so long as credit expansion continues

Economics Economics Questions
1

The reduction in the demand for money for cash holding occurs because so long as credit expansion continues, it is possible for business firms to borrow easily and profitably…

http://www.capitalism.net/articles/A_Blog_02_09.html

there are a lot of quotes from mises texts about busts…but if credit expansion occurs according to the above excerpt…does a bust necesarily have to or even take place?

i have read often at mises sites that inflation is harmful and described as an ill or disease…my understandign was because prices would increase (somehow in a bad way…issues with low and fixed income individuals) and sometime after prices increased a bust would occur (sub prime loans making up 10 to 12 percent of all mortgages) leaving many worse off…the bust occurred because credit expansion stopped??

is that correct?

2

Its because inflation distorts the capital structure making the country less productive and putting resources towards inviable projects. This projects are not sustainable and so they need to fail and the resources (labor included) has to be switched to a new area (and this process is what its call a recession).

So basically yes. I would recomend you learning about the capital structure, for me its one of the best austrian theories. Once I understood it, I become really surprised that monetarist and keynesians have macroeconomic theory without a capital structure theory. Its just unveliable.

3

Credit expansion does not necessarily have to cease for there to be a downturn, and it often doesn’t. A bust happens when the earlier capital malinvestments are discovered to be unprofitable and sometimes even worthless. The process of correction through liquidation or some sort of capital modifications are then put underway. From what you said, I take it that you mean that so long as credit infusions continue to be made, that the boom could go on forever? That is exactly what regulators are attempting to do by propping up dying industries and firms. The damage, you must understand, is not the bust itself, but the excesses in the boom period. Banks loaned out mediums of exchange that were not covered by any tangible asset in enormous quantities and assumed that the interest from the returns would outweigh any imbalances. The risky loans did not pay off of course, hence where we are now. It all went to waste. The money is still in the system, it didn’t go anywhere, but it was used to transfer tangible and scarce resources into various purposes that were discovered later to have little utility to either the owners, or anyone else. When people began to default on paying their interest, the banks plunged into bankruptcy.

I hope that was a decent explanation, others could probably say it better.

4

A boom will continue while credit expansion takes place at an accelerating rate, until the people lose faith in the money (hyperinflation).

5

That is exactly what regulators are attempting to do by propping up dying industries and firms.

i thought many firms were liquidated.

in another article it said there were 37 bank closures in less than a year…i assume that to be a large number?

and if credit expansions keep some firm open…so what? wouldnt some also go into new firms as well…continuing the boom or growth phase continuously?

6

What causes the malinvestment is the decrease in the cost to borrow capital. This means that capital-goods become relatively more profitable than consumer-goods, causing entrepreneurs to invest in capital-goods. As long as credit expands at an accelerating pace, that relationship will be kept, and the malinvestments will continue until money loses its perceived value altogether (hyperinflation) or until credit expansion slows or ends, thus causing the ratio of prices between consumer-goods and capital-goods to readjust.

7

" This means that capital-goods become relatively more profitable than consumer-goods, causing entrepreneurs to invest in capital-goods." this doesnt make any sense.

the so called tech bubbble wasnt a capital good. it was service and consumer goods.

if the consumer good was a refrigerator and kept food 3 times as long as before …well less trips to market, less wasted food freeing up agriculure land becasue less food markets are needed for other uses.

and so what though? some might become relativly more profitable. that can happen without mal-investment.

and i didnt say 2 percent this year 3 percent next year 4 percent year after that…i just said credit expansion. 2 percent per year.

the link i posted says “so long as credit expansion continues…”

8

I’m not so sure that this is correct. Sure, there were consequences on the supply of the final consumer good, but all that development requires the investment of capital-goods. I don’t know much on the topic, but there is a paper in the Quarterly Journal of Austrian Economics on the topic: http://mises.org/journals/qjae/pdf/qjae6_2_3.pdf

Well, I’m not sure the connection is correct (better refrigerators mean less land necessary for agriculture), but I have a feeling that wasn’t your point. I’m not sure what your point is, or how this is relevant.

