designated “peak month” and “trough month” into three equal parts, and assuming that everything in between peak and trough is a straight line of expansion or contraction, boom or bust.

In other words, in the real world, any given time series, say copper prices, or housing starts in California, might have dawdled near the trough, gone quickly upward, and stayed at a plateau or multi-peak for many months. But on the Procrustean rack of National Bureau doctrine, the activity is squeezed into a single, one-month trough; a straight line expansion, divided into three parts by time; reaching a single-month peak; and then going down in a similar linear, jagged-line contraction. In short, National Bureau methods inevitably force the economy to look falsely like a series of jagged, saw-toothed, straight lines upward and downward. The triumphant conclusion that “life is a series of sawtooth lines” is imposed by the way the Bureau massages the data in the first place.

That massaging is bad enough. But then the Bureau compounds the error by averaging all the specific cycles, its leads and lags, etc. as far as the data will go back, say from the 1860s to the 1980s. It is from that averaging that the Bureau has developed its indices of “leading . . . coincident,” and “lagging” indicators, the first of which are supposed to (but not very successfully) forecast the future.

The problem with this averaging of cycle data over the decades is that it assumes a “homogeneous population,” that is, it assumes that all these cycles, say for copper prices or housing starts in California, are the same thing, and operate in the same context over all these decades. But that is a whopping assumption; history means change, and it is absurd to assume that the underlying population of all this data remains constant and unchanging, and therefore can be averaged meaningfully.

When the National Bureau set forth this methodology in Arthur F. Burns and Wesley C. Mitchell, Measuring Business Cycles (National Bureau of Economic Research, 1946), it was correctly criticized by a distinguished econometrician for being “Measurement without Theory” in the Journal of Political Economy, but still it quickly swept the board to achieve oracular status.

Particularly irritating were the claims of the Bureau that those of us who held definite business cycle theories were partial and arbitrary, whereas the Bureau spoke only from the facts of hard, empirical reality. Yet the Bureau has had far less respect for empirical reality than have allegedly “anti-empirical” Austrians. Austrians realize that empirical reality is unique, particularly raw statistical data. Let that data be massaged, averaged, seasonals taken out, etc. and then the data necessarily falsify reality. Their Baconian methodology has not saved the Bureau from this trap; it has only succeeded in blinding them to the ways that they have been manipulating data arbitrarily.

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First published in June 1988.

67

INFLATIONARY RECESSION, ONCE MORE

I am by no means a complete “contrarian,” but I have one contrarian index to offer as a sound “leading indicator” of recession: every time Establishment economists and financial writers trumpet the existence of a brave new world of permanent boom with no more recessions, I know that a big recession is just around the corner.

It never fails. During the late 1920s the Establishment, led by proto-Friedmanite economist Irving Fisher, proclaimed a “New Era,” an era of permanent boom with no more depressions—all because of the wise fine-tuning of that wonderful new institution, the Federal Reserve System. And then came 1929.

During the 1960s we were assured by the Keynesian Establishment that business cycles were a relic of the bygone Bad Old Days of laissez-faire: that wise fine-tuning by Keynesian officials would insure a world of continuous full employment without inflation. So sure of themselves were Establishment economists that “Business Cycle” courses in graduate school were abolished.

Why linger in the antiquities of a pre-modern world? Instead, they were replaced by courses in “Macroeconomics” and “Economic Growth.” And then bingo! came not only the deep recessions, but the seemingly impossible phenomenon of inflationary recessions: recessions and price inflation at the same time, first in 1973–75, and then the two-humped recession of 1980–82, the biggest and steepest recession since the Great Depression. (In the old days, such major recessions would have routinely been called “depressions,” but therapy-by-semantics has taken over, and the word “depression” has been effectively outlawed as too . . . depressing.)

