Austrian Business Cycle Theory

[Matthew Ed Moran]

Hey there!

 

I was just inspired to summarize the Austrian Business Cycle Theory as succinctly as possible for those in the community who may not be familiar, and who just want the essence: that which is really important about how the theory functions in empirical reality (but I repeat myself).

 

Central Banks are a modern phenomena which reign control over the particular amount of money in the economy. At any given point in time, there is an amount of money which correlates to the distribution of goods in society, and this is reflected by prices. In a free market, the amount of money fluctuates as more or less of it enters the market over time according to the demand for money.

 

Central Banks turn the typical intuition of how the money supply would fluctuate over time on its head. With a central bank, money can be printed on demand of political swindlers, and the money supply can be increased exponentially if so chosen by these pernicious scum.

 

When money is printed by a politician, it is then handed out to a private actor. This is where the essence begins. The private actor who first is able to spend the newly created money accrues a special benefit. Since his money was not earned from production for consumers, but was gained by political fiat, it is essentially hidden from the economy. When it enters, it has the effect of being as fresh and powerful as any other money which was the result of valuable, market demanded production. It disguises itself to be just the same, but it is not, since no productive act was behind its creation.

 

When it is first spent, it will accrue productive resources from others who are in vain of its disguise. If there is a lot of newly printed money to be spent, it will quickly chase and gather new resources until it is accounted for by everyone else. Only after much time will it be completely factored into the market prices, to reflect the increase in the money supply which had not been demanded, and which could not have been anticipated by other market actors.

 

Political bandits have become masters of counterfeit, and so they know how to maximize their gains. They bring new money to bear into the market gradually over time, and by doing so they create economic bubbles. This is the last bit of the essence, so stay along with me for this.

 

Since other economic actors who are not politically connected lose out by inflation as more and more money is printed over time, they are given incentive, if not coerced to use their money to chase whichever industry is getting the benefit of new, gradual monopolization of resources by the use of disguised money. Looking to limit their losses and gamble on gains, investors who are not politically connected invest, and they invest, and they invest into the disguised money monopoly industry.

 

At some point there must be a relative slowing of the increase in money supply. It cannot go on forever, lest catastrophic inflation shows its face. This is when the disguised money disrobes itself to show its bloated body. What was thought to be economic production is now seen as a political shindig, and what prices were thought to be a reflection of real consumer demands are now seen as completely fraudulent. A picture is painted across the skyline, signaling to everyone the massive and horrifying scale of what was lost. Capital thought to be suckling at the teat of future wealth is now seen shattered and dispersed across the landscape in irrecoverable ways. Savings for years and years has dispersed into thin air it seems, and living standards which were anticipate to be much glorious are now faint and gloomy.

 

The bust is the wake of what is lost. It is the market opening its eyes to what had been disguised to it, and its attempt to pick up the pieces and begin all over again, with full knowledge that some of what was lost will never be restored.

 

As you can see, counterfeit is not just a criminal affair. It is the literal enslaving of millions of people, clueless to the fact that their lives have been wasted profiteering for politicians. Millions of people carrying on their backs a few men, to see their lives wasted and their accumulations ruined when the promises they have been told are revealed years later.

 

That was fun, but I hope it was also clear. Let me know if there is anything I can add to complete the picture of what a boom/bust cycle really is. Or if I got it all wrong, please let me know that too!

[rosencrantz]

In a free market, the amount of money fluctuates as more or less of it enters the market over time according to the demand for money.

 

While this is true, banks create money in a free society too. When silver and gold coins were accepted as money, goldsmiths were used as vaults. You brought your money to them and you got a note as a receipt. Over time, people used these notes to pay bills and so on. All was fine and dandy until the goldsmiths realized that it seldom occured that all people that had deposits cashed in their receipts at the same time. When this is the case, you can issue credits and offer other financial services that exceed the money you have stored in your vault. Add to that you can apply the fractional reserve system to these receipts and you have the phenomenon that goldsmiths (or private banks in that case) seem to be able to create money out of thin air. 

