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 wellbeing: 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 business 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.
&n
bsp; Thus it becomes obvious how vain it is to justify a new credit expansion by referring to unused capacity, unsold—or, as people say incorrectly, “unsaleable”—stocks, and unemployed workers. The beginning of a new credit expansion runs across remainders of preceding malinvestment and malemployment, not yet obliterated in the course of the readjustment process, and seemingly remedies the faults involved. In fact, however, this is merely an interruption of the process of readjustment and of the return to sound conditions.15 The existence of unused capacity and unemployment is not a valid argument against the correctness of the circulation credit theory. The belief of the advocates of credit expansion and inflation that abstention from further credit expansion and inflation would perpetuate the depression is utterly false. The remedies these authors suggest would not make the boom last forever. They would merely upset the process of recovery.
The Fallacies of the Nonmonetary Explanations of the Trade Cycle
In dealing with the futile attempts to explain the cyclical fluctuations of business by a nonmonetary doctrine, one point must first of all be stressed which has hitherto been unduly neglected.
There were schools of thought for whom interest was merely a price paid for obtaining the disposition of a quantity of money or money substitutes. From this belief they quite logically drew the inference that abolishing the scarcity of money and moneysubstitutes would abolish interest altogether and result in the gratuitousness of credit. If, however, one does not endorse this view and comprehends the nature of originary interest, a problem presents itself the treatment of which one must not evade. An additional supply of credit, brought about by an increase in the quantity of money or fiduciary media, has certainly the power to lower the gross market rate of interest. If interest is not merely a monetary phenomenon and consequently cannot be lastingly lowered or brushed away by any increase, however large, in the supply of money and fiduciary media, it devolves upon economics to show how the height of the rate of interest conforming to the state of the market’s nonmonetary data reestablishes itself. It must explain what kind of process removes the cashinduced deviation of the market rate from that state which is consonant with the ratio in people’s valuation of present and future goods. If economics were at a loss to achieve this, it would implicitly admit that interest is a monetary phenomenon and could even disappear completely in the course of changes in the money relation.
For the nonmonetary explanations of the trade cycle the experience that there are recurrent depressions is the primary thing. Their champions first do not see in their scheme of the sequence of economic events any clue which could suggest a satisfactory interpretation of these enigmatic disorders. They desperately search for a makeshift in order to patch it onto their teachings as an alleged cycle theory.
The case is different with the monetary or circulation credit theory. Modern monetary theory has finally cleared away all notions of an alleged neutrality of money. It has proved irrefutably that there are in the market economy factors operating about which a doctrine ignorant of the driving force of money has nothing to say. The catallactic system that involves the knowledge of money’s non-neutrality and driving force presses the questions of how changes in the money relation affect the rate of interest first in the short run and later in the long run. The system would be defective if it could not answer these questions. It would be contradictory if it were to provide an answer which would not simultaneously explain the cyclical fluctuations of trade. Even if there had never been such things as fiduciary media and circulation credit, modern catallactics would have been forced to raise the problem concerning the relations between changes in the money relation and the rate of interest.
It has been mentioned already that every nonmonetary explanation of the cycle is bound to admit that an increase in the quantity of money or fiduciary media is an indispensable condition of the emergence of a boom. It is obvious that a general tendency of prices to rise which is not caused by a general drop in production and in the supply of commodities offered for sale, cannot appear if the supply of money (in the broader sense) has not increased. Now we can see that those fighting the monetary explanation are also forced to resort to the theory they slander for a second reason. For this theory alone answers the question of how an inflow of additional money and fiduciary media affects the loan market and the market rate of interest. Only those for whom interest is merely the outgrowth of an institutionally conditioned scarcity of money can dispense with an implicit acknowledgment of the circulation credit theory of the cycle. This explains why no critic has ever advanced any tenable objection against this theory.
