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Nov. 21, 2006 - Freedomain Radio - Stefan Molyneux
43:33
522 The Business Cycle Part 2 (video available)
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Alright people, we've got no time to chat-chat, chit-chat, no time for date introductions, no time for nothing.
We've got a lot of material to cover today, so we really better get moving on.
Whee! These afternoon cappuccinos really do help me get my focus on, get my learning groove on.
So we're going to go on with the Austrian Business Cycle Theory Part 2.
With any luck, I will actually get it finished.
This will be a No Tangent Podcast.
I will be strong!
I will survive! Anyway...
So, to move on from where we were this morning, and hopefully you're not listening to these directly in sequence, otherwise you'll realize how little I remember from this morning, but Austria, lovely land of elk.
No, that wasn't it.
The real question around the business cycle and its monetary impact, or the impact of monetary theory and practice on the business cycle, to really sort of get the hang of that, you kind of first...
We need to get a handle on the question of inflation and why the government wants to inflate and so on.
And I won't make this very long because that won't leave me much time for the actual topic.
And it's not a tangent. It's an introductory, pre-tangent, hexagonal, orthogonal kind of oblique approach.
Of course, governments like to get a control of the money supply because wouldn't it be great if you were the only legal counterfeiter in the world, right, or in your country?
So if you were the only person who was allowed to print money and your job was simply running a photocopier to produce all the money in the world that you wanted to spend, wouldn't that be great?
And if you could throw anyone else in jail who tried to counterfeit and you yourself could run the printing press off, at least to begin with, and then as you got more sophisticated, You could just log into your online national bank account and just type in whatever number you wanted to create money for yourself.
Wouldn't that be oh so much fun?
And naturally, that kind of magical power is the kind of power that governments want, because it's a form of taxing people without any of the hassle of people really realizing that they're being taxed.
So governments have an enormous incentive to inflate the money supply, to print as much money as they want, with the sort of limiting factor that if they print an enormous amount, then they get this Weimar Republic slash Argentinian style slash Mexican peso currency devaluation, where you've got to take sack loads of money that's devaluing as you run in order to go and buy a loaf of bread.
And that tends to not result in very good things for the society.
And so there is a limit, a theoretical upward limit.
But governments, they sure do love to print the money and to put the money into circulation.
Now, over the 20th century, let me go back to the 19th century because, of course, we want this to be a nice, rapid podcast.
But in the 19th century, there really was no such thing as the business cycle.
And I want you to imagine a shoal of fish, actually a number of shoals of fish, a very large ecosystem.
Now, businesses come and businesses go, and people make good decisions and people make bad decisions.
And overall, though, business grows, you know, ideally sort of 4% to 6% to 7% a year if you've got a relatively free market.
We don't know what a pure free market would look like.
It would be higher, no doubt.
But let's just say a couple of percent, you know, four to six to eight percent a year of growth in the business environment.
Now, of course, many firms are growing.
We are on the government road, so it's a little bit like getting your kidneys punched.
Some companies are growing 10%, 12%, 14%, 20%, and other companies are cratering, which hoovers capital out and destroys it, and useless busy work and binders that get put in people's basements and never opened again and thrown out when they die.
So there is destruction, and the creative destruction of capitalism causes some companies to grow and others companies to not grow.
But overall, on average, there's this growth.
Now... You can think of this in terms of fish population that is, you know, generally, you know, stable.
Just think of the...
Because, of course, the fish population can't grow forever.
Otherwise, you'd be able to walk across the water.
Hey, maybe that's the explanation.
No tangents come back.
Oh, we must be strong.
But imagine that there's a whole bunch of shoals of fish, a whole complex ecosystem, and then imagine that 40% or 30% of the fish just die in a year.
Now, yeah, theoretically it could be the case that they all just happen to get sick at the same time, and that's just a real fluke, but given that there are thousands upon thousands of fish, that seems highly unlikely.
And what you would do, of course, is you would not look at the health of the individual fish, other than to figure out what collective concern had affected them.
But you would look at the environment.
Specifically, you would look at water impurities or temperature or acidity or alkaline or whatever.
You would look at some factor that would be logically affecting all of the fish, right?
I mean, that would be the logical thing to do.
