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Source link: http://archive.mises.org/8995/business-cycles-not-our-fault/

Business Cycles, Not Our Fault

November 21, 2008 by

These are times when you just feel like yelling at the people who write the news, particular the business press. They are happy to report, word for word, what the Fed and Treasury Department, and their message is always the same: hey, it’s not our fault; in fact, we are fixing the problem!

We are told that the economy has tanked because foreigners invested too much in the US, that foreigners saved too much money, that we all lived beyond our means, that greedy capitalists fed our materialist instincts until we popped, or any combination of the above. Or maybe business cycles are just like weather, cold one season and hot the next. Regardless is the government that must come to the rescue with the usual combination of cockamamie schemes.

Discovering the Austrian business cycle theory, then, is a revelation, because through it, you learn how the whole business traces to loose money and credit generated by the Fed. The money is pumped into the capital-goods fashion of the day, in this case housing. The whole sector becomes overbuilt and unsustainable and it turns, tanking many other affected sectors. The only answer the problem is not more of the poison that caused the problem but a real liquidation.

This time around, the theory is more in circulation than ever before — thanks to the Mises Institute — but you still don’t see evidence of consciousness on the part of “establishment” journalists. FULL ARTICLE


fundamentalist November 21, 2008 at 9:19 am

The cause of depressions was understood long before the Great D as well. Below is an except on credit expansion from Washington Irving’s “Crayon Papers” written in 1819. He wrote about the Mississippi Bubble in Paris of 1720, but was clearly applying the lessons to the depression of his own day for those who would listen and heed the lessons.

Washington Irving:

[There occasionally arise] those calm, sunny seasons in the commercial world, which are known by the name of “times of unexampled prosperity” … Every now and then the world is visited by one of these delusive seasons, when “the credit system” … expands to full luxuriance, everybody trusts everybody; a bad debt is a thing unheard of; the broad way to certain and sudden wealth lies plain and open; and men are tempted to dash forward boldly, from the facility of borrowing.

Promissory notes, interchanged between scheming individuals, are liberally discounted at the banks, which become so many mints to coin words into cash; and as the supply of words is inexhaustible, it may readily be supposed what a vast amount of promissory capital is soon in circulation. Every one now talks in thousands; nothing is heard but gigantic operations in trade; great purchases and sales of real property, and immense sums made at every transfer. All, to be sure, as yet exists in promise; but the believer in promises calculates the aggregate as solid capital, and falls back in amazement at the amount of public wealth, the “unexampled state of public prosperity.”

Now is the time for speculative and dreaming or designing men. They relate their dreams and projects to the ignorant and credulous, dazzle them with golden visions, and set them madding after shadows. The example of one stimulates another; speculation rises on speculation; bubble rises on bubble; every one helps with his breath to swell the windy superstructure, and admires and wonders at the magnitude of the inflation he has contributed to produce.

Speculation is the romance of trade, and casts contempt upon all its sober realities. It renders the stock-jobber a magician, and the exchange a region of enchantment. It elevates the merchant into a kind of knight-errant…. The slow but sure gains of snug percentage become despicable in his eyes; no “operation” is thought worthy of attention that does not double or treble the investment. No business is worth following that does not promise an immediate fortune….

Could this delusion always last, the life of a merchant would indeed be a golden dream; but it is as short as it is brilliant. Let but a doubt enter, and the “season of unexampled prosperity” is at end. The coinage of words is suddenly curtailed; the promissory capital begins to vanish into smoke; a panic succeeds, and the whole superstructure, built upon credit and reared by speculation, crumbles to the ground, leaving scarce a wreck behind…

When a man of business, therefore, hears on every side rumors of fortunes suddenly acquired; when he finds banks liberal, and brokers busy; when he sees adventurers flush of paper capital, and full of scheme and enterprise; when he perceives a greater disposition to buy than to sell; when trade overflows its accustomed channels and deluges the country; when he hears of new regions of commercial adventure; of distant marts and distant mines, swallowing merchandise and disgorging gold; when he finds joint-stock companies of all kinds forming; railroads, canals, and locomotive engines, springing up on every side; when idlers suddenly become men of business, and dash into the game of commerce as they would into the hazards of the faro table; when he beholds the streets glittering with new equipages, palaces conjured up by the magic of speculation; tradesmen flushed with sudden success, and vying with each other in ostentatious expense; in a word, when he hears the whole community joining in the theme of “unexampled prosperity,” let him look upon the whole as a “weather-breeder,” and prepare for the impending storm.

Book 'em Danno November 21, 2008 at 11:25 am

Can anyone trump Fundamentalist’s Irving quotation?

Matthew Pearson November 22, 2008 at 4:50 am

The answer has to be no – what an incredible quote!

I think that certainly sums things up beautifully, with such a powerful turn of phrase that one wonders how anyone could stand in the way of such an argument, so thanks to Fundamentalist for that.

In wrapping up the nature of what has just happened to the market in this business cycle, it also raises the next important question: what does a man of business do now? What are sound principles for real markets?

