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Introduction
by Greg Byrne
Gerry
Jackson kindly allowed me to write this introduction. At first, I thought I
would just write a basic outline. It was then that I realised the full import
of what Gerry had written. For years Australia’s establishment right has
promoted Steve Kates’ argument that the classical economists believed that
booms and busts were an unavoidable and natural product of capitalism and
that we must learn to live with them. This is totally at variance with the
historical facts.
This
bothered me because it supported the socialist argument that capitalism was
terribly unstable and therefore required constant government interference to
maintain employment and output. No one on our right has successfully
countered this argument. For example, Professor Sinclair Davidson’s response
has been typical in that it is both superficial and purely descriptive.
My training as an engineer has taught me to expect much better than this from
professors. This tightly packed article, however, exposes the right’s
argument as an inexcusable error that is completely at odds with the
historical facts.
Thanks
to Gerry Jackson’s indefatigable efforts we now find that these classical
economists (members of the currency school) believed that booms and busts
were a monetary phenomenon created by the banking system. Gerry introduces us
to the much neglected Colonel Robert Torrens as the man who not only played a
central role in this drama but who also exposed John Stuart Mill’s banking
school ‘theory’ of the trade cycle as utterly fallacious.
Unfortunately
it is this very ‘theory’ Steve Kates is erroneously presenting as the true
classical theory. The right is now left with no other choice but to either
defend Steve Kates’ argument or abandonment it in favour of the facts.
(BTW. Gerry has assured me that anyone who feels their views have been
misrepresented will have full right of reply).
The Real Classical School Theory of the Trade Cycle
Gerard Jackson
The
left thrives on economic myths and the greatest and probably the most
effective of these is its myth of the trade cycle*. Unfortunately most
mainstream economists also share this belief — and Australian economists are
no different. Every Australian author I have read on this topic stated
without reservation that “boom and bust are part of the natural order of
capitalism”1, that “capitalism is guilty of generating booms and
busts”2 and that “recessions are the result of systematic,
economy-wide errors in production decisions”3 that are inevitable
given the nature of a market economy. Confronted by this phalanx of dogmatic
certainty it is no wonder the left remains unchallenged in this area.
Regrettably
another egregious economic error is taking root among Australia’s
establishment right. Steve Kates has successfully promoted the notion that
the classical theory of the trade cycle “was essentially a theory based on
the structure of production being out of phase with the structure of demand”4
and that these situations are created by the undue optimism of
businessmen. I am at a complete loss as to how any person with a
passing knowledge of the contemporary literature could draw this conclusion.
At the end of the day this just leaves us with Keynes’ meaningless “animal
spirits”, a sort of “irrational exuberance”.
From
the early part of the nineteenth century until the 1850s5 the
currency school’s monetary theory of the boom bust cycle was the one that
dominated contemporary thinking. According to the theory the banking system
lowered interest rates by expanding the money supply. This encouraged excess
business investments, fuelled “insane speculation”6 and created
disproportionalities7. This was a straightforward and pretty good
theory that exonerated the market while fingering reckless banking as the
real culprit8. That this theory was the generally accepted one was
confirmed by George Warde Norman, a prominent director of the Bank of England
and an opponent of the monetary theory.
In a
letter to Charles Wood MP, who was chairing the Committee of the House of
Commons on the Note Issue, Norman lamented the fact that public opinion stood
behind the monetary theory of booms and busts9. Ironically, this
very point was stressed by Karl Marx. In an effort to make capitalism solely
responsible for the existence of the so-called trade cycle Marx adopted the
banking school explanation (which really should be called the Tooke-Mill
theory) of this monetary-driven phenomenon, arguing that
The
superficiality of Political Economy shows itself in the fact that it looks
upon the expansion and
contraction of credit, which is a mere symptom of the periodic changes of the
industrial cycle, as their cause…. the whole process, which always reproduces
its own conditions, take on the form of periodicity10. (Emphasis
added.)
