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Source link: http://archive.mises.org/14535/boom-bust-in-microcosm/

Boom-Bust in Microcosm

November 8, 2010 by

The key to avoiding “busts” is to avoid the credit expansion and “booms” that cause them. Booms are not periods of prosperity but of the squandering of wealth. The longer they last, the worse is the devastation that follows. FULL ARTICLE by George Reisman


Allen Weingarten November 8, 2010 at 9:29 am

Thank you Dr. Reisman for a clear and simplified analysis. Perhaps another analog is where a person takes a loan from a bank, ignoring that it will not have to be repaid? Or similarly that someone uses a steroid which provides an immediate burst of energy?

Stephen Grossman November 9, 2010 at 2:07 pm

And the steroid’s energy comes from one’s body, producing a feeling of tiredness in the long run. Inflation is like the light-headed feeling at the beginning of being drunk. Eventually one becomes tired, falls down and awakens to vomit and a headache.

Jonathan November 8, 2010 at 9:31 am

Aren’t you forgetting that these booms also finance a massive amount innovation and business while they last? After the bust only the businesses with the best balance sheets and access to credit will be left. Maybe an amount of inflation followed by deflation and job loss occurs but isn’t that the way businesses are tested in the government managed economy? If you avoid the boom, an idea I had a couple years ago, then you have more stable growth but that growth would be extremely slow and probably unacceptable to many governments. In fact, when you have GDP growth in the double digits, its more likely that businesses are being supported that would not be profitable if there were not easy credit. That boom is helping to develop places like China and India when there would be only minimal real growth without their monetary policies of quantitative easing and low interest rates. Correct me if I’m wrong.

Patrick Barron November 8, 2010 at 10:10 am

I’m not Dr. Reisman, of course, but you are wrong. Malinvestment is a squandering of capital. There may be some businesses that survive that would not have been started in the absence of the boom, but these cannot offset the loss of capital that must be abandoned. Think of it in Dr. Reisman’s terms of the single individual. Lets say that you have several brothers and brothers-in-law who want money to start their dream businesses. In the absence of the boom you would be very circumspect in lending to any of them. You may lend to some, but probably not all. Even then it is possible that you could lose the entire proceeds of your loans, but your chances of being paid back are good, because there is no illusion that more capital exists than really is the case and prices of all factors of production are stable. But under the boom you lend freely to all. Since there is more lending, it is possible that one or two might survive and actually pay you back. But the losses from the others would negate it all. And there would be losses, because the illusion of more capital encourages such business start ups and expansions, but the prices of all factors of production go up. You will lose much more than in a stable money environment. You would be worse off than before the boom. By the way, this is exactly what happened to the banking industry.

Allen Weingarten November 8, 2010 at 11:11 am

Jonathan, when businesses have a promising product they need to make a convincing case in order to attract investors. There are other ventures that seek to be beneficiaries of government largesse. In other words, there are ‘market entrepreneurs’ and ‘government entrepreneurs’. The financing of these booms tend to go to the latter (such as for ethanol). Yet even if they went to the former, the best plan for growth would be in accordance with the available resources, rather than in the pretense that other resources exist. Consider people landing on a deserted island. The only developments they can bring is with their existing resources; no gain occurs by pretending that there are additional resources. (I concede that on rare occasion there is an exceptional opportunity or emergency where it is advisable to go into debt or to use a steroid.)

Dagnytg November 8, 2010 at 3:35 pm

The other causality often not considered is how many good ideas are destroyed because of the boom/bust cycle and the effect that has on the progress of society.

Conventional wisdom states, those who survive the bust must have had the best business ideas. In realty, they are the best capitalized or because of their size have access to additional capital.

The companies that have great ideas but are under capitalized tend to make incredibly risky decisions during the boom period (gaining mkt share vs. slow sound growth). On top of that, boom time investor psychology (professional or otherwise) is to make a quick profit. Thus, when the bust comes investors bail. The company with the great idea goes bankrupt and the idea dies with it.

