I found Hawtrey’s explanation of the business cycle quite interesting, mainly because I’ve been using a similar explanation recently for relative noobs to the business cycle. I usually explain the business cycle by showing how credit expansion causes real interest rates to fall, but how the ensuing inflation will force banks to hike both their nominal and real rates to hedge for inflation. Higher rates will cause a fall in demand for goods traditionally bought with borrowed credit - mainly “higher order” goods like houses, cars, machinery, land, factories, and other durable consumer goods and capital.
Hawtrey has a similar argument:
R.G. Hawtrey has perhaps the most famous “pure money” theory which he outlined in a barrage of articles and books (1913, 1926, 1928, 1933, 1937). His theory, as noted, is Wicksellian in many respects. But his chief characters are wholesalers and middlemen who rely unduly on bank credit and are thus highly sensitive to interest rates. Any slight injection of money which lowers the money rate of interest induces these middlemen to increase inventories. They do so by borrowing from banks increases and demanding increases in production from firms. But because increasing production takes time, the money supply of the economy is momentarily too large for the given amount of income (think of a Cambridge cash-balance theory). This “unspent margin” leads to higher demand for goods by consumers - but that extra demand will itself lower the inventories of these middlemen. Realizing their falling inventories, they will then call again upon firms to step up production and borrow money to do so. But again that leads to an excess supply of money, etc.
The turning points in the Hawtrey cycle arise when production (and thus income) finally catches up with the higher money supplies. They will catch up, Hawtrey tells us, because banks will begin to close off credit when they see their reserves being stretched too far. Then we jump into the recession: when banks stop lending to middlemen, these will reduce their demands on firms. Production will slow down and so will incomes - but with a lag again. The fall in money supply comes first and so consumers now have excess demand for money and will thus lower their demand for goods. That leads to inventory build up and a further demand by middlemen that production reduce further. The downturn continues until the banks are flushed with money once again and need to lend out.
Hawtrey’s analysis is flawed IMO because it doesn’t take into account the actions of a central bank. If the CB keeps low rates despite inflation, or even lowers their rates, I believe that inflation will force the banks to raise their rates anyways (not to mention loanable funds in the forms of stocks and CDs will decrease due to inflation). So Hawtrey’s business cycle theory is more dependent on “supply shocks” of credit, while a more Austrian approach explains the rising real rates based on inflation (or at least that’s partially how Jesus Huerta de Soto explained it).
His explanation focuses on money, rather than physical goods. Nor do I think there is any need to talk specifically about middle men or wholesalers in order to understand trade cycles. If you step back and focus on the physical goods that are floating around you get a much less abstract and easier to understand explanation of the phenomenon.
Fundamentally it comes down to this - if you capped the price of bread at 30c tomorrow (price ceiling) then you can be pretty sure we’d run out of bread in the very near future. That’s what price caps do - they inhibit the market’s ability to send (precious) signals from suppliers to consumers and vice versa so that supply meets demand and so the scarce quantities of economic goods are allocated to the most pressing needs first.
Now look at the money supply. What are interest rates? They’re a price, right? Interest rates are the price of money - or more precisely, the price of borrowing money. They are the price at which savers will lend money to investors. However, when a farmer borrows $100,000 to buy a tractor, he isn’t really borrowing $100,000 - he’s borrowing a tractor. The money that savers lend and that investors borrow represents real goods and the interest rates that are charged for that money represent the availability of real (and most certainly scarce) economic goods in the market place.
We know what happens when we cap the price of bread so it shouldn’t really be that difficult to figure out what happens when you cap the price of money (or the price of savings, to be more accurate - and to be clear, we’re talking about the price of real savings - money is just the tool that we use to represent that price). If we cap the price of savings then we’ll run out of savings, right - just like we ran out of bread? Exactly… so at first, the market gets confused signals - it gets sent a low interest rate (an artificially low/capped interest rate - set by the central bank). It misreads this as an indication that the actual supply of savings (real savings) is higher than it is and as a consequence those scarce savings are not assigned to only the most pressing needs/investments. Investors that had business plance that could justify borrowing cash at 8% (because they would yeild profits justifying such high interest rates) will be joined by investors who’s business plans could only be justified if interest rates were extremely low (say in the 3% range) - however both groups of investors has been fooled - the quantity of real savings available is not accurately reflected by the artifically low interest rates and there are not enough real savings present to see the successful completion of all of these business plans. Some of them must, inevitably, fail - and not necessarily the least important ones.
Typically the business plans that will fail will be the longest ones - not the least important ones. The shorter plans will succeed before the real savings of physical goods (like tractors) are exhausted and both prices and interest rates start to rise. The longer term business plans, however, were set in course before the actual level of real savings that was available was revealed (the point at which price inflation occurs and the central bank is forced to recognize this either by increasing interest rates or undermining it’s currency entirely, through hyperinflation)… and it is typically these longer term plans that will be punished most severely.
Hawtrey’s article is kind of interesting, but I think he’s focusing on symptoms and details - not root causes.