You wouldn't just say, well, it's innate to a seafood ecosystem or a sea ecosystem, a sea ecosystem, that, you know, every now and like every 10 years or so, 20% of the fish die, right?
Or whatever, and the rest of them don't do very well.
You would look for some sort of cyclical thing that would occur.
And it would be something that would be in a common environment to all of them, because we can assume that fish every 10 years don't just up and lose the will to live and become sort of despondent and, I don't know, Throw themselves onto land and kill themselves that way.
We have to assume that the fish in any given year are pretty much like the fish in any preceding year, that they want to live and survive and so on.
Nothing major has changed.
So if a large number of them are dying, then it must be something in the environment.
And that's the approach that I would like to invite you to take when we look at the business cycle.
Now, the first thing to understand about the business cycle is that for the first 150 years of capitalism, it really wasn't an issue.
It really wasn't an issue, just as inflation was not an issue.
In fact, it was deflation that was occurring.
So, in the early days, and sort of I'm talking 1750, 1760 to the late 19th century, so like 130, 140, maybe 150 years, during this time frame, There really was no business cycle to speak of.
It was not understood as a general phenomenon.
Now, of course, there were businesses that failed, and sometimes there were entire sectors of business that failed, but as a whole, and taken in general...
There was no business cycle.
No business cycle. And this is, of course, when capitalism was in its freest state relative to what came later because, of course, the most fundamental thing that needs to be out of the hands of the government in order for For capitalism to be a free market environment, it's not the law courts, it's not property rights, it's not contract enforcement, it's not any of these things.
The most fundamental thing that needs to be kept out of the government's hands in order to guarantee a free market, or at least this is the first and most necessary component of a free market, is currency, is money.
Money is the one thing that is common to all business transactions in a market situation.
And a corrupted currency destroys the free market.
And then, of course, who gets blamed?
Anyone? Class? Yes, the free market.
You We've got it.
And so what happened throughout the 19th century was deflation, right?
Because this is sort of what you expect.
That as the economy matures, as you get a nice juicy capital goods industry going, as the consumer goods side of things starts cooking along, Things get more efficient.
There's a deflation, right?
I mean, if you look at sort of pin production in the 17th century versus the 19th century, there was like a 2,000-fold increase in pin production per labor hour.
Of course that's going to drive the price of goods down.
There's no question of it. And so what occurred throughout the 19th century were price reductions, price drops that were continual.
No business cycle, constant deflation, constant increase of living standards, just as you would expect from a situation where people don't have guns pointed in their face quite to the degree that we do today.
And then what happened was you began to have the government starting to muck about with the currency.
And I'm sorry, there were two exceptions in the United States around this no-business cycle and general deflation, the War of 1812 and the War Between the States.
Those are sort of obvious government activities in one form or another.
So, what happened in the late 19th, early 20th century was governments began to muck about with the money.
Now, governments just desperately want to get their piggy, bloody little hands all over your currency because then they get to print themselves all the money that they want.
You get stuck with the deflation of your savings and the loss of wages that occurs in an inflationary society.
And they're going to come up with lots of different ways to do it.
Now, they're sort of crude form.
It's just printing lots of money.
And that's one way of doing it.
But that kind of like leaves a trail, right?
So if you get all these huge bills floating around and everyone's awash in money and it's all getting kind of worthless, people might have some sort of idea that the government might be involved in the problems to do with the economy.
So the government wants to Retreat in its slithering eel-like way into an obscure camouflage of weird regulations and weird setups so that only bankers and economists who focus on this kind of stuff and maybe you and I after this podcast will be able to follow the trail.
Nonetheless, the increase in the money supply can be achieved in very many different ways other than a mere printing of dollar bills and coinage and so on.
And so the sort of two major events, just sort of focusing on the US economy, the two major events that occurred in the 20th century with regards, I guess three major events that occurred with regards to freeing up the government to just print whatever the hell it wanted, We're all to do with the dissociation from the gold standard.
The gold standard is that you use gold for your currency.
Just use that sort of basic thing.
You have gold coins and that's your currency.
What happens with the gold standard is that you can't just artificially inflate the money supply.
Because gold is hard to get a hold of.
You've got to sweat. You've got to dig it out.
You've got to haul it out of the earth.
You've got to refine it. So it's not easy to get a whole lot of gold.
