first majestic silver

Fear The Boom! Not The Bust

February 4, 2015

I have really been meditating on your point, that a boom is entirely unrelated to economic growth, and so the succession of booms keeps destroying capital and impoverishing us.” LH

The statement above from a friendly personal email was about the nicest Christmas present I could have hoped for in this time when people and the media unthinkingly parrot the Wall Street fable that the economy is recovering, thanks to the efforts of the Federal Reserve System…saving capitalism from itself once again!

There is no denying that stocks have made record moves; and that employment, GDP, profit, credit, and consumption are all expanding – in the US – at least nominally.  That is exactly why central banks are under pressure everywhere to follow suit, or face the dreaded deflation and government default of which gold bugs keep warning!

So then what’s happening here?

Why do I, and many others in our camp, insist that what the media says is growth is actually the opposite?  For one thing, Wall Street has an interest in promoting the growth story for obvious financial reasons while central planners and politicians have a vested interest as well –both groups want to be reappointed and reelected, and the more money they make for the financial district the better their odds.

I used to have an interest in this narrative by fault of sheer ignorance, having bought the myth that I was working in a competitive free market protected by a laissez faire government policy.  I don’t think it occurred to me until well past my fifth year as a broker that central banks were, well, “central”…that they were there to centralize and socialize the industry, not to provide some mythological perfectly engineered currency or safety net.  Even though they were called central banks, it never occurred to me to think of them as anything other than symbols of free market capitalism because they were so obviously necessary to make stock markets go up.  Right?

Only when certain things began to happen in the late nineties that couldn’t be explained by economics as I learned it did I begin to think and read about the monetary problem.  Until then I thought people like Casey were crackpots.  I had not even heard of Mises yet, back in the mid-nineties.  Soros was still a role model.  Like many other libertarian-anarchists I grew up believing that Reagan and Thatcher favored laissez faire.  I had so much to learn.  Eventually I found what was wrong with the party line.

But you know what the most heart breaking part was?

I couldn’t save people from themselves – from their determination to inflict pain on themselves through bad investment decisions – even once I saw it for what it truly was.  The reason the growth story was so easy to sell is because that’s what people wanted to hear.  It’s an easy business if you bury your head in the sand, stay in the middle of the crowd, and if you take a risk make sure you bet the farm.

It gets tougher if you try to tell people what they really should do because they won’t want to hear it.

Among many things, the central bank policy incentivizes reckless imprudent behavior by rewarding the high rollers while punishing the prudent in the boom.  It encourages excessive risk taking by rewarding unsound bets.  I was still naïve enough to think there was a demand for prudent advisors back then.

I’m sorry to say, there’s a bear market in prudency; and it starts every time the Fed creates a boom!

There’s The Rub

The thing is, a boom looks and feels like growth.  But it is by definition the opposite.

The boom-bust cycle is not inherent in free market capitalism.  Neither is unemployment.  These are Marxist myths, which everyone has unfortunately fallen for except for the Austrian School.  The cycle is caused by interest rate manipulation.  That is, government policy-intervention produces recessions.

Big surprise.

But the boom still is a good, isn’t it?

Some people think the boom times are so much fun they are worthwhile despite the busts.  After all, without the investment boom, would we still have all the great technologies created in its midst??

This is a natural line of reasoning if you don’t quite grasp what we’re trying to tell you.  In truth, all the really good stuff, the stuff that has the most urgent/real value to society, is the result of the productive forces of free market capitalism.  The boom is not merely like growth on steroids.  Nor is it produced by irrational exuberance, not in the Austrian theory of the business cycle…not in our framework.

As our emailer intimated, it is “entirely unrelated to economic growth.”

In the Misesian framework, the definition of a boom is a process incentivized by the policy of interest rate suppression affecting a diversion of wealth from its creators to its ultimate wasters or consumers.

It is defined as a period of wasteful malinvestment, not of lasting capital formation.

It is straight up hostile to the underlying process of growth.  It is its antithesis.  It is the result of a policy that aims at undermining the free market price mechanism necessary to have sustainable growth.

The policy that manufactures it effectively stretches scarce given resources, wastes capital, and taxes growth.  It subsidizes consumption at the expense of potential growth by discouraging real saving.

It is paid for with the bust…by the imposition of a cycle of fits and starts supplanting otherwise more sustainable growth.  Yet the bust is just the market system trying to return to real prices.

The boom is a consumption binge on the one hand and a redistribution of wealth on the other.

The reason it fools us is because it is based on fraud and deceit.  It is rooted in the unsound practice of fractional reserve banking and employs deceit by fooling entrepreneurs into perceiving that more savings are available for investment in the earlier stages of the capital structure than truly exist.

The crux of the con is the interest rate mechanism.

Just like changes in prices are generally supposed to contain and relay information that entrepreneurs use in their daily deployment and organization of resources (and capital) interest fluctuations do too.

The Price of Time

The difference is that money prices reflect exchange terms for the present value of goods while the interest rate results from an exchange between the present and future value of a monetary good.