I know what you said and what you didn’t say. I’m saying that for a boom to continue, according to Austrian theory credit expansion has to occur at an accelerating rate (see: Huerta de Soto, Jesús, Money, Bank Credit and Economic Cycles). Reisman’s article doesn’t go into much depth. He suggests reading his book Capitalism, and Mises’ book Theory of Money and Credit. If you read these, you will find that they agree with me (or, more accurately, I agree with them).

9

“What causes the malinvestment is the decrease in the cost to borrow capital. This means that capital-goods become relativelymore profitable than consumer-goods, causing entrepreneurs to invest in capital-goods.”

i dont see a much of a point here. a decrease in the cost to borrow capital -means- capital-goods become realtivly more profitable than consumer goods??? huh???

i just simply brought up an example of a refrigerator as a consumer good that could (by keeping other consumer goods usable for longer) expand consumer goods profitability and perhaps reduce costs of some capital expenditures as far as large places keeping trying to keep food fresh for short periods of time, less trips to market because food can be stored at home…less capital goods in some areas more perhaps in others.

which is why i dont understand when you say capital goods will somehow automatically become more profitable than consumer goods.

additionally, it seems that while there might be (from what i have read elsewhere) some malinvestments that cause harm…they seem to be confined to small sectors of the economy. and many prices for goods are reported to decline once adjusted for inflation.

you can reply here but you just dont make much sense to me, so no more replies please on this issue.

10

This question is too complicated to answer with any degree of clarity or detail. I attempted, and wrote a 3 page response which was wholly inadequate. But essentially, if the rate of interest rises or slows down then the bust is underway–it’s inevitable.

11

wrote a 3 page response which was wholly inadequate.

that had to be a letdown

12

Check this out.

His answer is NO, which I agree with. There is nothing deterministic about human behavior. Responding one way to an event does not mean a person will respond identically in a future situation. However, people do make errors. The Austrian Theory of the Business Cycle describes a particular error made by businessmen in an artificially low interest rate environment. Simply put - they believe there is more capital available than there actually is and thus engage in long-term investments, which are only profitable at such low interest rates. Later on, costs and interest rates rise, and it becomes clear that the investment cannot be profitably completed. If they were to all recognize this folly and no longer engage in such investments, there would be no business cycle.

Hulsmann identifies error and incorporates it into business cycles. Error requires action, illusion, and revelation. First the erroneous action is taken due to a belief that is false - “Long-term investments are profitable in this environment”. The illusion is the period between the action and the revelation. Generally, the longer the illusion, the more costly the error likely is. Finally, the revelation is the discovery that the initial belief was false.

This, however, does not account for cyclic patterns of error. Such occurs when the victims of error misinterpret why their initial action did not produce the results they intended. In the case of Austrian Business Cycle Theory, Hulsmann identifies fractional reserve banking as the root cause of business cycles. The government, American people, and most investors, however, are not aware of or do not accept this premise. They blame other causes like lack of regulation, lack of government deposit insurance, lack of central banking, the redeemability of bank notes or account credit, commodity money, etc. Thus, investors act under the presumption that artificially low interest environments are suitable for long term investments, so long as ___ intervention is in place.

…

I think your question is if an artificial boom can continue indefinitely due to continued credit expansion. The answer is no. There are numerous ways for the boom to end. Lower interest rates increases long-term investments while diminishing incentives to save, pumping up consumer prices. This pushes demand for resources into two opposite directions. The more long-term investments are undertaken, the more consumer goods cost, and the more laborers demand to be paid. For the long-term investments to retain their workforce, they must borrow greater and greater amounts of money. Thus, the only means to maintain the boom is to expand credit at an ever-increasing rate. A steady rate of expansion will result in the same problem as cutting off credit.

Ramping up money creating can cause the currency to be abandoned, which will surely cause a bust. On the other hand, constantly pushing resources towards higher-order capital can cause capital consumption in intermediate or later stages, which causes a breakdown of the capital structure. The higher-order capital will be unprofitable without intermediate-order capital. Consider mining copper with no refiners to sell your ore to. Likewise, lower-order industries will also struggle, as their costs will surge. Consider a manufacturer who was to pay 100x normal price for refined copper.