So what happens is the gold standard prevents governments from just sort of making up money.
But what happens is people don't like to carry around gold and so they start to put their gold in banks and they start to carry around signed certificates or sort of permanent checks which turn into currency and then governments grab a hold of the currency and then governments get rid of the gold so that then it just becomes what's called fiat money wherein there is no gold redeemability.
Originally, certainly the first third of the 20th century, You could take your dollar bills to any bank and you could get them exchanged for gold.
This put an upward limit on the amount of On the amount of money that the government could print relative to the economy, right?
So they were always afraid of sort of a bank run, right?
You remember these sort of old movies where this sort of would occur.
And this occurs when a bank has put out way too many pieces of paper relative to the gold in the sort of fractional reserve banking scenario where you lend five to ten times out based on the fact that a whole bunch of people put their gold into your vaults and don't come back to it for many years.
You don't want that gold to just sit there.
You want to... I want to put your money to work for you.
That's that great Seinfeld line.
Yeah, you know, I did put my money to work for me.
Turns out my money gets fired quite a lot.
Now I'm like, I'll go to work.
You stay home. I think that's quite funny.
No, tangent. That's not a tangent.
That's just a tiny joke. And not even mine.
And therefore funny. So...
What happens, of course, the first thing that happened was the government takeover of the currency, which occurred.
And, of course, then people think it's the government who then runs it, but that's not the case at all.
The Federal Reserve is a private institution, as we mentioned this morning.
But the government took over the sole printing.
And prior to that, in the 19th century, banks would put out their own notes and they were exchangeable with other banks.
And the bank which had the best gold-to-note ratio would be the one that was considered the most stable.
But the ones that had lower gold-to-notes ratio or gold-to-currency ratios would give you a higher rate of return, although they'd be more risky.
So it was kind of like, you know, investment and so on.
But what happened then was the government got rid of all of that nonsense through the progressive movement culminating in the 1913 creation of the Fed, which leased out to a private company the sole right to produce currency.
But it was still on the gold standard, right?
And then in 1933, I think 33, 32 or 33, at the height of the Great Depression, the US went off the gold standard so that you were no longer allowed to exchange Your currency for your sort of paper currency, which is worthless unless you need to wipe your ass, you were no longer allowed to exchange your paper currency for gold, right?
So then this removed a pretty significant upward pressure on the state because now it could just print whatever the hell it wanted.
And people would just have to live with it, right?
Suck it up. Which, of course, opened up the way to fund, and most of the countries in the West went off the gold standard in the 1930s, which made World War II possible.
I mean, these things have enormous, enormous implications.
Once you go off the gold standard, just print whatever money you want, use it to pay troops, use it to pay war suppliers, and you don't really have to worry about it because the inflation can be kept rigidly down through wartime controls and screwing up all the resource allocations down the road.
But, you know, these decisions, they sound very esoteric.
Ooh, we went off the gold standard.
Who gives the rats behind? But it has enormous implications on what the government can and cannot do.
And then the third major thing that occurred was that the United States kept on the gold standard internationally, right?
So domestically, citizens couldn't exchange gold.
They're dollar bills for gold, but internationally, foreign governments could.
And so balance of trade payments were becoming problematic because as the U.S. inflated its currency, and you'll notice that basically in the late 30s and through and past the Second World War, and especially after the Second World War, inflation was a constant problem.
And this, of course, was because the U.S. had gone off the gold standard, and the government could just print whatever the hell it wanted, right?
And as you print more money, of course, the value of each individual dollar goes down, and so the value of the money that you have erodes, and this has all become sort of a huge, messy, ugly problem, and it's just an indirect form of taxation, right?
If I print $10,000 and then go and spend it locally in my town in a closed economy, everybody else's value, value of everyone else's money goes down by $10,000, because now you have $10,000 more representing the same amount of goods.
So then in 1971, the U.S. sort of officially declared or unofficially declared bankruptcy and defaulted and refused after a fair amount of haggling and pseudo-diplomacy backed up by larger guns and bombs.
The U.S. basically said, well, sucks to be you, foreign governments.
You can no longer exchange your U.S. holdings for gold.
We're just defaulting completely.
We'll pay you with the worthless arse-wiping paper bullshit that we pump out, but we're not going to pay you with any actual gold.
