Bubbles, Booms, & Busts: Toward an Extended Application
Written by Will Porter.
Interest Rates & Spontaneous Order
Among those interested in free market economics, the “business cycle,” or the cyclic generation of “booms” and “busts” in the market, is of high significance in this modern age of recession. Economic theory explains certain market downturns by referring to harmful and misguided interventions undertaken by state agencies. A business cycle is brought about when government, through central banking institutions, creates conditions that bring about an artificial boom, or “bubble,” in the economy. After some time, this is then followed by a corrective bust, which takes shape as a recession, downturn, panic, or depression of some sort.
To elaborate further, in the US the Federal Reserve will tamper with interest rates, usually pushing them well below the rate that a freely functioning market would have set them at. When credit becomes cheaper, it acts as a signal to entrepreneurs and investors to start their business projects, especially those involved in the “higher order” stages of production: heavy industry, mining raw materials, etc. These businessmen see a lower interest rate as a sign to begin their long-term investment activities, since more time-intensive undertakings will be easier to fund with a lower rate of interest.
The interest rate acts as a coordinating mechanism in an industrial economy, lining up consumption, savings, and investment over time. When consumers save their money in a bank, it means they are foregoing spending and consumption in the present in exchange for slightly more consumption in the future (as their savings accrue interest too). At a point when bank-savings is relatively high, more money is then available for that bank to loan out, making credit more abundant, and therefore cheaper. For borrowers, since attaining funds in the present is valued more highly than attaining funds in the future, bank-lending becomes a valued service. This gives rise to the rate of interest as compensation to banks for that service.
Under the natural ebb and flow of the market economy (i.e. under free association) the interest rate not only tells investors when credit is cheaper, but it also serves as a sign that consumers are deferring consumption, thereby allowing resources to be allocated toward other things, like long-term investment projects. However, when the Federal Reserve intervenes to set interest rates arbitrarily low, it sends out the same signal to investors, yet now without the usual corresponding increase in savings and decrease in consumption.
Because it did not fall due to the real accumulation of savings, the arbitrarily determined interest rate does not, in fact, reflect the real state of the economy. Businessmen are nonetheless enticed to begin their time-intensive ventures because, even if not genuine, the rates are still low, credit is still easier to come by. This leads to a systematic “cluster of errors,” where investors have miscalculated the sustainability and/or value of their projects.
When these errors eventually become apparent, a huge waste of resources, time, and energy is revealed, leading to a mad scramble to consolidate, adjust investments, and restructure business activity to avoid future malinvestment. In the end, this is devastating for an economy, most especially for lower-earning consumers and workers, who are least insulated from the damage done by economic standstill.
Because entrepreneurs are misled about the true condition of the economy, they begin unsustainable projects which they initially appraise as profitable. Their half-completed projects will have to be torn down, or put on hold until the market can offer a more suitable economic environment.
Business cycles can amount to large setbacks to human civilization and standards of living across the board. The boom is caused by the artificially cheap credit, leading to a flurry of new entrepreneurial ventures, while the bust comes after the recognition that some large portion of these new ventures is simply unsustainable. The boom-prosperity is an illusion, while its resulting negative effects are very real.
The bust is, in reality, the “good” part of the equation, as it means that errors have been acknowledged, and steps toward a healthier economy can begin. The “popping” of an economic bubble is certainly not painless, but—analogous to the predicament of a drug addict—a prosperous, sustainable condition can only be reached after going through a period of unpleasant readjustment.
Stated more broadly, a business cycle takes place because an effective mechanism of social decision-making is replaced with an inconceivably more primitive and inept one. The free market—more specifically the pricing system—is constituted by a vast web of millions of decisions made by individuals over their own lives, based on each person’s own set of values and preferences. When the individuals that comprise an economy exchange with one another, eventually a system of prices naturally emerges, reflecting peoples’ aggregated valuations in the form of quantifiable monetary units.
When government attempts to replace this beautifully sophisticated system with some central planner, it spells disaster. Central planning cannot succeed, in part, because top-down bureaucratic agencies simply do not have access to all of the relevant information needed to properly determine the needs of a complex economy. For this reason, they don’t only fail at economic planning, but any sort of large-scale social planning in general.