And now, in the middle and late 1980s, the Reaganite Establishment began to assure us that, once again, a new economic era had arrived, that the miracle of the Reagan tax cuts (actually non-existent) had, along with a more global and technologically sophisticated technology, assured us that there would never be any more recessions, except perhaps some painless rolling readjustments in specific industries or regions.

It was time for another Big One, and sure enough, here we are. Not only has the Establishment forgotten about recessions, but in particular they totally forgot that postwar recessions have been inflationary. Combining the worst of both worlds, unemployment, bankruptcies, and declines of activity have been accompanied by steep increases in the cost of living. A half-century of Keynesian fine-tuning (from which we still suffer, despite the Reaganaut label) has not cured inflation or recessions; it has only accomplished the feat of bringing us both at the same time.

Everyone is afraid to use his judgment on whether we are in a recession; it has become the custom of everyone to await breathlessly the pronouncement of the National Bureau of Economic Research (NBER), a much revered private institution which has established a Dating Committee of a handful of experts, who sift the data to figure out when, if ever, a recession has begun. The problem is that it takes many months into a recession for the NBER to make up its mind: by the time it pronounces that we’re in a recession, it is almost over. Thus, the steep recession that started in November 1973 was only pronounced a recession a year later; but six months after that, by March 1975, we were on the way to recovery. Most recessions are over in a year or year and a half. Of course, maybe that’s the point: for the Establishment to lull us all to sleep until the recession is over.

The reason why it takes the NBER such a long time to make up its mind, is because it feels that it has to get the precise month of the onset of the recession absolutely right; and the reason it suffers from this precise month fetish (which, in all reason and common sense, doesn’t make a heck of a lot of difference) is because the entire deeply flawed NBER approach to business cycles depends on getting the “reference month” down precisely, and then basing all of its averages, and leads and lags, on that particular month. To date the recession one or two months either way would mess up all the calculations based on the NBER paradigm. And that, of course, comes first, way before trying to figure out what is going on and getting the knowledge to the public as quickly as possible.

Looking at the housing market, unemployment, debt liquidation, and many other factors in 1988, I am willing to state flatly that we are in another inflationary recession. What does this mean? It is heartwarming to see some economists welcoming the recession as having an important cleansing effect on malinvestment and unsound debt, paving the way for more rapid and more sustainable economic growth. Thus, Victor Zarnowitz of the University of Chicago states that “it may be healthier for the economy to endure an occasional recession . . . than to grow sluggishly for a prolonged period,” and David A. Poole, economist of Van Eck Management Corp., warns that there shouldn’t be a recovery too soon, presumably stimulated by government, for then “the recessionary cleansing process will not have had time to work.” Welcome to Austrian Economics!

But how is the current Establishment (the Bush administration center plus Democratic left-liberalism) proposing to deal with this recession? Remarkably, by violating every tenet of every school of thought known to economics: by steeply raising taxes! Every school: Austrian, Keynesian, monetarist, or classical, would react in horror to such a plan, which obviously worsens a recession by lowering saving and investment, and productive (as opposed to parasitic and wasteful government) consumption. Raising taxes does nothing to help the inflation, and does a lot to make the recession more severe; and it aggravates the deadweight burden of government on the economy.

But wouldn’t raising taxes cure the budget deficit? No, it would only give government an excuse (as if they needed one!) to increase the burden of government spending still further. The one thing worse than a deficit, furthermore, is higher taxes; increasing taxes will only bring us more of both.

Can’t the government do anything to alleviate our current inflationary recession? Yes, it can, and quickly. (Never say that Austrians can’t come up with positive, even short-run, suggestions for government policy.)

First, to stop the inflationary part of current crisis, the Federal Reserve can stop, permanently, all further purchase of any assets, or lowering of reserve ratios. This will stop all future inflationary credit expansion. Second, it can cut all taxes drastically: sales, excise, capital gains, medicare, social security, and income (for upper, middle, and lower incomes). Third, it can cut government spending, everywhere, even more drastically: thus cutting the deficit as well as all its other benefits. And that’s for openers. You think Newt Gingrich is tough?

