Monday, February 20, 2017

Saturday, February 18, 2017

Milo to Deliver Keynote at CPAC

The Conservative Political Action Conference (CPAC) has announced that Milo Yiannopoulos will deliver a keynote speech at this year's conference.

Other speakers will include Vice President Mike Pence, Steve Bannon, John Bolton, Nigel Farage, and Ted Cruz.

The conference will be held from February 22-25 at the Gaylord National Resort & Convention Center, National Harbor, MD

Friday, February 17, 2017

Breaking Out of the Walrasian Box: The Cases of Schumpeter and Hansen

By Murray N. Rothbard

 Since World War II, mainstream neoclassical economics has followed the general equilibrium paradigm of Swiss economist Leon Walras (1834-1910).1 Economic analysis now consists of the exegesis and elaboration of the Walrasian concept of general equilibrium, in which the economy pursues an endless and unchanging round of activity—what the Walrasian Joseph Schumpeter aptly referred to as “the circular flow.” Since the equilibrium economy is by definition a changeless and unending round of robotic behavior, everyone on the market has perfect knowledge of the present and the future, and the pervasive uncertainty of the real world drops totally out of the picture. Since there is no more uncertainty, profits and losses disappear, and every business firm finds that its selling price exactly equals its cost of production.
     It is surely no accident that the rise to dominance of Walrasian economics has coincided with the virtual mathematization of the social sciences. Mathematics enjoys the prestige of being truly “scientific,” but it is difficult to mathematize the messy and fuzzy uncertainties and inevitable errors of real world entrepreneurship and human actions. Once one expunges such actions and uncertainties, however, it is easy to employ algebra and the tangencies of geometry in analyzing this unrealistic but readily mathematical equilibrium state.
     Most mainstream economic theorists are content to spend their time elaborating on the general equilibrium state, and simply to assume that this state is an accurate presentation of real world activity. But some economists have not been content with contemplating general equilibrium; they have been eager to apply this theory to the real world of dynamic change. For change clearly exists, and for some Walrasians it has not sufficed to simply translate general equilibrium analysis to the real world and to let the chips fall where they may.
     As someone who has proclaimed that Leon Walras was the greatest economist who ever lived, Joseph A. Schumpeter (1883-1950) faced this very problem. As a Walrasian, Schumpeter believed that general equilibrium is an overriding reality; and yet, since change, entrepreneurship, profits, and losses clearly exist in the real world, Schumpeter set himself the problem of integrating a theoretical explanation of such change into the Walrasian system. It was a formidable problem indeed, since Schumpeter, unlike the Austrians, could not dismiss general equilibrium as a long-run tendency that is never reached in the real world. For Schumpeter, general equilibrium had to be the overriding reality: the realistic starting point as well as the end point of his attempt to explain economic change.2
     To set forth a theory of economic change from a Walrasian perspective, Schumpeter had to begin with the economy in a real state of general equilibrium. He then had to explain change, but that change always had to return to a state of equilibrium, for without such a return, Walrasian equilibrium would only be real at one single point of past time and would not be a recurring reality. But Walrasian equilibrium is a world of unending statis; specifically, it depicts the consequences of a fixed and unchanging set of individual tastes, techniques, and resources in the economy. Schumpeter began, then, with the economy in a Walrasian box; the only way for any change to occur is through a change in one or more of these static givens.
      Furthermore, Schumpeter created even more problems for himself. In the Walrasian model, profits and losses were zero, but a rate of interest continued to be earned by capitalists, in accordance with the alleged marginal productivity of capital. An interest charge became incorporated into costs. But Schumpeter was too much of a student of Böhm-Bawerk to accept a crude productivity explanation of interest. The Austrian approach was to explain interest by a social rate of time preference, of the market’s preference for present goods over future goods. But Schumpeter rejected the concept of time-preference as well, and so he concluded that in a state of general equilibrium, the rate of interest as well as profits and losses are all zero.
      Schumpeter acknowledged that time-preference, and hence interest, exist on consumption loans, but he was interested in the production structure. Here he stressed, as against the crude productivity theory of interest, the Austrian concept of imputation, in which the values of products are imputed back to productive factors, leaving, in equilibrium, no net return. Also, in the Austrian manner, Schumpeter showed that capital goods can be broken down ultimately into the two original factors of production, land and labor.3 But what Schumpeter overlooked, or rather rejected, is the crucial Böhm-Bawerkian concept of time and time-preference in the process of production. Capital goods are not only embodied land and labor; they are embodied land, labor, and time, while interest becomes a payment for “time.” In a productive loan, the creditor of course exchanges a “present good” (money that can be used now) for a “future good” (money that will only be available in the future). And the primordial fact of time-preference dictates that every one will prefer to have wants satisfied now than at some point in the future, so that a present good will always be worth more than the present prospect of the equivalent future good. Hence, at any given time, future goods are discounted on the market by the social rate of time-preference.
     It is clear how this process works in a loan, in an exchange between creditor and debtor. But Böhm-Bawerk’s analysis of time-preference and interest went far deeper, and far beyond the loan market for he showed that time-preference and hence interest return exist apart from or even in the absence of any lending at all. For the capitalist who purchases or hires land and labor factors and employs them in production is buying these factors with money (present good) in the expectation that they will yield a future return of output, of either capital goods or consumer goods. In short, these original factors, land and labor, are future goods to the capitalist. Or, put another way, land and labor produce goods that will only be sold and hence yield a monetary return at some point in the future; yet they are paid wages or rents by the capitalist now, in the present.
      Therefore, in the Böhm-Bawerkian or Austrian insight, factors of production, hence workers or landowners, do not earn, as in neoclassical analysis, their marginal value product in equilibrium. They earn their marginal value product discounted by the rate of time-preference or rate of interest. And the capitalist, for his service of supplying factors with present goods and waiting for future returns, is paid the discount.4 Hence, time-preference and interest income exist in the state of equilibrium, and not simply as a charge on loans but as a return earned by every investing capitalist.
Schumpeter can deny time-preference because he can somehow deny the role of time in production altogether. For Schumpeter, production apparently takes no time in equilibrium, because production and consumption are “synchronized.”5 Time is erased from the picture, even to the extent of assuming away accumulated stocks of capital goods, and therefore of any age structure of distribution of such goods.6 Since production is magically “synchronized,” there is then no necessity for land and labor to receive any advances from capitalists. As Schumpeter writes:
There is no necessity [for workers or landowners] to apply for any “advances” of present consumption goods. . . . The individual need not look beyond the current period. . . . The mechanism of the economic process sees to it that he also provides for the future at the same time. . . . Hence every question of the accumulation of such stocks [of consumer goods to pay laborers] disappears.
     From this bizarre set of assumptions, “it follows”, notes Schumpeter, “that everywhere, even in a trading economy, produced means of production are nothing but transitory items. Nowhere do we find a stock of them fulfilling any functions.” In denying, further, that there is any “accumulated stock of consumer goods” ready to pay laborers and landowners, Schumpeter is also denying the patent fact that wages and rents are always paid out of the accumulated savings of capitalists, savings which could have been spent on consumer goods but which laborers and landowners will instead spend with their current incomes.
     How can Schumpeter come to this conclusion? One reason is that when workers and landowners exchange their services for present money, he denies that these involve “advances” of consumer goods, because “It is simply a matter of exchange, and not of credit transactions. The element of time plays no part.” What Schumpeter overlooks here is the profound Böhm-Bawerkian insight that the time market is not merely the credit market. For when workers and landowners earn money now for products that will only reap a return to capitalists in the future, they are receiving advances on production paid for out of capitalist saving, advances for which they in effect pay the capitalists a discount in the form of an interest return.7
     In most conceptions of final equilibrium, net savings are zero, but interest is high enough to induce gross saving by capitalists to just replace capital equipment. But in Schumpeter’s equilibrium, interest is zero, and this means that gross saving is zero as well. There appear to be neither an incentive for capitalists to maintain their capital equipment in Schumpeterian equilibrium nor the means for them to do so. The Schumpeterian equilibrium is therefore internally inconsistent and cannot be maintained.8
     Lionel Robbins puts the case in his usual pellucid prose:
If there were no yield to the use of capital . . . there would be no reason to refrain from consuming it. If produced means of production are not productive of a net product, why devote resources to maintaining them when these resources might be devoted to providing present enjoyment? One would not have one’s cake rather than eat it, if there were no gain to be derived from having it. It is, in short, an interest rate, which, other things being given, keeps the stationary state—the rate at which it does not pay to turn income into capital or capital into income. If interest were to disappear the stationary state would cease to be stationary. Schumpeter can argue that no accumulation will be made once stationary equilibrium has been attained. But he is not entitled to argue that there will be no decumulation unless he admits the existence of interest.9 (emphasis added)
     To return to Schumpeter’s main problem, if the economy begins in a Walrasian general equilibrium modified by a zero rate of interest, how can any economic change, and specifically how can economic development, take place? In the Austrian-Böhm-Bawerkian view, economic development takes place through greater investment in more roundabout processes of production, and that investment is the result of greater net savings brought about by a general fall in rates of time-preference. Upon such a fall, people are more willing to abstain from consumption and to save a greater proportion of their incomes, and thereby invest in more capital and longer processes of production. In the Walrasian schema, change can only occur through alterations in tastes, techniques, or resources. A change in time-preference would qualify as a very important aspect of a change in consumer “tastes” or values.
