11.15. Business Fluctuations

0:0015. Business Fluctuations In the real world there will be continual changes in the pattern of economic activity, changes resulting from shifts in the tastes and demands of consumers, in resources available, technological knowledge, etc. That prices and outputs fluctuate, therefore, is to be expected, and absence of fluctuation would be unusual. Particular prices and outputs will change under the impact of shifts in demand and production conditions. The general level of production will change according to individual time preferences. Prices will all tend to move in the same direction instead of shifting in different directions for different goods whenever there is a change in the money Money Relation.

0:57Only a change in the supply of or demand for money will transmit its impulses throughout the entire monetary economy and impel prices in a similar direction, albeit at varying rates of speed. General price fluctuations can be understood only by analyzing the money relation. But simple fluctuations and changes do not suffice to explain that terrible phenomenon so marked in the last century and a half, the business cycle. The business cycle has had certain definite features which reveal themselves time and again. First, there is a boom period, when prices and productive activity expand.

1:46There is a greater boom in the heavy capital goods and higher order industries, such as industrial raw materials, machine goods and construction, and in the markets for titles to these goods, such as the stock market and real estate. Then suddenly, without warning, there is a crash, a financial panic with runs on banks ensues. These fall very sharply, and there is a sudden piling up of unsold inventory, and, particularly, a revelation of great excess capacity in the higher-order capital goods industries. A painful period of liquidation and bankruptcy follows, accompanied by heavy unemployment, until recovery to normal conditions gradually takes place.

2:39This is the empirical pattern of the modern business cycle. Historical events can be explained by laws of praxeology, which isolate causal connections. Some of these events can be explained by laws that we have learned. A general price rise could result from an increase in the supply of money, or from a fall in demand. Unemployment from insistence on maintaining wage rates that have suddenly increased in real value, a reduction in unemployment from a fall in real wage rates, etc. But one thing cannot be explained by any economics of the free market, and this is the crucial phenomenon of the crisis.

3:26Why is there a sudden revelation of business error? Suddenly, all or nearly all businessmen find that their investments and estimates have been in error, that they cannot sell their products for the prices which they had anticipated. This is the central problem of the business cycle, and this is the problem which any adequate theory of the cycle must explain. No businessman in the real world is equipped with perfect foresight. All make errors. But the free market process precisely rewards those businessmen who are equipped to make a minimum number of errors. Why should there suddenly be a cluster of errors?

4:12Furthermore, why should these errors particularly pervade the capital goods industries? Sometimes sharp changes, such as a sudden burst of hoarding, or a sudden raising of time preferences, and hence a decrease in saving, may arrive unanticipated, with a resulting crisis of error. Error. But since the 18th century there has been an almost regular pattern of consistent clusters of error which always follow a boom and expansion of money and prices. In the Middle Ages and down to the 17th and 18th centuries, business crises rarely followed upon booms in this manner.

4:59They took place suddenly, in the midst of normal activity, and as the result of some obvious and identifiable external event. Thus, W. R. Scott lists crises in 16th and early 17th century England as irregular, and caused by some obvious event, famine, plague, seizures of goods in war, bad harvest, crises is in the cloth trade as a result of royal manipulations, seizure of bullion by the king, etc. But in the late 17th, 18th and 19th centuries there developed the aforementioned pattern of the business cycle, and it became obvious that the crisis and ensuing depression could no longer be attributed to some single external event or single act of government.

5:55Since no one event could account for the crisis and depression, observers began to theorize that there must be some deep-seated defect within the free market economy that causes these crises and cycles. The blame must rest with the capitalist system itself. Many ingenious theories have been put forward to explain the business cycle as an outgrowth Both of the free market economy, but none of them has been able to explain the crucial point, the cluster of errors after a boom. In fact, such an explanation can never be found, since no such cluster could appear on the free market.

6:41The nearest attempt at an explanation stressed general swings of over-optimism and over-pessimism in the Business Community. But put in such fashion, the theory looks very much like a deus ex machina. Why should hard-headed businessmen, schooled in trying to maximize their profits, suddenly fall victim to such psychological swings? In fact, the crisis brings bankruptcies regardless of the emotional state of particular entrepreneurs. We shall see in Chapter 12 that feelings of optimism do play a role, but they are induced by certain objective economic conditions. We must search for the objective reasons that cause businessmen to become over-optimistic, and they cannot be found on the free market.

7:35The positive explanation of the business cycle, therefore, will have to be postponed to the in the next chapter.