The best example of that, in my personal experience, is Webvan- the online grocery store/delivery service of the late Internet boom/bust period. The most arcane activity people do in America is go to the grocery store. There is no reason to go and look at mass produced items that we eat. Most of the Webvan investors I know were also customers and when they talk about Webvan, they don’t talk about the money they lost, they talk about the excellent service they lost.

So, one of the great causalities (among many others) of the boom/bust cycle are good ideas and every time I go grocery shopping I am constantly reminded… that no one is going to invest in another Webvan in my lifetime. I wonder how many other great ideas have been washed away from a boom/bust cycle?

James Guerrero November 8, 2010 at 10:46 am

What does a good company do when a boom is approaching, or while it’s in a boom?

jon November 8, 2010 at 10:49 am

reisman does not square his assertion of malinvestment in his scenario with the cornerstone subjective theory of value. any one individual cannot be said to necessarily squander resources if that’s really what they want to do with them. the reason boom phases are rife with malinvestment is not that the currency is somehow tainted in its essence because it comes from a fractional reserve system, yet neither is it the case when real money is used that booms are rife with malinvestment because the gold coins are chasing luxury items instead of food and fuel. the problem is in the price-fixing: the individual’s natural course of calculations are made to never happen by means of fraud. it doesn’t matter what in the universe happens — what the laws of economics dictate the course of events shall be — because fraud is the precedent. the figures available to serve as prices are intentionally manipulated in the fractional reserve system. reisman’s example really doesn’t get to the heart of that at all.

Jonathan M. F. Catalán November 8, 2010 at 11:23 am


any one individual cannot be said to necessarily squander resources if that’s really what they want to do with them.

Even the rational market agent makes mistakes, especially when the price mechanism sends false signals (as a result of interference with the natural rate of interest).

Ryan Vann November 8, 2010 at 1:24 pm

I don’t think Jon had an entrepreneurial agent in mind when he asserted his strange (to me) argument that the marginal theory of value somehow precludes squandering resources. You are correct in bringing those essential agents up though.

Eric November 8, 2010 at 1:24 pm

The question of how would business grow if there was not a boom was not addressed in the article. The answer is that some people will have to create some wealth, through hard work, and then NOT consume that wealth.

Wealth that is true, not just illegitimate money, would have sustained the individual in the example. If, for example, it was real hard earned money saved over a lifetime that had been given through inheritance to the individual, then anything done with that money would have been real, not an illusion that left the individual in debt.

He then could have lent the money to anyone starting up a business and more wealth might have been created overall. If he was foolish with his investments, well then that would be no different than had he squandered it himself. It would simply be that saved wealth in the past was consumed today.

These analogies are not perfect, but they provide the basic real economics of savings, investment, and growth.

Brett in Manhattan November 8, 2010 at 1:47 pm

This same scenario can be found in the episode of “The Honeymooners” in which Ralph finds a suitcase with 50k in it on his bus, but, in the end, the money turns out to be counterfeit.

JK Meaders November 8, 2010 at 2:09 pm

The truth of it is obvious. The question we face as a nation (and a planet) is: “How do we get the politicians (and the central banks) to stop manipulating our currency?” No politician will take responsibility–Senator Aldrich is long gone. The central banks are outside the law. Bernanke wont even disclose where this money went/goes. Politicians can’t make promises without raising taxes unless the Fed monetizes debt, and you cant get elected without making promises. Then what, who, can stop this? What can be done–realistically? I just don’t see any way out unless we suffer a full collapse as Mises predicts. Please, someone raise my hopes.

ET November 8, 2010 at 3:12 pm

You are asking a philosophical question. Is the nature of man such that we can live in a better world.

Look at all of nature. There are likely more parasites in the world than other species. I recently read that some 5% of our body weight is made of bacteria living on and inside us. The parisites that survive the longest don’t kill their hosts. But life is certainly not efficient, nor is it fair. Nature could care less if we suffer or not. Some parasites invade our brains and provide chemicals that attach to our dopamine receptors – to push us in directions they wish.

In nature, extinction is common. Everything lives and dies. One day there will be a revolution and the American form of government will become extinct. What will replace it is unknown. Will it be better? Unknown. If you’re looking for a grand purpose then you need to look to religion. Economics is closer to biology and evolution than religion. And politics is merely parasites at the level of society.