     But for Schumpeter, there is no time-preference, and no savings in equilibrium. Consumer tastes are therefore irrelevant to increasing investment, and besides there are no savings or interest income out of which such investment can take place. A change in tastes or time-preferences cannot be an engine for economic change, and neither can investment in change emerge out of savings, profit, or interest.
     As for consumer values or tastes apart from time-preference, Schumpeter was convinced that consumers were passive creatures and he could not envision them as active agents for economic change.10 And even if consumer tastes change actively, how can a mere shift of demand from one product to another bring about economic development?
     Resources for Schumpeter are in no better shape as engines of economic development than are tastes. In the first place, the supplies of land and labor never change very rapidly over time, and furthermore they cannot account for the necessary investment that spurs and embodies economic growth.
      With tastes and resources disposed of, there is only one logically possible instrument of change or development left in Schumpeter’s equilibrium system: technique. “Innovation” (a change in embodied technical knowledge or production functions) is for Schumpeter the only logically possible avenue of economic development. To admire Schumpeter, as many economists have done, for his alleged realistic insight into economic history in seeing technological innovation as the source of development and the business cycle, is to miss the point entirely. For this conclusion is not an empirical insight on Schumpeter’s part; it is logically the only way that he can escape from the Walrasian (or neoWalrasian) box of his own making; it is the only way for any economic change to take place in his system.
     But if innovation is the only way out of the Schumpeterian box, how is this innovation to be financed? For there are no savings, no profits, and no interest returns in Schumpeterian equilibrium. Schumpeter is stuck: for there is no way within his own system for innovation to be financed, and therefore for the economy to get out of his own particularly restrictive variant of the Walrasian box. Hence, Schumpeter has to invent a deus ex machina, an exogenous variable from outside his system that will lift the economy out of the box and serve as the only possible engine of economic change. And that deus ex machina is inflationary bank credit. Banks must be postulated that expand the money supply through fractional reserve credit, and furthermore, that lend that new money exclusively to innovators—to new entrepreneurs who are willing and able to invest in new techniques, new processes, new industries. But they cannot do so because, by definition, there are no savings available for them to invest or borrow.
     Hence, the conclusion that innovation is the instrument of economic change and development, and that the innovations are financed by inflationary bank credit, is not a perceptive empirical generalization discovered by Joseph Schumpeter. It is not an empirical generalization at all; indeed it has no genuine referent to reality. Suggestive though his conclusion may seem, it is solely the logical result of Schumpeter’s fallacious assumptions and his closed system, and the only logical way of breaking out of his Walrasian box.
     One sees, too, why for Schumpeter the entrepreneur is always a disturber of the peace, a disruptive force away from equilibrium, whereas in the Austrian tradition of von Mises and Kirzner, the entrepreneur harmoniously adjusts the economy in the direction of equilibrium. For in the Austrian view the entrepreneur is the main bearer of uncertainty in the real world, and successful entrepreneurs reap profits by bringing resources, costs, and prices further in the direction of equilibrium. But Schumpeter starts, not in the real world, but in the never-never land of general equilibrium which he insists is the fundamental reality. But in the equilibrium world of stasis and certainty there are no entrepreneurs and no profit. The only role for entrepreneurship, by logical deduction, is to innovate, to disrupt a preexisting equilibrium. The entrepreneur cannot adjust, because everything has already been adjusted. In a world of certainty, there is no room for the entrepreneur; only inflationary bank credit and innovation enable him to exist. His only prescribed role, therefore, is to be disruptive and innovative.
     The entrepreneur, then, pays interest to the banks, interest for Schumpeter being a strictly monetary phenomenon. But where does the entrepreneurinnovator get the money to pay interest? Out of profits, profits that he will reap when the fruits of his innovation reach the market, and the new processes or products reap revenue from the consumers. Profits, therefore, are only the consequence of successful innovation, and interest is only a payment to inflationary banks out of profit.
     Inflationary bank credit means, of course, a rise in prices, and also a redirection of resources toward the investment in innovation. Prices rise, followed by increases in the prices of factors, such as wages and land rents. Schumpeter has managed, though not very convincingly, to break out of the Walrasian box. But he has not finished his problem. For it is not enough for him to break out of his box; he must also get back in. As a dedicated Walrasian, he must return the economy to another general equilibrium state, for after all, by definition a real equilibrium is a state to which variables tend to return once they are replaced. How does the return take place?
     For the economy to return to equilibrium, profits and interest must be evanescent. And innovation of course must also come to an end. How can this take place? For one thing, innovations must be discontinuous; they must only appear in discrete clusters. For if innovation were continuous, the economy would never return to the equilibrium state. Given this assumption of discontinuous clusters, Schumpeter found a way: When the innovations are “completed” and the new processes or new products enter the market, they out-compete the old processes and products, thereby reaping the profits out of which interest is paid. But these profits are made at the expense of severe losses for the old, now inefficient, firms or industries, which are driven to the wall. After a while, the innovations are completed, and the inexorable imputation process destroys all profits and therefore all interest, while the sudden losses to the old firms are also ended. The economy returns to the unchanging circular flow, and stays there until another cluster of innovations appears, whereupon the cycle starts all over again.
     “Cycle” is here the operative term, for in working out the logical process of breakout and return, Schumpeter has at the same time seemingly developed a unique theory of the business cycle. Phase I, the breakout, looks very much like the typical boom phase of the business cycle: inflationary bank credit, rise in prices and wages, general euphoria, and redirection of resources to more investment. Then, the events succeeding the “completion” of the innovation look very much like the typical recession or depression: sudden severe losses for the old firms, retrenchment. And finally, the disappearance of both innovation and euphoria, and eventually of losses and disruption—in short, a return to a placid period which can be made to seem like the state of stationary equilibrium.
     But Schumpeter’s doctrine only seems like a challenging business cycle theory worthy of profound investigation. For it is not really a cycle theory at all. It is simply the only logical way that Schumpeter can break out and then return to the Walrasian box. As such, it is certainly an ingenious formulation, but it has no genuine connection with reality at all.
     Even within his own theory, indeed, there are grave flaws. In the Walrasian world of perfect certainty (an assumption which is not relaxed with the coming of the innovator), how is it that the old firms wait until the “completion” of the innovation to find suddenly that they are suffering severe losses? In a world of perfect knowledge and expectations, the old firms would know of their fate from the very beginning, and early take steps to adjust to it. In a world of perfect expectations, therefore, there would be no losses, and therefore no recession or depression phase. There would be no cycle as economists know it.
      Finally, Schumpeter’s constrained model can only work if innovations come in clusters, and the empirical evidence for such clusters is virtually nil.11 In the real world, innovations occur all the time. Therefore, there is no reason to postulate any return to an equilibrium, even if it had ever existed in the past.
     In conclusion, Schumpeter’s theory of development and of business cycles has impressed many economists with his suggestive and seemingly meaningful discussions of innovation, bank credit, and the entrepreneur. He has seemed to offer far more than static Walrasian equilibrium analysis and to provide an economic dynamic, a theoretical explanation of cycles and of economic growth. In fact, however, Schumpeter’s seemingly impressive system has no relation to the real world at all. He has not provided an economic dynamic; he has only found an ingenious but fallacious way of trying to break out of the static Walrasian box. His theory is a mere exercise in equilibrium logic leading nowhere.
     It is undoubtedly at least a partial realization of this unhappy fact that prompted Schumpeter to expand his business cycle theory from his open-cycle model of the Theory of Economic Development of 1912 to his three-cycle schema in his two-volume Business Cycles nearly three decades later.12 More specifically, Schumpeter saw that one of the problems in applying his model to reality was that if the length of the boom period is determined by the length of time required to “complete” the innovation and bring it to market, then how could his model apply to real life, where simultaneous innovations occur, each of which requires a different time for its completion? His later three-cycle theory is a desperate attempt to encompass such real-life problems. Specifically, Schumpeter has now postulated that the economy, instead of unitarily breaking out and returning to equilibrium, consists of three separate hermetically sealed, strictly periodic cycles—the “Kitchin”, the “Juglar,” and the “Kon-dratieff”—each with the same innovation-inflation-depression characteristics. This conjuring up of allegedly separate underlying cycles, each cut off from the other, but all adding to each other to yield the observable results of the real world, can only be considered a desperate lapse into mysticism in order to shore up his original model.
     In the first place, there are far more than three innovations going on at one time in the economy, and there is no reason to assume strict periodicity of each set of disparate changes. Indeed, there is no such clustering of innovations as would be required by the theory. Secondly, in the market economy, all prices and activities interact; there therefore can never be any hermetically sealed cycles. The multicycle scheme is an unnecessary and heedless multiplication of entities in flagrant violation of Occam’s Razor. In an attempt to save the theory, it asserts propositions that cannot be falsifiable, since another cycle can always be conjured up to explain away anomalies.13 In an attempt to salvage his original model, Schumpeter only succeeded in adding new and greater fallacies to the old.
