The Austrian Theory of the Business CycleAn overview study of the effects of the Federal Reserve and Modern Implications

Animal Spirits Ben “Helicopter” Bernanke

In the long run, we are not all dead- we live in the meantime

It helps to think Printing Presses are evil Gold is Real Money

After 15 million human beings had perished in the war, the foremost statesmen of the world were assembled to give mankind a new international order and lasting peace . . . and the British Empires financial expert [Keynes] was amused by the rustic style of the French Prime Minister’s footwear.

Background

Built upon Smith Say

Important People Carl Menger Ludwig von Mises -

Quotes Murray Rothbard Fredrick Hayek – Nobel

Prize Winner

Lenin’s ideal was to build a nations production effort according to the model of the post office.

Mises

Rothbard

Business Cycle vs Business Fluctuations Business Fluctuations

Entrepreneurs forecastPredict consumer demandThey try hard, but fail oftenNot a problem – even a “farm depression”

Business CycleGeneral decline in business activity

He who proclaims the godliness of the State and the infallibility of its priests, the bureaucrats, is considered as an impartial student of the social sciences.

Business Cycle?

Some businesses are always failing Why are there a cluster of errors at the

same time??Good Businessmen are good at forecasting

Why did they fail all at once?

This is an important question!!!

A most popular doctrines is crystallized in the phrase: A public debt is no burden because we owe it to ourselves. If this were true, then the wholesale obliteration of the public debt would be an innocuous operation, a mere act of

bookkeeping and accountancy.

Banking Originally:

Deposit money with goldsmith for safe keeping

A fee would be paid for this serviceThe depositor would receive a certificate

(claim check) The certificate traded on par or even a

premium to physical gold

Interventionism begets economic nationalism. It thus kindles the antagonism resulting in war. An abandonment of economic nationalism is not feasible if nations cling to interference with business. Free trade in international relations requires domestic free trade

Federal Reserve

Passed December 23, 1913 Centralized Banking

Monopoly on note issueCompelled banks to joinFixed minimum reserve ratios

Inherently inflationaryThe assertion that there is irrational action is always rooted in an evaluation of a scale of values different from our own. Whoever says that irrationality plays a role in human action is merely saying that his fellow men behave in a way that he does not consider correct.

Fractional Reserve Banking

You go to PNC and deposit your paycheck as a demand deposit

A credit is made to your account About 90% is loaned out Two entities have title to the same money The bank can not guarantee your deposit IT IS BANKRUPT

It is not in the power of the government to make everybody more prosperous.

Time

Pretend there is $X $Y will be spent on consumption $X-Y will be saved

This is the time preference Prefer future goods with interest to present goods

Lower time preference More investment vs consumption “Lengthening of the structure of production”

Converse is true for high time preference

"inflation is always and everywhere a monetary phenomenon." – Milton Friedman

Natural Rate of Interest

Aggregate time preference value scale Supply and Demand Entrepreneurial Risk Expected change in

purchasing power NOT FISHER EFFECT

The factory owners did not have the power to compel anybody to take a factory job. They could only hire people who were ready to work for the wages offered to them…. Their only refuge was the factory. It saved them, in the strict sense of the term, from death by starvation.

Money Creation

Banks create moneyModern day “open market operations”Fractional Reserve Banking

New money lowers the rate of interestAppears that the supply of investment funds

increased People are saving (deferring current consumption)

Mahatma Gandhi expresses a loathing for the devices of the petty West and of devilish capitalism. But he travels by railroad or by motor car and, when ill, goes for treatment to a hospital equipped with the most refined instruments of Western surgery.

Effects

Businessmen lengthen the capital structure Laymen’s terms: THEY INVEST Prices of capital goods increase Shifts investment toward higher ordered capital goods

Farther from consumer goods

New funds flow around economy Increase in wages, prices, rents (INFLATION)

How pale is the art of sorcerers, witches, and conjurors when compared with that of the government's Treasury Department!

Downward Effects

People return to their old waysThere was no real demand for new capital

goods Demand for CG’s declines CG industries must liquidate

“malinvestments”

To assign to everybody his proper place in society is the task of the consumers. Their buying and abstention from buying is instrumental in determining each individuals social position.

OH NO – The D Word

Here comes the crisis Finally the end of distortions Comes when banks curtail credit expansion

Depression Liquidates malinvestments Reestablishes efficient service of genuine consumer

desires Is needed to realign the economy “Soft Landing” just tries to prevent the inevitable

We owe the origin and development of human society and, consequently, of culture and civilization, to the fact that work performed under the division of labor is more productive than when performed in isolation.

Depression #2

Interest rate must go up Fall in the price of goods

Especially higher ordered CG Realignment of labor force

There will be unemployment The quicker the realignment

Quicker to prosperityAssistance granted to the unemployed does not dispose of unemployment. It makes it easier for the unemployed to remain idle.

Depression can not be prevented The market adjusts itself

DON’T INTERFERE - IT ONLY MAKES IT WORSE

Government can: Prevent or delay liquidation Inflate Further Minimum Wage Maintain Prices Stimulate Consumption

Discourage Saving Subsidize Unemployment

Those politicians, professors and union bosses who curse big business are fighting for a lower standard of living.

Don’t Fear the Reaper (Deflation) Deflation speeds adjustment

Increases reserve ratios Increases confidence in money (gold)

Bank runs are good Liquidate bankrupt banks

Banks are inherently bankrupt under Fractional Reserve Banking

Gov’t should reduce taxes and spending Encourage proper savings and investment

If one rejects laissez faire on account of mans fallibility and moral weakness, one must for the same reason also reject every kind of government action.

Some Theories of Depression:Overproduction Economic desires are always unfulfilled “Surplus” stock can always be sold at a

lower price Entrepreneurs made poor forecasts

Why? Answered by the Austrian theory

Even the manifest futility of the International Monetary Fund does not deter authors from indulging in dreams about a world bank fertilizing mankind with floods of cheap credit.

Under consumption

Somehow consumer demand becomes insufficient during boom

There will always be consumer demand i.e.. Food

Prices will change- Supply=Demand Entrepreneurs predict demand Others?

If a man drinks wine and not water I cannot say he is acting irrationally. At most I can say that in his place I would not do so. But his pursuit of happiness is his own business, not mine.

Conclusion

Government intervention in the market place:Creates intertemporal misallocations of capitalMisallocations must be liquidatedCauses the business cycle

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.

A BANK HAS LESS THAN 10% OF YOUR DEPOSITS!!!!!!!!!!!!

The Future

Expect the USD to weaken significantly Expect the value of real money (gold) to

go up Expect many bank failures

Keynes did not add any new idea to the body of inflationist fallacies, a thousand times refuted by economists… He merely

knew how to cloak the plea for inflation and credit expansion in the sophisticated terminology of mathematical economics.

Sources

This presentation was adapted from America’s Great Depression by Murray RothbardAll charts can be found in the online versionwww.mises.org

Quotes are from Ludwig von MisesThe Quotable Mises