Lewis poses excellent questions and gives fairly good answers. His questions include: Should prices in general be stable, fall, or rise? and Should the stock of money grow continuously, never, or sometimes? He conducts a dialog with himself over these questions, first defending a “yes” answer, then a “no,” and then offering additional replies and counter-replies. His sympathies lie with what he describes as “the Austrian, laissez-faire, or free-market point of view,” but he endeavors to represent the alternative Keynesian view fairly.

Lewis is to be applauded for presenting the case for letting prices fall in a growing economy. Unfortunately he appears to have overlooked some of the strongest previous presentations of that case. We must distinguish between a harmless deflation, where technological progress or other sources of improved productivity lower costs and thereby gently draw prices down, and a harmful deflation, where shrinkage in the stock of money or its velocity brings unsold inventories and thereby painfully forces prices down. Lewis recognizes a distinction between gentle and painful, but oddly claims that, in the view of its defenders, “deflation is always good,” even when “quite painful.” Claiming that deflation is always good is absurd because there is no benefit from deliberately creating a deflation by shrinking the money stock. Auric Goldfinger’s plan, in the James Bond story, to nuke the gold in Fort Knox, thereby raising the purchasing power of his own gold, was the plan of a villain not a hero. Just as a central-bank-engineered monetary expansion disrupts the economy and causes misallocation of resources—something Lewis recognizes—so too does a central-bank-engineered monetary contraction.

To his credit Lewis identifies the error of monetary expansionism: “If you have four apples and a dollar, the dollar may help you price and trade the apples. But adding another dollar will not increase wealth; it will simply raise the price of the apples.” Unfortunately, he fails to identify the corollary error of deliberate contractionism.

In the second half of the book, Lewis discusses what he calls “the problem of banks,” meaning the question of fractional-reserve banking. Here Lewis—following and citing Murray Rothbard’s The Case Against the Fed—offers the view that fractional-reserve banking is prone to runs, “inherently destabilizing” for the broader economy, and should be outlawed as fraudulent. Uncharacteristically, he neglects to consider the other side: the historical studies indicating that free banking with fractional reserves is not run-prone but robust, the theoretical arguments for the efficiency and economically stabilizing character of free banking, and the jurisprudential arguments for the legitimacy of voluntary fractional-reserve arrangements based on freedom of contract.

Defenders of fractional-reserve free banking (the present reviewer included) would reject the claim that, like a central bank, “a fractional reserve bank can also ‘print’ new money” arbitrarily. Any bank in a competitive system issuing gold-redeemable notes and deposits is tightly constrained, unlike a monopoly central bank. Contra Lewis, the money supply in a fractional-reserve free banking system is neither “over elastic” nor “generally expanding.” Lewis might have consulted Mises’s The Theory of Money and Credit and Human Action more closely on these points.

Lewis does a good job of sketching the Austrian theory of the boom-bust cycle resulting from a central bank’s cheap-credit policy. And he sagely notes that when a central banker promises to inflate the economy and bail out financially troubled firms, “then it becomes more rational to speculate, to take excessive risk, and not at all rational to save, to take precautions, to be prudent. In this respect . . . so-called stabilization is actually de-stabilizing.”

The book contains three appendices, respectively concerning the Federal Reserve System and its operations, the gold standard and other international monetary arrangements and institutions, and nonmonetary cycle theories. The appendix on the Fed unfortunately gives an incorrect account of how the money multiplier and open-market operations determine the money stock.

The academic economist-reviewer cannot resist noticing some other errors. For example, no sensible view holds that a period of inflation typically or automatically leads to a period of deflation in a fiat money economy. A determined central bank can issue enough money to keep the price level rising continuously, as almost all have since the fiat era began in earnest in 1971.

Despite its shortcomings, this book is an interesting and useful introduction to the important question posed in its title.

The marvel is the speed with which Woods put together a book of almost 200 pages and Regnery got it on the market. Under the circumstances, one might expect the book to come up short in coverage or depth of analysis, but it doesn’t. In fact Meltdown, despite a couple of minor flaws, is the best one-stop analysis of the recession available, which makes it the book to give anyone who wants to understand how government intervention caused this mess and how Austrian economics can explain those causes and the problems with the proposed cures.

