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End risk-taking if you want an end to boom and bust

Regular Samizdata commentator Ian B made a good point on this comment thread (scroll down) about the issue of economic cycles. As he says, many of the boom-bust cycles have been associated with new products and markets where there is scanty information about how large a market might be. For instance, the technology boom of the 1990s involved an area – the Web – which was still unknown territory to most of us. Yes, most of us now are familiar to the nth degree with the Internet but that is because a lot of bold, not necessarily reckless, investors, geeks and entrepreneurs took a punt. With hindsight, some of these investment propositions were pie in the sky. Well, without perfect knowledge of the future, malinvestments get made. The same can be said of the 1840s railway boom. There were shysters and boosters like the 19th Century financier George Hudson, but out of the inevitable mistakes and broken dreams came a country that was criss-crossed with railways. Out of the bust of the tech boom came the Googles, Yahoos, Amazons and Facebooks of today. These technologies, for instance, have changed how I can do my job in all manner of ways, almost all of them for the better. Out of the hundreds of automobile companies set up at the start of the last century came the motoring titans of today. The examples multiply.

As Ian put it, if people don’t want these busts, then maybe they are expecting the impossible if they also want to get still all the good things that a boom can produce. For sure, it would be good to stop fuelling mad cycles with fiat money, and that is why I want genuine free market banking, and not the quasi-statist dog’s breakfast, instead. But I am most certainly not in favour of the “calm” that comes when there is no change or disruptions at all. That is to demand the peace and quiet of the grave.

Update: via the National Review’s Corner blog, I came across this in a similar mood to my point.

20 comments to End risk-taking if you want an end to boom and bust

  • Innovation = good. New investment flows to new ideas, some good, some bad, overall we almost certainly gain.

    However this overlooks that ninety per cent of any boom-bust cycle is a straightforward credit bubble/property price bubble that’s booming and busting, which has been the case since time immemorial. And there is usually massive government interference in stoking these.

  • RRS

    What is called CAPITALISM in common parlance today is NOT an “ism.”

    That word is a definition from a critic of the “Rentier”
    aspects of the Economies at the maturing of the Industrial Revolution in Europe.

    What people are referring to is a “Price System” whereby services are exchanged for services [Bastiat] on the basis of private choices, reflected by prices, evaluated through a medium of exchange (money)

    Unlike various “isms.” the system has no social or political objectives, leaving those to private choice. However, there are constant movements and pressures to direct activities within the system to specific objectives (for all sorts of “reasons”).

    Given, numerous factors affect those elements of: (i)choice, (ii) money (and its alter ego – credit) etc. In addition we recognize the impacts of social and political factors on the services themselves, and on how they are exchanged (exogenously imposed conditions).

    The periodic DISORDERS in this Pricing System are often called Crises.
    But, they are not defects of the system, despite the vulnerability to impacts on its elements.

    Sorting out the factors that contribute to a disorder at any particular time period should not be tantamount to a search for flaws in the pricing system. Rather that sorting out should call for an examination of those factors that had adverse impacts on the elements of the system – be they money (credit), social and political restraints, war, timing – just everything.

    We are looking at something like a sick child. We should be loath to say this child is a defective organism, rather than look at what made the child ill – which as we know can be caused by conduct; but, other more likely factors should not be overlooked.

    Perhaps we do not have a “crisis” at all, but a disorder that is useful (if renamed) to some for their objectives in directing the sorting out.

  • Dutch Guy

    Johnathan ever heard of the Austrian business cycle?

  • Johnathan Pearce

    Johnathan ever heard of the Austrian business cycle?

    Yes. Why you ask?

  • Midwesterner

    I generally agree with Ian’s point but we must make very clear that the boom bust cycles will be minuscule in the absence of central bank manipulations.

    Central banks as a matter of policy attempt to maintain at least a one to three percent inflation rate. This is deliberate, not a byproduct of other goals. One of the purposes of this inflation is to keep the velocity of money high. Keeping the velocity of money high is another way of saying ‘discourage money hoarding’. ‘Hoarding’ is central banker speak for ‘saving’.

    So in a politically managed economy, money is a hot potato that must be protected by ‘investing’ it in something. In this case, ‘investing’ in fact means trying to avoid getting robbed by inflation.

