One of the most striking lessons I have learned during the financial crisis is that while many branches of economics are fundamentally flawed, the so-called Austrian School has much to teach the modern investor.
For me, the Austrian approach amounts to a belief in three specific things: sound money; small government; and the primacy of the individual. It values the genuine wealth creation of the entrepreneur over the dead and largely value-destructive hand of the leviathan state.
Why is it so relevant to today’s ongoing financial crisis? Because the view of (Austrian) scholar Murray Rothbard, expressed in his classic study, America’s Great Depression, is that rather than ‘solving’ the depression, government intervention made it dramatically worse.
Rothbard describes Austrian business cycle theory as follows: bank credit expansion (easy lending) causes an inflationary boom, marked by an expansion in the money supply; that boom triggers mal-investments, both by bankers and businesspeople more generally.
In other words, when money is free and easy, people don’t discriminate between projects as much as they do when money is tight. Cheap credit also pushes up asset prices in certain areas, leading to more money chasing easy capital growth rather than long-term returns.
When credit expansion halts abruptly and those mal-investments become visible, the “depression recovery” starts the process of adjustment and economic healing.
“Inefficient firms, buoyed up by the artificial boom, must be liquidated or have their debts scaled down or be turned over to their creditors. Prices of producers’ goods must fall, particularly in the higher orders of production – this includes capital goods, lands and wage rates,” says Rothbard.
What the Great Depression has in common with today’s crisis
But that is not what happened in the US in the 1930s. The government did everything it could to ‘support’ various industries (and interfere in the market’s clearing process).
And it has not happened this time round either, with extraordinary levels of government support granted to the financial crisis’ largest culprits – the banks themselves.
Rothbard identified a number of ways in which government exacerbated rather than resolved recessions, among them:
• Preventing or delaying liquidation by the ongoing lending of money to insolvent businesses;
• Further inflation, which blocks the necessary market clearing process of lower prices;
• Keeping prices up above their free market levels;
• Stimulating consumption and discouraging saving.
All of which are occurring today. Rothbard concluded that any depression will be prolonged and worsened by inflationist intervention on the part of politicians. Sound familiar?
Category: Economics