June 5, 2010

The business cycle is the result of distortion of the market caused by the varying supply of money. The distortion during the period of increasing money results in increasing investment in capital equipment. This is the “boom” phase of the cycle.

When the investments, in time, fail, Keynesian economists call such investment “overinvestment”. Actually, the increased money supply was initiated, in accordance with Keynesian theory, to correct a supposed “underinvestment”. Thus the finger of blame can point at the foolish investor who overreacted to the initial stimulus.

The implication of the word “overinvestment” is that in time, the new machine or factory invested in will be put to good use, so the waste of the investment is only temporary. This, however, is not the case, so Austrian economists call it malinvestment. That identifies the investment as a permanent loss. The investment was a big mistake, because the invisible source of the new money hides the inevitable results of its creation, the price inflation which causes the failure of the investment.

The new money (actually increased credit) is created by the banks in response to a signal from the Federal Reserve. The signal is a reduction of the interest rate at which the Fed will lend to the banks. This enables the banks to reduce the interest rate at which the banks will lend to industry.

The entrepreneur is always on a lookout for ways to change, improve, expand, and increase profits. Each possible change involves investment now, which must improve sales enough to pay back the investment later, with interest. If he makes such an investment, he usually does it with borrowed money.

So the interest rate he pays for the borrowed money can make or break the profitability of the investment. The new, lower, interest rate will persuade many people to borrow and invest in something that, until that point, showed no hope of profit.

The entrepreneur’s calculations are based on other things beside the interest rate. He includes known costs of materials and labor and overhead. Unfortunately, he assumes that these will remain stable for long enough to make the investment profitable. That assumption is his downfall.

The reason for this is that the source of the loan was newly created credit: that is, counterfeit money. This constitutes a theft of value from all the dollars in existence and an invisible subsidy for the borrower.

The dollar has been debased. As the entrepreneur spends that loan to start his new project, the market begins to reflect the increased flow of dollars and the reduced value of the dollar. Prices begin to rise, not only on the things he invests in, but eventually throughout the economy. When the project goes into production, the costs of materials and labor begin to rise. In time the project proves unprofitable. The project is shut down, people are laid off, and we have a recession. The new factory and equipment, purpose-built for the project, is of little use for any other purpose. It is sold at a loss or left to disintegrate.

Of course it is not just the effect of a loan to one company that causes the price inflation. Thousands of companies investing millions of counterfeit dollars are all adding to the debasement of the dollar and the price inflation.

The Fed has triggered a boom. The trick is to maintain the boom by constantly adjusting the interest rate. It can’t be done, because you can’t reduce the interest rate any more, once it reaches zero. That is our position today.

The malinvested money has gone into projects which are inherently unprofitable. They appeared profitable only because they were subsidized by the theft of wealth which is counterfeiting, and the unsustainable low interest rate. When the projects prove unsustainable, they are abandoned. The materials and labor that went into them are a permanent loss, except for what parts of them can be sold off for other, more profitable ventures. The crash has arrived and we’re into the depression.


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