A Beginners Guide to the Austrian Business Cycle
The Austrian Business Cycle has been interpreted in popular economics with some fault. Many suppose for example that it assumes a fixed exchange rate, or that the central bank controls the money supply. Yet this is not true. There may be floating exchange rates, or banks may not be limited by reserves. The austrian business cycle however would still be valid. Our attempt in this very short article is to, in a simple fashion, clarify what the austrian business cycle theory means, and some of the words used by austrians.
The starting point of this theory is that banks, whether the central bank or commercial banks, see increased opportunities for lending and so make new money out of thin air and lend them out to business or consumers. More often than not this goes out to businesses.
One important point is that the market rate of interest, the percent the person who takes out the loan pays back to the creditor is determined by what is called the loanable funds market. This means that the interest rate is determined by the available supply of funds to loan out, and the demand for those funds. So if banks see new lending opportunities, this in their eyes would mean that the demand for loans has increased, and they make more funds by satisfying that new demand. However, in this case there is not actually any increased demand, the bank has created money out of thin air.
Since the bank has created money out of thin air and they want to make profits by making more loans, they lower the interest rate. This means that people will have to pay back less for taking out loans. Businessmen will think that this means real savings have increased and that there are more real funds available. But as we know, real savings have not increased and instead the bank created money out of thin air.
Because of this lower interest rate, longer production seems more profitable than at higher interest rates and so businessmen looking for more profit will invest in things like the construction of houses or fancy cars that will take a long time. Of course to do this they need to use different factors of production. This means they need to give people jobs and purchase or rent capital and land. They also need businessmen to organise the plans. Because of this new investment, more people can get jobs in car factories, house construction and more and the business will start paying wages to the workers.
Workers getting these wages will spend them on goods and services in the economy, for example purchasing a TV or going for a car wash since they have some extra money than expected. This will make things more expensive.
However, things do not all become more expensive at once. If you think of clothing shops you can see that different clothes cost different amounts and when say a top gets more expensive, jeans might get less expensive or remain the same. This means that not all goods will become more expensive at the same time. Further, if you think about friends, family, co-workers, etc you know that not everyone gets paid the same amount. When someone gets promoted say, not everyone will also get promoted at the same time and so wages also do not go up or down at the same time.
When prices rise, the value of money goes down. This means that for every $1 you have, you will be able to buy less than you could previously. So because these loans aren’t made to everyone, and not everyone in the economy gets jobs at the same place the money that was created out of thin air doesnt go to everyone at the same time.
This means that some people will get the money created out of thin air first while everyone else has to wait for it. This also means that some people will get more money from their jobs before prices rise while some people will not get any extra money, and yet things will become more expensive for them. This is known as the Cantillon Effect.
To understand why this supposed ‘growth’ cannot be sustained we need to think of it simply. Imagine you were the first person on earth, with no other humans around to support you. Now imagine you had an available source of fish to eat, but you would have to fish for them and cook them. You may just use your hands, but this is difficult and tiring so you decide you want to construct a net in order to catch some more fish. Well what must you do? In order to be able to make the net, you need to give up consuming some fish in the present to catch much more in the future. Let’s say that instead of eating 3 fish a day you only eat 1 and after a week, you have 14 fish saved up. This is what we call saving. So using this saving of fish, you can now work on constructing a rod while not catching any more fish. Let’s say this process takes a week, and you eat 2 fish a day. You can thus survive this longer period of production and construct the rod, only due to the advent of productive savings. Now that the rod has been constructed, let’s say instead of 3 fish a day you can now catch 50 a day with less effort. It is clear why saving greatly contributes to making civilisation, and thus why, in a sustainable economy, new production processes start not from savings but from money created out of thin air. In our example, this would be like a magician conjuring up fake fish, and giving them to you claiming they were real, edible fish. However, in reality they were fake and inedible, and once you begin the production process you will realise there isn’t enough real fish to keep you alive, just as the entrepreneur in the case of a modern economy realises that there isn’t enough real savings to finish his production process.
Once prices begin to rise, and people begin to notice that they no longer have ‘excess money balances’ they will begin to stop spending as much, and they will save more. Profits in consumer goods industries will fall, and those entrepreneurs that originally invested the loans will realise that there is not enough available capital to finish production. They will begin to disperse the capital, or liquidate it and workers in those industries will begin to lose jobs as recovery begins. Widespread unemployment will result, and many, many people will be harmed in the process of a political game of hot potato. Because this process takes time, politicians will find it desirable to create artificial booms to give the illusion to voters that the economy is doing well, when in the next terms the economy goes to bust, because of that politician.
This is the traditional austrian story of economic depressions, giving great insight into the course of how economic downturns are created, and why they are so common. The business cycle is yet another of the government’s sins, to add to an already insurmountable list. The government is, and always has been since its very creation, the most evil and despicable institution ever created that can only get away with its crimes due its insurmountable brainwashing of the population, particularly young children.
