Monetary activism must end in a slump

On Friday, I spoke against monetary activism once again, complaining about the use of expectation management and new monetary instruments in an attempt to defibrillate the economy. It’s a mistake, not least because a failure to contain inflationary expectations could be catastrophic, as I set out last yearMark Carney understands the argument that monetary activism will cause a damaging “intertemporal misallocation of capital” but he chooses to believe wise intervention elsewhere can compensate. I am sure this is wrong.

This morning, I rediscovered Mises’ short 1951 essay Inflation Must End in a Slump. The essential characteristics of the real world have not changed since but currency debasement subsequently became much worse. Here’s the article:

This country [the USA], and with it most of the Western world, is presently going through a period of inflation and credit expansion. As the quantity of money in circulation and deposits subject to check increases, there prevails a general tendency for the prices of commodities and services to rise. Business is booming.

Yet such a boom, artificially engineered by monetary and credit expansion, cannot last forever. It must come to an end sooner or later. For paper money and bank deposits are not a proper substitute for non-existing capital goods.

Economic theory has demonstrated in an irrefutable way that a prosperity created by an expansionist monetary and credit policy is illusory and must end in a slump, an economic crisis. It has happened again and again in the past, and it will happen in the future, too.

If one wants to avoid the recurrence of periods of economic depression, one must start by preventing the emergence of artificial booms. One must prevent the governments from embarking upon a policy of cheap interest rates, deficit spending, and borrowing from the commercial banks.

This is, of course, a very difficult task. Governments are in this regard very obstinate. They long for the popularity that booming business conditions seldom fail to win for the party in power. The Unavoidable crash, they think, will appear only later; then the other party will be in power and will have to account to the voters for the evils which their predecessors have sown.

Thus there is no doubt that we shall one day have to face again an economic recession, although it is impossible to determine the date of its outbreak and the degree of its severity. It will be bad indeed. But worse than the crisis itself could prove the psychological and ideological consequences of an erroneous interpretation of its causes.

For the spokesmen of the artificial expansionist policy are busy denying that economic crises are the inevitable effect of the preceding expansionist policy. They are anxious to exonerate the governments. As they see it, inherent shortcomings of the capitalist mode of production cause the periodical recurrence of bad business. There is no other means, they conclude, to avoid a crisis than to put the economic system under the full tutelage of a central planning board.

This is essentially the doctrine of Karl Marx. Those supporting it, those passionately attacking the insight that it is the policy of inflation and credit expansion which produces economic depressions are – sometimes unwittingly – serving the cause of the Communists. When the slump comes, people indoctrinated by their teachings will argue precisely as Stalin expects them to. They will think: The efforts to preserve capitalism have proved vain; capitalism necessarily results in the recurrence of economic catastrophes; if we want stability, we must turn toward Communism.

In the antagonism between the doctrine of the economists who ascribe the emergence of economic crises to the policy of credit expansion and the official doctrine that ascribes them to alleged inherent defects of capitalism there is much more at stake than a merely doctrinal quarrel. The way in which people will react to the – unfortunately hardly avoidable – letdown of business that will follow the end of the present armament boom may decide the fate of our civilization.

People must learn in time what the inevitable consequences are of the monetary and credit policies adopted by the present administration. They must realize that what the collapse of the artificial boom will establish will not be any insufficiency of capitalism, private enterprise, and the market economy, but the failure of the methods of financing public expenditure as practiced by the New Deal and the Fair Deal.

A comprehension of the nature of the boom will also make people more cautious in their business dealings. They will not fall victim to the deception that the boom will go on forever.

This article was previously published at


  • Just one problem with Mises’s article: it flies in the face of reality. That is, the amount of government or central bank created money has expanded about a thousand percent since WWII, but where is the catastrophic slump which that caused?

    Of course there was the 1970s stagflation, but I put that down to silly wage demands, and that is supported by the chart here:

    As to the recent crisis, that was preceded by an orgy of COMMERCIAL BANK created credit, not specifically by credit or money created by CENTRAL banks.