     In the years before and during World War II, the most popular dynamic theory of economic change was the gloomy doctrine of “secular stagnation” (or “economic maturity”) advanced by Professor Alvin H. Hansen.14 The explanation of the Great Depression of the 1930s, for Hansen, was that the United States had become mired in permanent stagnation, from which it could not be lifted by free market capitalism. A year or two after the publication of Keynes’s General Theory, Hansen had leaped on the New Economics to become the leading American Keynesian; but secular stagnation, while giving Keynesianism a left-flavor, was unrelated to Keynesian theory. For Keynes, the key to prosperity or depression was private investment: flourishing private investment means prosperity; weak and fitful investment leads to depression. But Keynes was an agnostic on the investment question, whereas Hansen supplied his own gnosis. Private investment in the United States was doomed to permanent frailty, Hansen opined, because (1) the frontier was now closed; (2) population growth was declining rapidly; and (3) there would be hardly any further inventions, and what few there were would be of the capital-saving rather than labor-saving variety, so that total investment could not increase.
     George Terborgh, in his well-known reputation of the stagnation thesis, The Bogey of Economic Maturity, concentrated on a statistical critique.15 If the frontier had been “closed” since the turn of the century, why then had there been a boom for virtually three decades until the 1930s? Population growth too, had been declining for many decades. It was easy, also, to demolish the rather odd and audacious prediction that few or no further inventions, at least of the labor-saving variety, would ever more be discovered. Predictions of the cessation of invention, which have occurred from time to time through history, are easy targets for ridicule.
     But Terborgh never penetrated to the fundamentals of the Hansen thesis. In an age beset by the constant clamor of population doomsayers and zero-population-growth enthusiasts, it is difficult to conjure up an intellectual climate when it seemed to make sense to worry about the slowing of population growth. But why, indeed, should Hansen have considered population growth as ipso facto a positive factor for the spurring of investment? And why would a slowing down of such growth be an impetus to decay? Schumpeter, in his own critique of the Hansen thesis, sensibly pointed out that population growth could easily lead to a fall in real income per capita.16
     Ironically, however, Schumpeter did not recognize that Hansen, too, in his own way, was trying to break out of the Walrasian box. Hansen began implicitly (not explicitly like Schumpeter) with the circular flow and general equilibrium, and then considered the various possible factors that might change—or, more specifically, might increase. And these were the familiar Walrasian triad: land, labor, and technique. As Terborgh noted, Hansen had a static view of “investment opportunities.” He treated them as if they were a limited physical entity, like a sponge. They were a fixed amount, and when that maximum amount was reached, investment opportunities were “saturated” and disappeared. The implicit Hansen assumption is that these opportunities could be generated only by increases in land, labor, and improved techniques (which Hansen limited to inventions rather than Schumpeterian innovations). And so the closing of the frontier meant the drying up of “land-investment opportunities”, as one might call them, the slowing of population growth, the end of “labor-investment opportunities,” leading to a situation where innovation could not carry the remaining burden. And so Hansen’s curious view of the economic effects of diminishing population growth, as gloomily empirical as it might seem, was not really an empirical generalization at all. Indeed, it said nothing about dynamic change or about the real world at all. The allegedly favorable effect of high population growth was merely the logical spinning out of Hansen’s own unsuccessful variant of trying to escape from the Walrasian box.
     And so Hansen’s curious view of the economic effects of diminishing population growth, as gloomily empirical as it might seem, was not really an empirical generalization at all. Indeed, it said nothing about dynamic change or about the real world at all. The allegedly favorable effect of high population growth was merely the logical spinning out of Hansen’s own unsuccessful variant of trying to escape from the Walrasian box.
The author learned the basic insights of this article many years ago from lectures of Professor Arthur F. Burns at Columbia University.
  • 1.Before World War II, the dominant paradigm, at least in Anglo-American economics, was the neo-Ricardian partial equilibrium theory of Alfred Marshall. In that era, Walras and his followers, the earliest being the Italian Vilfredo Pareto, were referred to as “the Lausanne school.” With the Walrasian conquest of the mainstream, what was once a mere school has now been transformed into “microeconomics.”
  • 2.In maintaining that Schumpeter was more influenced by the Austrians than by Walras, Mohammed Khan overlooks the fact that Schumpeter’s first book, and the only one still untranslated into English, Das Wesen und der Hauptinhalt der Theoretischen Nationalekonomie (The Essence and Principal Contents of Economic Theory) (Leipzig, 1908), written while he was still a student of Böhm-Bawerk, was an aggressively Walrasian work. Not only is Das Wesen a nonmathematical apologia for the mathematical method, but it is also a study in Walrasian general equilibrium that depicts economic events as the result of mechanistic quantitative interactions of physical entities, rather than as consequences of purposeful human action—the Austrian approach. Thus, Fritz Machlup writes that Schumpeter’s emphasis on the character of economics as a quantitative science, as an equilibrium system whose elements are “quantities of goods,” led him to regard it as unnecessary, and, hence, as methodologically mistaken for economics to deal with “economic conduct” and with “the motives of human conduct” (Fritz Machlup, “Schumpeter’s Economic Methodology,” Review of Economics and Statistics 33 (May 1951: 146-47). Cf. Mohammed Shabbir Khan, Schumpeter’s Theory of Capitalist Development (Aligarh, India: Muslim University of India, 1957). On Das Wesen, see Erich Schneider, Joseph Schumpeter: Life and Work of a Great Social Scientist (Lincoln, Neb.: University of Nebraska Bureau of Business Research, 1975), pp. 5-8. On Schumpeter as Walrasian, also see Schneider, “Schumpeter’s Early German Work, 1906-17,” Review of Economics and Statistics (May 1951): 1-4; and Arthur W. Marget, “The Monetary Aspects of the Schumpeterian System,” ibid. p. 112ff. On Schumpeter as not being an “Austrian,” also see “Haberler on Schumpeter,” in Henry W. Spiegel, ed., The Development of Economic Thought (New York: John Wiley and Sons, 1952), pp. 742-43.
  • 3.Thus, Schumpeter wrote that in the normal circular flow the whole value product must be imputed to the original productive factors, that is to the services of labor and land; hence the whole receipts from production must be divided between workers and landowners and there can be no permanent net income other than wages and rent. Competition on the one hand and imputation on the other must annihilate any surplus of receipts over outlays, any excess of the value of the product over the value of the services of labor and land embodied in it. The value of the original means of production must attach itself with the faithfulness of a shadow to the value of the product, and could not allow the slightest permanent gap between the two to exist. . . . To be sure, produced means of production have the capacity of serving in the production of goods. . . . And these goods also have a higher value than those which could be produced with the produced means of production. But this higher value must also lead to a higher value of the services of labor and land employed. No element of surplus value can remain permanently attached to these intermediate means of production (Joseph A. Schumpeter, The Theory of Economic Development: An Inquiry Into Profits, Capital, Credit, Interest, and the Business Cycle. New York: Oxford University Press, 1961, pp. 160, 162).
  • 4.See the attack on this Austrian view from a Knightian neoclassical perspective in Earl Rolph, “The Discounted Marginal Productivity Doctrine,” in W. Fellner and B. Haley, eds., Readings in the Theory of Income Distribution (Philadelphia: Blakiston, 1946), pp 278-93. For a rebuttal, see Murray N. Rothbard, Man, Economy, and State vol. I (Los Angeles: Nash Publishing Co., 1970), 431-33.
  • 5.On this alleged synchronization, see Khan, Schumpeter’s Theory, pp. 51, 53. The concept of synchronization of production is a most un-Austrian one that Schumpeter took from John Bates Clark, which in turn led to the famous battle in the 1930s between the Clark-Knight concept of capital and the Austrian views of Hayek, Machlup, and Boulding. See ibid., p. 6n. Also see F.A. Hayek, “The Mythology of Capital,” in Fellner and Haley, Readings, pp. 355-83.
  • 6.In Khan’s words, for Schumpeter “capital cannot have any age structure and perishes in the very process of its function of having command over the means of production” (Khan, Schumpeter’s Theory, p. 48). Schumpeter achieves this feat by sundering capital completely from its embodiment in capital goods, and limiting the concept to only a money fund used to purchase those goods. For Schumpeter, then, capital (like interest) becomes a purely monetary phenomenon, not rooted in real goods or real transactions. See Schumpeter, Economic Development, pp. 116-17.
  • 7.See Schumpeter, Economic Development, pp. 43-44.
  • 8.Clemence and Doody attempt to refute this charge, but do so by assuming a zero rate of time-preference. Capitalists would then be interested in maximizing their utility returns over time without regard for when they would be reaped. Hence, capital goods would be maintained indefinitely. But for those who believe that everyone has a positive rate of time-preference, and hence positively discounts future returns, a zero rate of return would quickly cause the depletion of capital and certainly the collapse of stationary equilibrium. Richard V. Clemence and Francis S. Doody, The Schumpeterian System (Cambridge, Mass: Addison-Wesley, 1950), pp. 28-30.
  • 9.In the excellent critique of Schumpeter’s zero-interest equilibrium by Lionel Robbins, “On a Certain Ambiguity in the Conception of Stationary Equilibrium,” Economic Journal 40 (June 1930): pp. 211-14. Also see Gottfried Haberler, “Schumpeter’s Theory of Interest,” Review of Economics and Statistics (May 1951): 122ff.
  • 10.Thus, Schumpeter wrote: “It is not the large mass of consumers which induces production. On the contrary, the crowd is mastered and led by the key personalities in production” (italics are Schumpeter’s) in “Die neuere Wirtschaftstheorie in den Vereinigten Staaten” (“Recent Economic Theory in the United States”) Schmollers Jahrbuch (1910), cited in Schneider, Joseph A. Schumpeter, p. 13.
  • 11.See Simon S. Kuznets, “Schumpeter’s Business Cycles,” American Economic Review (June 1940).
  • 12.Joseph A. Schumpeter, Business Cycles: A Theoretical, Historical, and Statistical Analysis of the Capitalist Process, 2 vols. (New York: McGraw-Hill, 1939).
  • 13.This does not mean that all propositions must be falsifiable; they can be selfevident or deduced from self-evident axioms. But no one can claim that the alleged Kitchin, Juglar, and Kondratieff cycles are in any sense self-evident.
  • 14.See Alvin H. Hansen, Fiscal Policy and Business Cycles (New York: W.W. Norton, 1941). For a clear summary statement of his position, see Hansen, “Economic Progress and Declining Population Growth,” in G. Haberler, ed., Readings in Business Cycle Theory (Philadelphia: Blakiston, 1944), pp. 366-84.
  • 15.George Terborgh, The Bogey of Economic Maturity (Chicago: Machinery and Allied Products Institute, 1945).
  • 16.Schumpeter, Business Cycles, p. 74.
The above originally appeared at

