Readings
for the Crisis
by
Bob Murphy
by Bob Murphy
DIGG THIS
 On
Friday the Federal
Reserve lowered its discount rate 50 basis points to 5.75 percent.
As the article linked above illustrates, the Fed decision showcases
the corner into which the government has painted itself. If the
Fed did "nothing" (i.e. continued to pump in counterfeit
money to keep interest rates on target) then Wall Street could have
suffered even further setbacks – troubling indeed since earlier
in the week all of the gains of 2007 had evaporated.
On the other
hand, if the Fed had announced a cut in the federal funds rate target
ahead of its scheduled September 18 meeting, that could have
worried investors that the situation was worse than earlier statements
from the grand wizards had indicated. The solution? On Friday the
Fed announced a moderate cut in the discount rate, not the
more important federal funds target rate. (The discount rate is
what the Fed itself charges banks to borrow reserves, whereas the
fed funds rate is what member banks charge each other for overnight
loans of reserves. In terms of volume, the interbank market dwarfs
borrowing at the Fed window.) This way, the Fed is "doing something"
while not contradicting its earlier announcements that things were
fine and that rate cuts could wait until September. Ah, the stressful
nuances of central banking!
 The
money and banking systems of modern, heavily regulated economies
are quite daunting indeed. If the government had a deficit, and
cranked out a billion new $100 bills off the printing press to cover
the hole, that would be easy to grasp. Of course, the public might
get suspicious of such naked counterfeiting, especially when prices
kept rising. Therefore, our system doesn’t work like that. Instead,
we have a Federal Reserve System, with member banks that have to
have a certain amount of reserves with the Fed or cash in the vault,
backing up their outstanding checkable deposits. Inflation of the
money supply is definitely occurring – just look at prices over
the years! – but it’s a very subtle process.
Unfortunately,
inflation of the money supply is an extremely important process,
and everyone needs to understand the basics. For not only does monetary
inflation lead to rising prices, it also causes the boom-bust cycle
(which is blamed on the "free market"). In this article,
I summarize articles and books of various depths, to bring the reader
up to his or her desired level of understanding on this crucial
topic.
 EASY
PIECES FOR THOSE IN A HURRY
For those who
just want to read a few short articles to get up to speed, I recommend
the following:
 A
BIGGER TIME COMMITMENT, BUT MORE REWARDING
For those who
are willing to put a few hours into it, the following are accessible
introductions to Austrian business cycle theory and the implied
critique of the US monetary and banking system:
- Rothbard
has written two excellent primers, What
Has Government Done To Our Money? and The
Case Against the Fed (reviewed here
by David Gordon).
- Henry Hazlitt’s
What You
Should Know About Inflation gives you the "news you
can use" in his refreshing style.
- Roger Garrison’s
Power Point
presentations are wonderful, but they are geared toward explaining
the Austrian business cycle theory with the concepts and diagrams
of mainstream economics. So if you remember the production possibilities
frontier (PPF) from your intro econ class, you’ll love the slide
show, but if you never took an undergrad economics class, you’re
better off reading the original expositions rather than Garrison’s
"translation."
 The
chapters on capital structure and the business cycle in Gene Callahan’s
Economics
for Real People were designed to be painless reading
for the layperson.
- I haven’t
personally read it, but I hear good things about Peter Schiff’s
Crash
Proof: How to Profit From the Coming Economic Collapse.
Schiff is famously pessimistic about the future of the US economy
– financial writers can always go to him for a dire quote – and
he ties his analysis to the Austrian school. (Long-time readers
might be puzzled at my recommendation, since I’ve picked fights
with Schiff in the past. But as I explain in this mea
culpa, I am now much more sympathetic to his views.)
- If you prefer
audio format, the lectures
at Mises University are wonderful introductions to the entire
core of Austrian theory. (Unfortunately, Roger Garrison’s lectures
on the business cycle are rather tied to his Power Point presentation,
and so don’t translate well into this medium. But the earlier
lectures provide excellent background material to understand the
present financial crisis. Also note that because of the redundancy,
each lecture isn’t repeated in every archive for every year; you’ll
have to search through multiple years to get every single lecture.)
 THE
FULL STORY
Finally, for
those who want to read full expositions of the Austrian theory of
money, credit, and the business cycle, I recommend the following:
- Rothbard’s
Man,
Economy, and State (especially chapters 5
and 6,
and section
11 of chapter 12). Although these recommended excerpts are
lengthy, they are very clearly written and can be your one-stop
shopping for a full explanation of the business cycle.
- The
Austrian Theory of the Trade Cycle is a collection
of essays by various writers. Its virtue is that it provides slightly
different perspectives and writing styles, and so at least one
of them is bound to appeal to the reader. On the downside,
it doesn’t present a systematic exposition.
 Mises’
Human Action
(especially chapters XIX and XX). It’s always fun and important
to go back to the master, but this is rather heavy stuff.
- Hayek’s
Prices and Production (.pdf)
comes at the Misesian theory from a different angle, so to speak.
Although this work is a classic in the literature, it is very
difficult reading indeed and I recommend it only for trained economists
who want to see a more analytical approach than that offered by
Mises and Rothbard in their treatises.
CONCLUSION
When I was
in graduate school, my peers would often ask, "So what the
heck is Austrian economics?" If I thought the person
really wanted to give me a good five minutes, I would steer the
conversation to the Misesian theory of the business cycle. This
is one clear-cut area where Austrian thinkers really know something
important about the world that other people lack.
 In
the coming years it seems the chickens will come home to roost from
the negative (inflation adjusted) interest rates that Alan Greenspan
foisted on the economy in the early 2000s. If you do your homework,
you’ll understand why events are unfolding this way, and you just
may be able to protect your assets as well.
August 20, 2007
Bob
Murphy [send him mail]
has a Ph.D. in economics from New York University, and is the author
of The
Politically Incorrect Guide to Capitalism.
He has a personal website at ConsultingByRPM.com
Bob
Murphy Archives
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