No Free Lunch: Economics for a Fallen World: Third Edition, Revised

Chapter Seventeen: A Short History of Macroeconomics 429 of a great mass of credit, every one dislikes to part with ready money, and many are anxious to procure it at any sacrifice. Almost everybody therefore is a seller, and there are scarcely any buyers; so that there may really be, though only while the crisis lasts, an extreme depression of general prices, from what may be indiscriminately called a glut of commodities or a dearth of money. But it is a great error to suppose, with Sismondi, that a commercial crisis is the effect of a general excess of production. It is simply the consequence of an excess of speculative purchases. It is not a gradual advent of low prices, but a sudden recoil from prices extravagantly high: its immediate cause is a contraction of credit, and the remedy is, not a diminution of supply, but the restoration of confidence. ” 5 Mill argues that the cause of depression is not too much production, but prior imprudent investment that results in a crisis and reduction of credit. J.R. McCulloch, in his Principles of Political Economy (1864), is even more explicit: At the same time it is most true that sudden and extensive changes in the value of the money of any great commercial country, or in the credit of its merchants, always exercise a powerful influence, and frequently, indeed, occasion great derangement in the channels of mercantile intercourse. An increase in the quantity of money occasions, by lowering its value, an increase in the prices of commodities, at the same time that it affords additional facilities for obtaining credit, and for indulging in speculation. But a contraction and consequent rise in the value of money, being usually accompanied by a sudden collapse of credit, has an opposite and commonly a much more decided influence, and leads sometimes to very extensive revulsions. Such changes cannot, indeed, take place without entailing the most serious losses on all who have on hand considerable stocks of produce; they are also very apt to involve those who have been carrying on their business by the aid of borrowed money in serious difficulties; and if the rise in the value of money be considerable , the influence of the shock given to industry, and the disturbance in commercial channels, may be such as materially to abridge the power of the society to make their accustomed purchases; and may thus occasion a glut of the market , not only in the country which is the seat of the revulsion, but also in those countries whence she has been accustomed to draw any considerable portion of her supplies (emphasis added). Depressions are thoroughly possible in the classical system—for who could deny their reality? The cause was to be found in incorrect proportion of goods produced, leading to a crisis of confidence and withdrawal of credit from the economy. This classical view would prevail until the Keynesian revolution.