Tuesday, February 14, 2017

Steve Bannon Believes Winter Is Coming

"History is seasonal and winter is coming.”
No, that’s not a Game of Thrones quote. It’s the last line of a 2010 documentary called Generation Zero, written and directed by Steven K. Bannon. Perhaps you’ve heard of him.
Strauss and Howe claimed that history runs in cycles.

Bannon is President Donald Trump’s senior counselor and chief ideologist. So great is his sway over the “leader of the free world” that Time Magazine recently dubbed him “the second most powerful man in the world.” He allegedly wrote most of Trump’s scathing inaugural address. He recently secured a seat in the National Security Council. And many observers see his fingertips on much of the administration’s initial flurry of executive orders, including the controversial travel ban.
Given this power, understanding Bannon’s belief that “winter is coming” to America becomes urgent. His lurid documentary was entirely premised on a theory of history formulated by William Strauss and Neil Howe, authors of The Fourth Turning: An American Prophecy. Howe himself delivered the film’s ominous closing prediction.
The Vision
Strauss and Howe claimed that history runs in cycles, each lasting roughly 80 years. Each cycle, or saeculum, consist of four phases, or “turnings.” By “winter,” Howe and Bannon were referring to the hugely important “fourth turning,” a cataclysmic crisis that ends an era and ushers in the next.
According to Strauss and Howe, all of the last three fourth turnings in American history culminated in wars, each bigger than the last: the Revolutionary War, the Civil War, and World War II. In “Generation Zero,” Bannon argues that the country is due for another fourth turning, and that the 2008 financial crisis, bailouts, and ensuing Tea Party reaction represented the beginning of the next one.
According to David Kaiser, one of the historians featured in “Generation Zero,” Bannon believes the coming “winter” will continue the pattern of being even worse than the last. Kaiser recalled Bannon making the extrapolation during the production of the film:
“You have the American Revolution, you have the Civil War, you have World War II; they’re getting bigger and bigger. Clearly, he was anticipating that in this Fourth Turning there would be one at least as big.”
It’s reasonable to infer that “at least as big” as World War II implies World War III.
Bannon seems to elaborate on the shape of this global clash in remarks made in subsequent years. In 2014, Bannon told an audience of conservative Catholic activists that, “We’re at the very beginning stages of a very brutal and bloody conflict” in which his audience would be compelled to fight for their beliefs against “this new barbarity that’s starting, that will completely eradicate everything that we’ve been bequeathed over the last 2,000, 2,500 years.”
“We’re In a War”
Bannon then detailed three “converging tendencies” leading to “this new barbarity.”
Bannon’s crusader rhetoric finds its mirror image in the ideology of ISIS.