I believe there are other ways that the boom can end without credit expansion being curtailed. See De Soto’s Money, Credit, and Economic Cycles.

See chapter 5.3 (page 363 begins the 6 microeconomic reasons the boom will reverse into a bust).

Also see chapter 6.2 which attempts to postpone the bust indefinitely.

13

" The Austrian Theory of the Business Cycle describes a particular error made by businessmen in an artificially low interest rate environment. Simply put - they believe there is more capital available than there actually is and thus engage in long-term investments"…

as knowledge has increased along with the speed of information and the expidited movement of financial capital…are businessmen at this point still bewildered and fooled by federal reserve and frb activity or do they fuck up inspite of the federal reserve and frb?

… If they were to all recognize this folly and no longer engage in such investments, there would be no business cycle.

The illusion is the period between the action and the revelation. Generally, the longer the illusion, the more costly the error likely is. Finally, the revelation is the discovery that the initial belief was false.

ok…with govt money data and bank financial statements abound, the business men who really move large amounts of money are seeing illusions where? that sounds weak and wrong to me.

. In the case of Austrian Business Cycle Theory, Hulsmann identifies fractional reserve banking as the root cause of business cycles.

http://www.economagic.com/em-cgi/daychart.exe/form says m2 (which i guess is a money measure closely affected by frb as you) over the last ten years went from 4.7 trillion to the present ~8.5 trillion. increasing at about 500 billion per year (sometimes a little less sometimes a little more) in what looks to be a rather steady predictable increase. i dont see wild swings in this increase of currency/credit measure. this information then seems widely available. so i am not sure what particular part of frb that is so mysterious by people truly move large amounts of money.

The government, American people, and most investors, however, are not aware of or do not accept this premise.

why?

I think your question is if an artificial boom can continue indefinitely due to continued credit expansion. The answer is no.

if it continues indefinitly it wouldnt be artificial would it. can ongoing, steady credit expansion (if true) produce economic growth and lowering prices adjusted for inflation?

The more long-term investments are undertaken, the more consumer goods cost, and the more laborers demand to be paid.

i dont know that only or more long term investments would be undertaken. and if they did, depending on the product how do you know that consumer goods would cost more?

i used the example of a refrigerator earlier - a consumer good. it could prolong the life of existing consumer goods…making fewer trips to get spoiling goods. less trips for deliveris to market bacause food can be stored. probably other things as well. so a particlular consumer good with specific properties can bring down the price of other consumer goods…long term refrigerator making, iow from credit expansion.

For the long-term investments to retain their workforce, they must borrow greater and greater amounts of money. Thus, the only means to maintain the boom is to expand credit at an ever-increasing rate. A steady rate of expansion will result in the same problem as cutting off credit.

unless the goods being produced do things in ways that i mentioned above…greater conveinience, time freeing processees and items?

Ramping up money creating can cause the currency to be abandoned,…unlikely in the us but if gold and silver would work better i woulnd mind seeing it abandoned

i just dont see what you say occurs with fractional reserve banking and the central bank.

when i first started reading this crap on mises there was alot of claims that inflation, form the current and previous modes of central banking and the commercial banks caused harm. it was called an ill and disease.

but then i see articles like “when prices are adjusted for inflation, Americans today spend “40% less on clothes, 20% less on food, more than 50% less on appliances, about 25% less on owning and maintaining a car” than they did during the early 1970s. Over that same period, Census Bureau tables show, US median household income rose by at least 18% in constant dollars …”

http://mises.org/daily/3730

now to the extent that the current system has created various credit-streams that led to various bubbles within the economy , ie. the sub-prime mortgage crisis (which i have read are only 10 to 12 percent of only the mortgage loan market) and that a 100 percent gold/silver system (His websites are located at: www.posfi.com andwww.lottostocks.com…perhaps these ideas would have been installed when the interent first started) would not even allow bank-initiated problems, then sure i am against the current system.

but i dont see the problems you say, it seems to me that some of these bubbles that i have reaad about at this site get spotted pretty quickly. maybe you have links to legitimate info showing otherwise.

