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Decelerating the expansion will cause real interest rates to rise dramatically as credit becomes increasingly scarce; bankruptcies would follow. Further accelerating the expansion will cause hyperinflation and a collapse of the monetary system.
The final throes of the boom take the form of a duel between labor unions, which have the political power to force wage rates higher, and the central bank, which can bring them back down (in real terms) by accelerating the rate of inflation.
The very potential for monetizing the Treasury’s debt eliminates the risk of default, and thereby puts the Treasury on a much longer leash than it would otherwise enjoy. The problem of an artificially low rate of interest in earlier episodes is overshadowed by the problem of an artificially low risk premium on government debt. Although risk-free to the holders of Treasury securities, this black cloud of debt overhangs the market for private securities, distorting the economy’s capital structure and degrading its performance generally
The creation of these additional fiduciary media permits them to extend credit well beyond the limit set by their own assets and by the funds entrusted to them by their clients. They intervene on the market in this case as “suppliers” of additional credit, created by themselves, and they thus produce a lowering of the rate of interest, which falls below the level at which it would have been without their intervention. The lowering of the rate of interest stimulates economic activity. Projects which would not have been thought “profitable” if the rate of interest had not been influenced by the
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Society is not sufficiently rich to permit the creation of new enterprises without taking anything away from other enterprises. As long as the expansion of credit is continued this will not be noticed, but this extension cannot be pushed indefinitely.
Finally, it will be necessary to understand that the attempts to artificially lower the rate of interest which arises on the market, through an expansion of credit, can only produce temporary results, and that the initial recovery will be followed by a deeper decline which will manifest itself as a complete stagnation of commercial and industrial activity.
It is today an almost generally accepted doctrine, that a lowering of the discount rate by the banking system, especially by the central banks, induces people to borrow more, so that the amount of the circulating medium increases and prices rise.
The principal defect of those theories is that they do not distinguish between a fall of prices which is due to an actual contraction of the circulating medium and a fall of prices which is caused by lowering of cost as a consequence of inventions and technological improvements.
It is true, if there is an absolute decrease of the quantity of money, demand will fall off, prices will have to go down, and a serious depression will be the result. Normal conditions will return only after all prices have been lowered, including the prices of the factors of production, especially wages. This may be a long and painful process, because some prices, e.g., wages, are rigid and some prices and debts are definitely fixed for a long time and cannot be altered at all.
The natural thing in such a situation would be for prices to fall gradually, and apparently such a fall of prices cannot have the same bad consequence as a fall of prices brought about by a decrease of the amount of money. We could speak, perhaps, of a “relative deflation” of the quantity of money, relative in respect to the flow of goods, in opposition to an “absolute deflation.”
We could say, there was a “relative inflation,” that is, an expansion of means of payment, which did not result in an increase of commodity prices, because it was just large enough to compensate for the effect of a parallel increase of the volume of production.
If, e.g., too much labor is used for lengthening the process and too small an amount for current consumption, we shall get a maladjustment of the vertical structure of production.
it can be shown that such an artificial decrease of the rate of interest will induce the business leaders to indulge in an excessive lengthening of the process of production, in other words, in over-investments. As the finishing of a productive process takes a considerable period of time, it turns out only too late that these newly initiated processes are too long. A reaction is inevitably produced—how, we shall see at once—which raises the rate of interest again to its natural level or even higher. Then these new investments are no longer profitable, and it becomes impossible to finish the
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First everything goes all right. But very soon prices begin to rise, because those firms who have got the new money use it to bid away factors of production—labor and working capital—from those concerns which were engaged in producing consumption goods.
Wages and prices go up, and a restriction of consumption is imposed on those who are not able to increase their money income.
But, after some time, a reaction sets in, which tends to restore the old arrangement that has been distorted by the injection of money. The new money becomes income in the hands of the factors which have been hired away from the lower stages of production, and the receivers of this additional income will probably adhere to their habitual proportion of saving and spending, that is, they will try to increase their consumption again.
The consequence is that those firms in the lower stages of production, which had been forced to curtail their production somewhat, because factors have been hired away, will in turn be able to draw away productive resources from the higher stages. The new roundabout ways of production, which have been undertaken under the artificial stimulus of a credit expansion, or at least a part of them, become unprofitable. They will be discontinued, and the crisis and depression has its start.
To maintain a price level, roughly 50 percent higher than before the war, was possible only by building a comparatively much larger credit structure on the existing stock of gold.
If the means of payment consist principally of gold and gold-covered notes and certificates, there is no danger that suddenly a large part of the circulating medium may be annihilated. A world-system of payments, however, which relies to a large proportion on credit money, is subject to rapid deflation, if this airy credit structure is once shaken and crushed down.
It is of vital importance to distinguish between these additional, secondary, and accidental disturbances and the primary “real” maladjustment of the process of production.
If we have, however, once realized that at the bottom of these surface phenomena lies a far-reaching dislocation of productive resources, we must lose confidence in all the economic and monetary quacks who are going around these days preaching inflationary measures which would bring almost instant relief.
Such a dislocation of real physical capital, as distinguished from purely monetary changes, can in no case be cured in a very short time.
It is primarily the construction of fixed capital and of the principal materials used for this—iron and steel—where the largest changes occur, the greatest expansion during the boom and the most violent contractions in the depression.
“No one believes that it will pay to electrify the railway system of Great Britain on the basis of borrowing at 5 percent. ... At 3 1/2 percent it is impossible to dispute that it will be worthwhile. So it must be with endless other technical projects.”
We live in a world of euphemism. Undertakers have become “morticians,” press agents are now “public relations counsellors” and janitors have all been transformed into “superintendents.” In every walk of life, plain facts have been wrapped in cloudy camouflage.
Invariably, the booms and busts are much more intense and severe in the “capital goods industries”—the industries making machines and equipment, the ones producing industrial raw materials or constructing industrial plants—than in the industries making consumers’ goods.
Banks can only expand comfortably in unison when a Central Bank exists, essentially a governmental bank, enjoying a monopoly of government business, and a privileged position imposed by government over the entire banking system. It is only when central banking got established that the banks were able to expand for any length of time and the familiar business cycle got underway in the modern world.
Central banking works like a cozy compulsory bank cartel to expand the banks’ liabilities; and the banks are now able to expand on a larger base of cash in the form of central bank notes as well as gold.
But what happens when the rate of interest falls, not because of lower time-preferences and higher savings, but from government interference that promotes the expansion of bank credit? In other words, if the rate of interest falls artificially, due to intervention, rather than naturally, as a result of changes in the valuations and preferences of the consuming public?
credit expansion is not one-shot; it proceeds on and on, never giving consumers the chance to reestablish their preferred proportions of consumption and saving, never allowing the rise in costs in the capital goods industries to catch up to the inflationary rise in prices. Like the repeated doping of a horse, the boom is kept on its way and ahead of its inevitable comeuppance, by repeated doses of the stimulant of bank credit. It is only when bank credit expansion must finally stop, either because the banks are getting into a shaky condition or because the public begins to balk at the
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the government must never try to prop up unsound business situations; it must never bail out or lend money to business firms in trouble. Doing this will simply prolong the agony and convert a sharp and quick depression phase into a lingering and chronic disease.
Hoover, not Franklin Roosevelt, was the founder of the policy of the “New Deal”: essentially the massive use of the State to do exactly what Misesian theory would most warn against—to prop up wage rates above their free-market levels, prop up prices, inflate credit, and lend money to shaky business positions. Roosevelt only advanced, to a greater degree, what Hoover had pioneered. The result for the first time in American history, was a nearly perpetual depression and nearly permanent mass unemployment.