A central planning board is completely incapable of replicating a genuine system of pricing, as prices under a free market are influenced by the decisions and preferences of every individual who participates. There are far too many variables involved; no bureaucracy can possibly hope to take them all into account.
Perhaps worst of all is when government tries to establish bureaucratic planning over the price of money itself, the lifeblood of an economy. This is precisely what the Federal Reserve does when it steps in to dictate interest rates. Attempting to socialize the price of credit has especially harmful, and systemic, repercussions. Because money is half of almost every economic transaction, tampering with its natural function will have harmful unintended consequences which affect the entire society.
This is the business cycle: the artificial creation of an economic bubble via state intervention, and the resulting damage brought about by the popping of that bubble (which often leads to further intervention in attempts to correct the errors just created).
Applying the Lesson: Foreign Intervention & Black Markets
For economic understanding, the Austrian business cycle theory is highly valuable. It helps to unveil the nuts and bolts of certain central bank activities, and also helps explain depressions and recessions. Yet, more importantly, this theory also yields a general lesson about government intervention.
This lesson has bearing beyond the narrow purview of economic study into a broader field of political philosophy. Using insights gleaned from the Austrian account of booms and busts, I wish to extend its application to two other distinct phenomena: foreign political/military intervention, and the domestic prohibition of drugs. While both of these obviously have their own economic components, I will not be strictly speaking of economic theory, but rather of equilibriums of power, political, military, or economic.
The general idea remains the same, however. Societies tend to operate on some basis of natural equilibrium, or spontaneous order. The interest rate is but an example of this. It illustrates the vital importance of natural balances, of the delicate harmonies which are attained organically in society, without the decree of any central authority. When government steps in to artificially—that is, coercively—change the free behaviors of individuals, it damages this balance and creates every sort of unforeseen catastrophe (well, not always unforeseen by everyone). This idea applies in the realm of the economy especially—where complex networks of human interactions and technological endeavors are organized—but it is also relevant to the social-political fabric of any civilization.
With an imperial, interventionist foreign policy, the United States government continually meddles in matters far beyond its comprehension to understand and capability to manage. They wage direct wars, impose economic sanctions, arrange wars by proxy, give material support to every sort of militant or rebel group, overthrow governments—or on the other hand, back brutal dictators—as well as influence the internal politics of foreign nations. Inevitably, this leads to disaster, caused by overt acts of the military or the covert actions of intelligence agencies.
When unintended negative consequences, especially violent consequences, occur because of covert operations, this is called “blowback”. In a similar way that bad monetary policy creates adverse effects, blowback is the result of a failed foreign policy. The artificial intervention into foreign political situations typically inflates bubbles of power, which are just as much of an illusion as economic bubbles are. By propping up a foreign dictator, for example, a potentially volatile situation is created.
Instability is fostered when outside intervention attempts to influence the “natural” progression of events in other countries, especially those with radically varying cultural values and political relations. Navigating the complex landscape of local politics, from tribes to modern states, almost always proves too difficult for imperial governments to accomplish.
As is often the case, a US-backed dictatorship might be oppressive to the people it rules over, or to certain ethno-linguistic-religious groups within that country. By propping up this despotic state, it typically stirs up resentment and anger among the populace, much of which is directed toward the country who keeps their tormentor-in-charge. When the artificial bubble of power eventually pops, or at least abruptly decreases in size, it may manifest in various ways. One possibility is that some people from the oppressed country might attempt to take violent revenge, illustrated by the multiple acts of terrorism in the US or on Americans abroad even in just the last decade.
In America today, terrorism is most associated with the Middle East, where outside military or political intervention has gone on for nearly a century unabridged. Leaders of militant Islamic groups frequently express their grievances, the major casus belli for their struggle. While it’s certainly true these radicals are motivated by their interpretation of a religious doctrine, the other half of their program is opposition to Western, or more specifically, US foreign policy. They cite, among other things, the backing of oppressive regimes—such as Israel—or the US military presence at holy sites—such as Mecca and Medina—as motivations to fight or harm the United States (whether that means harming citizens, government, or interests probably varies among militant groups.)