    With this artificial pseudo-market force interfering with sound and deliberate investment it is inevitable that in their scramble to avoid the inflationary penalties for holding money there are a serial stream of bubbles.

    Eliminate political control of money and bubbles will diminish probably by a full order of magnitude.

  • Current

    Jonathan, Hayek wrote about this.

    Remember without a central bank backed fiat money system new investment is funded by saving. If there is a new innovation then there may be much investment in it. However investment can only occur from the savings pool. This makes it unlikely that a boom in one sector could develop as they do today. It would require that profitable investments in other sectors be abandoned, this is unlikely to happen to any great extent.

    In our modern booms this has not happened. Investment in other areas stayed on track in normal nominal levels. Newly created money went to the boomy areas, hi-tech and then housing.

  • Janine

    Jonathan, Hayek wrote about this.

    hahaha… I kind of suspect he read that. Correct me if I’m wrong but I think some of the writers here actually knew and spoke to Hayek 🙂

  • RobinG

    Continuing with Hayek, it’s not just about risk but about freedom:

    “The value of freedom consists mainly in the opportunity that it provides for the growth of the undesigned”


    “If there were omniscient men, if we could know not only all that affects the attainment of our present wishes but also our future wants and desires, there would be little case for liberty. And, in turn, liberty of the individual would, of course, make complete foresight impossible. Liberty is essential in order to leave room for the unforeseeable and unpredictable; we want it because we have learned to expect from it the opportunity of realizing many of our aims. It is because every individual knows so little and, in particular, because we rarely know which of us knows best that we trust the independent and competitive efforts of many to induce the emergence of what we shall want when we set it.”

  • Johnathan Pearce

    I think some of the commenters, such as Current, are making perfect valid statements of fact but I think they are also slightly missing the point; I do not contest, at all, that fiat money has been behind a lot of the recent madness. Take a look at this blog’s archives – I have probably bored the pants off the readership by railing against fiat money, hubristic central banks, etc. But I think that you can observe that manias for new areas do occur under different economic systems. Take the Dutch tulip bubble. The 1840s railway bubble was not, as far as my understanding of mid-Victorian monetary history goes, driven by ludicrously cheap cash. With the tech boom, yes, for sure, there was a signficant cheap-money aspect to this.

    All I am saying is that with new technologies, there will be a constant chance of what – with hindsight – is over-investment. I most certainly did not say that this was the main cause of booms or busts, or try to exonerate policymakers for their foolishness.

    Sorry but I like to think I am being understood!

  • Current

    My point is that we don’t really have to suppose that a world without booms and busts would have the quiet of the grave.

    The economy is very sectoral. Increasingly there are more types and sub-markets of industry. All kinds of problems may go on within those without affecting the rest of the market seriously.

    The fact is we don’t know what would happen with a decent monetary system in place. There may still be some booms and bust or there may not.

    Also, the Railway mania of the 1840s was related to money. In 1844 the Bank act was passed which made the BoE the central bank and began the system of the regulated gold standard. In the early 1840s the money supply was constricted. But, the BoE then rapidly expanded it after September 1844. The BoE nearly bankrupted themselves in the 1840s and were saved by the government suspending convertibility in 1847. We don’t know that monetary issues caused railway mania, but it’s not out of the question.

  • Midwesterner


    The Dutch tulip bubble was driven by the government retroactively turning tulip futures contracts into tulip options contracts.

  • I may have asked this before, but is this a coincidence? I couldn’t find legal tender history for European countries other than France.

  • Midwesterner

    Also, you may want to read this(PDF).

    The story of Tulipmania is not only about tulips and their price movements, and certainly studying the “fundamentals of the tulip market” does not explain the occurrence of this speculative bubble. The price of tulips only served as a manifestation of the end result of a government policy that expanded the quantity of money and thus fostered an environment for speculation and malinvestment. This scenario has been played out over and over throughout history.

  • Johnathan Pearce

    Mid, thanks!

  • Midwesterner

    Your welcome. I’ve become mildly enamored with the tulip bubble and think the jury is still out on it. An interesting oddity about it that may support Ian B’s general point is that they created a currency boom that was in fact founded on gold and silver. It was not a ‘fiat-money’ bubble. In many ways the gold and silver pouring into Holland resemble the Chinese goods pouring into the West, which is the net result of China buying T$’s.

