Austrian Business Cycle Theory and artificial credit for consumption

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meambobbo Posted: Thu, Jul 3 2008 4:30 PM

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Curious about this - the source of our artificial credit seems to me to be the Federal Government, who issue the debt ultimately "backed" by taxes.  Of course, when this debt is bought by the FED, and brought into the banking system, it is made available as credit to investors (and multiplied many times over).

The ATBC deals with artificial credit being made available to investors.  The problem seems to be that artificial credit is an attempt to change society's consumption:saving ratio, and the reapportionment of such changes price relations so that investments are revealed to be in error.

What about all the debt the government takes to fund consumption, such as make-work jobs and welfare payments?  Could artificial credit for investment cancel out with credit for consumption, preventing the business cycle from occurring?

Do we face a different problem from this, other than general price inflation and the ensuing chaos?

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krazy kaju replied on Fri, Jul 4 2008 7:02 PM

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Increasing government consumption cannot make up the difference. The problem is that when the increased credit dries up and real interest rates rise, a lot of businesses that invested in projects that were profitable before will go under no matter what. The only thing the government could possibly do would be to start buying up all the capital goods created. But this would just worsen the tax burden and leave us with a lot of capital goods in some warehouse somewhere.

Take the housing market as an example. If there is more saving and investment in the economy, more people will buy houses since more people will save more money for them and more people will invest in CDs driving interest rates down. This causes an increase in the demand for houses in a free market. Things are different when credit is injected via a central bank. In this case, interest rates are driven artificially low, so people begin to take out loans and buy durable consumer goods (like houses and cars) while businesses buy more capital goods. When real interest rates inevitably rise, the businesses supplying durable consumer goods and capital goods won't be as profitable any more, and they'll probably end up firing a lot of workers and some businesses might go bankrupt.

As previously mentioned, the only thing the government could do to prevent this from happening would be to buy the excess durable consumer goods and capital goods. But that wouldn't make any sense and it could not possibly be done indefinitely. The government could step in and begin hiring all the workers who lost their jobs in the capital goods market, but this would also be bad since those workers would be more efficiently allocated in other sectors of the economy where demand is still high.

In short, it is possible to avoid a recession but doing so will have negative long term results. Recessions, in the Austrian view, are really times of growth when the market is throwing out all the unprofitable ventures and allocated resources more accurately to fit people's demands.