And this is one of the things that, you know, right after this, like immediately after this, you start to get this wacky 13% a year inflation, you get stagflation, all of this kind of stuff, all perfectly predictable under the Austrian model.
And this was really the precipitating moment that screwed up the world.
It was the entire world's economy that went nuts because the last anchor to gold was gone, which meant that everybody was just circulating all this nonsense paper rather than any real currency like gold or silver or whatever.
So that sort of sets the stage for understanding the business cycle in that you have a constant desire for the governments to continue to print more money to pay off their bills.
So, for instance, all the banks in the United States that are covered by the insurance guarantee, they have accounts at the Fed, the Federal Reserve, the nation's private bank.
And what happens is that the Fed allows them to lend some multiple, and last I read sort of six times, who knows what it is now, six times the amount of money that they have on deposit with the Fed they can lend out to their own sort of private lenders.
And so, for instance, I'll sort of give you an example.
If the Fed buys a computer for $2,000, then it gives the computer company...
I'm taking this example from Murray Rothbard, although he didn't use a computer because it's a little earlier in time.
So the Fed buys a computer for $2,000, and then it pays Dell.
$2,000. Then Dell takes the check to the bank and deposits it, and then the bank takes the check to the Fed and asks for $2,000.
And then the Fed types, oh, we have $2,000 more in our account, and then it transfers that $2,000 to Dell.
And, of course, the Fed hasn't earned any money, right?
I mean, the Fed is not an investing institution in that sense, and it certainly doesn't produce anything.
So all that's happened is the Fed has typed into its computers, oh, let's just pay $2,000.
It's like a total get-out-of-reality free card, or rather, get-out-of-reality and be subsidized by everyone else who's got to foot the bill.
And so what's happened is $2,000 has now been added to the economy, right?
Because you just magically have the Fed make up this $2,000.
And so the...
The Fed puts $2,000 into the account of the bank that Della works with, but remember this sort of six times multiple.
Now what happens is that the bank, because it has a $2,000 credit from the Fed, can now multiply that by six and use that as the basis for lending out to other people.
So you have $12,000 magically created plus the $2,000 original.
You have a massive multiple here of money that's created.
And this is how the government inflates money by just sort of making up money on its own and then allowing banks to lend out a multiple of it.
None of it's based on anything real, of course.
None of it's based on any real asset.
The computer is not an asset that was created by the $2,000.
The $2,000 is magically created in order to buy the computer.
Which, of course, well, anyway, we won't get into any of that.
No dungeons, even productive ones.
And so this is one way in which the government inflates the money supply and you can imagine how much the Fed buys.
And of course the Fed doesn't buy a whole lot of computers relative to it goes out and buys treasury bonds and then it inflates the money supply that way, inflates the money supply by buying stuff and putting money in banks and defense contracts and so on.
So there's an enormous amount of inflation that's going on here which doesn't have anything to do with printing money but just some of the electronic stuff.
So, if you sort of understand all that, the next thing that we need to do is to notice some characteristics of a boom and a bust, right?
So, very, very briefly, a boom is...
It always starts in the capital markets first, and prior theories, theories prior to the Austrian theory or the Mesian theory, didn't really explain this particular characteristics of the boom and bust cycle.
The boom and bust cycle always is worse in the capital goods market and is less severe in the consumer goods market.
And just for those who don't know what the hell that means, well, even more briefly, in one other sort of sub-warren of the explanation, the capital goods markets is sort of the business-to-big-business, big monolithic refinery...
You know, when Intel goes to create a new factory to spend $10 billion on a new factory to create a new kind of computer chip, that's all in the capital goods market.
The computer chip itself is sold to consumers, right?
So that's in the consumer goods market.
And some new excavating hoe for gutting the earth to put a new hotel in is a capital good.
And the hotel that then serves customers and, you know, Folds down their bed and delays their food orders by an hour and a half.
That is in the consumer goods market and these two things are sort of differentiated for a variety of reasons but mostly to do with time preference.
So in a recession or a depression, in the sort of business cycle that goes on sort of every 10 to 12 years, the capital goods market is hit way worse than the consumer goods market.
And what also doesn't get explained by earlier non-Austrian views of the business cycle is why all of the capitalists just suddenly turn into idiots.
