The Austrian Business Cycle Theory states that entrepreneurs are not able to distinguish between money that comes from genuine savings and money created through credit expansion by the Fed. But surely the Fed keeps track of how much money they loan into existence.. If entrepreneurs know this, shouldn’t they be able to adjust the interest rate appropriately and not be fooled into malinvestments?
I know there are holes in this argument, but I’m having trouble putting together a cohesive counter-argument in my head..
I’ve had this q also, and it’s been asked many times.
My personal answer has been, look at the recent bubbles, housing and dot.com. There was a business cycle, and malinvestments, but a bit different from how Mises mapped it out, I believe. Hard to say that a dot.com stock or a house is a high order capital investment.
I was forced to conclude that what really counts is easy money, meaning money created by credit expansion by the Fed. It’s very existence will creat a boom, as people look for a place to spend it.
Maybe Mises was writing in the days before there was an FDIC, so that banks had to be careful where they invested their money, lest they go bankrupt. But nowadays they can gamble recklessly, and do.
As for the original purely theoretical q, won’t the enterepeneurs wise up sooner or later, I think Mises himself addressed this question, and i think his answer was “When they do, if ever, things may be different.”
Don’t look at it as “money which comes from real savings” and “money which is created by credit expansion;” the key is that profitable investment requires real savings (actual resources). Expanding the money supply, and therefore lowering the rate(s) of interest makes it seem like society has more resources then it actually does, which causes the malinvestments. Also, the FED does not control the money supply; it merely controls one component of the money supply (the monetary base). It doesn’t loan money to the public; commercial banks do, which increases the supply of money (constrained by the demand for money). So entrepreneurs cannot know what the “real” equilibrium interest rate is because they don’t know the real supply of savings (also, they don’t know the demand for investment). Essentially, you need markets for accurate pricing (unavoidable conclusion).
Interest rates effect long term durable goods (like housing) and producer goods (higher order goods).
"Theory states that entrepreneurs are not able to distinguish between money that comes from genuine savings and money created through credit expansion by the Fed.
does the fed actually do credit expansion??? or do they distribute dollars on the treasury/mints behalf??
would it make any difference if it was paper dollars or credit expansion as you say??
“Don’t look at it as “money which comes from real savings” and “money which is created by credit expansion;” the key is that profitable investment requires real savings (actual resources). Expanding the money supply, and therefore lowering the rate(s) of interest makes it seem like society has more resources then it actually does,…”
if say a deposit of iron ore is found and it would take about 6 months to gather up a bunch of stiing saved dollars to mine the iron would that be different that creating dollars from thin air and mining the iron in six weeks??? is that what so=called credit expansion does???
also if the area where the iron ore was was owned how could society have more resources than it actually does??
“The Austrian Business Cycle Theory states that entrepreneurs are not able to distinguish between money that comes from genuine savings and money created through credit expansion by the Fed…”
would it really matter where the dollars come from??? does money even come from the fed???
“So entrepreneurs cannot know what the “real” equilibrium interest rate is because they don’t know the real supply of savings …”
how does a mortgage lender get his hands on fed credit expansion??? by talking to someone???
does the commercial bank get credit from the fed via a fed purchase of assets??? does the banker then tell this to someone else??? is this information posted somewhere??
I agree that the credit expansion will inevitably lead to the new money being snatched up and utilized, but shouldn’t entrepreneurs be able to realize that investing this money in long-term projects would be a mistake? Is it simply a matter of not enough people being familiar with the ABCT?
But if people know that the new money is being generated through essentially counterfeiting, shouldn’t they have the foresight to avoid investing this new money in long term projects? Even if they’re not familiar with the formal ABCT, shouldn’t experience teach them this anyways?
This is a good point, but for the sake of argument let’s assume there is no fractional reserve banking. If the money supply was entirely controlled by the Fed, would entrepreneurs be able to avoid the boom-bust cycle if they knew exactly how much money the Fed was pouring into circulation?
Some of the money comes from the Fed creating it, some comes through commercial banks lending out money while still having it be redeemable on demand, known as fractional reserve banking. And yes it does matter where the dollars come from.. if they come from people saving money, it means people are foregoing present luxuries to invest in production that makes them better off in the future. If the dollars come from the Fed, not only are the real savings not there because people are still consuming at the same rate, but it will also lead to inflation.