14

Actually, it was the capital side that was a bubble. For example, pets.com never really penetrated the consumer pets market, it simply inflated enormously on the stock market, its capital side.

The biggest business failures during the tech crash were heavy capital firms, such as WorldCom and NorTel.

15

the natural interest rate has not been known for a long time. we know it’s higher than the actual interest rate but how much lower? how quickly will inflation set in? to those who understand ABCT, they still have to deal with the distortion and instabilities introduced into the market. the essential question of business cycles is why do so many people make poor investment decisions simultaneously and in recurring cycles.

now who got stuck with the bills for our recent debacle? a few banks, speculators, fannie and freddie, aig, securities buyers (pension funds), but more than anyone it was the taxpayer. so more than anything else, the american taxpayer is not aware of the problems of fractional reserve banking and all the government interventions designed to protect it.

nevertheless, when people see other people getting rich in a boom, they try to get in while the getting’s good. the largest problem is that all the guiding signals are skewed and mistakes are made.

that they can make long-term investments profitably in an environment of credit expansion where money is created. business men might actually favor a low interest environment, even if it is artificial. and some might make nice profits. it’s a subsidy and a curse.

the real interest rate is all over the place, and that’s calculated using a flawed “consumer price index”. Also, the artificial rate masks changes in the underlying supply of real savings, which may deviate strongly. Even if the rate remains constant but savings disappear, a bust can occur.

We’re obviously not voting against the current system…

Well the growth would have to outpace the rate of expansion. On average it’s 8% money growth…GDP including gov’t spending is much lower. in any case, it doesn’t matter if consumer prices rise or fall, only their rise or fall in relation to the rise or fall of other prices. The point is that you need ever-expanding credit - that you literally need hyperinflation. Obviously there’s a breaking point.

YOU SHOULD READ THE LINK I PROVIDED…ALL OF THIS IS CLEARLY EXPLAINED.

So that’s because of easy credit…or in spite of it? Is government responsible for technology, or is it something else? I’m sure the millions of unemployed Americans will be happy to know that some forms of goods are cheaper.

Anyway, for the same period, look at the levels of debt that America took on. Also, are we simply importing many of those goods? Our savings have also gone to crap. So is our present prosperity sustainable, or is it a foolish binge? This current crisis is another sign that it isn’t, just like the 70’s.

16

the real interest rate is all over the place, and that’s calculated using a flawed “consumer price index”. Also, the artificial rate masks changes in the underlying supply of real savings, which may deviate strongly. Even if the rate remains constant but savings disappear, a bust can occur.

if the real intererst rate is all over the place but inflation is rather constant…that seems like predictable money growth. low rate get money , high rate back off.

although on the surface it would seem that a non central bank and and a system of 100% reserves here would in a way make a rate more reflective of economic conditions.

as for unemeployment i dont know how much of that is actually fed/frb created or other govt intervention/foreign competition / cultural issues that would confirm what you say.

""The collapse of world socialism has made vast pools of cheap and willing labor in Asia and Mexico available to US capital and technology…But the truth is, for many years, rather than exporting capital to the rest of the world, the United States has, on net balance, been importing substantial sums of capital from the rest of the world. " all this foreign capital , coming to the us to expensive labor when the us ships capital to cheap labor??? that doesnt make much sense.

i dont know if american technology is particularly better than that in asia or europe…proboboly not.

http://mises.org/daily/2361

17

Not feasible for long-term investments. If rates rise, you COULD simply put the investment on hold indefinitely…lay off all your employees, etc. but you’d still have to service the debt you already took on. Your investment is not able to create profitable goods yet. Its only value is in liquidation, which will likely fetch a lower price in a high interest environment, if the capital can be liquidated at all.

I agree, but the cyclic nature of boom/bust also contributes.

I didn’t read the whole article, but it seems true. And simply because American companies and government are taking on lots of debt doesn’t mean it’s necessarily being used to fund long-term investments that depend on sustained low interest rates.