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First published in January 1991.

68

DEFLATION, FREEOR COMPULSORY

Few occurrences have been more dreaded and reviled in the history of economic thought than deflation. Even as perceptive a hard-money theorist as Ricardo was unduly leery of deflation, and a positive phobia about falling prices has been central to both Keynesian and monetarist thought.

Both the inflationary spending and credit prescriptions of Irving Fisher and the early Chicago School, and the famed Friedmanite “rule” of fixed rates of money growth, stemmed from a fervid desire to keep prices from falling, at least in the long run.

It is precisely because free markets and the pure gold standard lead inevitably to falling prices that monetarists and Keynesians alike call for fiat money. Yet, curiously, while free or voluntary deflation has been invariably treated with horror, there is general acclaim for the draconian, or compulsory, deflationary measures adopted recently—especially in Brazil and the Soviet Union—in attempts to reverse severe inflation.

But first, some clarity is needed in our age of semantic obfuscation in monetary matters. “Deflation” is usually defined as generally falling prices, yet it can also be defined as a decline in the money supply which, of course, will also tend to lower prices. It is particularly important to distinguish between changes in prices or the money supply that arise from voluntary changes in people’s values or actions on the free market; as against deliberate changes in the money supply imposed by governmental coercion.

Price deflation on the free market has been a particular victim of deflation-phobia, blamed for depression, contraction in business activity, and unemployment. There are three possible causes for such deflation. In the first place, increased productivity and supply of goods will tend to lower prices on the free market. And this indeed is the general record of the Industrial Revolution in the West since the mid-eighteenth century.

But rather than a problem to be dreaded and combatted, falling prices through increased production is a wonderful long-run tendency of untrammelled capitalism. The trend of the Industrial Revolution in the West was falling prices, which spread an increased standard of living to every person; falling costs, which maintained general profitability of business; and stable monetary wage rates—which reflected steadily increasing real wages in terms of purchasing power.

This is a process to be hailed and welcomed rather than to be stamped out. Unfortunately, the inflationary fiat money world since World War II has made us forget this home truth, and inured us to a dangerously inflationary economic horizon.

A second cause of price deflation in a free economy is in response to a general desire to “hoard” money which causes people’s stock of cash balances to have higher real value in terms of purchasing power. Even economists who accept the legitimacy of the first type of deflation react with horror to the second, and call for government to print money rapidly to prevent it.

But what’s wrong with people desiring higher real cash balances, and why should this desire of consumers on the free market be thwarted while others are satisfied? The market, with its perceptive entrepreneurs and free price system, is precisely geared to allow rapid adjustments to any changes in consumer valuations.

Any “unemployment” of resources results from a failure of people to adjust to the new conditions, by insisting on excessively high real prices or wage rates. Such failures will be quickly corrected if the market is allowed freedom to adapt—that is, if government and unions do not intervene to delay and cripple the adjustment process.

A third form of market-driven price deflation stems from a contraction of bank credit during recessions or bank runs. Even economists who accept the first and second types of deflation balk at this one, indicting the process as being monetary and external to the market.

But they overlook a key point: that contraction of bank credit is always a healthy reaction to previous inflationary bank credit intervention in the market. Contractionary calls upon the banks to redeem their swollen liabilities in cash is precisely the way in which the market and consumers can reassert control over the banking system and force it to become sound and non-inflationary. A market-driven credit contraction speeds up the recovery process and helps to wash out unsound loans and unsound banks.

Ironically enough, the only deflation that is unhelpful and destructive generally receives favorable press: compulsory monetary contraction by the government. Thus, when “free market” advocate Collor de Mello became president of Brazil in March 1990, he immediately and without warning blocked access to most bank accounts, preventing their owners from redeeming or using them, thereby suddenly deflating the money supply by 80 percent.