[Matthew Ed Moran]

While this is true, banks create money in a free society too. When silver and gold coins were accepted as money, goldsmiths were used as vaults. You brought your money to them and you got a note as a receipt. Over time, people used these notes to pay bills and so on. All was fine and dandy until the goldsmiths realized that it seldom occured that all people that had deposits cashed in their receipts at the same time. When this is the case, you can issue credits and offer other financial services that exceed the money you have stored in your vault. Add to that you can apply the fractional reserve system to these receipts and you have the phenomenon that goldsmiths (or private banks in that case) seem to be able to create money out of thin air. 

 

At least in America, banks had to rely on significant government intervention to keep these types of schemes afloat. Banks were given different legal advantages, so that they didn't have to incur the full risk of their actions. One such advantage was that when bank runs did happen, they did not have to issue out the holdings which belonged to their customers, but they could remain solvent. This is plain theft facilitated by the government. There were other advantages that I can't remember off the top of my head, but usually they had the effect of subsidizing institutions which acted criminally with their customers holdings. In a free market, these institutions would be out-competed over time as customers switched to more reputable companies.

 

Even so, bubbles were not as large with fractional reserve banking without a central bank. The steady printing of money could not be sustained without a bank run happening, and it was only when central banks were invented with the ability to print money at will and control interest rates that bubbles could grow to be as large as they are today. Also, if legal tender laws exist, then money which is being inflated must be accepted to have the same monetary value as money which is not being inflated. Naturally, people would hold onto the valuable money, and use the less valuable money to trade, since it was given legal advantage. This is called Gresham's Law, as you probably know.

 

Thanks for reading and for the comment, Rosen! I am thinking now that interest rates might be an important part that I left out, so I wonder how I would fit that in...

[Spenc]

You're missing what many of the Austrians would definitely draw attention to, that the time structure of production would be affected as well.

 

Keynesian methodology will generally present aggregate demand as just a bundle of interchangeable economic demand, whereas Austrians will point to fundamental difference in the nature of goods and services, particularly as they follow different time schedules in the market.

 

e.g. If you read Jim Rogers' "Hot Commodities" he will frequently bring up the fact that commodity production, or the expansion thereof can often take a decade to bring online.  To scout out ore, establish facilities, clear through the red tape, etc. to get gold or oil from the ground requires long-term planning.  Compare that to Silly Bands or Teeny Babies or something that is intended to be manufactured in great numbers in a standard facility that can be replicated and modified easily and be trendy for a year or two before disappearing from the market.

 

It's not imperative to understand how inflation will impose recessionary pressures down the line, but it helps to understand how resources become misallocated, which is what explains the functional process of the recession.

[Cornetto97]

I am thinking now that interest rates might be an important part that I left out, so I wonder how I would fit that in...

Well when interest rate are artificially lowered money becomes cheaper for both the governmnet to constantly borrow from the central bank, and for banks to constantly lend to the people.

 

When interest rates are kept artificially low, it also means the deposit rate is lowered, meaning the banks now have less incentives to keep extra reserves overnight at the central bank. Since it is more profitable to lend this money out they now have more money available to lend out, and since supply is artificially cranked up, interest rates on your average home loan are lowered. The banks are now much more ready to lend out to the people, the government is now selling bonds at lower interest rates to the fed, and thus spawning more money into existance, credit cards now have even lower repayments, and more money on them. And when the banks don't have enough to keep their reserve amount at the fed, they can do intra bank lending at even lower interest rates.

 

The amount of damage that beaurocrats do when pulling the strings of interest rates is one of the biggest contributors to these 2 - 10 year booms and busts that the average tax payer bears the brunt of. It is truly just amoral, and evil with no contempt for the people who have their savings shattered. The worst is the overwhelming majority can't see what casues it. 1/1000 Mike Maloney quoted it as, 1 out of every thousand peoole don't even realise this slight of hand system called fiat money, taking away their prosperity.

[Matthew Ed Moran]

Thank you I very much appreciate your comments and the time you took to read my post.