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The Business Cycle Explained


It Didn’t Have to Be This Way: Why Boom and Bust Is Unnecessary — and How the Austrian School of Economics Breaks the Cycle by Harry C. Veryser (Intercollegiate Studies Institute 2012), 318 pages.

This is one instance where a book’s subtitle tells the reader much more about its content than the title does. You know at once that the book is devoted to explaining Austrian-school thinking, especially with respect to the problem of cycles of economic booms followed by recessions.

The United States enjoyed a boom, largely due to the housing bubble, from 2002 to 2007, and since then it has languished in a recession that shows no sign of abating, much less turning into another boom. Economists and politicians keep proposing to solve the economy’s troubles by “stimulating” it with more government spending and more money creation by the Federal Reserve. Once you have read this book, you will understand why such “solutions” must not only fail but can only make matters worse. More than that, you will understand why most of what passes as “mainstream” economic thinking is the furthest thing from the sound principles that could lead to prosperity.

Many Americans regard economics as a bewildering jumble of mathematics and opaque jargon that they can’t begin to decipher. Therefore, they shrug and say that it is something we have to “leave to the experts.” Veryser addresses that destructive notion, writing, “Economics is not — or does not have to be — a mysterious science. Quite simply, it is the study of reconciling the unlimited wants of man with limited resources.” Properly explained, ordinary people can easily grasp the lessons of economics and see the adverse consequences of government’s tampering with money, prices, and incentives. That is exactly what the book does.

Veryser weaves his lessons in Austrian economic thinking into the story of the modern economic condition. He starts with a chapter covering the development of the Austrian school, from Carl Menger up to the present day. This is more than a cursory overview. In addition to writing about the contributions of the best-known Austrians (Ludwig von Mises and Friedrich A. Hayek), he also dwells on lesser-known scholars, such as Frank Fetter and Wilhelm Röpke, and non-academics who helped to popularize Austrian thinking, such as Henry Hazlitt.

The fall of liberalism

The chapter that follows discusses the age of classical liberalism — the century from the fall of Napoleon to the outbreak of World War I. During that century living standards and longevity increased far more rapidly than ever before. That happened, Veryser shows, because the major nations adopted (for the most part, at least) the principles that make economic progress possible, namely, the rule of law (including the sacredness of contracts), free trade, sound money based on precious metal, economic freedom, and low taxation. While the U.S. government surely interfered less in the economy during that period than later on, the book would have been strengthened by explicitly noting that interventions such as protective tariffs, land grants, and subsidies for favored businesses such as railroads kept economic growth from being as great and as widespread as it might have been.

Before long, however, the increasing wealth brought about by liberalism was targeted by “Social Gospel” reformers, Marxists, and other advocates of a powerful and intrusive state. Believing that they knew how to engineer a much better society, they worked incessantly to undermine the classical principles with “social-insurance” legislation and laws that eroded property rights and liberty of contract.

The immense cataclysm of World War I not only claimed millions of lives and destroyed vast amounts of property, but also tore down the foundations of classical liberalism. Veryser writes,

After the Great War, the pillars of classical liberalism fell: the rule of law gave way to arbitrary government, taxation levels were raised to finance the war and then to pay off war debts, and economic freedom was curtailed (including by requiring passports for travel); world trade was restrained, as was capital movement; and the gold standard was suspended, never to be restored.

The grave economic troubles of the 1930s were a direct result of the new economic order the war had produced, and Veryser makes it clear that the nation would never have suffered the Great Depression if it had stayed with the old liberal precepts.

Why did the Great Depression (and indeed all depressions) occur? Veryser carefully explains the Austrian theory that government meddling with money and credit to drive down interest rates leads to a temporary, unsustainable boom. He then supports the theory with historical data, such as the short-lived Florida land craze in the latter 1920s.

The great Austrian economists of the time, Mises and Hayek, vigorously attacked the governmental policies that created the boom as well as the policies that, intending to alleviate it, made it worse. But no one in power paid any attention to them. The turmoil of the 1930s set the stage for World War II, which probably would not have occurred but for the ruinous, anti-market interwar economic policies.