This act was generally praised as a heroic measure reflecting “strong” leadership, but what it did was to deliver the Brazilian economy the second blow of a horrible one-two punch. After governmental expansion of money and credit had driven prices into severe hyperinflation, the government now imposed further ruin by preventing people from using their own money. Thus, the Brazilian government imposed a double destruction of property rights, the second one in the name of the free market and “of combatting inflation.”

In truth, price inflation is not a disease to be combatted by government; it is only necessary for the government to cease inflating the money supply. That, of course, all governments are reluctant to do, including Collor de Mello’s. Not only did his sudden blow bring about a deep recession, but the price inflation rate, which had fallen sharply to 8 percent per month by May 1990, started creeping up again.

Finally, in the month of December, the Brazilian government quickly expanded the money supply by 58 percent, driving price inflation up to 20 percent per month. By the end of January, the only response the “free market” government could think of was to impose a futile and disastrous price and wage freeze.

In the Soviet Union, President Gorbachev, perhaps imitating the Brazilian failure, similarly decided to combat the “ruble overhang” by suddenly withdrawing large-ruble notes from circulation and rendering most of them worthless. This severe and sudden 33 percent monetary deflation was accompanied by a promise to stamp out the “black market,” i.e., the market, which had until then been the only Soviet institution working and keeping the Soviet people from mass starvation.

But the black marketeers had long since gotten out of rubles and into dollars and gold, so that Gorby’s meat axe fell largely on the average Soviet citizen, who had managed to work hard and save from his meager earnings. The only slightly redeeming feature of this act is that at least it was not done in the name of privatization and the free market; instead, it was part and parcel of Gorbachev’s recent shift back to statism and central control.

What Gorbachev should have done was not worry about the rubles in the hands of the public, but pay attention to the swarm of new rubles he keeps adding to the Soviet economy. The prognosis is even gloomier for the Soviet future if we consider the response of a leading allegedly free-market reformer, Nicholas Petrakov, until recently Gorbachev’s personal economic adviser. Asserting that Gorbachev’s brutal action was “sensible,” Petrakov plaintively added that “if, in the future, we go on just printing more money everything will just go back to square one.” And why should anyone think this will not happen?

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First published in April 1991.

69

BUSHANDTHE RECESSION

Unfortunately, John Maynard Keynes, the disastrous and discredited spokesman and inspiration for the macroeconomics of virtually the entire world since the 1930s (and that includes the Western World, the Third World, the Gorbachev era, as well as the Nazi economic system), still lives. President Bush’s reaction to this grim recession has been Keynesian through and through not surprising, since his economic advisers are Keynesian to the core.

Since Keynesians are perpetual trumpeters for inflationary credit expansion, they of course do not talk about the basic cause of every recession; previous excesses of inflationary bank credit, stimulated and controlled by the central bank—in the U.S., the Federal Reserve system. To Keynesians, recessions come about via a sudden collapse in spending—by consumers and by investors. This collapse, according to Keynesians, comes about because of a decline in what Keynes called “animal spirits”: people become worried, depressed, apprehensive about the future, so they invest, borrow, and spend less.

The Keynesian remedy to this “market failure” brought about by private citizens being irrational worry-warts, is provided by good old government, the benevolent Mr. Fixit. When guided by wise and coolheaded Keynesian economists, government is able, as a judicious seacaptain at the helm, to compensate for the foolish whims of the public and to steer the economy on a proper and rational course.

There are, then, two anti-recession weapons available to government in the Keynesian schema. One is to spend a lot more money, particularly by incurring large-scale deficits. The problem with this weapon, as we all know far too well, is that government deficits are now permanently and increasingly stratospheric, in good times as well as bad. Current estimates for the federal deficit, which almost always prove too low, are approaching the annual rate of $500 billion (especially if we eliminate the phony accounting “surplus” of $50 billion in the Social Security account).

