America's Great Depression - Chapter I

I could not stand bloomberg.tv any longer - had to shut off the shallow arguments.

What I will do instead is start to read Murray N. Rothbard’s Americas’s Gread Depression. Not the first time I try to accomplish this, but so far I really could not focus enough to get over the first chapters. I really love his ‘The Mystery of Banking’, so I guess it’s my fault I could not get any further. One reason I did not finish this book straight away is the language: Rothbard is clearly able to write in simple and plain English. But whereas I could go through ‘The Mystery of Banking’ without looking up a single word, I feel the need to consult www.leo.org here quite often. I will take it as an opportunity to improve my English.

Skipping all the introductions to editions one to five we start with PartI: Business Cycle Theory. Note that the book was written in 1963, and you can get a full on-line-edition for free at: http://www.mises.org/rothbard/agd.pdf

Still I suggest you get a hard-copy of the book. 

Chapter I: The Positive Theory of the Cycle

Business Cycles and Fluctuations   -   Rothbard states, that there are always fluctuations in demand and that is nothing to worry about. Take a shift in consumer taste: if suddenly Windows operating system is no longer in demand, but Linux is – this is nothing to be covered by the theory of a (general) Business Cycle

Murry quite early links (general) price development here with the supply of Money. High supply of money will lead to increasing price levels, not in a specific sector, but in general. He expects a constant purchasing power of a currency, if the demand for holding cash (in aggregate) equals the cash provided by central banks. 

The problem: The cluster of error   -   Unfortunately, supply of money does not explain the development of business cycles at all. Why does ‘real’ output shrink? Who do entrepreneurs make errors in forecasting future demand? Why do they invest ‘too much’? Why are some industries hit harder than others (industrial goods vs. consumer goods) in a depression? 

The Explanations: Boom and Depression   -   Core thesis of Rothbard (and the Austrian School) is: there will be no cluster of error in a truly free economy. There will be errors – but the boom-bust-cycle is generated by intervention, specifically credit expansion and not a cluster of errors.
Markets will develop a ‘normal’ rate of interest, based on the time preferences of individuals. Printing money will distort this ‘normal’ rate of interest. Lower interest rates – indicating a higher demand for products now – will lead to higher investment, more output. And two steps down the road to higher wages, rents, interest. Unless time preferences have changed, things will revert back to the old equilibrium. But in the meantime malinvestments have occurred.
The depression is the ‘recovery’ process. The distortion coming from credit expansion and the following boom Is requiring a bust to get back to normal.

Secondary Features of Depression: Deflationary Credit Contraction  -   What happens next is banks will (have to) cut back on credit lines. ‘Being inherently bankrupt anyway’, banks cannot afford to look instable at all. There will be a flight to liquidity/money – falling prices follow. This ‘return to normal’ cannot be avoided, it can only be prolonged by fighting it. Prices of producers’ goods will even fall more rapidly than do consumer good prices.

Deflation (reduced money supply) helps to speed up the correction process – which will only end, when we return to the desired consumption-savings pattern. If those patterns change, the adjustment process can be shortened: what helps to speed up the process is not more consumption, but more savings. 

Government Depression Policy: Laissez-Faire   -   Rothbards view is clear: Don’t interfere with the markets adjustment process. He lists policies, which will delay the recovery and aggravate the depression:
- Prevent or delay liquidation
- Inflate further
- Keep wage rates up
- Keep prices up
- Stimulate consumption and discourage savings
- Subsidize unemployment

Rothbard’s suggestion therefore is, that a government should encourage deflation. To do a thing positively, it should LOWER its relative role in the economy. And he clearly warns from inflating its way out of the mess: this will only lead to hyperinflation – destroying the currency and thus the lifeblood of the economy.

Preventing Depressions   -   no easy task for governments. First of all, Rothbard suggests to prevent any inflationary credit expansion (leading later on to a depression). Allowing fractional reserve banking he deems a first step to failure. But governments followed that path, ending up with central banking, the worst outcome possible. Rothbard instead suggests to outlaw fractional banking, to impose a 100 % gold standard. Failing such extreme measures, it should at least use every measure possible to prevent the expansion of money and credit. 

Problems in the Austrian Theory of the Trade Cycle --- Rothbard closes the chapter with citing some critical arguments against the Austrian Theory and provides counter-arguments why those critics are not right.