The wavelike movement affecting the economic system, the recurrence of periods of boom which are followed by periods of depression, is the unavoidable outcome of the attempts, repeated again and again, to lower the gross market rate of interest by means of credit expansion. There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.
The only objection ever raised against the circulation credit theory is lame indeed. It has been asserted that the lowering of the gross market rate of interest below the height it would have reached on an unhampered loan market may appear not as the outcome of an intentional policy on the part of the banks or the monetary authorities but as the unintentional effect of their conservatism. Faced with a situation which would, when left alone, result in a raise in the market rate, the banks refrain from altering the interest they charge on advances and thus willy-nilly tumble into expansion.12 These assertions are unwarranted. But if we are prepared to admit their correctness for the sake of argument, they do not affect at all the essence of the monetary explanation of the trade cycle. It is of no concern what the particular conditions are that induce the banks to expand credit and to underbid the gross market rate of interest which the unhampered market would have determined. What counts is solely that the banks and the monetary authorities are guided by the idea that the height of interest rates as the free loan market determines it is an evil, that it is the objective of a good economic policy to lower it, and that credit expansion is an appropriate means of achieving this end without harm to anybody but parasitic moneylenders. It is this infatuation that causes them to embark upon ventures which must finally bring about the slump.
If one takes these facts into consideration one could be tempted to abstain from any discussion of the problems involved in the frame of the theory of the pure market economy and to relegate it to the analysis of interventionism, the interference of government with the market phenomena. It is beyond doubt that credit expansion is one of the primary issues of interventionism. Nevertheless the right place for the analysis of the problems involved is not in the theory of interventionism but in that of the pure market economy. For the problem we have to deal with is essentially the relation between the supply of money and the rate of interest, a problem of which the consequences of credit expansion are only a particular instance.
Everything that has been asserted with regard to credit expansion is equally valid with regard to the effects of any increase in the supply of money proper as far as this additional supply reaches the loan market at an early stage of its inflow into the market system. If the additional quantity of money increases the quantity of money offered for loans at a time when commodity prices and wage rates have not yet been completely adjusted to the change in the money relation, the effects are no different from those of a credit expansion. In analyzing the problem of credit expansion, catallactics completes the structure of the theory of money and of interest. It implicitly demolishes the age-old errors concerning interest and explodes the fantastic plans to “abolish” interest by means of monetary or credit reform.
What differentiates credit expansion from an increase in the supply of money as it can appear in an economy employing only commodity money and no fiduciary media at all is conditioned by divergences in the quantity of the increase and in the temporal sequence of its effects on the various parts of the market. Even a rapid increase in the production of the precious metals can never have the range which credit expansion can attain. The gold standard was an efficacious check upon credit expansion, as it forced the banks not to exceed certain limits in their expansionist ventures.13 The gold standard's own inflationary potentialities were kept within limits by the vicissitudes of gold mining. Moreover, only a part of the additional gold immediately increased the supply offered on the loan market. The greater part acted first upon commodity prices and wage rates and affected the loan market only at a later stage of the inflationary process.
However, the continuous increase in the quantity of commodity money exercised a steady expansionist pressure on the loan market. The gross market rate of interest was, in the course of the last centuries, continually subject to the impact of an inflow of additional money into the loan market. Of course, this pressure for the last hundred and fifty years in the Anglo-Saxon countries and for the last hundred years in the countries of the European continent, was far exceeded by the effects of the synchronous development of circulation credit as granted by the banks apart from their—from time to time reiterated—straightforward endeavors to lower the gross market rate of interest by an intensified expansion of credit. Thus three tendencies toward a lowering of the gross market rate of interest were operating at the same time and strengthening one another. One was the outgrowth of the steady increase in the quantity of commodity money, the second the outgrowth of a spontaneous development of fiduciary media in banking operations, the third the fruit of intentional anti-interest policies sponsored by the authorities and approved by public opinion. It is, of course, impossible to ascertain in a quantitative way the effect of their joint operation and the contribution of each of them; an answer to such a question can only be provided by historical understanding.
What catallactic reasoning can show us is merely that a slight although continuous pressure on the gross market rate of interest as originating from a continuous increase in the quantity of gold, and also from a slight increase in the quantity of fiduciary media, which is not overdone and intensified by purposeful easy money policy, can be counterpoised by the forces of readjustment and accommodation inherent in the market economy. The adaptability of business not purposely sabotaged by forces extraneous to the market is powerful enough to offset the effects which such slight disturbances of the loan market can possibly bring about.
Statisticians have tried to investigate the long waves of business fluctuations with statistical methods. Such attempts are futile. The history of modern capitalism is a record of steady economic progress, again and again interrupted by feverish booms and their aftermath, depressions. It is generally possible to discern statistically these recurring oscillations from the general trend toward an increase in the amount of capital invested and the quantity of products turned out. It is impossible to discover any rhythmical fluctuation in the general trend itself.
