Austrian economists Ludwig von Mises and Friedrich A. Hayek’s Austrian business-cycle theory provides the framework to explain speculative bubbles. The Austrian theory points out that it is government’s increasing the supply of money that serves to lower interest rates below the natural rate or the rate that would be set by the collective time preferences of savers in the market. Entrepreneurs react to these lower interest rates by investing in “higher order” goods in the production chain, as opposed to consumer goods.
Despite these actions by government, consumer time preferences remain the same. There is no real increase in the demand for higher order goods and instead of capital flowing into what the unfettered market would dictate — it flows into malinvestment. The greater the monetary expansion, in terms of both time and enormity, the longer the boom will be sustained.
But eventually there must be a recession or depression to liquidate not only inefficient and unprofitable businesses, but malinvestments in speculation — whether it is stocks, bonds, real estate, art, or tulip bulbs.
According to the article (I didn’t confirm this, but I trust it), M2 supply has increased 11 fold since 1971. Probably has something to do with what’s happening now, huh?
So the next time you or someone you know wants to blame the evil ‘big’ coporations, or the fat cats, or the rich, or the greedy investors, think for a minute.
Maybe it’s big government at work?