If increasing the deficit further is no longer a convincing tool of government, the only thing left is to try to stimulate private spending. And the principal way to do that is for the government to soft-soap the public, to treat the public as if it were a whiny kid, that is: to stimulate its confidence that things are really fine and getting better so that the public will open its purses and wallets and borrow and spend more.

In other words, to lie to the public “for its own good.” Except that many of us are convinced that it’s really lying for the good of the politicians, so that the deluded public will continue to have confidence in them. Hence all the disgraceful gyrations of the Bush administration: the year-long claim that we weren’t in a recession, then the idea that we had been in it but were now out, then the soft-soap about a “weak recovery,” then the nonsense about “double-dip” recession, and all the rest. Only when an aroused public hit him in the face did the President acknowledge that there’s a real problem, and that maybe something should be done about it.

But what to do, within the Keynesian framework? First, the Fed drove down interest rates, expecting that now people would borrow and spend. But no one feels like lending and borrowing in recessions, and so nothing much happened, except that short-term Treasury securities got cheaper to buy—not very useful for the private economy. But, darn it, credit card rates stayed high, so Bush got the idea of talking down credit card rates, stimulating more consumers to borrow.

The resulting fiasco is well-known. Senator Al D’Amato (RNY), ever the eager beaver, figured that forcing rates down is more effective than talking them down, and so Congress only just missed passing this disaster by a vigorous protest of the banks and a mini-crash in the stock market bringing it to its senses. Outgoing chief-of-staff John Sununu, as ever attentive to the actions of “this President,” tried to justify Bush’s jawboning as correct, asserting that Congress’s error was to try coercion.

But Bush’s idea of talking credit card rates down was only slightly less idiotic than forcing them down. The point is that prices on the market, including interest rates, are not set arbitrarily, or according to the good or bad will of the sellers or lenders. Prices are set according to the market forces of supply and demand.

Credit card rates did not stay high because bankers decided to put the screws to this particular group of borrowers. The basic reason for credit card rates staying high is because the public—in its capacity as borrowers, not in its capacity as economic pundits—doesn’t care that much about these rates. Consumers are not credit-card rate sensitive.

Why? Because basically there are two kinds of credit-card users. One is the sober, responsible types who pay off their credit cards each month, and for whom interest charges are simply not important. The other group is the more live-it-up types such as myself, who tend to borrow up to the limit on their cards. But for them, interest rates are not that important either: because in order to take advantage of low-rate cards (and there are such around the country), they would have to pay off existing cards first—a slow process at best.

There was another gaping fallacy in the Bush-D’Amato attitude, which the bankers quickly set them straight about. Interest rates are not the only part of the credit-card package. There is also the quality of the credit: the ease of getting the card, the requirements for getting it and keeping it, as well as the annual fee, etc. As the banks pointed out, at a 14 instead of a 19 percent rate, far fewer people are going to be granted credit cards. Pathetically, the only positive thing that President Bush can think of to speed the recovery is to spend money faster, that is: to step up government spending, and hence the deficit, early in the year, presumably to be offset later by a fall in its rate of spending.

What about tax cuts? Here the Bush administration is trapped in the current Keynesian view that, the deficits already being too high, every tax cut must be balanced by a tax increase somewhere else: i.e., be “revenue neutral.” Hence, the administration feels limited to the correct but picayune call for a cut in the capital gains tax, since this presumably will be made up by a supply-side increase to keep total revenue constant.

What is needed is the courage to bust out of this entire fallacious and debilitating Keynesian paradigm. Massive tax cuts, especially in the income tax are needed (a) to reduce the parasitic and antiproductive burden of government on the taxpayer, and (b) to encourage the public to spend and especially to save more, because only through increased private savings will there come greater productive investment.

Moreover, the increased saving will speed recovery by validating some of the shaky and savings-starved investments of the previous boom. First of all, massive tax cuts may force the government to reduce its own swollen spending, and thereby reduce the burden of government on the system. And second, if this means that total government revenue is lower, so much the better. The burden of tax-rates is twofold: rates that are high and cripple savings and investment activity; and revenues that are high and siphon off money from the productive private sector into wasteful government boondoggles. The trouble with the supply-siders is that they ignore the second burden, and hence fall into the Keynesian-Bush “revenue-neutral” trap.

