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future economic holocaust will cause the American public to turn away from failed nostrums and toward the analysis and policy conclusions of the Austrian School.

MURRAY N. ROTHBARD

Stanford, California

September 1982

Introduction to the Third Edition

America is now in the midst of a full-scale inflationary depression. The inflationary recession of 1969–71 has been quickly succeeded by a far more inflationary depression which began around November 1973, and skidded into a serious depression around the fall of 1974. Since that time, physical production has declined steadily and substantially, and the unemployment rate has risen to around 10 percent, and even higher in key industrial areas. The desperate attempt by the politico-economic Establishment to place an optimistic gloss on the most severe depression since the 1930s centers on two arguments: (a) the inadequacy of the unemployment statistics, and (b) the fact that things were much worse in the post-1929 depression. The first argument is true but irrelevant; no matter how faulty the statistics, the rapid and severe rise in the unemployment rate from under 6

percent to 10 percent in the space of just one year (from 1974 to 1975) tells its own grisly tale. It is true that the economy was in worse shape in the 1930s, but that was the gravest depression in American history; we are now in a depression that is certainly not mild by any pre-1929 standards.

The current inflationary depression has revealed starkly to the nation’s economists that their cherished theories—adopted and applied since the 1930s—are tragically and fundamentally incorrect. For forty years we have been told, in the textbooks, the economic journals, and the pronouncements of our government’s economic advisors, that the government has the tools with which it can easily abolish inflation or recession. We have been told that by
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juggling fiscal and monetary policy, the government can “fine-tune” the economy to abolish the business cycle and insure permanent prosperity without inflation. Essentially—and stripped of the jargon, the equations, and the graphs—the economic Establishment held all during this period that if the economy is seen to be sliding into recession, the government need only step on the fiscal and monetary gas—to pump in money and spending into the economy—in order to eliminate recession. And, on the contrary, if the economy was becoming inflationary, all the government need do is to step on the fiscal and monetary brake—take money and spending out of the economy—in order to eliminate inflation. In this way, the government’s economic planners would be able to steer the economy on a precise and careful course between the opposing evils of unemployment and recession on the one hand, and inflation on the other. But what can the government do, what does conventional economic theory tell us, if the economy is suffering a severe inflation
and
depression
at the same time
?

Now can our self-appointed driver, Big Government, step on the gas and on the brake at one and the same time?

Confronted with this stark destruction of all their hopes and plans, surrounded by the rubble of their fallacious theories, the nation’s economists have been plunged into confusion and despair.

Put starkly, they have no idea of what to do next, or even how to explain the current economic mess. In action, all that they can do is to alternate accelerator and brake with stunning rapidity, hoping that something might work (e.g., President Ford’s call for higher income taxes in the fall of 1974, only to be followed by a call for lower income taxes a few months later). Conventional economic theory is bankrupt: furthermore, with courses on business cycles replaced a generation ago by courses on “macroeconomics” in graduate schools throughout the land, economists have now had to face the stark realization that business cycles
do
exist, while being in no way equipped to understand them. Some economists, union leaders, and businessmen, despairing of any hope for the free-market economy, have in fact begun to call for a radical shift to a collectivized economy in America (notably, the Initiative Committee for National Economic Planning, which includes in its ranks
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economists such as Wassily Leontief, union leaders such as Leonard Woodcock, and business leaders such as Henry Ford II).

In the midst of this miasma and despair, there is one school of economic thought which predicted the current mess, has a cogent theory to explain it, and offers the way out of the predicament—a way out, furthermore, which, far from scrapping free enterprise in favor of collectivist planning, advocates the restoration of a purely free enterprise system that has been crippled for decades by government intervention. This school of thought is the “Austrian” theory presented in this book. The Austrian view holds that persistent inflation is brought about by continuing and chronic increases in the supply of money, engineered by the federal government. Since the inception of the Federal Reserve System in 1913, the supply of money and bank credit in America has been totally in the control of the federal government, a control that has been further strengthened by the U.S. repudiating the domestic gold standard in 1933, as well as the gold standard behind the dollar in foreign transactions in 1968 and finally in 1971. With the gold standard abandoned, there is no necessity for the Federal Reserve or its controlled banks to redeem dollars in gold, and so the Fed may expand the supply of paper and bank dollars to its heart’s content. The more it does so, the more prices tend to accelerate upward, dislocating the economy and bringing impoverishment to those people whose incomes fall behind in the inflationary race.

The Austrian theory further shows that inflation is not the only unfortunate consequence of governmental expansion of the supply of money and credit. For this expansion distorts the structure of investment and production, causing excessive investment in unsound projects in the capital goods industries. This distortion is reflected in the well-known fact that, in every boom period, capital goods prices rise further than the prices of consumer goods.

The recession periods of the business cycle then become inevitable, for the recession is the necessary corrective process by which the market liquidates the unsound investments of the boom and redirects resources from the capital goods to the consumer goods industries. The longer the inflationary distortions continue, the more severe the recession-adjustment must become. During
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the recession, the shift of resources takes place by means of capital goods prices falling relative to consumer goods. During the depression of 1974–75, we have seen this occur, with industrial raw material prices falling rapidly and substantially, with wholesale prices remaining level or declining slightly, but with consumer goods prices still rising rapidly—in short, the inflationary depression.

What, then, should the government do if the Austrian theory is the correct one? In the first place, it can only cure the chronic and potentially runaway inflation in one way: by
ceasing to inflate
: by stopping its own expansion of the money supply by Federal Reserve manipulation, either by lowering reserve requirements or by purchasing assets in the open market. The fault of inflation is not in business “monopoly,” or in union agitation, or in the hunches of speculators, or in the “greediness” of consumers; the fault is in the legalized counterfeiting operations of the government itself.