It's sort of an important thing to understand.
I've run a company, been a capitalist myself, and you really have to be careful with the decisions you make and the resources that you allocate and all this kind of juicy stuff.
So why should it be that all of a sudden, out of nowhere, The capitalists just become sort of mouth-breathing idiots and can't figure out how to invest and put everything into the wrong things and hire people in the wrong areas.
Have they all just become stupid?
Are they stupider than the previous generations that didn't have a problem with the business cycle?
Well, again, I'm sort of pointing out that when a number of fish die, you don't look at each individual fish.
And you don't look at the interactions of the fish between themselves, you look at the interactions of the fish and what is common to all the fish, which in this case of, in the metaphor extension to the money supply, the water is the cash, or the cash is common to all economic transactions.
And so, how do you explain this?
That all the capitalists become idiots and make all these bad decisions?
And also, why would it hit the capital goods market much more so than the consumer goods market?
Well, this is the Austrian theory in a nutshell, and I think I can do it if I don't breathe for the remainder of this podcast.
One sec. Okay, I'll try and do that trumpet Dizzy Gillespie thing where I'm blowing.
Anyway. So, the explanation sort of runs a little bit like this.
So... You have a situation where the government is increasing the money supply in some backhanded pay-yourself kind of nefarious manner.
And what that does is it increases the money supply.
So, there's lots of money swilling around in the banks that the banks are eager to loan out.
Now, of course, the supply of money is increased, so what happens to the price of something when the supply is increased?
Yes, of course, the price of something goes down.
If you double the production of bread, the price of bread is going to go down by some factor.
That's not insignificant. And so, when the government artificially increases the money supply, then the price of money, which is the interest rate that is charged on money being lent out, the price of money goes down, right?
Interest rates go down. Now, when interest rates go down Normally, like in the absence of a weird, screwy government thing with money, when interest rates go down, the reason for that is because people are saving, not spending.
This is a very, very important thing to understand.
Normally, interest rates go down and banks have an excess of capital to lend because people are saving and not spending.
Because these are the two things that people do with their money, assuming that they're not weird Satanic fetishists who burn them in bonfires, people either save their money.
I mean, this is basic, but it's important, right?
People either save their money or they spend their money, right?
So, for instance, in China, 20 or 25 percent of people's income goes into savings, which means that the price of capital is low, and this is why the Chinese manufacturing industry and other kinds of industries are doing so well.
In America, nobody saves a damn thing anymore because they have credit cards.
So, although I wouldn't blame the Americans for that, again, this is an environmental thing, like why are the fish all acting in the same way?
Why are the salmon all lined up?
Well, because it's the current. It's not because each salmon makes an individual choice to do that.
You always look at the environment first in economics, and the environment is always the government, right?
So, when the price of capital goes down, when interest rates go down, that's a signal to the capitalists that people are saving and not spending.
Now, when people are saving and not spending, a wise capitalist will invest in capital goods.
When people are saving and not spending, a wise capitalist will invest in capital goods.
Because people are going to spend at some point.
They're just not spending as much right now.
So when the interest rate goes down, again, forget about the government.
Let's just pretend that it's all a free market, beautiful libertopia, heaven, paradise.
When the interest rate goes down, then that's a signal to a capitalist to invest in capital goods rather than to invest in consumer goods.
Because the price of interest has gone down, which means that stuff which wasn't profitable before might be profitable now, which means it's going to be like...
And we all know this from real estate, right?
When the interest rate goes down, people have a tendency to buy more houses, right?
When the interest rate is very high and when inflation is very high, people want to spend the money now because it's just going to lose value.
So when the interest rate dips, people start investing in capital goods, right?
So what do they do? Well...
They are reading the signal of the market to understand, and correctly so, right?
To understand that people are saving and not spending.
So now's the time to invest because it's cheap to invest.
And then when people start spending, you'll be much better positioned to solve the additional increase in the requirements for goods and so on.
So what the good capitalists do is they start investing in all this capital equipment.
And what happens is then the wages, they bid up the prices of the wages of the people and the workers and so on involved in the capital goods industry.
So they're buying all this juicy capital goods, the orders for capital goods for big factory parts and all this kind of juicy stuff, construction equipment and factories and all this.
The requirements for that all go up.