And finally, if the Bush administration is so worried about the deficit, it should do its part by proposing drastic cuts in government spending, and justify it to the public by showing that government spending is not helpful to a prosperous economy but precisely the opposite. Then, if Congress rejects this proposition, and keeps increasing spending, the Administration could put the onus for prolonging the recession squarely upon Congress. But of course it can’t do so, because that would mean a fundamental break with the Keynesian doctrine that has formed the paradigm for the world’s macroeconomics for the past half-century.

We will never break out of our economic stagnation or our boom-bust cycles and achieve permanent prosperity until we have repudiated Keynes as thoroughly and as intensely as the peoples of Eastern Europe and the Soviet Union have repudiated Marx and Lenin. The real way to achieve freedom and prosperity is to hurl all three of these icons of the twentieth century into the dustbin of history.

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First published in February 1992.

70

LESSONSOFTHE 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 irreparable 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 shareholders 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 in the unlikely event that banks could not stimulate further loans, they can always use their reserves to purchase securities, and thereby push money out into the economy. The key is whether or not the banks pile up excess reserves, failing to expand credit up to the limit allowed by legal reserves. The crucial point is that never have the banks done so, in 1990 or at any other time, apart from the single exception of the 1930s. (The difference was that not only were we in a severe depression in the 1930s, but that interest rates had been driven down to near zero, so that the banks were virtually losing nothing by not expanding credit up to their maximum limit.) The conclusion must be that the Fed pushes with a stick, not a string.

Early this year, moreover, the money supply began to spurt upward once again, putting an end, at least for the time being, to deflationist warnings and speculations.

Lesson #6: The banks might collapse. Oddly enough there is a possible deflation scenario, but not one in which the deflationists have ever expressed interest. There has been, in the last few years, a vital, and necessarily permanent, sea-change in American opinion. It is permanent because it entails a loss of American innocence. The American public, ever since 1933, had bought, hook, line and sinker, the propaganda of all Establishment economists, from Keynesians to Friedmanites, that the banking system is safe, SAFE, because of federal deposit insurance.

The collapse and destruction of the savings and loan banks, despite their “deposit insurance” by the federal government, has ended the insurance myth forevermore, and called into question the soundness of the last refuge of deposit insurance, the FDIC. It is now widely known that the FDIC simply doesn’t have the money to insure all those deposits, and that in fact it is heading rapidly toward bankruptcy.

Conventional wisdom now holds that the FDIC will be shored up by taxpayer bailout, and that it will be saved. But no matter: the knowledge that the commercial banks might fail has been tucked away by every American for future reference. Even if the public can be babied along, and the FDIC patched up for this recession, they can always remember this fact at some future crisis, and then the whole fractional-reserve house of cards will come tumbling down in a giant, cleansing bank run. To offset such a run, no taxpayer bailout would suffice.

But wouldn’t that be deflationary? Almost, but not quite. Because the banks could still be saved by a massive, hyper-inflationary printing of money by the Fed, and who would bet against such emergency rescue?

Lesson #7: There is no “Kondratieff cycle,” no way, no how. There is among many people, even including some of the better hard-money investment newsletter writers, an inexplicable devotion to the idea of an inevitable 54-year “Kondratieff cycle” of expansion and contraction. It is universally agreed that the last Kondratieff trough was in 1940. Since 51 years have elapsed since that trough, and we are still waiting for the peak, it should be starkly clear that such a cycle does not exist.

Most Kondratieffists confidently predicted that the peak would occur in 1974, precisely 54 years after the previous peak, generally accepted as being in 1920. Their joy at the 1974 recession, however, turned sour at the quick recovery. Then they tried to salvage the theory by analogy to the alleged “plateau” of the 1920s, so that the visible peak, or contraction, would occur nine or ten years after the peak, as 1929 succeeded 1920.