However, just as bacteria have evolved geometrically to become resistant to anti-microbials, there is an evolution afoot in the bio-genomic field – moving at geometric speed. Man is on the verge of creating a new layer on top of the layers that exist. We can now reprogram ourselves. Where that will lead is unknown. But it has the potential to make a new species of man that can survive without a parasitical control layer – government. Brave new world? Maybe. But it gives me hope that we can change things. Maybe it will happen when humans move off the planet. What I don’t expect is that it will happen in my lifetime, however. So, I think the near future will simply be more of the same. War, poverty, misery, with a few at the top living like kings. That’s as optimistic as I can get, sorry.

kyoki November 9, 2010 at 8:45 pm

economics is akin to natural selection rather than evolution. Its survival of the fittest. Thats the common vehicle of progression. The development is actually ingenuity rather than development by chance/mistake/accident etc.
Reprogram? The hope we can have i believe would be in ‘software’(ie ideas, thinking etc) rather than the hardware(our brain[in the case of microbes eg mrsa etc they actually devolve]). We don’t need to look too far ahead. It can happen suddenly i believe. Look at what a departure the american system of government was from a monarchy(diluted or not)?

I think a collapse may be what we need. A correction of sorts. The same way a short but painful correction in the economy is the best medicine.

Allen Weingarten November 8, 2010 at 3:12 pm

JK, if the public were aware of the losses accruing from “manipulating our currency” they would select politicians who demanded solvency.
How can the public be educated? By focusing on the immorality involved in: redistributing wealth, fraud, and irresponsible behavior by government. And also by providing simple commonsensical explanations for economic processes.
Do you think that if the public knew that “manipulating our currency” was counterproductive and immoral, they would favor politicians who advocated doing so?

F. Beard November 8, 2010 at 3:33 pm

Yes, a nice justification for the bust and deflation, I’m sure.

But aren’t you Austrians missing a little item called justice and restitution?

What are the moral implications of a government backed fractional reserve banking cartel using the government enforced monopoly money supply?

Are they not that:

1. Savers are cheated of honest interest rates
2. borrowers are driven into non-servicable debt by the dilemma that if they don’t borrow from the counterfeiting cartel themselves that someone else might and thereby price them out of the market forever?

In truth, the entire population is a victim of the FR bankers, not just the savers.

Here’s a remedy to fix them all:

1) Slap a 100% reserve requirement on the banks to put them out of the counterfeiting business.
2) Send a huge check of new, debt and interest free legal tender fiat, United States Notes, to every American family which in total should equal M1.

So, no deflation, no plausible price inflation, no hangover, no more counterfeiting and just compensation for the theft that has already occurred.

And after the debt has been cleared in the system, then fundamental liberty in private money creation should be allowed.

BioTube November 8, 2010 at 6:29 pm

Except that the sole interest of this article was economics; justice wasn’t mentioned even once.

F. Beard November 8, 2010 at 9:17 pm

Except that the sole interest of this article was economics; justice wasn’t mentioned even once. BioTube

Aren’t we seeing how “successful” amoral economics is?

But more to the point. The author mentions Illusionary wealth. Is a McMansion an illusion? Or is it a property that would be perfectly sustainable if only the owner had not lost his job because of the bust? And isn’t the bust almost 100% a monetary problem (excessive debt caused by FRL) that could be solved with fiat money? And would not a bailout of the entire population provide that fiat money?

So even forgetting justice for a moment, would not a one-time bailout of the population be a very pragmatic way to avoid a severe Depression and possibly WW III? And if it is followed by fundamental reform, then who cares if the “malinvestments” are not purged since a true free market would deal with them anyway?

Daniel November 9, 2010 at 8:54 am

So even forgetting justice for a moment, would not a one-time bailout of the population be a very pragmatic way to avoid a severe Depression and possibly WW III?


And if it is followed by fundamental reform, then who cares if the “malinvestments” are not purged since a true free market would deal with them anyway?