People start bidding that stuff up.
And so people are then drawn, because of the increased wages, into the capital goods industry.
And away from the consumer goods industry, right?
Again, I'm not saying everyone switches careers totally, but, you know, people given the choice will go in there or they may sort of cross over.
So you may get somebody who starts working in a factory rather than in a restaurant because the wages are so much higher in the factory that it just, you know, hey, who wouldn't, right?
It's not like the retraining takes years.
So... Then, a thing happens that is not too...
This goes on for a while, right?
It takes a while to get these capital goods things up and running.
It can take a year or two to build a sort of modern factory.
So, this is all...
The economy is sort of poising itself ready to start supplying all of the consumer goods when people stop saving and start spending, which goes in cycles in sort of various ways, right?
So, you know, just think of your life, right?
You're saving up to buy a house.
You're saving, saving, saving. You have kids.
You're spending, spending, spending. You're near retirement, you're saving, and then when you get to retirement, you're spending and you're not saving as much because you're drawing down on your capital.
So this is true for demographics and so on.
This is true for society as a whole, that there's a cycle for saving and spending, which is why resources flow back and forth between the consumer goods and the capital goods markets.
Suddenly we're in Connecticut.
And so then what happens is all of the capital goods get tuned up and they're ready to sort of burst forth with all these consumer goods and they're ready to do all of this stuff.
Unfortunately, the big surge in consumer spending never happens because it was totally artificial.
There is a signal that people are saving, not spending, which is reflected in lower interest rates.
Then you invest in all your infrastructure.
If you're in a software company when you're not as busy with implementations, you work in upgrading your software.
That's sort of a natural thing to do.
Now, the problem that has occurred is that the signal that the capitalists are getting, because of the low interest rates, is not because of anything to do with what the consumers are doing.
So the consumer's time preference, which is supposed to be reflected in the interest rate, i.e., I would rather save and defer my income gratification, or my gratification based on income, I want to spend more later and not now, that would normally result in a lower interest rate.
Once the government gets control of the currency, what happens is that the interest rates are low because the government is printing too much money.
So the banks are awash with all this bullshit money, and they want to lend to everyone because it's just sitting around, and so they have to lower the price because everyone else has got so much money too.
The government gets, however, by hook or by crook, and particularly the latter, gets a whole bunch of money into circulation, And this then causes the interest rates to decline.
And the capitalists all think, oh my god, people are saving, not spending, interest rates are cheap, so let's start investing in capital goods because stuff is profitable now that wasn't before.
There's all this deferred spending and there's no point trying to go out and sell stuff now because people are saving and that's why the interest rates are low and blah, blah, blah.
All perfectly logical, but the problem is that the lower interest rates have nothing to do with consumer preferences at all.
They're entirely to do with the thieving, graspy, grubby, eely hands of government slithering in their ghostly way through everyone's wallet, picking them clean of lint and coinage in the form of inflation and printing money and diluting and dissolving everybody's net worth.
What happens is the capital goods industries end up not returning the money on the investment.
People will borrow at low interest and they will start investing in their capital goods to produce all these extra goods, but the extra goods have to be sold.
In order to justify the investment.
But given that there's no big pent-up demand and consumers aren't about to start spending more, because the low interest rates is entirely based on artificial government stuff, this expected boom does not occur.
And there has been an over-investment in the capital goods market.
People have read the wrong signals from the interest rates and have over-invested in the capital goods market.
This is double plus and good in business.
You make these kinds of mistakes for your company.
They can sometimes be your last.
In technology, again, I know there's a lot of technology, so listen to this.
If you go to a new programming platform like Flex2 or Ajax or.NET 3.0 or Windows Foundation classes, if you go to that, Too soon, then you get all the bleeding edge crap and, you know, there's a lot of problems and people don't want to buy it because it's too new.
But if you go too late, then people don't want to buy it either because you're on crappy old VB6 or something like that still.
So, you know, picking the right time is very important.
And these kinds of business decisions are all very delicate and require a lot of skill to navigate.
It's hard to say misread the interest rate signals in the economy because they read them correctly, but they ascribed the wrong cause.
Not illogically, but just because no real understanding, right?
So what's happened is there's been an overinvestment in the capital goods industry.
And so what happens is that then people don't make money off their capital goods investments, and so they start to lay people off.