The Kondratieffists there fell back on 1984 as the preferred date of the beginning of the deep contraction. Nothing happened, of course; and, now, seven years later, we are in the last gasp of the Kondratieff doctrine. If the current recession does not, as we have maintained, turn into a deep deflationary spiral, and the recession ends, there will simply be no time left for any plausible cycle of anything approaching 54 years. The Kondratieffist practitioners will, of course, never give up, any more than other seers and crystal-ball gazers; but presumably, their market will at last be over.

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First published in July 1991.

71

THE RECESSION EXPLAINED

“Itold you so!” may not be considered polite among Recession friends or acquaintances, but in ideological clashes it is important to remind one and all of your successes, since neither the indifferent nor your enemies are likely to do the job for you.

In the case of Austrian business cycle theory, shouldering this task is particularly important. For not only have our ideological and methodological enemies been all too quick to bury Austrian theory as either (a) hopelessly Neanderthal and reactionary, and/or (b) obsolete in today’s world, but also many of our erstwhile friends and adherents have been joining the chorus, maintaining that Austrian theory might have been applicable in the 1930s, or, more radically, only in the 19th century, but that it definitely has no application in the modern economy.

Well, to paraphrase the great philosopher Etienne Gilson on natural law, Austrian cycle theory always survives to bury its enemies. In contrast to conventional wisdom, from Keynesian to monetarist to eclectic, Austrian theory has recently triumphed over its host of detractors in the following ways:

1. The perpetual boom of the ’80s. As the 1980s went on, the Conventional Wisdom (CW) trumpeted that recessions were a thing of the dead and unlamented past. Here was a new era, of perpetual prosperity. Wise governmental fiscal and monetary policies, combined with structural changes such as the age of the computer and global capital markets, have made sure that we never have a recession again, that 1981–82 was the Last Recession.

I have long asserted that the best “leading indicator” of a recession is when the CW has started proclaiming the end of the business cycle and perpetual prosperity. Sure enough, here we are, and, as Austrians point out, the bigger and the longer the boom, the greater and deeper will tend to be the recession necessary to wash out the distortions and malinvestment of the inflationary boom, brought on by bank credit expansion.

2. The end of inflation. During the great boom of the ’80s, the CW also proclaimed that inflation was a thing of the past. It was over, licked. Again: wise government monetary and fiscal policies, coupled with structural economic changes, and “efficient markets,” insured that inflation was finished. And yet, inflation, which never really disappeared, is back in full force, and is even stronger now, in the depths of recession, than it was during most of the boom—a sure sign that not only is inflation still with us, but that it is going to pose a severe and accelerating problem as soon as recovery occurs.

3. (A corollary of one and two.) They forgot about inflationary recession. Inflation has persisted in every post-World War II recession since 1973–74, and indeed really began in the 1957–58 recession, after a couple of years of recovery. Yet everyone—and that means everyone including all wings of Establishment economics, and financial writers and forecasters—forgets all about the new reality of inflationary recession (also called “stagflation”), and writes and talks as if the choice in the coming months is always between inflation or recession.

There is a long-running dispute among Austrian economists on whether market participants can or do learn from experience. Whatever the answer is (and I believe it is “yes”), it becomes increasingly clear that the body of economists and the financial press seem to be incapable of this simple learning experience. Look fellas: every recession is going to be inflationary from now on.

Presumably, the reason for this failure to learn is because it violates the basic theoretical prejudices of both Keynesian and monetarist economists: that either we are experiencing an inflationary boom or we are in a recession, never both. And indeed, no one can truly learn about these matters without a correct theory. But it just so happens that Austrian theory alone predicts and explains why all recessions, precisely in the modern world, will be inflationary. The reason: the scrapping of the gold standard and the shift to fiat money in the 1930s meant that there is no longer any restraint on the government or the Federal Reserve from creating as much money as it wishes—and it always wishes. This act does not eliminate business cycles; in fact, it makes them worse, by adding inflation and rising costs of living on top of recessions, falling asset values, bankruptcies, and unemployment.

