; H. Sennholz

It does not matter whether they fully understand the ultimate causes ·of the economic dilemma. They usually know from experi ence that a boom created by infla tion or credit expansion cannot last and must lead to a slump. This is why they often call on econo mists and expect of them what is beyond the ability of any man. It is true, many economists can explain logically why the boom plants the seeds for depression. They are aware of the differences between simple inflation and credit expansion, which confuse most 11 12 THE FREEMAN January businessmen. But they have no special crystal ball through which they can view the future. Simple Inflation It does not matter whether the government treasury issues new legal tender notes directly to the people or places its obligations in the banking system which then monetizes the debt. In both cases the proceeds accrue to the govern ment for deficit spending, which is the characteristic of simple in flation. It creates an atmosphere of prosperity and affluence. While many prices rise, business profits a.re good, stock market profits are excellent, and wages soar. It is true, the unfortunate victims of inflation, such as pensioners and individuals who live on fixed in comes, are forced to curtail their consumption. But most business men, workers, and government employees are led to increase their consumption. In fact, businessmen may even consume some capital.

In addition, the expectation of rising prices causes many people to reduce their cash holdings. They prefer to purchase goods and services now before prices rise again. And this reduction in cash holdings in turn raises goods prices even further. Economic production promptly adjusts to the inflation pattern of spending. Industries catering to government demand and consum ers' goods prosper and expand; other industries tend to lose some capital and labor. In fact, the capi tal consumption by government and business, in addition to the malinvestment of capital in in flated consumers' goods industry, creates a general shortage of capi tal. Interest rates soar. If the in flation is continued, interest rates will rise to astronomical levels, the purchasing power of money will fall, and the economy sink into deterioration and depression. If the inflation should be halted before that dreadful finale, the economy will suffer the pains of readjustment. The inflated indus tries will contract, evidencing the symptoms of depression, stock prices decline, and interest rates fall. When the people are finally convinced that the inflation has come to an end, they may restore their normal cash holdings, which reaction tends to raise the value of money and reduce goods prices.

And business will evidence more symptoms of recession. Economists know all this. But they cannot know when the gov ernment will halt the inflation. After all, this is an arbitrary de cision by the monetary authorities moved by political consideration, pressured by the beneficiaries of inflation, and misguided by infla tionary doctrines. Even the mone1970 'FORECASTING 13 tary authorities themselves may not know whether and when they will make the decision. Will they really stabilize the currency or merely reduce the rate of infla tion? When will they resume the inflation? At what rate? And fi nally, no one can foresee the re action of the people. When will they increase their cash holdings? How much? Credit Expansion Credit expansion differs materi ally from simple inflation. Newly created money enters the loan market where it lowers the inter est rate. The U.S. government may balance its budget, but in order to stimulate business and promote full employment it may flood the banking system with new credits.

The lower interest rates induce business to embark upon ambi tious proj ects of expansion and modernization, which leads to a boom in such capital goods indus tries. as steel and tool making. It is obvious that this boom lacks the real capital that flows from savings and profits plowed back. It is based on newly created money and therefore, sooner or later, must induce the feverish chills, of a maladj usted economy. The boom activity pushes up the prices of capital goods which are business costs. Also, labor costs tend to rise, which leads to greater consumption expenditures and higher consumers' goods prices. But they usually trail be hind the prices of producers' goods, which gradually reduce the profit margins of business. When the growing maladj ustment .of prices and costs finally inflict busi ness losses, the depression· begins. It is a period of readjustment and correction, in accordance with the true state of consumer choices and capital markets.

Many economists understand the causal connections of boom and de pression. They know the irrepara ble harm done by credit expansion artificially induced in the struc ture of economic production. But they cannot possibly know the minds of .the monetary authorities who initiate the credit expansion. How long will these men continue to feed the boom with more money? When will they finally be frightened by the consequences of their policies and decide to aban don.them? Will they substitute credit contraction for expansion, or merely stabilize the money sup ply? Will they pursue the new course with conviction or waver between the new and the old? And when will the public realize that the signals have changed? What will·trigger the stock market panic which indicates that the multi tudes of investors are finally rec ognizing the change of signals and 14 THE FREEMAN January rushing to adjust their invest ments to the new situation?