And factories, they don't entirely close, but product lines and lines close, and people don't get paid.
Businesses go out of business because they gambled a lot on this capital goods investment, and they can't pay it off, and so people get stiffed, and there are layoffs, and there are problems.
And this also does occur sort of in a trickle effect in the consumer goods market, but not to the same degree.
Not to the same degree.
So then you have this contraction, right?
And what's happening in this contraction is...
I'm going to sound cold and heartless, but just this is economics talk.
I don't think that I don't have sympathy, but what has happened is that the people who were or are on the way out of the capital goods market, they're sort of thrown out on the street, and they sort of pick themselves up and dust themselves off and say, well, that kind of sucks.
I went from being a waiter to being a factory worker for like six months.
I got paid a lot of money, and now I'm thrown out of my ass, and the factory's closed down.
Well, what do they do? They say, okay, well, I can go back to being a waiter, or whatever.
I'm just going to make whatever it's going to be.
But they shift back to where they're actually required, based on the real price signals, which have been obscured through government manipulation, they go back to the consumer goods market.
They go back to whatever, they're producing, you know, they go back to being a CD store clerk or something like that, or, you know, they sort of move back.
And this is true for the managers and the executives as well, right, when the business goes down.
And so the over-allocation of resources that went into the capital goods market It turns out it was wrong.
It was wrongly allocated.
When you reach for an ice cream cone and it turns out to be a fire, you pull your hand back.
When you've made a mistake in allocation or hand resource allocation, you correct yourself.
There is then a recession in the capital goods areas, the capital goods markets.
And there is a sort of flow of capital and resources away from the capital goods market towards the consumer goods market.
Now, this is oftentimes either provoked...
It's generally provoked by sort of one of two things.
Either the inflation...
It goes along, right?
So the inflation starts to increase because there's all of this money that's come into circulation.
And it takes a while.
It usually takes 12 to 24 months for a sort of significant increase in the money supply to be felt across the economy as a whole, at which time you're heavily embedded in your capital goods projects.
But what happens is the interest rates start to go up because of inflation, right?
So if the inflation is 5% and you want to make 3% on your interest, you have to charge 8% interest, right?
So interest rates start to go up.
So refinancing the capital goods project starts to become a problem.
Because you borrowed at 3% and now you've got to pay 8 or 10% back and you can't afford it, right?
And the inflation is eating away and this and that.
You didn't calculate all the inflation into your calculations, which, of course, lowers consumer demand because people then can't borrow as cheaply to get your capital goods.
You can't go and buy the plasma.
Screen TV when inflation and interest rates are at 10%.
So there's lots of problems, right?
So when the inflation starts to go up, then the banks start to sort of get really worried, right?
Because they lent at 3% and they have fixed contracts for a year at 3%.
So they have to eat those losses as the inflation creeps up past 3% during that year.
They have to sort of eat those losses.
And then they have to claw back and get those losses from the businesses when they refinance.
So when they refinance the loans for the capital goods industries, they have to go for even higher than the prevailing rate because they have to make back the money that they lost based on the deterioration of the value of their money because of the interest rates.
Sorry, I know this is... I'm going rapidly, but I'm getting close to home.
I'm going to finish... So, like, if you lend money to someone at 3%, and then it turns out that inflation was 6%, then you've just lost 3%.
So when you refinance that, you're going to have to tack on that 3% to your new loan, and you're also going to worry about whether inflation is going to continue at 6%, so you're actually going to have to make it 12%.
Because you have to get back your 3% and you have to get your new 3% over and above the 6%.
So you're starting with a base of 9, you tack on 3 for the 3 that you lost and you're suddenly at 12%.
Now the difference between a 3% loan and a 12% loan is quite considerable.
Throw it into a mortgage calculator and have a look at the difference over 20 years.
It's like buying three houses.
So suddenly the capital goods increases which looked amazing at 3% look self-destructive at 12% even if you count that it's only 9% and so then you don't want to do it anymore so everything collapses and you change and all that kind of stuff, right? So this is what sort of, and of course the consumer demand is not pent up because the signals were false.
And so what happens is then you get this very sharp and unpleasant correction in the capital goods industries, lots of layoffs, lots of problems, and this is all occurring with, yes, you guessed it, ladies and gentlemen, high inflation.