4. The average person knows when we’re in a recession long before economists do. Establishment economists, mired in their methodology of statistical correlation based on precise dating of cycle peaks and troughs, take a very long time to decide the precise month of the peak—in the current recession, July 1990. It took almost a year after that point before economists deigned to tell us what we already all knew: that we were in a big recession.

5. The average person knows we’re in a recession long after the economists have proclaimed “recovery.” Here we have a failing among economists far less excusable than methodological error. For hardly were we told, at long last, that we were in a recession, when the Establishment hastened to tell us that recovery was already under way. In a spectacular mistake, Establishment economists, professionally and politically bedded, as any Administration is, to Pollyanna optimism, hastened to assure us that the recession was over by the beginning of the third quarter of 1991.

When it came to forecasting recovery, professional economic caution was shamefully thrown to the winds. Ever since the middle of 1991, the political and economic establishment has been desperately searching for signs of “recovery.” “Well, it’s there but it’s feeble”; “recoveries always begin weakly”; and on and on. Finally, by November, as most indices were clearly getting worse, economists, reluctant to admit their glaring error of the summer, started muttering about a possible “double-dip recession,” about the danger of “slipping back into recession,” etc. Look, let’s face reality, and let the revered Dating Committee of the National Bureau of Economic Research, the semiofficial but universally exclaimed gurus of business cycle dating, go hang.

6. Once a recession has taken hold, the government cannot inflate out of it; government can only delay recovery, not hasten it. This is a vital truth of Austrian economics that has been absorbed by virtually no one. Once a recession is underway, Keynesian-monetarist type stimulation: cheap money, accelerating the money supply, etc., can only make things worse. But look at what has happened to such alleged anti-inflation “hawks” as Alan Greenspan and the Cleveland Fed: as soon as the recession took hold, and even though inflation is now worse than it has been in years, they have all thrown over their alleged anti-inflation principles and have been cutting interest rates like mad, trying rashly and vainly to hype the sick horse with another shot of inflationary stimulus.

7. Tax cuts are good in a recession, or any other time. Students of human folly can only stand in wonder at the Keynesian, one of whose traditional proposals was for tax cuts during recession, suddenly adopting a conservative, monetarist stance. During this recession, Keynesians declare that “yes, well, tax cuts are good in theory (?) but they won’t help us out of recession, because of inevitable lag in the results of fiscal policy.” The complaint is that the cuts will only take effect after a recovery (they hope) has already begun. Well, so what?

Tax cuts are good at any time, especially for the long run. Apart from the business cycle, the American economy has been suffering from stagnation for the past twenty years; since 1973, the American standard of living has been level and even slightly declining. This is a highly worrisome feature of the modern American economy. One way to remedy this problem is tax cuts, the deeper the better. Keynesian tax cuts were only designed to stimulate consumer spending in recession; Austrian tax cuts are a means of partially loosening the fetters by which the government has been chaining and binding down the private and productive sector of the economy, a crippling effect that has gotten steadily worse in recent years.

But what about the deficit? The deficit is indeed monstrous and out of control, but the one way it should not and cannot be combatted is by raising taxes or keeping them high. Lower taxes would mean that government spending would have to be cut, and government spending cuts are the only sound way to cure deficits. Indeed, Austrian theory is unique in advocating government spending cuts even in a recession as a way to shift social spending from excessive consumption to much needed saving-and-investment. For, contrary to Keynesian myth, government spending is not “investment” at all (a cruel joke), but is wasteful “consumption” spending. The “consumers,” in this case, are the politicians and government officials who leech off the productive private sector.

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First published in January 1992.