The Future Cannot be Calculated There are no rules covering the political actions of man or fixing the time of his reaction. The fu ture is uncertain, and therefore, it is impossible to calculate the fu ture structure of the market. In fact, there are no constant rela tions in economics. For instance, the effects of a 10 per cent expan sion of the money supply on goods prices is unpredictable. Prices may rise little or much, depend ing on the reaction of men to the inflation. A bumper crop of wheat that exceeds last year's crop by 20 per cent may cause prices to fall little or greatly, depending on the variable behavior of men. If a statistician ascertains that prices actually declined 5 per cent at a certain point of time in a certain market, he merely established a historical fact, no constant meas urable relationship that is valid for all times and places. In the natural sciences, the in dividual factors of change can be observed and measured in isola tion. But no such isolation is pos sible in human action. Experi ences are always complex phe nomena that do not provide the factual bases on which theories and predictions can be built. They cannot be made "quantitative" and be measured.

Quantitative economics, as it is practiced by central planners and would-be dictators, also disre gards the market process. Its equations merely describe imagi nary states of rest and equilib rium. It cannot explain why and how such states are brought about and cannot analyze actions that bring changes to the market process. The quantitative econ omist cannot perceive the activi ties of enterprising men, the en trepreneurs and speculators, who continually rearrange economic production in order to profit from price changes. In short, the eco nomics of central planners is in capable of dynamic analysis; it is static and therefore contributes nothing to the elucidation of the market process. It miscalculates the future every time. Entrepreneurial Judgment The world is a scene of changes. Today is not yesterday, and to morrow will not be today. We our selves change. How, then, can we foretell man's works and deeds of tomorrow? Change, indeed, is painful, yet ever needful.

Entrepreneurs as businessmen and investors speculate on eco nomic changes. They· expose their wealth and income to the changes in the market place. In anticipa1970 FORECASTING 15 tion of specific changes they re arrange their factors of produc tion in order to prepare for future consumer wants. If they antici pate future changes correctly, they will earn entrepreneurial profits; if their judgments are wrong, they will suffer losses. Genuine profits, which must be distinguished from interest on in vested capital and managerial re muneration of the businessman, flow from the correct anticipation of future changes in demand and supply, resulting from changes in fashion and technology, govern ment intervention, labor union policy, competition, and even the weather. On the search for such profits entrepreneurs must walk lonely roads, for profits can be found only where others have not prepared for changes and failed to adjust in time. When the multi tude of investors arrives on the scene, the readj ustment has been completed, and the opportunity for profit has disappeared. In fact, the multitude of late-comers usually overreacts and thereby creates new maladjustments which neces sitate more readjustments.

Entrepreneurs do not depend on economists for reliable informa tion about the future. They are skeptical about economists' advice and prognostication. But they are ever mindful of. the need for re liable information on all relevant data. This is why they read the financial pages of newspapers and magazines, subscribe to advisory services, employ business econo mists, listen to the promises of government officials and watch their actions. Nothing must es cape them. But all the data gath ered cannot remove the uncertainty of the future. More than 1,500 years ago Saint Augustine offered this explana tion: "God will not suffer man to have a knowledge of things to come; for if he had prescience of his prosperity, he would be care less; and if understanding of his adversity, he would be despairing and senseless." ® IDEAS ON LIBERTY Historical Analysis IN RETROSPECT historical analysis tries to show us that the out come could not have been different from what it really was. Of course, the effect is always the necessary resultant of the factors operating. But it is impossible to deduce with certainty ... the future conduct of men, whether individuals or groups of indi viduals.

LUDWIG VON MISES, Theory and History Statist Bureaucracy in the Modern Economy GARY NORTH r-/ Where distinction and rank are achieved almost exclusively by becoming a salaried servant of the state, where to do one's assigned duty is regarded as more laudable than to choose one's own field of usefulness, where all pursuits that do not give a recognized place in the official hierarchy or a claim to a fixed income are regarded as inferior and even somewhat disreputable, it is too much to expect that many will long prefer freedom to security. F. A. HAYEK! ! The Road to Serfdom (Chicago: University of Chicago Press, 1944), p. 132. 16 SOCIOLOGY as a separate academic pursuit had its-origin in the nine teenth century, beginning with the studies of Alexis de Tocque ville on American life and ending at the turn of the century with the contributions of Max Weber. Robert A. Nisbet has referred to this period as the golden age of sociology, and his book, The Soc iological Tradition (1966), indi cates why this should he the case.