9. The Market Economy as Affected by the Recurrence of the Trade Cycle
The popularity of inflation and credit expansion, the ultimate source of the repeated attempts to render people prosperous by credit expansion, and thus the cause of the cyclical fluctuations of business, manifests itself clearly in the customary terminology. The boom is called good business, prosperity, and upswing. Its unavoidable aftermath, the readjustment of conditions to the real data of the market, is called crisis, slump, bad business, depression. People rebel against the insight that the disturbing element is to be seen in the malinvestment and the overconsumption of the boom period and that such an artificially induced boom is doomed. They are looking for the philosophers' stone to make it last.
It has been pointed out already in what respect we are free to call an improvement in the quality and an increase in the quantity of products economic progress. If we apply this yardstick to the various phases of the cyclical fluctuations of business, we must call the boom retrogression and the depression progress. The boom squanders through malinvestment scarce factors of production and reduces the stock available through overconsumption; its alleged blessings are paid for by impoverishment. The depression, on the other hand, is the way back to a state of affairs in which all factors of production are employed for the best possible satisfaction of the most urgent needs of the consumers.
Desperate attempts have been made to find in the boom some positive contribution to economic progress. Stress has been laid upon the role forced saving plays
in fostering capital accumulation. The argument is vain. It has been shown already that it is very questionable whether forced saving can ever achieve more than to counterbalance a part of the capital consumption generated by the boom. If those praising the allegedly beneficial effects of forced saving were consistent, they would advocate a fiscal system subsidizing the rich out of taxes collected from people with modest incomes. The forced saving achieved by this method would provide a net increase in the amount of capital available without simultaneously bringing about capital consumption of a much greater size.
Advocates of credit expansion have furthermore emphasized that some of the malinvestments made in the boom later become profitable. These investments, they say, were made too early, i.e., at a date when the state of the supply of capital goods and the valuations of the consumers did not yet allow their construction. However, the havoc caused was not too bad, as these projects would have been executed anyway at a later date. It may be admitted that this description is adequate with regard to some instances of malinvestment induced by a boom. But nobody would dare to assert that the statement is correct with regard to all projects whose execution has been encouraged by the illusions created by the easy money policy. However this may be, it cannot influence the consequences of the boom and cannot undo or deaden the ensuing depression. The effects of the malinvestment appear without regard to whether or not these malinvestments will appear as sound investments at a later time under changed conditions. When, in 1845, a railroad was constructed in England which would not have been constructed in the absence of credit expansion, conditions in the following years were not affected by the prospect that in 1870 or 1880 the capital goods required for its construction would be available. 'Die gain which later resulted from the fact that the railroad concerned did not have to be built by a fresh expenditure of capital and labor, was in 1847 no compensation for the losses incurred by its premature construction.
The boom produces impoverishment. But still more disastrous are its moral ravages. It makes people despondent and dispirited. The more optimistic they were under the illusory prosperity of the boom, the greater is their despair and their feeling of frustration. The individual is always ready to ascribe his good luck to his own efficiency and to take it as a well-deserved reward for his talent, application, and probity. But reverses of fortune he always charges to other people, and most of all to the absurdity of social and political institutions. He does not blame the authorities for having fostered the boom. He reviles them for the necessary collapse. In the opinion of the public, more inflation and more credit expansion are the only remedy against the evils which inflation and credit expansion have brought about.
Here, they say, are plants and farms whose capacity to produce is either not used at all or not to their full extent. Here are piles of unsalable commodities and hosts of unemployed workers. But here are also masses of people who would be lucky if they only could satisfy their wants more amply. All that is lacking is credit. Additional credit would enable the entrepreneurs to resume or to expand production. The unemployed would find jobs again and could buy the products. This reasoning seems plausible. Nonetheless it is utterly wrong.
If commodities cannot be sold and workers cannot find jobs, the reason can only be that the prices and wages asked are too high. He who wants to sell his inventories or his capacity to work must reduce his demand until he finds a buyer. Such is the law of the market. Such is the device by means of which the market directs every individual's activities into those lines in which they can best contribute to the satisfaction of the wants of the consumers. The malinvestments of the boom have misplaced inconvertible factors of production in some lines at the expense of other lines in which they were more urgently needed. There is disproportion in the allocation of nonconvertible factors to the various branches of industry. This disproportion can be remedied only by the accumulation of new capital and its employment in those branches in which it is most urgently required. This is a slow process. While it is in progress, it is impossible to utilize fully the productive capacity of some plants for which the complementary production facilities are lacking.
