The Boom and Bust Business Cycle

April 5, 2010

The Boom-Bust Business Cycle
The economy consists of producers creating goods (including services) and the exchange of those goods for other goods created by other producers, and the ultimate consumption of goods. In parallel with this flow of goods from producers to consumers is a parallel flow of money in the opposite direction, from consumers to producers. Competition of buyers, and competition of sellers, constantly causes the adjustment of prices with the result that the flow of money is matched to the flow of goods.
All producers are also consumers so the flow of money is unending. The same money keeps circulating throughout the economy, facilitating the exchange of goods, so the money is not consumed as the goods are. There is no need to add new money to the economy. There is, in fact, a good reason not to. Adding new money results in the increase in prices which we call inflation. More importantly, it transfers wealth from everyone who possesses money to the bank that creates the new money.
The bank lends the new money to, say, a manufacturer. The manufacturer believes that, because of the low interest rate, he can profitably invest in capital goods: newer, better production tools to increase production and reduce his operating cost. This will hopefully enable him to pay off his debt with interest to the banker, and still make a profit for himself.
However, many manufacturers, borrowing newly created money from banks to expand their business, or start new businesses, will distort the economy. Makers of the capital goods they buy will hire more workers. To get workers to move to new jobs, the makers of capital equipment will have to offer higher wages, buy more materials, and perhaps invest in new tools themselves, all with newly created money to meet the increased demand for their products. There is a boom in the sector of the economy which makes capital equipment.
The creation of new money has brought apparent prosperity, at least in the tool-making sector. Who pays for this prosperity? Who loses in the boom?
The boom has been created with stolen wealth, by reducing the value of all money. The theft is the stolen value of your wages and my pension, and of our investment in life insurance policies and bonds and such. Except for the winners in the capital goods industries, everyone loses.
The transfer of materials and labor to the capital goods industry has reduced the supply of consumer goods, and thus reduced the standard of living for most of us.
This might bring some benefit to us in time, providing us with newer, better, cheaper products from the expanding producers. However, this is not our free choice. We have, by stealth, been forced to subsidize the expansion of some producers by meanwhile reducing the production, and our consumption, of goods from other producers.
Moreover, at some point banks will refuse to extend continuing credit, or increase the interest rate on the credit. This will happen when the Fed decides the economy is “overheating” and forces the banks to reduce their outstanding loans. Without the subsidy of the low interest loan, the business expansion will collapse, and people will lose their jobs. This completes the classic sequence of boom, bust, and depression.
This is in contrast to what would happen in a free market. Banks would not be permitted to create new (counterfeit) money. Enterprising producers would have to borrow real money from our savings, paying the free market interest rate. The interest rate would have to be enough to impel us to reduce our current consumption to save the money to lend.
In time we would be repaid with real money plus interest. In a free market, banks would simply act as middleman between savers and borrowers.

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