The Austrian school of economics asserts that “cheap money is the root of all evil” as an explanation for all boom and bust cycles. This also works for startups, where cheap money occurs when too many investors jump on a bandwagon. Experts argue that a higher percentage of startups fail with too much money, rather than too little.
Anyone care to take a stab at it? Correct or incorrect usage/understanding?
Yep. The theory that is ABCT does not explain only the artificial increase of risk tolerance by entrepreneurs. This is just a tiny fraction of the whole theory.
Cheap money is the root of all evil in business cycles because when there is only a little money it gets invested in the good stuff; when there is more money it gets invested in the iffy stuff; when there is still more money all that is left is to invest in is the inferior stuff. And the inferior stuff loses money.
How does this apply to startups? If the startup is a good solid can’t miss business, why would having a lot of investors put up money decrease its chance for success? The experts may argue that it is so, but they only show a correlation, not a cause effect.
The bottom line I get out of this article is that Austrian economics is becoming a fashionable buzz word in the MSM. Good.
Obviously money in any form or quantity isn’t the root of anything, it is simply the medium of exchange and unit of account. And infact the people who created the science will universally tell you that Economics to be a science must be value free.
The Austrian Business Cycle Theory holds that extra money and credit unbacked by extra savings looks like excess savings to entrepreneurs. These entrepreneurs then solicit this new money and attempt to start ventures to capture new or existing demand and make profits. So everybody is happy in this boom period caused by the new money and credit, consumers get new, more or better stuff, entrepreneurs make profits, and people seeking work find it. The problem is that over time this new money and credit gets out into the economy and turns into rising prices. Consumers see these rising prices and cut back purchases because they do not have the savings to cover them. So the whole boom unravels as these same entrepreneurs shed jobs and cut back new activities trying to cut production. Inventories grow and the unravelling speeds up.
I do not think the folks can uphold the statement about a higher percentage of startups fail with too much money rather than too little. I can say that cash to a start up is one of if not the most important factor in sustaining a new business so I would presume that it is incorrect. They are probably just incorrectly interpreting what happens in the bust period of the business cycle given that the the entrepreneurs looked like they had enough initial cash to get their operations going.
It omits the key feature: money supply expansion. If the money supply stayed constant and all that changed were interest rates, then banks recently would have ran out of money to lend, preventing the unsustainable housing boom from happening.