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been wasteful.8 Businessmen were led to this error by the credit
expansion and its tampering with the free-market rate of interest.
The  boom, then, is actually a period of wasteful misinvest-
ment. It is the time when errors are made, due to bank credit s tam-
pering with the free market. The  crisis arrives when the con-
sumers come to reestablish their desired proportions. The
 depression is actually the process by which the economy adjusts
to the wastes and errors of the boom, and reestablishes efficient
service of consumer desires. The adjustment process consists in
rapid liquidation of the wasteful investments. Some of these will be
abandoned altogether (like the Western ghost towns constructed
in the boom of 1816 1818 and deserted during the Panic of 1819);
others will be shifted to other uses. Always the principle will be not
to mourn past errors, but to make most efficient use of the exist-
ing stock of capital. In sum, the free market tends to satisfy volun-
tarily-expressed consumer desires with maximum efficiency, and
this includes the public s relative desires for present and future
consumption. The inflationary boom hobbles this efficiency, and
distorts the structure of production, which no longer serves con-
sumers properly. The crisis signals the end of this inflationary dis-
tortion, and the depression is the process by which the economy
returns to the efficient service of consumers. In short, and this is a
highly important point to grasp, the depression is the  recovery
process, and the end of the depression heralds the return to nor-
mal, and to optimum efficiency. The depression, then, far from
being an evil scourge, is the necessary and beneficial return of the
economy to normal after the distortions imposed by the boom.
The boom, then, requires a  bust.
Since it clearly takes very little time for the new money to filter
down from business to factors of production, why don t all booms
come quickly to an end? The reason is that the banks come to the
rescue. Seeing factors bid away from them by consumer goods
8
 Inflation is here defined as an increase in the money supply not consisting of an
increase in the money metal.
The Positive Theory of the Cycle 13
industries, finding their costs rising and themselves short of funds,
the borrowing firms turn once again to the banks. If the banks
expand credit further, they can again keep the borrowers afloat. The
new money again pours into business, and they can again bid factors
away from the consumer goods industries. In short, continually
expanded bank credit can keep the borrowers one step ahead of
consumer retribution. For this, we have seen, is what the crisis and
depression are: the restoration by consumers of an efficient econ-
omy, and the ending of the distortions of the boom. Clearly, the
greater the credit expansion and the longer it lasts, the longer will
the boom last. The boom will end when bank credit expansion
finally stops. Evidently, the longer the boom goes on the more
wasteful the errors committed, and the longer and more severe will
be the necessary depression readjustment.
Thus, bank credit expansion sets into motion the business cycle
in all its phases: the inflationary boom, marked by expansion of the
money supply and by malinvestment; the crisis, which arrives when
credit expansion ceases and malinvestments become evident; and
the depression recovery, the necessary adjustment process by
which the economy returns to the most efficient ways of satisfying
consumer desires.9
What, specifically, are the essential features of the depression-
recovery phase? Wasteful projects, as we have said, must either be
abandoned or used as best they can be. 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. Just as the boom
was marked by a fall in the rate of interest, i.e., of price differentials
between stages of production (the  natural rate or going rate of
9
This  Austrian cycle theory settles the ancient economic controversy on
whether or not changes in the quantity of money can affect the rate of interest. It
supports the  modern doctrine that an increase in the quantity of money lowers
the rate of interest (if it first enters the loan market); on the other hand, it supports
the classical view that, in the long run, quantity of money does not affect the inter-
est rate (or can only do so if time preferences change). In fact, the depression-read-
justment is the market s return to the desired free-market rate of interest.
14 America s Great Depression
profit) as well as the loan rate, so the depression-recovery consists
of a rise in this interest differential. In practice, this means a fall in
the prices of the higher-order goods relative to prices in the con-
sumer goods industries. Not only prices of particular machines
must fall, but also the prices of whole aggregates of capital, e.g.,
stock market and real estate values. In fact, these values must fall
more than the earnings from the assets, through reflecting the
general rise in the rate of interest return.
Since factors must shift from the higher to the lower orders of
production, there is inevitable  frictional unemployment in a
depression, but it need not be greater than unemployment attend- [ Pobierz całość w formacie PDF ]