For the government is the only institution in society with the power to counterfeit—to create new money. So long as it continues to use that power, we will continue to suffer from inflation, even unto a runaway inflation that will utterly destroy the currency. At the very least, we must call upon the government to stop using that power to inflate. But since all power possessed will be used and abused, a far sounder method of ending inflation would be to deprive the government completely of the power to counterfeit: either by passing a law forbidding the Fed to purchase any further assets or to lower reserve requirements, or more fundamentally, to abolish the Federal Reserve System altogether. We existed without such a central banking system before 1913, and we did so with far less rampant inflations or depressions. Another vital reform would be to return to a gold standard—to a money based on a commodity produced, not by government printing presses, but by the market itself. In 1933, the federal government seized and confiscated the public’s gold under the guise of a temporary emergency measure; that emergency has been over for forty years, but the public’s gold still remains beyond our reach at Fort Knox.

As for avoiding depressions, the remedy is simple: again, to avoid inflations by stopping the Fed’s power to inflate. If we are in a depression, as we are now, the only proper course of action is to
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avoid governmental interference with the depression, and thereby to allow the depression–adjustment process to complete itself as rapidly as possible, and thus to restore a healthy and prosperous economic system. Before the massive government interventions of the 1930s, all recessions were short-lived. The severe depression of 1921 was over so rapidly, for example, that Secretary of Commerce Hoover, despite his interventionist inclinations, was not able to convince President Harding to intervene rapidly enough; by the time Harding was persuaded to intervene, the depression was already over, and prosperity had arrived. When the stock market crash arrived in October, 1929, Herbert Hoover, now the president, intervened so rapidly and so massively that the market–

adjustment process was paralyzed, and the Hoover–Roosevelt New Deal policies managed to bring about a permanent and massive depression, from which we were only rescued by the advent of World War II. Laissez-faire—a strict policy of non-intervention by the government —is the only course that can assure a rapid recovery in any depression crisis.

In this time of confusion and despair, then, the Austrian School offers us both an explanation and a prescription for our current ills.

It is a prescription that is just as radical as, and perhaps even more politically unpalatable than, the idea of scrapping the free economy altogether and moving toward a totalitarian and unworkable system of collectivist economic planning. The Austrian prescription is precisely the opposite: we can only surmount the present and future crisis by ending government intervention in the economy, and specifically by ending governmental inflation and control of the money supply, as well as interference in any recession–

adjustment process. In times of breakdown, mere tinkering reforms are not enough; we must take the radical step of getting the government out of the economic picture, of separating government completely from the money supply and the economy, and advancing toward a truly free and unhampered market and enterprise economy.

MURRAY N. ROTHBARD

Palo Alto, California

May 1975

Introduction to the Second Edition

In the years that have elapsed since the publication of the first edition, the business cycle has re-emerged in the consciousness of economists. During the 1960s, we were again promised, as in the New Era of the 1920s, the abolition of the business cycle by Keynesian and other sophisticated policies of government. The substantial and marked recession which began around November, 1969, and from which at this writing we have not yet recovered, has been a salutary if harsh reminder that the cycle is still very much alive.

One feature of this current recession that has been particularly unpleasant and surprising is the fact that prices of consumer goods have continued to rise sharply throughout the recession. In the classic cycle, prices fall during recessions or depressions, and this decline in prices is the one welcome advantage that the consumer can reap from such periods of general gloom. In the present recession, however, even this advantage has been removed, and the consumer thus suffers a combination of the worst features of recession and inflation.

Neither the established Keynesian nor the contemporary

“monetarist” schools anticipated or can provide a satisfactory explanation of this phenomenon of “inflationary recession.” Yet the “Austrian” theory contained in this book not only explains this occurrence, but demonstrates that it is a general and universal tendency in recessions. For the essence of recession, as the Austrian theory shows, is a readjustment of the economy to liquidate the distortions imposed by the boom—in particular, the overexpansion
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of the “higher” orders of capital goods and the underinvestment in consumer goods industries. One of the ways by which the market redirects resources from the capital goods to the consumer goods sphere is by prices declining relatively in the former category and rising relatively in the latter category. Bankruptcies and relative price and wage contractions in the overblown and malinvested higher orders of capital goods will redirect land, labor, and capital resources into consumer goods and thereby reestablish the efficient responsiveness to consumer demands that is the normal condition of an unhampered market economy.

In short, the prices of consumer goods always tend to rise, relative to the prices of producer goods, during recessions. The reason that this phenomenon has not been noted before is that, in past recessions, prices have
generally fallen
. If, for example, consumer goods prices fall by 10 percent and, say, cement prices fall by 20

percent, no one worries about an “inflation” during the recession; but, actually, consumer goods prices in this case, too, have risen
relative to
the prices of producer goods. Prices in general fell during recessions because monetary and banking deflation used to be an invariable feature of economic contractions. But, in the last few decades, monetary deflation has been strictly prevented by governmental expansion of credit and bank reserves, and the phenomenon of an actual
decline
in the money supply has become at best a dim memory. The result of the government’s abolition of deflation, however, is that general prices no longer fall, even in recessions. Consequently, the adjustment between consumer goods and capital goods that must take place during recessions, must now proceed without the merciful veil of deflation. Hence, the prices of consumer goods still rise relatively, but now, shorn of general deflation, they must rise absolutely and visibly as well. The government policy of stepping in to prevent monetary deflation, therefore, has deprived the public of the one great advantage of recessions: a falling cost of living. Government intervention against deflation has brought us the unwelcome phenomenon of inflationary recession.