    So Mises’s article is an argument against fractional reserve banking (which makes possibly the latter “orgy”), rather than an argument against monetary adjustments by government or central bank. And in that connection, I applaud Steve Baker’s campaign against fractional reserve banking.

    • Craig Howard says:

      where is the catastrophic slump which that caused?

      It’s all around us. Now, if by “catastrophic”, you mean we’re all reduced to living in caves and under bridges, then I suppose you’re right. But, in the U.S., alone, millions have left the labor force for lack of work, millions more have been accepted onto the disability and welfare rolls, and tens of millions now receive Food Stamps.

      To paraphrase Bill Clinton, I guess it depends on what “catastrophic” is.

  • Paul Marks says:

    Mr Musgrave – there have been many slumps, so (by denying this) it is YOU who “flies in the face of reality”.

    For example, the slump of the early 1990s was caused by Alan Greenspan’s monetary expansion of the late 1980s (helped along by the Bank of England’s expansioniary policy).

    And the present bust (which has barely stated yet) is caused by Alan Greenspan’s policy of monterary expansion in more recent years – which “Helecopter Ben” is carrying on with (thus making the fundemental situation worse).

    “But, Mr Marks, where is CATASTROPHIC slump?”

    Your wish is my command Mr Musgrave…..

    Please observe the next few years (starting now).

    As for Fractional Reserve Banking.

    Why do you not say “lending should be from real savings”?

    You do not say that, because you do not want to put an end to lending from funny money – you just want, like General Peron before you, the GOVERNMENT to do it (by printing money), and you (most likely) want the government to do it even MORE than the banks have done.

    This Peronist policy did not work in Argentina – indeed it dragged Argentina from living standards on a par with Canada (which it had before Peron), right down to the Third World.

    • Government or central bank activism does not necessarily explain the booms and slumps since WWII because such booms and slumps occurred in the 1800s when there was no such activism. Indeed, they had a credit crunch in Ancient Rome when there certainly weren’t any regular attempts at activism by government “activism”. The exception was their attempt to escape their crunch which they did much more quickly than we’ve managed, and indeed they did it by “activism”: that consisted of opening the treasury doors and distributing money to all and sundry, and it worked.

      Moreover, not only did they have booms and slumps in the 1800s, but to judge by a chart produced by Samuel Brittan, the 1800s gyrations were a bit worse then the gyrations since WWII, far as I can see. See:

      I.e. if that chart is any guide, then activism has improved things a bit.

      Next, you ask why I don’t use the phrase “lending should be from real savings?” instead of attacking fractional reserve. The answer is I’m pretty much in agreement with you there. That is, fractional reserve enables commercial banks to create money out of thin air and lend it out. In contrast, under full reserve, one person can only borrow if someone else has deliberately decided to save.

      I used phrase “pretty much” above because full reserve as advocated by many Austrians is not quite the same as full reserve as advocated by e.g. Positive Money or Laurence Kotlikoff. The former tend to want the monetary base frozen, whereas the latter are happy to see it expanded if stimulus is in order.

  • Paul Marks says:

    Ralph – you start you reply with a false claim, that there was no monetary activism in the 19th century (not true – see Murray Rothbard’s “The Panic of 1819”).

    It is true that bank credit bubbles were not always backed by the government (that is why they tended to be smaller than they are now), but they often were.

    Not just the bubble of 1819 – but also the bubble of the late 1830s, Jackson got rid of the National Bank but he backed State “Pet Banks” (thus leaving a nightmare for his friend Martin Van Buren to inherit).

    And then came the “National Banking Acts” – where it was made actually ILLEGAL to “discount” bank debt paper.

    Neither Britain or the United States can be described as examples of free banking.

    Canada has been argued to be such an example (in the period before 1935), but this is contested.

    Actually, like you Ralph Musgrave, I am wary of the idea of “free banking” – but, I repeat, neither 19th century Britain or the United States are an example of such a system.

  • Paul Marks says:

    Ralph Musgrave – you claim that commercial bank credit bubbles have not been supported by Central Bank activity. You are wrong – see (for example) Thomas Woods’ book “Meltdown”.

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