Could you please explain why you do not agree with the Austrian conception of the business cycle?
I disagree with the very foundation of Austrian economics, which is subjectivism. While Austrian economists do make some cogent points which I wholeheartedly agree with, their theory of the business cycle is not one of them.
As far as I understand it, the theory seems to say that any “credit expansion” is going to cause a “boom” and then a “bust,” regardless of whether it is enacted by private banks in a free economy or by a central bank. I understand that the term “credit expansion” refers to any expansion of the money supply resulting primarily out of the action of banks, as opposed to the action of gold mines. In a free, gold-based fractional banking system, that would mean the banks reducing their reserve rates, loaning out a greater proportion of their depositors’ money. Under central banking, the mechanism is different, but the theory sees no essential difference: both are considered an “artificial” expansion of credit that creates a “false sense of prosperity,” making producers somehow think that they can afford longer-term investments than they otherwise could. This leads to the “boom” phase. But then, the true time preferences somehow “reassert” themselves and the producers, who have apparently expected the low interest rates to last indefinitely and made them a part of their business plan, find that they cannot afford the additional loans they need to complement their original investments.
Am I more or less correct in my interpretation?
If I am, then there are several points that I am either in outright disagreement with or not convinced about. First of all, you cannot simply equate the actions of free banks and a central government bank and say that they both lead to the same undesirable economic consequence. Not if you are a supposed defender of capitalism who is arguing that the undesirable in economics is always the un-capitalist.
Second, I do not see how loaning out funds that, in the bank’s judgment, are available for loaning out, can create a false sense of prosperity–unless the bank’s judgment is incorrect, but banks that systematically make incorrect judgments do not stay in business for long in a free economy. If the bank has been thinking it necessary to keep a 50% reserve in gold, but the calculations of its experts indicate that a 45% reserve would now be enough to satisfy the demands of its clients (due to a change in market conditions, e.g. the more widespread use of credit cards), that means that 5% of the gold lying in its vaults is performing no useful function there. Far from being essentially similar to Greenspan, the bank’s experts have performed a role comparable to that of the gold miners: they have found unused gold. The proper thing to do with unused wealth is to invest it where it is needed.
If the market conditions revert and a higher reserve rate is needed, then the bank should be prepared for that and adopt tighter lending policies until its reserves reach 50% again. Or, if the demand for gold as a means of payment continues to be outstripped by other payment forms (which I maintain is going to be the long-term trend), then the bank should consider lowering its reserve rate further.
It is also unclear to me what exactly is meant by the time preferences “reasserting” themselves. What actions by what market participants does that term refer to?
And why do the businessmen who plan the investments believe that a low interest rate today means they are going to be able to borrow at the same low interest rate 5 years from now? An interest rate is a price, and I have never heard of any rational manager expecting any prices to remain unchanged for years in a free market. Whenever you make a business plan, you have to factor in the possibility of the price of your own product declining, and the prices asked for by your suppliers, the wages asked for by your employees, and the interest asked for by your creditors increasing.
Also, what, in your view, is the cause of business cycles?
In a totally free market, there can be some cyclicality in the supply of goods that take a long time to produce caused by their producers being unable to predict the number of their competitors. For example, if oil is expensive, that is a signal for companies to do more oil exploration. But it is difficult to know how many other companies will also engage in similar exploration as a result of the high price, and even more difficult to predict how successful they will be at it. If a lot of companies end up finding large oil fields, the price of oil will drop precipitously, which in turn will cause businesses to divest from oil–but again, they are not guaranteed to predict with success how many others are also divesting, so if too many do, the price of oil may rise very high again, restarting the cycle. In the case of goods whose supply has a major impact on the economy, such as oil, this product-specific cycle may cause visible fluctuations in the general level of economic growth.
But a much more important factor in causing economic cycles in our present-day mixed economy is government intervention. A statist candidate is elected; his actions cause the economy to weaken; he sees the weak economy as a “failure of the market” and is eager to “fix” it with more statism–and soon you have a full-blown economic bust. Eventually, when there is a lull in government intervention, the creativity of producers manages to turn the economy around and growth picks up again. And if it were only up to the creativity of productive men, the growth could continue for millennia–but then, another statist comes along, and the cycle starts again.
One statist interventions you can count on to stymie any boom is … the raising of interest rates. According to the still-prevalent Keynesian fallacy, a growing economy is an unnatural condition that carries a danger of “overheating.” The Keynesian mind cannot imagine that there can be any source of apparent growth other than inflation. So whenever the economy is growing, the Fed will sooner or later begin to worry about inflation and come to the “rescue” by deliberately cooling down the “overheating” economy.