The first consisted of two pernicious strands of capitalism that he regarded as antithetical to what he called “enlightened capitalism.” There was the crony capitalism that was his chief target in “Generation Zero.” He also condemned “libertarian capitalism” for commodifying human beings.
The second strand was “an immense secularization of the West” and especially the youth.
Then he raised the third strand, saying “we are in an outright war against jihadist Islamic fascism. And this war is, I think, metastasizing far quicker than governments can handle it.” He later added, “we’re now, I believe, at the beginning stages of a global war against Islamic fascism.”
Later in the Q&A period, Bannon said:
“If you look back at the long history of the Judeo-Christian West struggle against Islam, I believe that our forefathers kept their stance, and I think they did the right thing. I think they kept it out of the world, whether it was at Vienna, or Tours, or other places…”
In November 2015, over a year later, his position had not changed. Bannon said, “…we’re in a war. We’re clearly going into, I think, a major shooting war in the Middle East again.”
Bannon’s crusader rhetoric finds its mirror image in the ideology of ISIS, which explicitly seeks to eliminate what it calls the “grayzone” of religious and cultural co-existence and to polarize the world into two warring camps: the “Crusader Camp” and the “Camp of (extremist) Islam.” The jihadis, like Bannon, believe that a global, apocalyptic “clash of civilizations” is inevitable.They seek to hasten that crisis by using terror attacks to elicit brutal western responses (like persecuting immigrants and Trump’s recent child-slaughtering raid in Yemen) in order to alienate and radicalize formerly non-violent Muslims. ISIS reportedly celebrated Trump’s sweeping immigration, even dubbing it “the blessed ban,” because it “shows that there is a clash of civilizations, that Muslims are not welcome in America etc."
While he regards radical Islam as the most pressing conflict, it is not the only one. In March 2016, Bannon anticipated a war with China:
“We’re going to war in the South China Sea in five to 10 years. There’s no doubt about that. They’re taking their sandbars and making basically stationary aircraft carriers and putting missiles on those. They come here to the United States in front of our face – and you understand how important face is – and say it’s an ancient territorial sea.”
Many anti-war libertarians hoped that the Trump administration would not only end the neocon-led era of Middle East interventionism but also thaw the new cold war with Russia. But in his 2014 remarks, Bannon, Trump’s chief strategist, said that even Putin would eventually have to be dealt with and that any current detente was merely strategic, for the purpose of dealing with the more pressing Islamic threat:
“Because at the end of the day, I think that Putin and his cronies are really a kleptocracy, that are really an imperialist power that wants to expand. However, I really believe that in this current environment, where you’re facing a potential new caliphate that is very aggressive that is really a situation — I’m not saying we can put it on a back burner — but I think we have to deal with first things first.”
Bannon seems to see conflict everywhere he looks: paranoid visions of expansionist incursions from all directions. This is symptomatic of what Ludwig von Mises called “warfare sociology.” According to Mises, such an ideology rejects the classical liberal notion of a natural harmony of interests based on the universal benefits of social cooperation and the division of labor. Instead, warfare sociology is rooted in an underlying philosophy according to which no party can gain except at the expense of another. In such a “zero sum” world, conflict among opposing interests is unavoidably endemic. In left-wing ideologies, this manifests as class warfare and identity politics. In right-wing ideologies, it manifests as culture warfare and the many manifestations of nationalism: protectionism (of which Bannon is an ardent advocate), wars, and geopolitical power plays. As Mises wrote:
“In principle class ideology is no different from national ideology. In fact there is no contrast between the interests of particular nations and races. It is national ideology which first creates the belief in special interests and turns nations into special groups which fight each other. Nationalist ideology divides society vertically; the socialist ideology divides society horizontally.”
Double-Timing History’s March
Historical determinists are rarely content to sit back and watch history unfurl.

All of this amounts to a bleak winter indeed. It might otherwise be dismissed as harmless crackpottery if it was not weaponized by Bannon’s sway over the man with the nuclear codes.
True believers in rigid theories of history tend toward fanatical, impervious dogmatism. Every major development is interpreted as a portent that confirms their theory: as another step in the inexorable march of history. And all evidence to the contrary is ignored or dismissed as insignificant counter-currents within the grand, unidirectional flow.
And historical determinists are rarely content to sit back and watch history unfurl. Like the Marxists, they often feel compelled to help along and hasten the inevitable. And prophecies of an inevitable war tend to be self-fulfilling when the prophet is in the position to start one. Steve Bannon, in bringing on the very winter he foresees, could be Cassandra and Agamemnon in one.
Dan Sanchez is Managing Editor of His writings are collected at
This article was originally published on Read the original article.

Monday, February 13, 2017

The Kondratieff Cycle: Real or Fabricated?

By Murray N. Rothbard

Man has always yearned to know his future. And, since it is an economic law that demand tends to create supply, there have always been gurus and mountebanks to meet that need, people who claim to have a special handle on all that the future may hold in store. Soothsayers, palm-readers, astrologers, crystal-ball gazers have poured in to take advantage of the credulous and the gullible.\

Forecasting and Soothsaying

Techniques of soothsaying or prophesying have changed over the centuries, but the basic tactics and strategy have remained the same. In the more frankly mystical atmosphere of the Middle Ages, it became common for gurus to arise and predict the Second Coming and the end of the world, with seemingly stunning precision. If the guru was shrewd enough, he made the date of the final days near enough to whip up excitement, but not so near that it would actually arrive and he would be caught out. Thus, the most famous of all these forecasters of doom, Joachim of Fiore, who lived in the late 12th century, predicted with absolute assurance that the day would come about fifty years afterward. That was close enough to develop a mighty movement of followers, but far enough away not to prove an embarrassment.

But suppose that the predicted day arrives and nothing happens? There have been various classical techniques to deal with that problem. The most obvious but the shakiest is to say, oops, I miscalculated, but now I have corrected my calculations and the precise day of the end of the world is eleven years and five months hence. Straightforward, but a bit desperate, and it is risky for the guru ever to admit error, for then his all-important aura of absolute self-confidence and infallibility will have begun to slip. Far better to use a fudge factor, which maintains one's air of omniscience and adds profundity to boot. "No, you see," the guru will reply loftily to his critics, "I was absolutely right; the end of the world has begun, we have now entered the period of the last days." If the guru is lucky enough, that period can last another century or so. And who is there to say him nay? The idea is to reinterpret for the faithful what had previously seemed to be clear and unmistakable language; a "day" has simply become an eon or two.

The High-Tech Gurus

In the modern era, when all things "scientific" are in vogue, the same sort of activity goes on, but now it comes cloaked in the wondrous trappings of the high-tech. The predictions of our new breed of soothsayers and crystal-ball-gazers – the managers of the high-speed computers and the charts and the econometric models – are just about as accurate as Joachim of Fiore. But the fudge tactics have become more elaborate.

For one thing, the task of the modern fortunetellers is less grandiose. Most of them are not trying to develop a mass of faithful followers who will gladly lay down their lives for the guru. They are simply trying to attain the Good Life for themselves. But some of the tactics are precisely the same. The favorite forecasts are those that are close enough to be interesting but not so close that anyone cares to remember when the time comes. Thus, a few years ago there was published a rash of vogue books forecasting with seemingly great precision the exact economic profile of the Year 2000 – the population, the GNP, the unemployment rate, etc. The books were publicized and sold, the authors made their reputations as eminent futurologists, and then ... and then what? When the year 2000 finally arrives, will anyone care? Will anyone bother checking up on the various forecasts? And if anyone does, will the reading public bother? Surely not, for they will have long since gone on to other years, other forecasts.

A few years ago, I sat on a panel where one of the speakers, with absolute authority and self-confidence, announced that his "researches had shown" that nuclear war would arrive in the summer of 2010. A gasp, a frisson of delighted fear, went through the large and intent audience. But, when the year 2010 comes around, will any of us still here remember, much less bother to call this man on his prediction?

But suppose that the forecast was short-term, or the predicted year has arrived, and the prophecy is manifestly way off. Then what? Then the modern gurus use the same fudge factor as the gentlemen who predicted the last days. The guru will not miss a beat. "The event I predicted has arrived, but it is temporarily being masked by other factors." The prediction has been subtly or not so subtly redefined to fit the facts.

Thus, for over a decade I have been arguing with economists and investment analysts who have been predicting imminent deflation, that is, a general fall in consumer prices, or rise in the value of the dollar in terms of goods and services. For over the same decade, these predictions have been proved patently and 180 degrees wrong. Inflation, whether steep or slightly less steep, has marked every year during this period. Yet never have I seen the slightest faltering in the enthusiasm or the absolute self-confidence of the deflationist soothsayers. Often they will use the fudge factor: "Look, zinc prices have fallen over the last six months. 'Deflation' has already begun." Or, "Deflation is here at last. It has just been 'masked' by the expansion of bank credit."

