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Boom/bust cycle without Inflation - Clarification Needed

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dfs250 posted on Sat, Mar 14 2009 6:57 PM

Hello All,

I'm trying to clarify something in my mind.  Everything is according to my understand at the moment, so if I am wrong, please correct me.

I believe that the Austrian school states that recessions occur due to restraining the money supply during an inflationary period.

The question often posed to me then is why was there a similar cycle occurring before manipulation of the money supply by a central bank?

I feel like there might be some equivocation occurring in my thoughts as well.  Perhaps I am confusing business cycle and boom-bust cycle.

Thank you in advance!





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I believe that the Austrian school states that recessions occur due to restraining the money supply during an inflationary period.

Nope. Not in the slightest.

The recession occurs because of malinvestment.

As a side note, I've noticed a "boom" in these topics.

"You don't need a weatherman to know which way the wind blows"

Bob Dylan

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Damian replied on Sat, Mar 14 2009 9:04 PM

An inflationary period IS an increase of the money supply. I think you might be thinking of the monetarist view of increasing the money supply to avoid recession. The recession in ABCT is the correction for the previous expansion of the money supply that created malinvestment and a misallocation of resources. As far as the historical question goes I believe Mises stated that not every boom-bust cycle can be accounted for by ABCT just most of them.

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dfs250 replied on Sun, Mar 15 2009 9:49 AM

Ahh, I understand now. 

So, just to make sure I'm crystal clear on this:

1) ALL recessions occur due to malinvestment, and are a necessary time period for markets to recover from mistakes.

2) In ABCT, recessions (caused by 1) are intensified and cyclical due to inflation.

Sorry if I'm being meticulous, I just want to have this down absolutely perfectly.

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Make sure you understand what malinvestment means.  This is a Ludwig Von Mises term.  It does not mean too much investment or investment in the wrong sectors in the economy.

What causes broad economic recessions / economic contractions is government intervention in the economy.  Companies do need to go bust.  Say a guy has a lot of snow one winter so he forecasts that future winters will be the same.  He goes and invests in a snow plow to create a snow clearing business.  The following winter brings very little snow.  His business goes bankrupt.  Another example, the circus comes to town for the whole summer.  Demand for fast food picks up.  A guy opens up a new burger restaurant and does well that summer.  The circus leaves in September and business falls for the fast food industry.  Buddy has to shut down his burger place because there was too much investment in the fast food industry.  This is not malinvestment.  This is localized bad investment decisions based on bad forecasting or unwise business decisions.  Not all new companies have good management.  Not all venture capitalists make good decisions.  Businesses go bust all the time due to bad decisions, but this doesn't cause a recession.  These localized corrections keep the economy on tract to supplying the most urgent needs to the consumers at the lowest prices.  Bad business decisions aren't in all sectors of the economy.  It's localized and the bust of these ventures don't affect the economy in a broad sense.

Then there's gov't interference.  If the gov't doesn't want an inefficient business to bust and layoff then they take tax revenue from the healthy companies and give it to the inefficient incompetent companies (the ones that made poor business decisions) for them to survive and compete against the efficient competent  businesses.  When the 'shot in the arm' wears off the zombie business will likely fail again because the fundamentals of poor decisions or ability to compete hasn't changed.

So what's a recession & malinvestment? Recession is where many businesses in many different industry sectors take a simultaneous downturn and all need a correction.  How could even the wise successful entrepreneurs too make bad business decisions - and need to correct their business direction?  The broad economic distortion that affects everyone comes from government interference in the money supply.  The Federal Reserve creates this distortion by creating too much credit out of thin air. This artificially drives down interest rates - as to suggest there are more savings available to borrow for investment.  Why does this create a boom & bust?  Because it creates Malinvestment.  Business will expand to make their stages of production more efficient or invest to make more or better products based on the amount of savings available to invest, and/or what they believe to be people's demand now -vs- demand later for these goods.  What are savings? If people produce more than they consume then the surplus is savings.  Commodity savings are the steel, copper, wood, cotton they don't consume when they save their money.  The effect is more surplus money savings are created for businesses to borrow and as a result there are more steel, copper, wood, cotton available for these businesses to use for investment and to make more or better products.  If the Federal Reserve central bank instead forces interest rates down to make businesses boom, they essentially create money out of thin air to give to banks to lend out.  Businesses borrow the money to expand business lines but there is no surplus steel, copper, wood, cotton available to expand their businesses.  Therefore the prices of input costs of production start to rise because more money chases the same number of goods.  Business expenses start to rise as prices rise and as price inflation goes up people start to speculate and feed the creation of a bubble.  People start to borrow big sums of money to "flip houses" or buy things for the sole purpose of selling it to someone else to turn a profit.  The Malinvestment is where businesses modify their production lines due to what they believe are more savings of both money and commodities - for them to make profitable business changes.  The bust comes when later they find out the house is more expensive to produce because the price of copper & wood is through the roof because of insufficient supply.  The house is too expensive to sell.  People don't have the savings to buy the expensive house and aren't willing to borrow the big sum of boney to buy the house.  The bubble finds its pin and the bursts. 


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