"Why do booms, historically, continue for several years? What delays the reversion process? The answer is that as the boom begins to peter out from an injection of credit expansion, the banks inject a further dose. In short, the only way to avert the onset of the depression is to continue inflating money and credit. For only continual doses of new money on the credit market will keep the boom going and the new stages profitable. Furthermore, only ever increasing doses can step up the boom, can lower interest rates further, and expand the production structure, for as the prices, rise, more and more money will be needed to perform the same amount of work. Once the credit expansion stops, the market ratios are re-established, and the seemingly glorious new investments turn out to be malinvestments, built on a foundation of sand. It is clear that prolonging the boom by ever larger doses of credit expansion will have only one result: to make the inevitably ensuing depression longer and more grueling. The way to prevent a depression, then, is simple: avoid starting a boom.
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"Historically, governments have fostered and encouraged credit expansion to a great degree. They have done so by weakening the limitations that the market places on bank credit expansion. One way of weakening is to anesthetize the bank against the threat of bank runs. In nineteenth-century America, the government permitted banks, when they got into trouble in a business crisis, to suspend specie payment while continuing in operation. They were temporarily freed from their contractual obligation of paying their debts, while they could continue lending and even force their debtors to repay in their own bank notes. This is a powerful way to eradicate limitations on credit expansion, since the banks know that if they overreach themselves, the government will permit them blithely to avoid payment of their contractual obligations. "Under a fiat money standard, governments (or their central banks) may obligate themselves to bail out, with increased issues of standard money, any bank or any major bank in distress. In the late nineteenth century, the principle became accepted that the central bank must act as the 'lender of last resort,' which will lend money freely to banks threatened with failure. Another recent American device to abolish the confidence limitation on bank credit is 'deposit insurance,' whereby the government guarantees to furnish paper money to redeem the banks' demand liabilities. These and similar devices remove the market brakes on rampant credit expansion. "A second device, now so legitimized that any country lacking it is considered hopelessly 'backward,' is the central bank. The central bank, while often nominally owned by private individuals or banks, is run directly by the national government. Its purpose, not always stated explicitly, is to remove the competitive check on bank credit provided by a multiplicity of independent banks. Its aim is to make sure that all the banks in the country are coordinated and will therefore expand or contract together - at the will of the government."
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Murray N. Rothbard (1926-1995) was the S.J. Hall Distinguished Professor of Economics at the University of Nevada, Las Vegas, and Academic Vice President of the Ludwig von Mises Institute. He studied under Mises and wrote 25 books -- including Man, Economy, and State; The Ethics of Liberty; and the 4-volume Conceived in Liberty, What Has Government Done to Our Money, and The Case Against the Fed -- and thousands of articles. He was the dean of the Austrian School of economics, the founder of modern libertarianism, and the leading advocate of anarcho-capitalism. His papers and library are housed at the Mises Institute in Auburn, Ala., which carries on his work.
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