In the same way, the astrologers fudge on their predictions. If you are a Pisces, they will proclaim that you are a mystic, who loves water. If you say, "You're right," they will smile triumphantly upon this confirmation of their analysis. But if you say, "Wrong. I'm a skeptic who hates water," they'll say, "Ahh, that's because your Jupiter is rising, and you're fighting your stars," or some such twaddle. The key point is that, with any guru worth his salt, there is no way ever to prove him wrong. He will always come up with the fudge factor. And, it should be clear to the wise that a prediction that somehow can never be proved wrong is worth far less than the paper it is printed on.

Furthermore, when anyone spends a lot of time predicting, on whatever grounds, once in a while some of these forecasts are bound to be proved right, just by chance. And so, in the world of economic as well as astrological forecasting, the soothsayers trumpet any successes they may have ("I predicted . . . !") while quietly burying their mistakes.

The Business Cycle

Business cycles began a mere two centuries ago. Despite the fevered hopes of some enthusiasts who claim to have observed business cycles going back to Methuselah, before the late eighteenth century there was no such phenomenon. Of course, there were centuries in which business improved and the economy progressed and there were other centuries (the Dark Ages, the 14th and 15th centuries) when it went into a long secular decline. But, within shorter time periods, business pegged along in a rough straight line year after year. Business was either good, bad or indifferent, but it tended to remain that way steadily for many decades.

Once in a while, it is true, something drastic happened. The king, as was the custom of monarchs, might need a lot of money quickly and therefore confiscated all the gold or silver he could lay his hands on. The result was a dramatic economic and financial collapse. Or a war would take place, and business might boom; or trade would be cut off in a war, and business collapse. The point is that there was nothing cyclical or wave-like about these events; and there was nothing esoteric or difficult to understand. It was clear to every observer what the problem was; the cause was exogenous, i.e., it came from outside the economic system and was imposed upon it. Almost always, that outside and disturbing force was government, and government intervention, in one form or another, was the clear cause of the sudden boom or more likely the sudden collapse. There was no need to conjure up any obscure "business cycle theory"; the cause was obvious.

Then, around the middle or latter part of the eighteenth century, something happened. A new phenomenon struck the world, occurring first in Britain, the most economically advanced country, and spreading to other advanced countries as they entered the market nexus of trade and finance. This phenomenon was a regular, continuing, wave-like movement of business activity. Instead of business proceeding on a straight line, it experienced a regular pattern of euphoric boom, sudden crisis or panic, bust or contraction, and gradual recovery, succeeded without pause by another boom. In contrast to earlier years, observers of business could find no clear-cut exogenous cause for these waves. They concluded that business is marked by a continuing, perpetual cycle, and that the cause, whatever it may be, comes from somewhere deep within the market economy, i.e., is endogenous to the economic system.

As economic theory developed and deepened, it became obvious that there was an inherent conflict between standard "micro-economic" theory, and factual observations of the business cycle. For theory tells us that, in the market economy, there is a continuing tendency to eliminate error and to "clear the market"; there is a tendency then, for losses to be minimized. So how could there possibly be periodic clusters of severe business losses, which constitute the onset of the panic, crisis or depression? The conclusion that most economists and observers unfortunately came to was that microeconomics does not realistically apply to the "macro" level.

It should be recognized that most business-cycle theories – Keynesian, Marxist, Friedmanite, or whatever – and remedies are grounded in the assumption that the cycle stems from some deep flaw in the free-market economy. But if micro-theory is correct, then it must apply to the "macro" sphere as well. The economy is not some entity split between a micro and macro half; it is a seamless web, inextricably linked together by the use of money and the price system. Therefore, whatever applies to one part of it must apply to all. The explanation for business cycles must somehow be integrated with the explanation of the micro-economy.

The Cycles Multiply

One of the worst things about the "business cycle" is its name. For somehow the name "cycle" caught on, with its implication that the wave-like movement of business is strictly periodic, like the cycles of astronomy or biology. An enormous amount of error would have been avoided if economists had simply used the term "business fluctuations." For man is all too prone to leap to the belief that economic fluctuations are strictly periodic and can therefore be predicted with pinpoint accuracy. The fact is, however, that these waves are in no sense periodic; they last for few years, and the "'few" can stretch or contract from one wave to the next. The periodic notion was unfortunately fed by the fact that the early panics seemed to be ten years apart: 1837, 1847, 1857, but pretty soon that periodicity broke down.

At that point, those who had made their reputations as forecasters of the cycle had two options: they could have simply given up the idea of periodicity. But that would have detracted from their aura of omniscience. And so, many of them introduced the first big fudge factor: the idea that cycles, despite appearances, are still strictly periodic, except that there are several mystical cycles all occurring simultaneously beneath the data, and that if you manipulated the data long enough, you could find these simultaneous, parallel, strictly periodic cycles, all going on at the same time. The apparently non-periodic data are only the random result of the interactions of the strictly periodic cycles.

This doctrine is mystic for two basic reasons. In the first place, very much like the "epicycles" of the Ptolemaic astronomers who fought against the Copernican Revolution, there is no way ever to prove the cycles wrong. If the cycles don't fit the facts, you can always conjure up one or two more "cycles" so as to make a perfect fit. Note that the fit has to keep changing in order to adapt to the new data that are always coming in. More epicycles get folded into the data. Secondly, as we noted above, the market is a seamless web. All facets of the market are interconnected through the price system, and the profit-and-loss motive. Booms and busts spread throughout the system; that is precisely why they are important. It is absurd to think that one part of the economy can peg along on a nine-year cycle, another on a three-year cycle, and still another on a 25-year cycle, with each of these cycles barreling along on a hermetically sealed track, not influencing and modifying each other. In fact, there can only be one real cycle going on in the economy at anyone time.

We have seen already that there can be only one business cycle at a time – the real, or evident one, the one that actually shows up in all the data – and that this cycle is emphatically not periodic. One of the mystical "cycles" that has been getting a lot of play from time to time is the flimsiest "cycle" of them all: the Kondratieff long cycle. The Kondratieff is supposed to be a strictly, or at least roughly, periodic cycle of about 54 years, which allegedly underlies and dominates the genuine cycles for which we have actual data. Even though, as we shall see, this cycle is strictly a figment of its fevered adherents' imagination, there does seem to be some sort of cycle in the periods when the "Kondratieff" captures the interest of financial and economic analysts.

In and Out of Vogue

The "Kondratieff" first made its appearance in the mid-1920s, the creature of the Soviet economist Nikolai D. Kondratieff. Even though it was translated into German at the time, it made no particular stir until the mid-1930s, when the German translation was, in abridged form, itself translated into English. The "long wave" had a brief vogue in the late 1930s, only to disappear until the 1970s, and since then it has had another and even bigger run. It seems clear that the times of fashion for the Kondratieff are a function of the economic climate of the day. Orthodox, mainstream economics had no explanation for the Great Depression of the 1930s, and so the Kondratieff was offered as one "explanation" for this phenomenon: "After all, we're at a Kondratieff trough; what else can one expect?"

After World War II, Keynesian economics was in the saddle, and claimed to be able to fine-tune the economy and eliminate inflation and recession alike. The simultaneous inflation-and-recession of 1973-75 inaugurated an era of many such "stagflations," which put an end to Keynesian dominance. Economists and financial analysts were led to look to some other explanation of this unwelcome phenomenon. And, lo and behold!, the old, forgotten "Kondratieff" was trotted out: for weren't we going past a "Kondratieff peak"?

Fortunately, Richardson & Snyder have now, for the first time, translated and published the full and unabridged Kondratieff work in English, so we are all in a position to judge the doctrine and the evidence for ourselves.