One can believe these prisoner-beheading lunatics are despicable, while at the same time partly agree with their complaints. What business does the American government have going around occupying foreign lands, or giving billions in tax-dollars to deplorably repressive states? The methods of savagery that Islamic militants frequently employ are to be denounced, but their gripe with US policy is, in many ways, correct. As long as they are in place, we will likely face more acts of reprisal from the victims of these policies.
Another possible adverse consequence of backing foreign dictators is the incitement of a bloody revolution, or insurrection. Sometimes revolution is necessary in order to cast off the fetters of a corrupt state, but they can easily fall apart, decaying into a larger problem than was present to begin with. When some faction attempts to take power, it tends to alarm other political factions, especially rivals, and often leads to armed conflict.
The particular faction that executes the coup d’état might have been motivated by the oppression of the US-sponsored dictator, but nonetheless allowing a corrupt regime an artificially long lifespan will foment all kinds of unrest and dissatisfaction, as well as an expected, but harsh anti-Americanism. Unless additional intervention is employed to sway the post-revolution government to the favor of the US, it will almost certainly take an anti-US, or anti-Western stance.
The mere existence of a state which does not fall in line with American decrees tends to elicit anything from economic sanctions to outright warfare from the US. Clearly, then, if inflating a power-bubble under a dictator can unintentionally bring about a totally unstable or hostile situation, it should be avoided. Precarious, messy revolutions not only harm countless citizens of the foreign country, but the interests of the United States as well.
On the other hand, in the case of purposely initiating, funding, or backing a revolution, there are other potential side-effects. By kick-starting a revolution that wouldn’t have otherwise gotten off the ground, the same type of instability is created. Revolutions are much more likely to succeed when a consensus among varying interest groups exists. To whatever degree the different political factions are willing to compromise and cooperate, a revolution will meet that much success.
When the US government makes a revolution start prematurely, before any kind of general understanding is reached among factions, the probability of post-coup civil war is much greater. Coming to enough of a consensus to allow a sustainable political revolution is a spontaneous, organic process that can take decades. Eventually, in the best of cases, dictators can naturally crumble under the weight of mass-dissent, and a peaceful dissolution of the corrupt state can be got under way. When, instead, one faction is armed or supported enough to begin the coup on their own, a natural balance of power is destroyed, and knee-jerk reactions ensue from those in opposition to that faction.
The bubbles of artificial power inflated by US foreign policy—whether among militant rebel groups or national governments—have created a much more dangerous world. When these bubbles pop, it isn’t just an economic downturn that results, but a large loss of life, great human suffering, and sometimes an entire collapse of the society.
Countries constantly plagued with violent political turmoil—fueled in large part by US and Western intervention—also tend to have a faltering, primitive economy. The desperation of political powerlessness and economic destitution can easily lead people to embrace militant doctrines, which seem to provide some way out of the bad situation. The world is lousy with deranged militant groups and corrupt political rulers in impoverished nations; we can thank the United States government, with its long-standing policy of extensive foreign intervention, for its part in keeping it that way.
Another prominent example of a bubble phenomenon can be found in the domestic war on drugs. With the state-enforcement of prohibition on various mind-altering substances, a giant bubble is inflated in the black markets which arise to meet the demand for these goods.
The domestic policies that make up the drug war constitute an artificial intervention in society, diverting human behavior down paths that probably wouldn’t have been taken otherwise. For example, because cannabis, a relatively harmless substance, is prohibited alongside harder substances like heroin, it forces the sale of these goods into the hands of black market dealers. Somebody who otherwise might have grown their own cannabis is now at risk of being exposed to all of the terrible maladies of heroin, simply because both substances are now associated with the same black market—where sometimes both are sold at the same place.
But the problem of pushing softer and harder drugs into closer proximity is dwarfed by the enormous social blight of the cartels and street gangs who have become devoted to the sale of illegalized substances. Criminal enterprises are only dangerous and powerful insofar as they have a steady means of income, precisely what prohibition has provided. This is essentially a strange form of neo-mercantilism, where government laws monopolize or cartelize certain industries, in this case into the hands of lawless criminals.