The opening chapter provides an overview of events as well as a taste of the mainstream media analysis of the meltdown. Mostly that consisted in blaming it on “free market,” or “unregulated” and/or “laissez-faire” capitalism, with almost no one asking whether such an assessment of blame makes any sense. That chapter also acknowledges the “elephant in the room”–namely, the Federal Reserve System. Woods rightly notes that almost all the commentary on the recession has ignored any substantive discussion of the role that the central bank played in creating the boom that in turn led to the bust.

The broad case for government as the cause of the meltdown is offered in chapter two. Woods names six “culprits.” First are Fannie Mae and Freddie Mac, the government-sponsored enterprises that dominate the mortgage market. Largely immune from profit and loss, and able to “make markets” in ways that truly private firms are not, Fannie and Freddie created implicitly government-backed markets for trading mortgages and mortgage-backed securities. This encouraged mortgage originators to keep creating new mortgages, however risky, knowing that Fannie and Freddie could use their special line of credit at the U.S. Treasury to buy those up and resell them on the secondary market. This was hardly a “free market.” Rather it was one in which these creatures of government operated without being subject to the market’s own normal regulatory processes–namely, profit and loss and risk management.

Minor culprits include the Community Reinvestment Act and other forms of affirmative action in lending, as well as the ways that government policy stimulated speculation. Among the factors Woods mentions here is the role played by the credit ratings agencies, which are themselves a cartel protected by the Securities and Exchange Commission. This is a point that many observers, even free-market ones, have overlooked in their analyses. Woods is to be commended for bringing it in.

But the bulk of his blame lies with the Fed. Woods offers a complete analysis of the Fed’s role in the context of an accessible account of the Austrian theory of the business cycle. He clearly explains the interaction of savings, time preferences, and interest rates under stable monetary conditions in order to show what happens when the Fed intervenes with an expansionary monetary policy. Chapter five follows up with a good discussion of the myths of the Great Depression.

The final two chapters are on money and “what now?” The key argument of both is that the Federal Reserve System and the other elements of central banking are the real source of trouble and that we should reconsider this institution. Woods includes a nice refutation of a number of arguments against gold and other commodity standards. These two chapters are valuable, although I wish Woods had acknowledged that his implicit monetary theory, including his definitions of inflation and deflation, is not the only one in the Austrian tradition. (It relies on a Rothbardian 100-percent-reserve perspective on money and banking.)

Although in a few places Woods comes across as unnecessarily angry, which might turn off readers not predisposed to his message, Meltdown is in many ways an extraordinary achievement. He has digested complex theory and a whole range of recent history and presented the single best analysis of the current recession out there. It is a terrific example of using Austrian economics and free-market thinking to analyze the real world–and doing it in a way that is highly accessible to the general reader.

Because I was a serious student of free-market economics, Sennholz invited me to join his “graduate seminar,” which met on Wednesday nights and read the classics. That year we read Carl Menger’s Principles and Investigations and Eugen von Böhm-Bawerk’s Capital and Interest. So on Sennholz’s orders I picked up my copy of Human Action and went to the library every night until I had read the book cover to cover. Thanks to my undergraduate mind and the speed with which I tried to absorb the material, I missed much more than I comprehended.

But what I did comprehend changed my life.

It was that experience more than any other that made me realize I wanted to be an economist–not just an advocate for the free market. A year later I applied, and was accepted, to law school, but decided to defer that and attend graduate school in economics instead. Studying economics in the way Mises described the discipline in Human Action seemed the appropriate path.

Over the next year I worked to clear up my misunderstandings of Mises by reading Murray Rothbard’s Man, Economy, and State and Percy Greaves’s Mises Made Easier. Then in the second semester of my senior year I reread Human Action for a senior project for Sennholz on the methodenstreit (the Austrians’ battle with the German Historical school over the legitimacy of economic theory) and the relationship between Mises and Max Weber.

