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The Economic Recessions of the Late 1970s and Early 1990s – Jesús Huerta de Soto (04/22/2019)

[Editors Note: The following article is excerpted from Huerta de Soto’s Money, Bank Credit, and Economic Cycles, originally written in 2001]

The most characteristic feature of the business cycles which have followed World War II is that they have originated in deliberately inflationary policies directed and coordinated by central banks.

During the post-war decades and well into the late sixties Keynesian theory led to the belief that an “expansive” fiscal and monetary policy could avert any crisis. Grim reality sank in with the arrival of severe recession in the 1970s, when stagflation undermined and discredited Keynesian assumptions. Moreover the 1970s and the emergence of stagflation actually marked the rebirth of interest in Austrian economics, and Hayek received the 1974 Nobel Prize in Economics precisely for his studies on the theory of the business cycle.

As a matter of fact, the crisis and stagflation of the seventies were a “trial by fire” which Keynesians did not survive, and which earned great recognition for Austrian School theorists, who had been predicting it for some time. Their only error, as Hayek admits, lay in their initial misjudgment of the duration of the inflationary process, which, unrestricted by old gold-standard requirements, was prolonged by additional doses of credit expansion and spanned two decades. The result was an unprecedented phenomenon: an acute depression accompanied by high rates of inflation and unemployment.1

The crisis of the late seventies belongs to recent economic history and we will not discuss it at length. Suffice it to say that the necessary worldwide adjustment was quite costly. Perhaps after this bitter experience, with the recovery underway, western financial and economic authorities could have been required to take the precautionary measures necessary to avoid a future widespread expansion of credit and thus, a future recession.

Unfortunately this was not the case, and despite all of the effort and costs involved in the realignment of western economies following the crisis of the late seventies, the second half of the eighties saw the beginnings of another significant credit expansion which started in the United States and spread throughout Japan, England, and the rest of the world. Despite the stock market’s “warnings,” particularly the collapse of the New York Stock Exchange on October 19, 1987, “Black Monday,” (when the New York Stock Exchange Index tumbled 22.6 percent), monetary authorities reacted by nervously injecting massive new doses of credit expansion into the economy to bolster stock market indexes.

In an empirical study on the recession of the early nineties,2 W.N. Butos reveals that between 1983 and 1987 the average rate of annual growth in the reserves provided by the Federal Reserve to the American banking system increased by 14.5 percent per year (i.e., from $25 billion in 1985 to over $40 billion three years later). This led to great credit and monetary expansion, which in turn fed a considerable stock market boom and all sorts of speculative financial operations. Moreover the economy entered a phase of marked expansion which entailed a substantial lengthening of the most capital-intensive stages and a spectacular increase in the production of durable consumer goods. This stage has come to be called the “Golden Age” of the Reagan-Thatcher years, and it rested mainly on the shaky foundation of credit expansion.3 An empirical study by Arthur Middleton Hughes also confirms these facts.

Furthermore Hughes examines the impact of credit expansion and recession on different sectors belonging to various stages of the productive structure (some closer to and some further from consumption). His empirical timeseries study confirms the most important conclusions of our theory of the cycle.4 Moreover this recession was accompanied by a severe bank crisis which in the United States became apparent due to the collapse of several important banks and especially to the failure of the savings and loan sector, the analysis of which has appeared in many publications.5 This last recession has again surprised monetarists, who cannot understand how such a thing happened.6 However the expansion’s typical characteristics, the arrival of the crisis and the ensuing recession all correspond to the predictions of the Austrian theory of the cycle.

Perhaps one of the most interesting, distinguishing characteristics of the last cycle has been the key role the Japanese economy has played in it. Particularly in the four-year period between 1987 and 1991, the Japanese economy underwent enormous monetary and credit expansion which, as theory suggests, affected mainly the industries furthest from consumption. In fact although the prices of consumer goods rose only by around 0 to 3 percent each year during this period, the price of fixed assets, especially land, real estate, stocks, works of art and jewelry, escalated dramatically. Their value increased to many times its original amount and the respective markets entered a speculative boom. The crisis hit during the second quarter of 1991, and the subsequent recession has lasted more than ten years. A widespread malinvestment of productive resources has become evident, a problem unknown in Japan in the past, and has made it necessary for the Japanese economy to initiate a painful, comprehensive realignment process in which it continues to be involved at the time of this writing (2001).7

Regarding the effect this worldwide economic crisis has exerted in Spain, it is necessary to note that it violently gripped the country in 1992 and the recession lasted almost five years. All of the typical characteristics of expansion, crisis and recession have again been present in Spain’s immediate economic environment, with the possible exception that the artificial expansion was even more exaggerated as a consequence of Spain’s entrance into the European Economic Community. Moreover the recession hit within a context of an overvalued peseta, which had to be devalued on three consecutive occasions over a period of twelve months.

The stock market was seriously affected, and well-known financial and bank crises arose in an environment of speculation and get-rich-quick schemes. It has taken several years for Spain to recover entirely from these events. Even today, Spanish authorities have yet to adopt all necessary measures to increase the flexibility of the economy, specifically the labor market. Together with a prudent monetary policy and a decrease in public spending and the government deficit, such measures are essential to the speedy consolidation of a stable, sustained recovery process in Spain.8 Finally, following the great Asian economic crisis of 1997, the Federal Reserve orchestrated an expansion of credit in the United States (and throughout the world) which gave rise to an intense boom and stock-market bubble. At this time (late 2001), it appears this situation will very probably end in a stock-market crash (already evident for stocks in the so-called “New Economy” of electronic commerce, new technologies and communications) and a new, deep, worldwide economic recession.9

Excerpted from Money, Bank Credit, and Economic Cycles

Jesús Huerta de Soto, professor of economics at King Juan Carlos University, is Spain’s leading Austrian economist, and a Senior the Mises Institute. As an author, translator, publisher, , he also ranks among the world’s most active ambassadors liberalism. He is the author of Money, Bank Credit, and Economic Cycles, as well as Socialism, Economic Calculation and Entrepreneurship (Edward Elgar 2010), The Austrian School (Edward Elgar 2008) and The Theory of Dynamic Efficiency (Routledge 2009).


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