Again, no

Going “cold turkey” is the best way out. A fundamental reform would help it be more moderate, like the 1920 Depression rather than the double-dip Great Depression

Daniel November 9, 2010 at 9:05 am

Not to mention, reducing government is EXTREMELY desirable during a recession.

Another “spread the wealth” squeme would just expand government in a direction which could utterly nullify any “fundamental reforms”

Daniel November 9, 2010 at 9:06 am

Not to mention, reducing government is EXTREMELY desirable during a recession

Another “spread the wealth” squeme would just expand government in a direction which could utterly nullify any “fundamental reforms”

F. Beard November 9, 2010 at 1:48 pm

Not to mention, reducing government is EXTREMELY desirable during a recession Daniel

Until your own job is directly or indirectly eliminated? Much of the socialism in the US is a reaction to the banker fascism we’ve had since 1913. How big was the government in 1929 when the bankers wrecked the economy?

Another “spread the wealth” squeme Daniel

Yes, it would spread the wealth (in real terms too). Our problem is unjust wealth concentration as a result of the government backed counterfeiting cartel. Restitution is just and is Biblical too. Where are the Austrians on this? The silence is deafening.

would just expand government in a direction

There would be no expansion of government. Where do you get that from? Did not Bush send “stimulus” checks to the American population? How did that grow government?

which could utterly nullify any “fundamental reforms”

Untrue as I indicate above but even accepting your premise, you don’t have much faith in the free market, do you? Fundamental reform would lead to general prosperity which would shrink the need for government.

But getting back to justice, a bailout of the population is justified. And whether you or the Austrians think it will do the economy any good is irrelevant. Or is justice irrelevant to the Austrians?

Sione November 14, 2010 at 2:25 pm

“But getting back to justice, a bailout of the population is justified. And whether you or the Austrians think it will do the economy any good is irrelevant.”

Purile collectivist nonsense from a crank.

What the writer describes is a hand-out to every person regardless of their personal circumstances and actions. He wishes to give money- from where, who pays, whose wealth is debased by the massive tidal wave of inflation he sets loose upon all? He wishes to reward those who borrowed without serious thought of repayment, those who played the system by dishonest statement, those who consumed without thought for the future, those who failed to save, those who ate to the point of morbid obesity, those who consumed various deleterious substances to the point that they no longer possessed wealth (let alone the ability to acquire it or even to apply reason in a rational manner), those who failed to plan ahead, those who didn’t work, those who took dishonest shortcuts (took the easy way), those who failed to avail themselves of the opportunity to upskill or study or take on greater responsibility. To the self-indulgent, the slothful, the greedy, the liar, the con-man, the cheat etc. he would give free bail-out money regardless. After all, in his view they should all should receive something for nothing.

He wants to institute a something for nothing scam and has the utter lack of integrity to call such a rort “justice.”

That such a crank twists economics into such a gordian knot of confusions and self-deceptions is bad enough. That he commits the same atrocity to the principle of justice is criminal.


gene November 9, 2010 at 2:22 pm

F. your 100 reserve requirement should not be a requirement. telling depositors that their funds are “on demand” and then investing those same funds however the bank sees fit is nothing but fraud backed by the deception of the FDIC.

we don’t need a requirement, simply lock up all the banksters and start over with some honesty.

F. Beard November 9, 2010 at 3:18 pm


My understanding of a 100% reserve requirement is exactly as you say. Banks would only be able to lend depositor’s money expressly deposited for that purpose with matching maturities or covered by the banks capital.

However, I would only ban FRL in the government’s money supply. I would allow it in private money supplies if for no other reason than to prove that a true free market in private money creation would eventually crush it.

RTRebel November 9, 2010 at 3:36 am

I think this is almost a better analogy of boom/bust cycle than the hangover analogy, but that one is still pretty good http://www.youtube.com/watch?v=d0nERTFo-Sk

Let’s hope they make a rap video on George Reisman’s version.

Stephen Grossman November 9, 2010 at 2:51 pm

Inflation can be caused by money and bank credit. I dont understand why Reisman discussed only one.

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