Authored by Frank Shostak via The Mises Institute,
[MD] The Mises Institute is professionally and universally clueless about money. But within that community, Frank Shostak holds the record for irrational thought. In the olden days his clarion call was “money pumping” … as if money could be pumped. Let’s see what he’s up to now.
According to the Austrian Business Cycle Theory (ABCT) the artificial lowering of interest rates by the central bank leads to a misallocation of resources because businesses undertake various capital projects that prior to the lowering of interest rates weren’t considered as viable. This misallocation of resources is commonly described as an economic boom.
[MD] According to the theory of park swings, if you push on a swing, it will oscillate. What in the world does Shostak think the business cycle is but the money changers farming operation? We here at MD know that a “real” money process does not allow any such perturbations … thus this is a non-sequitur. Now let’s watch him sequitur.
As a rule businessmen discover their error once the central bank – that was instrumental in the artificial lowering of interest rates – reverses its stance, which in turn brings to a halt capital expansion and an ensuing economic bust. From the ABCT one can infer that the artificial lowering of interest rates sets a trap for businessmen by luring them into unsustainable business activities that are only exposed once the central bank tightens its interest rate stance.
[MD] As we love to do here, we point out the nonsense that happens or is imagined to happen without a real money process in operation. What Frank writes about here “can not happen” with a real money process. INTEREST collections are in a bear hug with DEFAULTs experienced. Neither INTEREST nor DEFAULTs are a knob anyone can turn.
Critics of the ABCT maintain that there is no reason why businessmen should fall prey again and again to an artificial lowering of interest rates. Businessmen are likely to learn from experience, the critics argue, and not fall into the trap produced by an artificial lowering of interest rates. Correct expectations will undo or neutralize the whole process of the boom-bust cycle that is set in motion by the artificial lowering of interest rates. Hence, it is held, the ABCT is not a serious contender in the explanation of modern business cycle phenomena.
[MD] What Frank writes here would be true … if we had a real money process. But we don’t. We have a manipulated money process. What could be more obvious when we see them repeatedly use the term “monetary policy”. A real money process has no such capability … and never will. But the so-called “business cycle” which requires no theoretical examination … is a real tool of manipulation. And it does what it is intended to do … to put traders off balance in a “predictable way” … predictable to those turning the knobs … not to the traders suffering the manipulations.
According to a prominent critic of the ABCT, Gordon Tullock,
One would think that business people might be misled in the first couple of runs of the Rothbard cycle and not anticipate that the low interest rate will later be raised. That they would continue to be unable to figure this out, however, seems unlikely. Normally, Rothbard and other Austrians argue that entrepreneurs are well informed and make correct judgments. At the very least, one would assume that a well-informed businessperson interested in important matters concerned with the business would read Mises and Rothbard and, hence, anticipate the government action.1
[MD] Consider an inventory control analogy. If you know exactly what demand will be and have total control of supply, you can have a part arrive at the exact moment a customer comes in to buy it. But if either of those expectations cannot be expected, you must lay in “safety stock” (i.e. surplus for eventualities) to keep service percentage high. Now if someone is artificially manipulating demand or supply for their own benefit, you have two things: (1) A cheater benefiting from his behavior; and (2) A non-optimal process that must pay the cost of defending against the cheater. There’s enough of that going on in business without having it being done covertly and overtly to the money itself … especially in the name of “price stability” and “full employment”.
Even Mises himself had conceded that it is possible that some time in the future businessmen will stop responding to loose monetary policy thereby preventing the setting in motion of the boom-bust cycle.
[MD] No they won’t. In the inventory control example, the businessman statistically observed the supply and demand patterns. When they are noisy and unpredictably cyclical, he must lay in more safety stock. When they’re highly predictable, he can trim his safety stock dramatically. Let’s see what the “Mises” genius himself has to say on the subject.
In his reply to Lachmann he wrote,
It may be that businessmen will in the future react to credit expansion in another manner than they did in the past. It may be that they will avoid using for an expansion of their operations the easy money available, because they will keep in mind the inevitable end of the boom. Some signs forebode such a change. But it is too early to make a positive statement.2
[MD] Idiot! The businessman has no choice. He must serve his customers in the face of any eventuality. Picture him going to his bank and saying he’s not going to pay his mortgage this month because of “tightening” but fear not, next month there will be “loosening” and I will make both payments then.
Do Expectations Matter?
Now, a businessman has to cater for consumers future requirements if he wants to succeed in his business.
So whenever he observes a lowering in interest rates he knows that this most likely will provide a boost to the demand for various goods and services in the months ahead. Hence, if he wants to make a profit he would have to make the necessary arrangements to meet the future demand.
[MD] What is Shostak arguing for? He hasn’t made a demand to institute a “real” money process to make this manipulation impossible.
For instance, if a builder refuses to act on the likely increase in the demand for houses because he believes that this is on account of the loose monetary policy of the central bank and cannot be sustainable, then he will be out of business very quickly. To be in the building business means that he must be in tune with the demand for housing.
[MD] Actually, he’s better to be in tune with the money changer’s farming operation. That’s the tune that is being played.
Likewise, any other businessman in a given field will have to respond to the likely changes in demand in the area of his involvement if he wants to stay in business.
If a businessman has decided to be in a given business this means that the businessman is likely to cater for changes in the demand in this particular business irrespective of the underlying causes behind changes in demand. Failing to do so will put him out of business very quickly.
[MD] But do you see these businessmen or Shostak demanding the institution of a real money process? I wonder if Shostak will demand anything to deal with this manipulation problem.
Hence, regardless of expectations once the central bank tightens its stance most businessmen will “get caught”. A tighter stance will undermine demand for goods and services and this will put pressure on various business activities that sprang up whilst the interest rate stance was loose. An economic bust emerges.
Furthermore, even if businessmen have correctly anticipated the interest rate stance of the central bank and the subsequent changes in the growth rate of money supply, because of the variable time lag from money changes to its effect on economic activity it will be impossible to establish the accurate timing of the boom-bust cycle.
[MD] Frank. Read some history! Thomas Jefferson wrote in 1802 “If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around them will deprive the people of all property until their children wake up homeless on the continent their Fathers conquered…. I believe that banking institutions are more dangerous to our liberties than standing armies…. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs.” And even if he didn’t write it, it’s absolutely true and obvious.
Due to the time lag, prior changes in money supply could continue to dominate the economic scene for an extended period. (Given that the time lag is variable, it is not possible to ascertain when a given change in the money supply growth rate is going to start to dominate the economic scene and when the effect of past changes in money supply is going to vanish).
We can conclude that correct expectations cannot prevent boom-bust cycles once the central bank has eased its interest rate stance.
The only way to stop the menace of boom-bust cycles is for the central bank to stop the tampering with financial markets.
[MD] And the only way to get them to do that … since they’re doing it “on purpose for their farming operation” … is to INSTITUTE A REAL MONEY PROCESS TO COMPETE WITH THEM. Asking them kindly “please don’t do that” isn’t going to work.