The fanaticism with which the supporters of all these nonmonetary doctrines refuse to acknowledge their errors is, of course, a display of political bias. The Marxians have inaugurated the usage of interpreting the commercial crisis as an inherent evil of capitalism, as the necessary outgrowth of its “anarchy” of production.16 The non-Marxian socialists and the interventionists are no less anxious to demonstrate that the market economy cannot avoid the return of depressions. They are the more eager to assail the monetary theory as currency and credit manipulation is today the main instrument by means of which the anticapitalist governments are intent upon establishing government omnipotence.17
The attempts to connect business depressions with cosmic influences, the most remarkable of which was William Stanley Jevons’ sunspot theory, failed utterly. The market economy has succeeded in a fairly satisfactory way in adjusting production and marketing to all the natural conditions of human life and its environment. It is quite arbitrary to assume that there is just one natural fact—namely, allegedly rhythmic harvest variations— with which the market economy does not know how to cope. Why do entrepreneurs fail to recognize the fact of crop fluctuations and to adjust business activities in such a way as to discount their disastrous effects upon their plans?
Guided by the Marxian slogan “anarchy of production,” the present-day nonmonetary cycle doctrines explain the cyclical fluctuations of trade in terms of a tendency, allegedly inherent in the capitalist economy, to develop disproportionality in the size of investments made in various branches of industry. Yet even these disproportionality doctrines do not contest the fact that every businessman is eager to avoid such mistakes, which must bring him serious financial losses. The essence of the activities of entrepreneurs and capitalists is precisely not to embark upon projects which they consider unprofitable. If one assumes that there prevails a tendency for businessmen to fail in these endeavors, one implies that all businessmen are short-sighted. They are too dull to avoid certain pitfalls, and thus blunder again and again in their conduct of affairs. The whole of society has to foot the bill for the shortcomings of the thick-headed speculators, promoters, and entrepreneurs.
Now it is obvious that men are fallible, and businessmen are certainly not free from this human weakness. But one should not forget that on the market a process of selection is in continual operation. There prevails an unceasing tendency to weed out the less efficient entrepreneurs, that is, those who fail in their endeavors to anticipate correctly the future demands of the consumers. If one group of entrepreneurs produces commodities in excess of the demand of the consumers and consequently cannot sell these goods at remunerative prices and suffers losses, other groups who produce those things for which the public scrambles make all the greater profits. Some sectors of business are distressed while others thrive. No general depression of trade can emerge.
But the proponents of the doctrines we have to deal with argue differently. They assume that not only the whole entrepreneurial class but all of the people are struck with blindness. As the entrepreneurial class is not a closed social order to which access is denied to outsiders, as every enterprising man is virtually in a position to challenge those who already belong to the class of entrepreneurs, as the history of capitalism provides innumerable examples of penniless newcomers who brilliantly succeeded in embarking upon the production of those goods which according to
their own judgment were fitted to satisfy the most urgent needs of consumers, the assumption that all entrepreneurs regularly fall prey to certain errors tacitly implies that all practical men lack intelligence. It implies that nobody who is engaged in business and nobody who considers engaging in business if some opportunity is offered to him by the shortcomings of those already engaged in it, is shrewd enough to understand the real state of the market. But on the other hand the theorists, who are not themselves active in the conduct of affairs and merely philosophize about other people’s actions, consider themselves smart enough to discover the fallacies leading astray those doing business. These omniscient professors are never deluded by the errors which cloud the judgment of everyone else. They know precisely what is wrong with private enterprise. Their claims to be invested with dictatorial powers to control business are therefore fully justified.
The most amazing thing about these doctrines is that they furthermore imply that businessmen, in their littleness of mind, obstinately cling to their erroneous procedures in spite of the fact that the scholars have long since unmasked their faults. Although every textbook explodes them, the businessmen cannot help repeating them. There is manifestly no means to prevent the recurrence of economic depression other than to entrust—in accordance with Plato’s utopian ideas—supreme power to the philosophers.
Human Action: A Treatise on Economics Page 83