A year later, when I started graduate school at George Mason University, Professor Don Lavoie impressed me when, in an undergraduate course, he held up Human Action and said to the students, “This is the greatest book ever written in economics. I love this book.” I understand what Lavoie meant. For the past 20 years I have had the good fortune to be able to use Human Action in at least one Ph.D. course every year.

No Substitute

To the American student of economics, Rothbard’s presentation in Man, Economy and State might be more straightforward than Human Action, and Israel Kirzner’s discussion in Competition and Entrepreneurship picks up more naturally than Human Action from where intermediate price theory leaves off. But to the serious student of Austrian economics, there is no substitute for a thorough reading of Human Action. Even Hayek’s Individualism and Economic Order is best read as a complement to Mises’s great work, certainly not as a substitute if you hope to understand not only Hayek’s thought and argument, but also how markets actually work and why government cannot effectively regulate, let alone plan, a modern economy.

Since it was first published, Mises’s great work has been misunderstood. It is not primarily a work in methodology; it simply lays out the methodological foundations at the beginning. It is not primarily a work about the failures of government and the superiority of the market economy, though that is a logical conclusion to draw from the work’s analysis of interventionism and socialism. It is not primarily a work in market theory and the price system, though it does place a priority on entrepreneurship and the quest for profit and the discipline of loss. It is not primarily a work dealing with money, capital, and interest, but it does devote considerable time to the coordination of economic activities through time and devotes considerable space to the nature of money and capital and the role played by interest. Finally, Human Action is not focused on the wages of workers or the pattern of international trade, but it does lay out the economic theory of factor pricing, the principle of comparative advantage in the allocation of labor, and the international division of labor and the gains from specialization and exchange.

Human Action is not exclusively any one of these things precisely because it is all of these and more. Mises wrote economics not as a series of specialized topics, but as an integrated whole grounded in the consistent and persistent study of the logic of purposive human action.

In my view there have been two great defining characteristics of economics since its birth as a discipline in the eighteenth century: the market economy’s self-regulating capacity (the invisible hand) and self-interest (rational choice). Self-regulation was the great discovery of the Schoolmen of Salamanca, the French Physiocrats, and the Scottish Enlightenment philosophers. The Austrian school of economics represents the modern refinement of this classical theory of spontaneous order. Mises inherited it from Smith, Say, Menger, and Böhm-Bawerk and developed the argument further. The unhampered market economy corrects itself through price adjustments; losses, which weed out imprudent decision makers; and profits for prudent decision makers. In the process the market directs scarce resources into wealth-creating activities and general prosperity. Through relative prices and profit-and-loss accounting, individuals’ exchanges and innovations align technology and resource availability with consumer preferences.

Coordination of Consumption and Production

One sign of Mises’s genius is that his demonstration of this harmonization was more thorough than any before him. He showed how purposive action within the institution of private property coordinates consumption desires and production plans according to the least-cost methods of production. The private-property market economy mobilizes individual initiative and enables people to rationally calculate the alternative uses of scarce resources. Consumers, buying and abstaining from buying, create profits and losses that guide business decisions and coordinate economic plans through time.

Mises’s work on rational economic calculation provided the decisive argument against socialism, but it also explains the foundation of the market order. The free market enables calculation, socialism makes it impossible, and interventionism distorts it. Without private property, freedom of contract, monetary stability, and fiscal responsibility, the process of rational economic calculation is thwarted.

Adam Smith articulated the idea of the invisible hand, but it was Mises who explained how the market economy actually works. Human Action is Mises’s fullest and finest statement of that explanation.

To put it bluntly, Human Action is the greatest work in economics in the twentieth century. It is the treatise in economics.

When Austrian-school theorists have examined the dynamics of market exchange, they have stressed the importance not only of the larger political context within which such exchanges take place, but also the ways in which politics influences and molds the shape and character of those exchanges. Indeed, with regard to financial institutions in particular, they have placed the state at the center of their economic theories on money and credit.