Kondratieff postulated a "long wave" of business that began somewhere in the late 1780s – it is all very murky since there are almost no statistical data for that period – and continues periodically roughly every 54 years. Well, what about the trough points? No question that the late 1930s – a "Kondratieff trough" – was a pretty miserable period. But what about the other three trough periods? What was wrong about the 1780s, for example? No particular depression there. And if we want to be generous and dismiss that "first trough" for lack of data or as only starting the whole thing, what about the alleged second trough? Fifty-four years from 1789 brings us to the "expected" trough year of 1843, a year in which everything was smooth sailing. Let us be generous and bend over backward for the Kondratieffites, and give them their admitted 1849 as the trough year. Even so, 1849 was a perfectly fine economic year, and in no sense whatever comparable to the late 1930s! In 1849, we were in the middle of continuing prosperity.

The third alleged Kondratieff horror point, or trough year, was 1896. But, again, there was nothing terribly wrong with that year either. Of all the trough years, or even trough zones, the only one that we can really say was bad and depressed was the late 1930s: One out of four!

On what basis, then, do the Kondratieffites presume to bracket 1940 with 1896 and 1849 and 1789 as the terrible years of Kondratieff troughs? Really, on one and only one ground: each of these years was a trough point for the index of wholesale prices. All the other alleged confirmations of the Kondratieff troughs were simply of prices, or else of monetary phenomena reflected in prices.
But wait! Is this really what we mean by a depression phase of a business cycle? After all, we are not really concerned about prices first and foremost. What really concerns us about a depression or recession is not that prices used to fall, but that there were and are sharp declines in production, clusters of bankruptcies and drastic increases in unemployment.

The Kondratieff "Depression"

Let us then look more closely at the long contraction, or "long depression," phases of the Kondratieff cycle. To make any sense, they should in some way look and feel like depressions, like grim periods of decline in business activity. The first Kondratieff long depression was supposed to be the period 1814-1849. But these thirty-five years were by and large a period of great expansion, prosperity and economic growth for the United States, England and France, the three countries Kondratieff used for his statistical analysis. And what of the second Kondratieff depression, the period 1866–96? Was that in any sense a depression? For the United States, and to a large extent for Western Europe as well, this was the period of the most dazzling spurt of production and economic growth in the history of the world. Production and living standards skyrocketed. How in the world could three such glorious decades be called a period of secular decline?

Obviously, it is absurd to call these periods long-wave depressions. The point is that in real terms – production, activity, growth, employment – these "Kondratieff depressions" were all periods of gigantic growth and prosperity. The only sense in which the two nineteenth-century "Kondratieff contractions" were contractions at all is that prices, by and large, fell during those decades. And that is that.

But if only prices fell, while all real or physical units increased, this means that the Kondratieff contractions could only be considered depressions if we define periods of falling prices as depressions or declines in economic well-being. And here we have one of the many fundamental fallacies of the Kondratieff doctrine.

Prices fell during most of the nineteenth century because prices always tend to fall on the free market. The natural course of events is for free market capitalism to pour forth an ever-increasing supply of goods and services, ever more production, and ever greater increases in the standard of living of everyone. If the government and its banking system do not inflate the money supply too much, prices will always tend to fall. But this does not mean depression in any sense, because costs are falling also, and productivity and production rising, so that business profits are in no way hurt by the price decline. Think of the computer and calculator industries in recent years, with their great rise in productivity and fall in prices, coupled with high growth and profits, and you will understand how this can work for free-market capitalism over many decades and epochs.

But if prices generally tend to fall, then what needs to be explained is why prices sometimes rise. During the nineteenth century, they indeed rose during Kondratieff booms. But dating the Kondratieff cycles only at the peak and trough completely distorts the real process at work. For prices did not rise continually from, say, 1789 to 1814, or once again, from 1849 to 1866. On the contrary, prices fell considerably, for example, from 1800 to 1812. The only "Kondratieff boom" took place in the brief span 1812 to 1814, i.e., precisely the years of the War of 1812 and the final years of the Napoleonic Wars. These were years in which the United States and Western nations inflated the money supply greatly in order to pay for massive war expenditures. Hence, the increase in prices. When the war and hence the need for war financing, was over, the monetary and price boom collapsed.

Similarly, there was no big price boom from 1849 on. In the United States, prices remained fairly flat from 1849 until 1861; the price boom lasted only during the few years of the Civil War, 1861 to 1866. Once again, there was no mystery and no long Kondratieff cycle at work. The war was short and devastating, and the U.S. government inflated madly in order to finance the massive burden of war expenditures. The monetary inflation drove up prices enormously, and then, after the war spending was over, money and prices collapsed.

Note that there are important lessons from both the first and second alleged "Kondratieff" boom periods. First, the "boom" covered only a few years and not two or three decades. The peak-and-trough focus on dating covers up the genuine economic reality. The booms were therefore short and intense, not in any sense "Kondratieff long booms." And second, the cause of the booms and of the subsequent contractions is all too clear. Namely, monetary inflation brought about by war finance. The so-called "Kondratieff" is merely a description of war and peace.

In short, Kondratieff long "depressions" were really booms in everything that counted except the fact that prices fell, and we have seen that falling prices are perfectly compatible with economic growth and prosperity. And Kondratieff long "booms" were really short booms fueled by devastating wars.

Torturing the Data

But what does Kondratieff say about his long depressions? Does he say that they are only money and price phenomena? No, for then he would scarcely dare to call them "depressions." Kondratieff asserts that the 1814–49 and 1866–96 periods were depressions in the physical sense by engaging in what statisticians aptly call "torturing the data." In his now-classic work, translated and published by Richardson & Snyder, Kondratieff presents us with several physical time series: coal production in England, mineral fuel consumption in France, and pig-iron and lead production in England. He managed to approach (but never really obtain) troughs, say, for 1896 as compared to the 1860s and 1870s, by the simple device of taking out the trend.

The rationale is that the tremendous upward trend of production throughout the nineteenth century was somehow a phenomenon totally isolated from the business cycle. In order, then, to get to the "true" cycle masked by this trend, Kondratieff manipulated the data to take out the trend. Moreover, he also divided the physical data by population, so as to further eliminate much of the upward trend by dragging it down by the massive growth in population – a growth largely induced by the industrial expansion and economic progress. Then, after extracting any possible iota of trend, he took a nine-year moving average of the remaining data, so as to eliminate any non-Kondratieff cycles that might be left.

As Kondratieff himself summed it up: the physical statistics of production and consumption, "taken as raw data, do not disclose the cycles with sufficient clarity." Therefore, "in order to bring out the presence or absence of long cycles, it was necessary to use more complex methods in processing the statistical series" (p. 33–34). In short, in the vital area of physical series, of production and living standards, the "Kondratieff cycle" does not and cannot exist; it is a pure statistical artifact, a product of the fallacious statistical manipulations that Kondratieff employed to get his desired result.
Oddly, Kondratieff admits that his manipulations are unsound, that it is in fact illegitimate to break down the market economy into hermetically sealed "trends" and various kinds of "cycles" and expect to arrive at a meaningful result. He concedes that "all elements of the capitalist economy are organically interrelated" (p. 33) and that therefore, eventually he would somehow have to put it all back together. But in the meanwhile, all he could do was to isolate and therefore falsify. The ideal of integration was of course promptly forgotten.

To summarize our analysis so far: for the nineteenth century – the "first two Kondratieffs" – there was never any depression as we know it: not in production, nor in employment or living standards. The "Kondratieff depression" is based on (a) statistical fallacies bordering on chicanery; and (b) the mistaken view that a price fall must mean depression. To the contrary, prices naturally tend to fall in a capitalist society. Furthermore, the "Kondratieff booms" were not long booms at all, but short inflationary spurts brought on by the creation of a great deal of money to finance major wars.