    Another fascinating thing about it is the futures/options thing I mentioned. It had apparently been under serious discussion for some time. When the tulip market began collapsing, the Federal Reserve Bank guild of Dutch florists convinced the Treasury Secretary, et al Dutch Parliament that the magnitude of the looming crisis meant that Fannie, Freddie and friends the tulip speculations had become ‘to big to fail’. So they enacted the bail-out futures to options change, which left the one group that didn’t screw up, the people who hold dollars grew tulips, to get badly burned.


  • Ian B

    I don’t think Johnathan’s kind reiteration of my point was trying to exhonerate fiat-central-bank-etc manipulations and their part in the general mayhem, any more than I was. My original point was that Libertarians tend to overstate the case by strongly implying, or outright declaring, that without fiat-central-bank-fractional-reserve-and-so-on the economy would never boom or dip at all and it would be a perfect graph of steady growth; i.e. rather than the reasonable point that statist manipulations cause exaggerated booms and busts, claiming that they are entirely and solely to blame for any deviation of the economy from “plain sailing”.

    So I think the point here is asking people to consider being more rhetorically cautious. Supplies of cheap money due to interest rate manipulations do, I think we all agree, make things far worse than they ought to be, and government attempts to “fix” the bust when it inevitably happens turns a drama into a crisis and then a total wipeout. But we aren’t going to abolish banking, nor credit, neither should we attempt to, and fractional reserve is just loan brokering and promisory notes, both of which are going to exist in a free banking system, let us understand that. The claim that we can create an economic utopia is no better than the Keynesians’ claim that they can. There will always be speculation, risk and failure, and the madness of crowds will ensure that there will be big lemming failures on occasion. The cheap credit makes it worse, but the rush to get in on the ground floor of the Next Big Thing is human nature.

    So in my view, we just need to accept that that’s going to happen, and to say that wise hens don’t put all their eggs in one speculative basket, and free markets require both daring and caution, and which is appropriate as to any specific investment is often little more than guesswork.

    I think people are drawn towards seeking singular explanations for things, and we libertarians are as guilty of that as anyone else. The booms and busts will be smaller in a true free market- hopefully far, far smaller, but they will not be eradicated.

  • Current

    Ian, Johnathan Pearce,

    Certainly we must not be too optimistic. But neither must we be too pessimistic.

    Let’s be clear what a slump or boom is. Both represent coordinated phenomena in a very uncoordinated world. Clearly a big, general cause may lead to them, such as the gold inflow Midwesterner mentions. But, are things like the web really similar? I’m not sure they are.

  • Paul Marks

    One does not have to end “risk taking” or “capitalism” to end the “boom, bust cycle”.

    The claim is not as absurd as that of Tim paid-by-the-banks-to-get-them-bigger-subsidies Congdon that by opposing credit money expansion I supported the later Ming Emperors of China in their ban on overseas trade.

    The “argument” (made when Tim Congdon still consented to speak to mortals) was that the Ming stopped issuing paper money, and the later Ming banned overseas trade – therefore…….. I must support both actions (no I had not mentioned China or the Ming in the discussion).

    The “economic cycle” is caused by the expansion of the credit money supply in an effort to reduce interest rates.

    It can be done by government – or it can be done by fractional reserve banks WITHOUT government (indeed it was credit bubble franctional reserve banking, or rather the regular crack up of it, that led to the demands to create the Fed in 1913).

    But the result is always to have a phony boom followed by a bust – with all the demands for statism that such a bust leads to.

    True the bust is different each time (sometimes worse depending on the specific circumstances – the present ones being the insane “afforable housing” policy in the United States) but there is always a bust.

    And you would still have railways and the internet and …….

    Without the credit bubble finance.

    David Hume understand a lot of this – and there is Ludwig Von Mises “Theory of Money and Credit” for those who do not.

  • Current

    Paul Marks: “(indeed it was credit bubble franctional reserve banking, or rather the regular crack up of it, that led to the demands to create the Fed in 1913)”

    Read about the National banking system that pre-dated the Federal Reserve. Government was noticable by it’s lack of absence.

    Before the Federal reserve the treasury changed the interest rate by open-market operations, much as they do now.