We are free-market capitalists, and we saw this coming, so while the rest of the marketplace is still chasing shadows in a corner somewhere, closed down to our discussion, what do those of us still manning our stalls look to do with our understanding and our idealism? Surely by leveraging our foreknowledge and using the (limited) freedoms we possess today, we should profit as the market corrects?

fundamentalist November 22, 2008 at 8:29 am

Please don’t stop with reading just Washington Irving’s intro to his history of the Mississippi Bubble and John Law. It exists in several places on the internet. The whole story is absolutely fascinating and beautifully written as only Irving could do. For example, there is a brief anecdote about a mansion that Law wanted to buy with his paper money and the owner refused to accept in payment anything but gold. At that time, early in his scheme, acceptance of paper was voluntary. Later, Law made it the law. The aftermath devastated Paris, but a few people made a fortune shorting the paper money and stock, including Cantillon. Law threatened to have Cantillon jailed for his activities, so Cantillon took his profits and went home. It’s as fascinating a read as any of Irving’s fiction.

Matthew: “Surely by leveraging our foreknowledge and using the (limited) freedoms we possess today, we should profit as the market corrects?”

That’s what Cantillon did in Paris 1720. If you follow the Austrian Business Cycle, you probably have cash now. Depressions are a great opportunity for people with cash. Many of the great fortunes of the past were made because wise men saw the storm coming and got out of debt and the stock market before the crash. Then they had the cash to buy assets at blue light special prices.

Some people will quibble about the ethics of buying distressed assets. You’re making a profit off the pain of others, they’ll say. Of course, they don’t consider that doctors, nurses, policemen, and the media all profit from the suffering of others. But the correct way to look at it is that if someone doesn’t buy the assets of failed companies and put them to good use, the economy will never recover. The buyer of those assets didn’t destroy the worth of thsoe assets by foolishly following Keynesian economics. Many of the “victims” of depressions are actually purps because they followed the false economics of the day, as Irving wrote.

newson November 22, 2008 at 10:08 pm

thanks to fundamentalist for the irving piece.

cantillon, whilst undoubtedly a clever operator, really belongs in the rogues’ gallery.
sadly the pdf doesn’t allow me to lift the quote, but those interested in his dodgy dealings in the mississippi trading company should look at jesus huerta de soto’s “money, bank credit and economic cycles”. (p142/906 on the mises.org pdf version).
p 143/906 has a withering criticism of cantillon by hayek.

there’s good reason for his not becoming a mises t-shirt. but his life deserves the hollywood treatment – there’s everything – great riches, fraud, flight and maybe even his own faked death.

fundamentalist November 24, 2008 at 11:46 am

If you consider fractional banking to be immoral as de Soto does, then yes Cantillon was a rogue. On the other hand, Cantillon did not invent fractional banking. It was legal at the time he conducted his trades. He merely took advantage of the law. Cantillon’s transaction were the same thing that we today call short selling. He “borrowed” the stock of others and sold it at a high price, then repurchased it at a lower price and returned it to the owners. The owners of the stock wanted to recoup their losses at Cantillon’s expense. Had Cantillon returned to them the exact pieces of paper which they had originally deposited with him, they would have had no reason to sue him but their losses would have been as great. As for Cantillon sneaking out of town, he did so because Law threatened to have him jailed for exposing his pyramid scheme. I don’t see anything wrong with what Cantillon did and he was a great economist, the first to understand the consequences of fractional banking and expose it in his essay on economics. Hayek considered him a brilliant economist, too, if you read Hayek’s essay on Cantillon available at the Econ Library web site.

newson November 29, 2008 at 8:28 am

to fundamentalist:

on page 154/906, huerta de soto makes the case for cantillon fleeing france to england, where the monetary irregular-deposit law contract was equated with the loan contract. in france, this distinction was upheld, and so his legal prospects were dimmer.

cantillon’s customers entrusted their shares to him as security against loans advanced to them, for which he charged interest. if i loan securities to a short-seller, i am paid an interest rate; there is no evidence that cantillon paid an offset, rather he just took the liberty of selling (without advising his clients) and then repurchasing. assuming the clients continued to pay interest, the title shouldn’t change over the shares. only in default would the banker be entitled to seize the shares and sell.

but thanks for the hayek tip, i’ll read it shortly.

fundamentalist November 29, 2008 at 9:20 am

I guess Cantillon’s dealings were shady. But he didn’t harm the depositors financially. He should not have collected interest on his loans in order to compensate them for borrowing their stock. But my understanding of the event says he fled the country, not because he had broken any laws but because Law feared he would expose his money scam. And Cantillon didn’t bring down the money scam by himself. Quite a few other people understood what was happening and converted all of their paper money into gold, which helped bring about he collapse. Anyway, I don’t know but I imagine that Cantillon never collected on his debts, so he was left with only what he made from his short selling. Technically, he may have broken some ethics, but he didn’t hurt anyone financially. The owners of the stock would have lost their money whether or not Cantillon used the stock for short selling.

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