Throughout the modern history of the system that most people call “capitalism,” banking institutions have had such a profoundly intimate relationship to the state that one can only refer to it as a “state-banking nexus.” As I point out in Total Freedom: Toward a Dialectical Libertarianism:

A nexus is, by definition, a dialectical unity of mutual implication. Aristotle . . . stresses that “the nexus must be reciprocal . . . [T]he necessary occurrence of this involves the necessary occurrence of something prior; and conversely . . . given the prior, it is also necessary for the posterior to come-to-be.” For Aristotle, this constitutes a symbiotic “circular movement.” As such, the benefits that are absorbed by the state-banking nexus are mutually reinforcing. Each institution becomes both a precondition and effect of the other.

The current state and the current banking sector require each other. They are so reciprocally intertwined that each is an extension of the other.

Remember this the next time somebody tells you, as New York Times columnist Bob Herbert did, that “free market madmen” caused the current financial crisis that is threatening to undermine the global economy. There is no free market. There is no “laissez-faire capitalism.” The government has been deeply involved in setting the parameters for market relations for eons; in fact, genuine “laissez-faire capitalism” has never existed. Yes, trade may have been less regulated in the nineteenth century, but not even the so-called Gilded Age featured “unfettered” markets.

One reason I have come to dislike the term “capitalism” is that, historically, it has never manifested fully its so-called “unknown ideals.” Real, actual, historically specific “capitalism” has always entailed the intervention of the state. And that intervention has always had a class character; that is, the actions of the state have always benefited and must always benefit some groups at the expense of others.

No Neutral Government Action

Mises understood this when he constructed his theory of money and credit. For Mises, there is no such thing as a “neutral” government action, just as surely as there is no such thing as “neutral” money. As he pointed out in The Theory of Money and Credit and other works, “Changes in the quantity of money and in the demand for money . . . never occur for all individuals at the same time and to the same degree and they therefore never affect their judgments of value to the same extent and at the same time.” He traced how, with the erosion of a gold standard, an inflation of the money supply would diffuse slowly throughout the economy, benefiting those, such as banks and certain capital-intensive industries, who were among the early recipients of the new money.

One reason the gold standard was abandoned is its incompatibility with a structural policy of inflation and with a system heavily dependent on government intervention. (It should be pointed out that a free-banking system need not necessarily entail a 100 percent reserve gold standard, but I leave this discussion for another day.) The profiteers of systematic inflation are not difficult to pinpoint. Taking their lead from Mises, Hayek, and Rothbard and such New Left revisionist historians as Gabriel Kolko and James Weistein, Walter Grinder and John Hagel III point out:

Historically, state intervention in the banking system has been one of the earliest forms of intervention in the market system. In the U.S., this intervention initially involved sporadic measures, both at the federal and state level, which generated inflationary distortion in the monetary supply and cyclical disruptions of economic activity. The disruptions which accompanied the business cycle were a major factor in the transformation of the dominant ideology in the U.S. from a general adherence to laissez-faire doctrines to an ideology of political capitalism which viewed the state as a necessary instrument for the rationalization and stabilization of an inherently unstable economic order. This transformation in ideology paved the way for the full-scale cartellization [sic] of the banking sector through the Federal Reserve System. The pressure for systematic state intervention in the banking sector originated both among the banks themselves and from certain industries which, because of capital intensive production processes and long lead-times, sought the stability necessary for the long-term planning of their investment strategies. The historical evidence confirms that the Federal Reserve legislation and other forms of state intervention in the banking sector during the first decades of the twentieth century received active support from influential banking and industrial interests. . . . [“Toward a Theory of State Capitalism: Ultimate Decision-Making and Class Structure,” Journal of Libertarian Studies, 1977.]

As Grinder and Hagel explain, “[C]artellization [sic] of banking activity permits banks to inflate their asset base systematically.” This has the effect of strengthening the “ultimate decision-making authority” of banking institutions over “the activities of industrial corporations,” and, by extension, “the capital market.” These banking institutions serve as a key “intermediary between the leading economic interests and the state.”

Thus one of the major consequences of inflation is a shift of wealth and income toward banks and their beneficiaries. But this financial interventionism also sets off a process that Hayek would have dubbed a “road to serfdom,” for inflation introduces a host of distortions into the delicate structure of investment and production, setting off boom and bust and, in Grinder and Hagel’s words, “a process of retrogression from a relatively free market to a system characterized by an increasingly fascistic set of economic relationships.”