This
brings us to Colonel Robert Torrens. Apparently influenced by James
Pennington Torrens abandoned his earlier and purely descriptive and
misleading approach to the boom-bust phenomenon11 and in 1837
joined the currency school with an astonishing pamphlet that laid out the
monetary theory of the cycle, complete with a description of the money
multiplier12. It was a tour de force and a scathing indictment of
the Bank of England. Dripping with sarcasm, Torrens asked the Bank and
its supporters:
Could a
surgeon, who had wounded an artery, instead of having opened a vein,
vindicate his professional reputation, by showing that he had secured the
blood vessel before his patient bled to death? Could an incendiary escape
condemnation, by proving that he had laboured at the engine by which the
conflagration which had had kindled was at length subdued? (p. 43)
His
analysis left no doubt where he thought the blame lay for the recurring
financial crises that plagued the country. The pamphlet immediately made
Torrens the currency school’s leading theoretician. Unfortunately, he failed
to persuade most of its members to agree with him that demand deposits were
money and should be included in their definition of the money supply. (On the
other hand, the banking school recognised that deposits were indeed money.
This was the only thing it did get right.) Torrens’ views on money and the
trade cycle also put him completely at loggerheads with John Stuart Mill, who
had become a leading supporter of the banking school.
In 1848
Torrens published13 a damning repudiation of the monetary views of
Mill and Thomas Tooke. He also took Mill to task over his misleading
criticism of the currency school’s theory of the trade cycle. Ten years later
Torrens once again brought the subject into the public arena with a roaring
defence of the monetary theory of the boom-bust cycle that was almost
Austrian in its analysis14. It was full-blooded assault on the
fallacies of Tooke, John Fullarton, James Wilson and John Stuart Mill.
Unfortunately for economics and the world the attack came too late to prevent
the fallacious Tooke-Mill ‘theory’ of the trade cycle, which assumes that the
money supply is passive, from overshadowing the currency school theory. Given
these facts is it any wonder I find it totally incomprehensible how any
informed person could place Torrens in the same camp as Mill.
The
Tooke-Mill explanation of the trade cycle does not deserve to be called a
theory. Moreover, its emergence as the dominant explanation for booms and
busts helped bring about the Great Depression: the result is that we now have
to endure the sight of Keynesian cultists publically declaring:
Since
capitalism’s beginnings, the market economy has been subject to fluctuations
— to booms and busts. Capitalist economies are not self-adjusting: Market
forces might restore eventually an economy of full employment, as economist
John Maynard Keynes said, but, in the long run, we are all dead”. (Taipei
Times, Joseph Stiglitz, The IMF is slow to
recognize its errors or Keynes’ correctness, 3 June 2002.)
This
dangerous nonsense will continue unabated until the true theory of the trade
cycle is restored to its rightful place and the currency school given full
recognition for its contribution to economics15.
* * *
*Like the classical economists I am
referring to a specific economic phenomenon and not to economic fluctuations
in general.
1Jonson,
P. D. Capitalism, Connor Court
Publishing, Pty, LTD, 2011 (p. 282).
2Smith,
Peter Bad Economics, Connor
Court Publishing, Pty, LTD, 2012 (p. 82).
3Kates,
Steven Free Market Economics,
Edward Elgar Publishing Limited, 2011 (p. 43).
4Kates,
Steven Says Law and the Keynesian
Revolution: How Macroeconomic Theory Lost its Way, Edward Elgar
Publishing Inc., 2009 (p. 121).
5It
was the 1847 financial crisis combined with John Stuart Mill’s standing as an
economist that caused the currency school’s theory to be eclipsed by what can
only be described as the Pollyanna theory. This is where capitalists go to
bed on Sunday night with realistic expectations of the future but then, for
some unaccountable reason, they awake in the morning full of irrational
optimism that causes them to pour huge sums of borrowed funds into
unprofitable ventures, creating malinvestments throughout the economy while
sparking a frenzied speculation which ends very, very badly.