High inflation, high unemployment.
If you remember, we talked about that this morning, what was occurring in the 1970s after the U.S. went off the international gold standard.
You had high interest rates and high inflation at the same time, right?
So this is, of course, a result of overprinting of the money supply, which increased vastly in the 1960s.
And, of course, the value of the U.S. dollar, particularly relevant to foreign currencies, went down considerably after the U.S. went off the gold standard because you couldn't then exchange it for any real money and you had no control over the value of your U.S. dollar holdings because you had no control over how much money the Fed was going to introduce into the economy, thus diluting the value of everything that you had in U.S. dollars.
Same thing sort of occurring now, which is why people are switching to the euro and the yuan and the yen and so on.
So you get this sharp contraction in the capital goods market, which then, of course, has a ripple effect on the consumer goods market because all these people that were making killer incomes in the capital goods market get laid off, and they immediately start to contract their consumer goods spending because they're, well, not so much with the employment, which causes a ripple effect, a ripple after effect in the consumer goods market.
And then, you know, 6 to 12 months afterwards, everything's been reallocated, reshuffled back to its original place, and then you start to get this, you know, the recession or the depression shallows out, and then you start to get economic growth again.
And then the government starts to inflate again, you get a boom, and anyway, all these sorts of things.
So this explains quite a lot, like this Austrian theory, and I think it's a very, very good theory.
It explains quite a lot. The one question that is sometimes asked is, well, why does it go on for so long?
Why does the boom last two or three years, rather than this overinvestment showing up very quickly, or at least after only one year?
And the reason for that, of course, is that the government keeps pumping more and more money into the money supply and diluting and taxing everyone's savings and stored capital.
The signals are all messed up and diluted.
It's only once the inflation hits, after 12 to 24 months, only after the inflation hits and after the contracts are up for renegotiation for funding the capital goods projects, that all this stuff starts to come down.
And then, of course, the reason that the recession lasts longer is that the government starts to throw money into failing industries and canned out government grants and government subsidies and tariff protections and preferential trade policies and tax breaks for relocating to new areas.
And then they start to tax higher to pay for the unemployment insurance and they give retraining subsidies.
So they're pulling the Band-Aid off one horrible, ugly pair at a time.
And that causes enormous problems and really lengthens out the necessary correction.
And I say necessary only because the government's been in there screwing around and stealing from everyone and really diluting all of the signals that the marketplace should be dealing with in a very sort of simple and proactive manner.
So when you look at the boom-bust cycle, I think that it's well worth examining.
I mean, obviously have a look at the competing theories, the evil elf theory, the innate instability of capital theory, courtesy of one Karl Marx, the irrational exuberance theory of Keynes and all this kind of stuff and other people.
Have a look at all of the other theories.
I haven't really found one in my sort of travels around this topic that really explains the variety of factors involved in the business cycle.
And I certainly don't believe it's anything to do with the free market, right?
Because when you have a large amount of people who are all very intelligent, suddenly all making bad decisions, it has to be a general signal that they're all getting.
And the only thing that is general to the economy as a whole is government regulation and money.
So these are the only things that are specific to or general to all industries, all interactions, all transactions.
And money is even more general than any sort of legality, which all have grandfather clauses and you can buy your way out of and you can sort of lobby to get them thrown over.
It's the water in which the economic fish swim.
So whenever there's a general trend, look to the money first.
Look to the money first. So I hope that this has been helpful.
I really appreciate it.
I'm very glad that I did this in 40 minutes.
I think that most people would give you a civilized couple of hours on this, or maybe that would be uncivilized, or maybe, just maybe they'd speak at a general pace.
That would be understandable, but I figure, hey, If you really want to hear this in a little bit more clarity, you can always slow down the recording.
Thank you so much for listening, and I look forward to your donations.
It's been a little dry, ladies and gentlemen.
The only notification that I got today of donations was that a gentleman had unsubscribed from his $20 a month or $18 a month US to support Free Domain Radio.
So, given that we're just sort of cruising nicely past our one-year anniversary, now might be the time to show your appreciation and consideration for the show here and my paltry efforts at bringing some interesting facts to light.
So, I hope that you will drop me a couple of shekels.
Thank you so much for listening.
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