Just as the institution of central banking generates a “process of retrogression” at home, engendering additional domestic interventions that try to “correct” for the very distortions, conflicts, and contradictions it creates, so too does it make possible a structure of foreign interventions. In fact, it can be said that the very institution of central banking was born, as Rothbard argues in The Mystery of Banking, “as a crooked deal between a near bankrupt government and a corrupt clique of financial promoters” in an effort to sustain British colonialism. The reality is not much different today, but it is a bit more complex in terms of the insidious means by which government funds wars, and thereby undermines a productive economy.

So where does this leave us today?

Much has already been said about the most recent financial crisis, viewed from a radical libertarian and Austrian perspective, which helps to clarify its interventionist roots. (See, for example, Steven Horwitz’s “An Open Letter to My Friends on the Left,” and Sheldon Richman’s “Bailing Out Statism“). The seeds for this particular crisis were planted some years ago. The origins of the housing bubble can be traced to the creation of Fannie Mae and Freddie Mac, government-sponsored enterprises that extended risky loans to low-income borrowers in the hopes of expanding the “ownership society.” But the larger crisis must be understood within the wider political-economic context shaped by inflationary government and Federal Reserve policies that fueled a binge of reckless borrowing. Horwitz explains:

All of these interventions into the market created the incentive and the means for banks to profit by originating loans that never would have taken place in a genuinely free market. It is worth noting that these regulations, policies, and interventions were often gladly supported by the private interests involved. Fannie and Freddie made billions while home prices rose, and their CEOs got paid lavishly. The same was true of the various banks and other mortgage market intermediaries who helped spread and price the risk that was in play, including those who developed all kinds of fancy new financial instruments all designed to deal with the heightened risk of default the intervention brought with it. This was a wonderful game they were playing and the financial markets were happy to have Fannie and Freddie as voracious buyers of their risky loans, knowing that US taxpayer dollars were always there if needed. The history of business regulation in the US is the history of firms using regulation for their own purposes, regardless of the public interest patina over the top of them. This is precisely what happened in the housing market. And it’s also why calls for more regulation and more intervention are so misguided: they have failed before and will fail again because those with the profits on the line are the ones who have the resources and access to power to ensure that the game is rigged in their favor.

This is precisely correct; indeed, there are those of a certain political bent who might seek to place blame for the current financial crisis on the recipients of subprime mortgages, particularly those in minority communities. But if elements of the current housing bubble can be traced to Clinton administration attempts to appeal to traditional Democratic voting blocs, it’s not as if the banks were dragged kicking and screaming into lending those mortgages. This is, in a nutshell, the whole problem, the whole history, of government intervention, as Horwitz argues. Even if a case can be made that the road to this particular “housing bubble” hell was paved with the “good intentions” of those who wanted to nourish the “ownership society,” their actions necessarily generated deleterious unintended consequences. When governments have the power to set off such a feeding frenzy, government power becomes the only power worth having, as Hayek observed so long ago.

We heard a lot about “change” during the last presidential campaign, and about the necessity to end the influence of Washington lobbyists on public policy. But that influence exists because Washington has the power to dispense privilege. And privileges will always be dispensed in ways that benefit “ultimate decision-makers.” That’s the way the system is rigged. It is not simply that intervention breeds corruption; it’s that corruption is inherent in the process itself.

It is therefore no surprise that the loudest advocates for the effective nationalization of the finance industry are to be found on Wall Street; at this point, failing financiers welcome any government actions that will socialize their risks. But such actions that socialize losses while keeping profits private are a hallmark of fascist and neofascist economies. They are just another manifestation of “Horwitz’s First Law of Political Economy” (“Capitalists, Capitalism, and the Siren’s Song of Stability”): “No one hates capitalism more than capitalists.”

It is the government’s monetary, fiscal, and global policies that have created insurmountable debt and record budget deficits, speculative booms and bubble bursts. What is needed is genuine structural change. But the primary battle is an intellectual and cultural one. It requires that we question the fundamental basis of the current statist system.