6Arbuthnot,
George Sir Robert Peel’s Act of
1844, Regulating the Issue of Bank Notes, Vindicated, London:
Longman, Brown, Green , Longmans, and Roberts, 1857, (p. 92). This work was a
devastating attack on the views of Thomas Tooke and the banking school. It is
certainly the equal of Torrens’ takedown of Tooke and Mill.
7Classical
economists linked the emergence of disproportionalities directly to the idea
of circulating capital being converted into fixed capital. James Wilson,
founder of the Economist, discussed
this issue in his magazine. The article in question was later published in
his book Capital, Currency and Banking
as Article XI, The Crisis, The Money
Market. Wilson’s opinion that “railway mania” caused excess
investment by converting circulating capital into fixed capital was supported
by John Stuart Mill (Principles of
Political Economy, Vol. II, University of Toronto Press, Routledge
& Kegan Paul, 1965, p. 543.) Colonel Torrens was also in full agreement,
stating that “[t] he railways were rapidly absorbing the circulating capital
of the country, and outbidding commerce in the discount market”. (The Principles and Practical Operation of Peel’s
Act of 1844 Explained and Defended, London: Longman, Brown, Green,
Longmans, and Roberts, 1857, p. 74.)
Ricardo
also raised the question of converting circulating capital into fixed capital
(Principles of Political Economy and
Taxation, ch. XXXI, On
Machinery.) However, Malthus was much better than Ricardo on this
issue (Principles of Political Economy,
Augustus M. Kelley, Publishers, Clifton 1974, pp. 236-7). There is also
Malthus’ remarkable article on forced saving that explains the emergence of
disproportionalities (Edinburgh Review,
February 1811, pp. 363-372). It’s unfortunate that these economists failed to
develop a theory that directly linked the phenomena of forced saving,
disproportionalities, the rate of interest and the conversion of circulating
capital into fixed capital to the role of time in production.
8Mushet,
Robert An Attempt to Explain from The
Facts the Effects of the Issues of the Bank of England upon Its Own
Interests, Public Credit and Country Banks, London: Baldwin,
Craddock, and Joy, Paternoster Row, 1826. This is a remarkable and highly
detailed work that should be compulsory reading for every economist and
economic historian.
9Letter To Charles Wood, Esq., M.P., On Money, And
The Means Of Economizing The Use Of It, London: Pelham Richardson,
1841 (p. 85).
10Karl
Marx, Capital Vol. I, Chicago:
Charles H. Kerr & Co. 1909, (p. 695). Marx’s opinion that the money
supply is passive is pure Tooke. In fact, there is no fundamental difference
between the Took-Mill theory of the trade cycle and Marx’s theory.
11An Essay on the Production of Wealth,
Longman, Hurst, Rees, Orme, and Brown, Paternoster Row, 1821. In this work
Torrens drew attention to the fact that using inflation to cut real wages
raised the demand for labour and accelerated the process of capital
accumulation. (p. 326.) This naturally raises the question of forced saving.
Thomas Malthus expressed brilliant insights into the process of forced saving
(Edinburgh Review, February
1811, No. XXXIV, pp. 363-372). I’ll deal with this phenomenon in later
articles.
12A Letter to the Right Honourable Lord Viscount
Melbourne on the Causes of the Recent Derangement in the Money Market, and on
Bank Reform, London: Longman, Rees, Orme, Brown, & Green,
Paternoster Row, 1837.
13The Principles and Practical Operation of Sir
Robert Peel’s Act of 1844, Explained and Defended, London:
Longman, Brown, Green, Longman’s, Paternoster Row, 1848.
14
The Edinburgh Review, or Critical Journal,
January 1858 – April 1858 (pp. 248-93). Torrens’ attack always brings to mind
Sir William Clay’s proto-Austrian analysis of the business cycle published in
1837. Clay, like Colonel Torrens, was also a member of the Political Economy
Club.
15For
the life of me, I just cannot see how someone could write about the
“classical theory of the trade cycle” without making a single reference to
the existence of the currency school or the banking school.
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