The Kondratieff in the Twentieth Century

Nikolai Kondratieff has been hailed by his current adepts as a prophet of the future as well as analyst of the past. Does his cycle fare then better in the twentieth century, before and after his own time? On the contrary, it does not seem possible, but his "cycle" is in even worse shape in our century. It is true that the alleged Kondratieff boom of 1896–1920 for once seems to fit the model, since prices were indeed rising throughout this entire period. But here again, we have to disaggregate and not pay myopic attention only to the years of peak and trough. The 1896–1914 era was the only peacetime period before 1945 when prices actually rose steadily. But the reason was not some mysterious "Kondratieff" force pushing them upward. The cause was much simpler: the burst of the last great gold discoveries in Alaska and South Africa, pushing up world prices in the first two decades of the twentieth century. But, even so, the rise was scarcely enormous, averaging 2.5 percent per year, a figure we would nowadays consider almost idyllic. The really massive inflation only took place during 1914–18, the years of World War I, where once again inflationary war finance drove up the world's money supply and prices. And once more, the boom stopped and was reversed upon the end of the war.

Next, there is the alleged third Kondratieff long depression. At first sight, this again seems to fit the model, since surely the 1930s were an authentic depression in every sense, including physical data. But what about the 1920–29 period, the biggest boom decade in American history? How in the world can this period be called a part of a long depression? If the 1920s were not a boom period, what were they?

This brings us to one of the Kondratieffites' many problems. Peak and trough dating is based on the wholesale price index, the longest continuous time series available. But the Civil War peak dating is a problem. While prices retreated from their wartime high, there was definitely another economic boom until 1873, with prices peaking and the Panic of 1873 touching off a recession. Similarly, the post-War-of-1812 price peak was indeed 1814 or 1815, and yet there was, at least in the U.S., a surging economic boom until 1818, succeeded by a dramatic collapse in the Panic of 1819. Kondratieff, writing in the mid-1920s, found it easy simply to fuzz over the peak dates, writing that his first peak came in "the period 1810–17," and the second in "the period 1870–75." Add a few more years for good luck on either end, and the anomalies of peak dating can be glossed over.

But Kondratieff had the good fortune to publish his work before the cataclysmic 1929 peak. What now? It simply became too much of an evident distortion to mumble something about a "1920–30" Kondratieff peak. Instead, the Russian's later disciples added another critical part of the current doctrine, a way of "saving the phenomenon." There is not one Kondratieff peak, you see, but two, and the period in between is the "plateau" before the "secondary" and really big depression. Well, we now have the "plateau" of the 1920s. It is a bit difficult to call this frenzied boom period a "plateau," but set that aside for purposes of discussion. We can then patch up the 1866-73 period as another plateau before alleged disaster. How about 1814–18? Three or four years is scarcely the majestic plateau of the 1920s, but again let that pass. If we are willing to fudge by shoving in some "plateaus," we can now try to absorb the damaging period of the 1920s into our doctrine. Why in the world should there be this "plateau," which sometimes looks instead like a raging boom, after the alleged main peak has passed? And in what sense has the peak then been passed? Once again, ours not to reason why. Who knows? Perhaps The Force, or whatever is supposed to fuel this mysterious underlying long cycle, needs a few years or even a decade to get a head of steam before it really does us in.

But the Kondratieffites' problems have only begun. Their real difficulties come after the alleged Kondratieff trough of 1940 – the last trough so far. The entire boom-bust "long" cycle is approximately 54 years in length. Allow a few years here and there. But still: It has already been 44 years since the Kondratieff trough. A 44-year boom! So where's the peak? The peak is getting long overdue. Most of the Kondratieffites confidently predicted that the peak would arrive in 1974, just 54 years after the previous peak. Previous peak-to-peak stretches had been 52 (from 1814 to 1866), and 54 (1866 to 1920). So where indeed is the peak? It is now 1984 and counting. We are ten years past the confident prediction and we still have inflation. The Kondratieffites have been forecasting imminent deflation since the magic 1974 year, but still . . . nothing!

The severe 1973–75 recession filled the hearts of the Kondratieffites with joy: the peak had arrived on schedule! But inflation still continued. The next big recession came swiftly, but still there seemed to be always recovery, and inflation continued throughout. What price Kondratieff now?

But, as in the case of Joachim of Fiore and other mystics, the Kondratieffite gurus have hardly given up – instead they have rushed to change the date. Or rather to announce: the peak already was! The 1973–75 recession was the peak. For now we are on the "plateau," the false boom, and soon, very soon, we will get the secondary depression, the Big Bang. Very soon now we will have our 1819, our 1873, our glorious 1929.

Well, here we are, ten years after the "primary peak," so surely the time for the Big Bang is Now. And yet, instead of that, the economy seems to be bubbling along, recovering nicely. Inflation is still continuing, despite all the propaganda about the problem being over.

Time is inevitably running out on the Kondratieffites. For there will be no Big Bang, no repeat of 1929. Pointing to problems in the economy, to stagnation, to stagflation, to falling commodity prices, to secular rises in the unemployment rate, while interesting and significant is not enough. It does not demonstrate the Kondratieff. After all, there are always economic problems. The point is that there is no permanent depression, and there is not, and will not be, any deflation. The idea that we are right now in the midst of a Kondratieff depression, but that the deflation is being masked by inflationary bank credit, cannot be the way out. For that is simply the mystic's fudge factor so that you can never prove him wrong, regardless of the evidence. No, the Kondratieff is dead, and now it is simply a question of how long it will take the Kondratieffites to lie down, to admit defeat and slip away into the night. How many years will it take before everyone sees that there has not been and will not be a "fourth peak"? And without such a peak, there can be no cycle.

Cycles of War?

To the criticism that "Kondratieff peaks" are simply the results of war-borne inflation, the Kondratieffites have an answer: "Ahh, but this analysis is superficial, for the wars themselves are caused by the arrival of the Kondratieff peak!" Well, in a sense: the War of 1812–Napoleonic War, the Civil War, World War I, major wars all, came at (i.e., brought about) Kondratieff peaks. Can we then say which was cause and which was effect – the war or the cycle? Aside from the fact that we would again have to postulate some mysterious force that drives men mad and on to war during Kondratieff peak periods, there is one mighty counter-example that destroys this theory totally: World War II, which came, not at the end of a Kondratieff boom, but rather – in stark contrast – at the end of a Kondratieff depression.

This example indicates another gross error in the Kondratieff analysis. Where real cycles exist, in physics, astronomy or biology, the scientist concludes that there are cycles after hundreds, if not thousands, of mutually confirming observations. But in the alleged "Kondratieff," there are, at very most, only three-and-a-half cycles. What kind of analysis builds a cycle theory on only three-and-a-half observations?

Why Business Cycles?

If "the Kondratieff cycle" is a myth and a chimera, why are there business cycles at all? There is no space here to present a positive solution to the business-cycle phenomenon. But we have already seen (1) that since the market is interrelated and a seamless web, there can be no multiple "underlying" and interacting cycles; there is only one business cycle. And (2) the real business cycle is in no sense periodic, but is a continuing, wave-like motion that varies considerably in length and intensity.
We can only sum up the correct answer to the problem of the business cycle. We have already seen a hint of the solution: that inflation and the inflationary boom are caused by bank credit expansion generated by governments. In fact, government's central banking system provides the key causal element for all business cycles, a cause exogenous to the market economy. Continuing government intervention sets in motion business cycles by generating inflationary booms. Because these booms distort the signals of the market place in interest rates and in relative prices they bring about grave distortions of production and prices, which must be corrected by recessions and depressions.

In short, government intervention cripples the market economy, and recession or depression is the painful but necessary adjustment by which the market reasserts itself, and liquidates the distortions committed by the government's inflationary boom. After each depression, the government generates inflation once again, because it is the government's natural tendency to inflate. Why? Quite simply, whoever is granted a monopoly of printing money (e.g., the Fed, the Bank of England) will use that monopoly and print – to finance government deficits, or to subsidize favored economic groups. Power will tend to be used, and the power to create money out of thin air is no exception to the rule.
And so we see – and this is the great insight of the "Austrian" theory of the trade cycle – that micro and macro economics are in harmony after all. The free market does tend to adjust harmoniously without boom and bust, without incurring clusters of severe business losses. It is government intervention in the market that creates the business cycle, and unfortunately makes the corrective adjustment of recessions necessary. The cause of the boom-bust cycle is not some mystical periodic Force to which man must bend his will; the fault, dear Brutus, is not in our stars but in ourselves, that we are underlings.

This article first appeared in two parts in Investment Insights for August and September 1984.