Would large, chaotic swings of booms and busts occur in a laissez-faire economy?

Economics Economics Questions
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Hello.

I have been getting interested in Austrian economics for some time now and have been involved in the associated political theories for a good deal longer. However, I was having a conversation with someone the other day and they brought up something that I was unable to answer because of a lack of historical and economic knowledge on the issue. I was hoping someone here could explain.

She asked, “Would large, chaotic swings of booms and busts occur in a government-free, laissez-faire economy?” and she was specifically referencing things like the Tulip Craze and Charles Mackay’s Extraordinary Popular Delusions and the Madness of Crowds and that she has not seen these elements explained without relying on the suggestion that its rooted in cognitive failing/general psychology.

To quote her properly:

" I am skeptical that laissez-faire can avoid “stupid people tricks” en masse. My going in position is that humans can be systemically stupid at one point of another, following the herd right off the cliff. Even in an enforced laissez-faire economy, the system of dependencies can move the entire system to global build-up or shutdown rather rapidly. Easter Islanders will still believe in their totem gods. People will still believe Word is better than WordPerfect. More importantly entire, interconnected societies can lose faith in their efficacy and their ability to create a better future for themselves and for their children. What I am also assuming at this time however is that, in an enforced laissez-faire economy, these spikes might be thinner (less durable over time), their lifespans of which might be must as fickle as the phenomena that created them."

There is also the very real dangers that large scale hiccups would trigger renewed interest in socialist governments, entice like minds to get together in fear once more, spurn revolutions, become violent, return governments to harsh roots once more…

Call me “sanguine” on the characteristics of human nature. Does Dr. Bernstein address this?"

(I referred her to Dr. Andrew Bernstein’s The Capitalist Manifesto at the time, in which he suggests

I appreciate any help in better understanding this and I will be happy to provide any extra clarification that someone feels is necessary. Thank You.

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I know someone (can’t remember the author’s name), who wrote “Tulip Mania”- which discusses the boom/busts including the Tulip craze, and shows how that was a gov’t boom- not free markets. Its here, on this site, at:

http://mises.org/journals/qjae/pdf/qjae9_1_1.pdf

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The business cycle could theoretically occur in a free market if:

a) “Fake Warehousing”. Normally, warehouse firms (which have, and most likely would arise on the free market) take grain, gold, or other valuables and stores them securly. Then, it somehow indicates who the owner is, such as through a “proof of ownership” slip. If the warehouse allows these indicators to be transferrable (and the free market would favor firms that allowed this, as it would be convienent to transfer the slip, instead of forcing people to redeem the slips if they wanted to transfer the good), then the slips can function as money, as they can be used while containing the value of the good. This is a service, with the warehouse receiving payment for the storage. Classical banking follows this system with gold (the object to be stored), and bank notes (the warehouse slip). Most modern banks store money, and keep tallies of how much each person has “stored”. However, they also engage in “Fake Warehousing”, which creates fractional reserve banking as only a fraction of money is stored.

However, if the warehouse firm consequently uses the deposits, either for consumption, or investment in another firm, it can create an artificial bubble via Austrian Business Cycle Theory. This is fraud, as the properity was not entrusted in a loan, but only to guard for the convienence of the owner.

b) “Fake slips”. Instead of giving slips merely when someone deposits goods, a firm, either the original warehouse or another person, can make a “fake” receipt, that passes as an actual receipt that can be used for a good. This is often called “counterfeiting” when done by another party, although strangely in today’s society, the “warehouse” is not criminalized for any fake receipts they create. This can also create a bubble even if the warehouse recognizes that the receipts are fake, as long as people believe they are genuine and don’t try to redeem them.

c) Nearby Governments - Government, which usually has the power to do the above two, will create the business cycle. As long as a free market is in trade with statist areas, business cycles will ripple into the market.

Yes, the business cycle can occur in a free market. However, there are several factors that can stop or limit business cycles (which would be reduced to sporadic that are usually absent when government controls banking.

  1. Limited scope - Firms in a free market have a limited scope compared to almighty government firms. Thus, if someone does a) or b), it will not affect as many people, as not as many will trade the bank notes. In a state run system, usually government has a monopoly.

  2. The Criminality - a) and b) are criminal actions. a) because the warehouse is violating their contract to have slips redeemible “on demand” and commiting fraud. b) Because someone is commiting fraud by posing receipts as “redeemible” or “can be exchanged”. In a government run system, these actions are often deemed legal, even “necessary” for the government to do. In the free market, their criminality places limits on the operation because of stigma, and doing more of a) or b) increases the risk of getting caught.

  3. Competing Firms - The threat of competition will limit what warehouses can do. Consumers will look for firms that have a reputation for trustworthy slips, as they are risking their wealth by storing it with a firm that does a) or b). A firm that did a) or b) would go out of business, as other firms took some profit.

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People are stupid en masse 24/7, no question about that. But where do they get the money to indulge their stupidity? So much money that they can upset the economy of a whole country? The money always comes from some form of money printing.

There’s a free book here, Early Speculative Bubbles, that discusses Tulip Mania.

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The point I am trying to make is that it is a fallacy to believe that getting rid of government will get rid of all coercion, fraud, and other human vices. Also, it is false to believe that only government can cause business cycles, although this has almost always (at least in the historical literature) been the case. However, it would certainly change in character, and people would probably view it as something else, although the cause and effects (albeit diminished) would remain.

Also, keep in mind that there is no cycle inherant in the “business cycle”, it is merely a one time occurance caused by the onset of additional money. The emergent appearance of a cycle simply results from governments using monetary creation as a remedy to the previous bust, or just the constant use, requiring people to readjust spending every so often.

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Getting rid of government will NOT get rid of all coercion, fraud, and other human vices. However, the incidents will be isolated. The business cycle can occur in a free market, but the duration and severity of it is aggravated by government. It becomes widespread rather than isolated. Government intervention is a compromised ship without water-tight compartments.

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Could large, chaotic swings of booms and busts occur in a laissez-faire economy?

Yes

Would large, chaotic swings of booms and busts occur in a laissez-faire economy?

Less likely