It is vain to object that there is also unused capacity of plants turning out goods whose specific character is low. The slack in the sale of these goods, it is said, cannot be explained by disproportionality in the capital equipment of various branches; they can be used and are needed for many different employments. This too is an error. If steel and iron works, copper mines, and sawmills cannot be operated to their full capacity, the reason can only be that there are not enough buyers on the market ready to purchase their whole output at prices which cover the costs of their current exploitation. As the variable costs can merely consist in prices of other products and in wages, and as the same is valid with regard to the prices of these other products, this always means that wage rates are too high to provide all those eager to work with jobs and to employ the inconvertible equipment to the full limits drawn by the requirement that nonspecific capital goods and labor should not be withdrawn from employments in which they fill more urgent needs.
Out of the collapse of the boom there is only one way back to a state of affairs in which progressive accumulation of capital safeguards a steady improvement of material well-being: new saving must accumulate the capital goods needed for a harmonious equipment of all branches of production with the capital required. One must provide the capital goods lacking in those branches which were unduly neglected in the boom. Wage rates must drop; people must restrict their consumption temporarily until the capital wasted by malinvestment is restored. Those who dislike these hardships of the readjustment period must abstain in time from credit expansion.
There is no use in interfering by means of a new credit expansion with the process of readjustment. This would at best only interrupt, disturb, and prolong the curative process of the depression, if not bring about a new boom with all its inevitable consequences.
The process of readjustment, even in the absence of any new credit expansion, is delayed by the psychological effects of disappointment and frustration. People are slow to free themselves from the self-deception of delusive prosperity. Businessmen try to continue unprofitable projects; they shut their eyes to an insight that hurts. The workers delay reducing their claims to the level required by the state of the market; they want, if possible, to avoid lowering their standard of living and changing their occupation and their dwelling place. People are the more discouraged the greater their optimism was in the days of the upswing. They have for the moment lost self-confidence and the spirit of enterprise to such an extent that they even fail to take advantage of good opportunities. But the worst is that people are incorrigible. After a few years they embark anew upon credit expansion, and the old story repeats itself.
The Role Played by Unemployed Factors of Production in the First Stages of a Boom
There are in the changing economy always unsold inventories (exceeding those quantities which for technical reasons must be kept in stock), unemployed workers, and unused capacity of inconvertible production facilities. The system is moving toward a state in which there will be neither unemployed workers nor surplus inventories.14 But as the appearance of new data continually diverts the course toward a new goal, the conditions of the evenly rotating economy are never realized.
The presence of unused capacity of inconvertible investments is an outgrowth of errors committed in die past. The assumptions made by the investors were, as later events proved, not correct; the market asks more intensively for other goods than for those which these plants can turn out. The piling up of excessive inventories and the catallactic unemployment of workers are speculative. The owner of the stock refuses to sell at the market price because he hopes to obtain a higher price at a later date. The unemployed worker refuses to change his occupation or his residence or to content himself with lower pay because he hopes to obtain at a later date a job with higher pay in the place of his residence and in the branch of busines
s he likes best. Both hesitate to adjust their claims to the present situation of the market because they wait for a change in the data which will alter conditions to their advantage. Their hesitation is one of the reasons why the system has not reached the state of the evenly rotating economy.
The advocates of credit expansion argue that what is wanted is more fiduciary media. Then the plants will work at full capacity, the inventories will be sold at prices their owners consider satisfactory, and the unemployed will get jobs at wages they consider satisfactory. This very popular doctrine implies that the rise in prices, brought about by the additional fiduciary media, would at the same time and to the same extent affect all other commodities and services, while the owners of the excessive inventories and the unemployed workers would content themselves with those nominal prices and wages they are asking—in vain, of course—today. For if this were to happen, the real prices and the real wage rates obtained by these owners of unsold inventories and unemployed workers would drop —in proportion to the prices of other commodities and services—to the height to which they must drop in order to find buyers and employers.
The course of the boom is not substantially affected by the fact that at its eve there are unused capacity, unsold surplus inventories, and unemployed workers. Let us assume that there are unused facilities for the mining of copper, unsold piles of copper, and unemployed workers of copper mines. The price of copper is at a level at which mining does not pay for some mines; their workers are discharged; there are speculators who abstain from selling their stocks. What is needed in order to make these mines profitable again, to give jobs to the unemployed, and to sell the piles without forcing prices down below costs of production, is an increment p in the amount of capital goods available large enough to make possible such an increase in investment and in the size of production and consumption that an adequate rise in the demand for copper ensues. If, however, this increment p does not appear and the entrepreneurs, deceived by the credit expansion, nevertheless act as if p had really been available, conditions on the copper market, while the boom lasts, are as if p had really been added to the amount of capital goods available. But everything that has been predicated about the inevitable consequences of credit expansion fits this case too. The only difference is that, as far as copper is concerned, the inappropriate expansion of production need not be achieved by the withdrawal of capital and labor from employments in which they would better have filled the wants of the consumers. As far as copper is concerned, the new boom encounters a piece of malinvestment of capital and malemployment of labor already effected in a previous boom, which the process of readjustment has not yet absorbed.
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