The violence and corruption of the black market is pervasive in almost every major city, not just in the US, but all over the world. Almost all other goods and services are provided without the sort of barbarism found in the black market. It is because of prohibition that these “vice” industries are run by criminal enterprises—pushed underground—instead of reputable businesses.
Perhaps one of the best case studies of prohibition is the American experiment with banning alcohol. Today almost everybody sees the clear error and absurdity of that policy, as well as the terrible consequences it brought. Just like contemporary prohibition, the illegalization of alcohol brought about exactly the same type of violent black markets, complete with street gangs and cartels, widespread police corruption, as well as crudely-produced, lethal intoxicants.
Because of the massive bubble inflated in the black market, drug cartels have gained unprecedented power as they dominate the multi-billion dollar industry. This creates some great difficulties for those who wish to see an end to prohibition. Popping this bubble all at once, by repealing all drug laws wholesale, could possibly lead to an immediate takeover of the industry by the already-enormous drug cartels. This situation was allowed to come about almost solely because of prohibition. Effectively restricting competition, it is only after decades of drug laws that such cartels could attain the size and scope they have today.
Setting aside for the moment some practical considerations, in a hypothetical world it might be a sensible to repeal drug prohibition in a slow and steady manner. This could potentially allow new competition to creep into the freed drug market to provide a counter-weight to existing black markets.
Drawing some lessons from the post-Soviet economic “shock treatment”—where a multitude of oligarchs, unfairly enriched by the former Soviet system, underhandedly took advantage of a newly freed economy—a similar sort of shock therapy in ending prohibition might allow the violent cartels who’ve gotten fat from it to swoop in and dominate the market. Although the current regime of drug laws benefits cartels immensely today, one can at least imagine ways in which abrupt full legalization might allow them to take some sort of unjust advantage using ill-gotten gains.
Of course, a slow abolition of the drug war is likely impossible, as incremental changes in politics are easily defused and quickly rendered inert. Alongside the inflated black market, various special interests also see artificial gains from prohibition. Among many others, private prisons and jail-bar manufacturers now have an incentive to lobby in favor of drug laws.
If this is true, in our very real, non-hypothetical world, an immediate repeal might be most desirable. To truly rid society of this dreadful government program, it may be necessary to do it all at once. The potential negative side effects of suddenly popping this bubble are outweighed by the horrendous consequences that will come with decades of continued drug prohibition. Fiat justitia ruat caelum.
Although the Austrian theory of the business cycle has its own unique economic implications, the general notion of bubbles being generated by state-intervention applies all over the fields of domestic, foreign, and economic policy. When human behavior is redirected and manipulated on a societal-scale by political fiat, the trajectory of that society is irrevocably altered, usually for the worse. Whether that intervention takes shape as military campaigns, economic sanctions, covert operations, or destructive domestic policies, the spontaneity of human action is crippled and society as a whole is damaged.
Part of what we learn from our analysis of bubbles is damaging to all statist ideology: the sheer inability of governments to properly do anything they set out to do. The decision-making process of government is not based in the same kind of rational calculation that allows private persons, business owners, and entrepreneurs to successfully exchange and allocate resources in a mutually-beneficial way. The operations of government, on the contrary, involve a net loss; it is a “zero-sum game”.
It is not despite the pain brought by booms and busts, but because of it that we must seek to end state-intervention in all aspects of human civilization. The longer these problems are pushed down the road, the greater the calamity their breaking-point will bring. In America, some bubbles—like the massive welfare bureaucracy—have grown so large that in the wake of their bursting, mass civil unrest will likely result. To avoid such a calamity, it is imperative to push to deflate every state-generated bubble in society, as quickly and painlessly as possible.
Governments worldwide have entrenched themselves into the very core of society, creating huge vested interests, as well as dehumanizing dependency. It seems pertinent to understand how to deflate bubbles—economic, political, or social—as to avoid the harsh consequences that come when they are allowed to grow until they explode. In the future, a more extensive and specific application of this same type of analysis might help to explain the continuous blunders of government. In all of the ill-fated attempts at social engineering, it is necessary that there is always an informed, cogent opposition standing in its way.