Postwar meddling

It did occur, of course, and in 1944 the Allied powers, seeing victory on the horizon, met in a conference at Bretton Woods, New Hampshire, to work out a postwar economic order that would lead to peace and stable growth. Veryser provides an excellent analysis of Bretton Woods, showing that it got some things right (especially the efforts at preventing trade protectionism) but got other things wrong. Its fatal flaw, which would not become evident for more than 20 years, was its reliance on the stability of the U.S. dollar rather than gold as the monetary anchor of the system. Putting trust in the dollar, which is subject to political manipulation, was a blunder, and Hazlitt and other Austrians said so.

Veryser raises a particularly welcome point when discussing postwar Europe: the Marshall Plan did not cause an economic rebound, as is widely believed.  The idea that government aid is necessary for economic growth is part of the interventionist mythology, but those European nations that recovered most quickly from the war did so because they followed relatively laissez-faire policies that allowed their people to build, produce, work, and trade. Notably, Britain had the slowest recovery despite the great amount of aid it received; that was because of the anti-market policies of the Labour Party government from 1945 on.

That fatal flaw in Bretton Woods — assuming that the American dollar would remain stable — began to reveal itself in the late 1960s, as Lyndon Johnson’s appetite for both welfare and warfare led to the depreciation of the dollar. Veryser rips “Nixon’s Folly” of eliminating the last vestige of the gold standard (the ability of foreign governments to redeem dollars for gold) and imposing a regime of wage and price controls. Austrians attacked those decisions at the time they were made (1971), and time has validated their criticisms. The years from Nixon through Carter were a time of inflation, stagnation, and government expansion because the country was drifting further and further away from the foundations for freedom and prosperity

“Reagan’s Rally,” as the author terms it, was a period of economic revival due to the relaxation of some government regulation and cuts in tax rates. Veryser argues that Reagan’s administration was marred in several major respects — especially by the use of protective tariffs and quotas — and that it blew the opportunity to return to gold.

Having given the reader a short course in economic history, Veryser returns at this point to economic theory — changing gears from “how things got this way” to “how things could improve.”

The last section of his book is entitled “A Reconstruction of Economics,” and here he expounds on the need for economists to focus again on the essentials of human action: the division of labor, entrepreneurship, sound money, a price system free of government meddling, savings, and capital formation. To those I would add the concept of opportunity cost. It is remarkable how frequently “mainstream” economists these days talk about government programs (especially policies that are supposed to “stimulate the economy”) without ever discussing the inevitable trade-offs between increased government activity and decreased private-sector activity. A few paragraphs on the problem of ignoring opportunity costs would have been a good addition to the book.

Except for the Austrians (and a few others), the economics profession has been wandering around in a theoretical fog, and to the extent that the advice it offers has been followed, we are much the worse for it. Perhaps, though, we are on the verge of what Veryser optimistically calls “an Austrian moment” — a return to the sound economic thinking the Austrian school stands for.

That, however, won’t happen easily. Veryser tells a revealing story concerning his teaching. In 2005 a dean criticized him for teaching economics that lacked “rigor.” What he meant was that Veryser’s Austrian approach did not use mathematics. The dean felt that “real” economics must involve teaching “financial engineering,” or, in the author’s words, transforming “dodgy debt into AAA bonds by the use of statistical tools.” When Veryser argued against teaching such alchemy, the dean roared back that “he had letters from companies who would not hire our graduates” unless they had been taught that pernicious nonsense.

The bursting of the housing bubble may have dampened the business world’s enthusiasm for the pseudo-economics of “financial engineering,” but it will take a lot of effort to dislodge the entrenched, harmful notions of “mainstream” economics.

It Didn’t Have to Be This Way is a powerful move in that direction. The book deserves a vast readership and national discussion.

This article was originally published in the November 2013 edition of Future of Freedom.

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    George C. Leef is the research director of the John W. Pope Center for Higher Education Policy in Raleigh, North Carolina. He was previously the president of Patrick Henry Associates, East Lansing, Michigan, an adjunct professor of law and economics, Northwood University, and a scholar with the Mackinac Center for Public Policy.