My own personal non-official answer to this is that easy money, even low interest loans kind of easy money, makes people really reckless and stupid. Add to that banks, who play with house money and are insured by govt in case they fail, and we don’t need those wily ole entrepeneurs to create the boom. But I’ve seen other answers, like “In the short term there IS a lot of money to be made, and its a gamble, maybe the Fed will keep rates low till I finish building my factory.” Also “Hey all my competitors are taking the money, so I’ll lose if I don’t take it.” if i was really energetic I’d dig up the links and emails about this frequently asked question.
I think you’re right to an extent.. I see this as helping to explain why the banks would be more willing to lend money, but not necessarily why entrepreneurs would be more likely to sink the money into big projects if they know they it will come back to bite them later on.
I agree this plays into it.. but if the entrepreneur gets his factory built before interest rates are raised, would he then sell it off immediately to make a quick profit? If he decides to run the factory, hire workers, etc, he knows the bust will come eventually either when interest rates are raised or when his factory begins to lose money because it has no buyers because consumers are still spending on lower-order goods. So he would probably try to sell it immediately. But if other investors are privy to the same knowledge, that the bust is coming soon, they would be fools to buy it. So it seems like the entrepreneur is banking on suckers who don’t see the bust coming to make his profit. Do you think if more investors were familiar with the ABCT, we would be able to lessen the severity of the recessions?
To this I respond with one of my previous points.. Sure the new money will be taken, but why does this dictate that it will be invested in long-term projects? Can’t entrepreneurs borrow the money and invest it in short-term projects if they know the long-term projects will prove toxic when the bust kicks in?
I tried searching for this, but honestly this forum engine is confusing.. I wish they would switch over to vbulletin or something
Entrepreneurs know perfectly well about the free punch-bowl and that money is much easier than it otherwise would be. The Fed has rung the bell and the zero-sum race of inflationary wealth reallocation has started. In this race, you have to keep running (borrowing, investing, taking risk, speculating, etc.) just to keep up with the rest. Hopefully, if you time your entry (when the punch bowl is brought in) and exit (right after the bust takes it away) well, then you come out ahead. The pre-boom wealth map has been re-shuffled into a post-bust wealth map, and sitting on the sidelines is more likely to make you a loser in the new map. IMO, this frantic zero-sum race is a neglected but inevitable “curse” of credit expansion beyond the availability of real capital.
Z.
When people go to gambling they know there is a substantial probability of them losing. The hope is that any acquired skills in whatever they’re playing will help them win, even if they know that the dealer is always working against them. Furthermore, most people are probably aware of the fact that if you win for long enough, you will lose big, yet they continue to play because they want to believe otherwise.
Entrepreneurship, as something innate, is a force existent whatever barriers government puts up. Humans are consistently looking for ways to maximize utility, invest capital and create wealth. I don’t see artificially low-interest rates as a signal to stop entrepreneurship. Surely, people aware of the Austrian business cycle theory may be a little more cautious, but entrepreneurs are not going to stop investing for some undetermined amount of time because interest rates are low. They may think that their will always be demand for their product, or that they will create wealth before the end of credit expansion.
Easy money does not make people “stupid”. In some cases it may eliminate moral hazard; this is especially true for the banking system. With a lot of available credit, banks will be more likely to approve loans to those who would have otherwise never gotten them. This is true for this past crisis; but, I’m not sure this was out of “stupidity” or “irrationality”.
Ultimately, I think the reason why entrepreneurs invest even when there is easy credit is out of the spirit of entrepreneurship innate within the human mind.
“The pre-boom wealth map has been re-shuffled into a post-bust wealth map, and sitting on the sidelines is more likely to make you a loser in the new map. IMO, this frantic zero-sum race is a neglected but inevitable “curse” of credit expansion beyond the availability of real capital.”
does the credit-expansion that you claim exists come in large part from the federal reserve regularly buying some type of financial assets from banks???
if so, (i dont know if its true or not, its what i was told), do the financial assets that the fed purchases (with instant dollars???) get paid off by over time by various loan payers…where those dollars would then disappear???
with the paying down and destruction of dollars (again, if true???) of fed held financial assets does the credit-dollars extended to the banks to purchase such financial assets then somehow outpace
the paid off assets and lead to the bubbles that have been said to happen at the mises sites???