That is, interest is the price of credit, and is basically determined by an interaction between the supply of savings (to the loan market) and the demand for those savings (i.e., borrowing or investment demand).  It governs their demand and supply the same way that a price governs the supply and demand for any old good –i.e., a freely fluctuating price keeps supply and demand in balance.

The interest rate not only balances this, but also governs the trade off between consuming and investing, which in turn affects the supply and demand for credit.  The main function of this regulation by the free market is for the coordination of resources and scarce factors of production along various inter-temporal stages of production.  The more savings there are the more can be invested in earlier stages like R&D, exploration, massive development projects, and so on.

The dominant financial economic dogma (Keynesianism), on the other hand, denies a link between saving and investment, and it denies the trade off between consumption and investment.

In their view, saving is a bad because it is a drain, while investment is cyclical because it is driven by manic animal spirits.  Due to these market failures, they have to step in to ensure a constant flow of investment, without anyone having to sacrifice an iota of consumption, else face economic depression.

Policy Aims at Inflating Financial Returns

Effectively, Keynesians aim at replacing voluntary saving with forced saving, and they view the rate of interest erroneously in the framework of the productivity theory of interest rather than time preference.

In English, one of the ways they can purport to be succeeding in their goal is by inflating the money value of earnings to show their policy is improving the return on capital, and that therefore capital must be forming by implication of all the money one can make in the business of churning out capital goods regardless of their kind.  Aside from falsifying earnings, there are two other problems with this policy.

Work for the Sake of Work is Still Not Growth

In this view it doesn’t matter what kind of capital goods are being produced because to the Keynesians (and Chicago schoolers as well) capital is just a giant homogenous blob.  It only grows or doesn’t.

They don’t care if what is being produced is needed by society.  You could go out breaking windows, or waging massive wars, and in their framework you would just be stimulating more economic growth.

But this is why: they measure in terms of money; and government fiat money of course can be printed up.  Goods can’t.  More money chasing a given quantity of goods is bound to produce an illusion.

Not only do they define growth in terms of the money they throw at the economy.  They equate it with consumption rather than investment (even though saving and investment is the source of growth) and fail to differentiate between growth in consumption funded by sustainable investment (and increased wealth) and that consumption financed by unsustainable investment (inflation) –i.e., at the expense of wealth.

Why Sustainable Growth Requires Actual Saving

Their world is two-dimensional: GDP expands or it does not, and they can make it expand by printing money.  They can make stocks and other asset values go up by printing money.  They can inflate the money value of earnings and wages and create the illusion of prosperity.  They can even create jobs, at least temporarily.  For, the second problem, in addition to the first (i.e., wasting capital on goods that society does not urgently need), is that the interference of policymakers in aiming for a central interest rate is the source of the cluster of errors that leads to malinvestment, and ultimately a business cycle.

The cause of the business cycle is the malinvestment and the shortfall of real saving that builds into an imbalance between saving and investment.  By creating money and unsound credit the fractional reserve banks essentially print up duplicate receipts (i.e., money) to an existing pool of savings and inject them into the loan/credit markets, thereby lowering the rate of interest charged on those loans.

This supply of forced or falsified saving displaces, supplants or crowds out voluntary or real saving, which is effectively discouraged by the low interest rate(s).  This has an added side benefit that the planners like.  It puts control of investment in the hands of their wall street cronies, and government.

At the same time, the lower rate of interest sends a signal to entrepreneurs and capitalists’ telling them it has become profitable to re-arrange (economize on) the given resources along the capital structure.

It suggests that resources previously devoted to producing consumer goods have just become free for redeployment to earlier stages of the structure of production –further out from the consumer.

In other words, if there was a general decline in the consumption of flat screen tv’s because people decided it was better to save and invest for the long term, some future shop employees might become available for hire in tree planting activities or in construction…maybe they have been going to school to study engineering and can be part of an R&D enterprise devoted to building higher order capital.

This saving would reflect in a lower interest rate and some entrepreneur might hire this employee for a new venture that was not previously economic at the higher interest rate but is now at the lower rate.

But in the case where the savings are forced consumers did not actually abstain; and the resources continue to be employed in the lower order stages of production serving the stimulated consumer.

The artificially lowered interest rate discourages any abstention from consuming.

But it encourages investment (borrowing) demand nevertheless.

You Mean Another Imbalance?

As a result, you get an imbalance between investment and saving.  That is, you get a shortage of saving; or in other words you get a shortage in credit that is backed by actual hard earned savings.

As long as the central bank continues to supplant this shortage of saving with duplicate receipts to the existing pool of savings it is not obvious that it is effectively putting the command of the given capital and scarce resources of the economy at the disposal of imprudent high rollers who destroy wealth.

Rising asset prices, incomes, gdp and a falling unemployment rate is proof enough of growth for most.

The Bust

The farce (or savings shortfall) is revealed either when,

  • The central bank stops printing money (and interest rates return to normal), and/or
  • The extra money fuels a bidding war for the scarce factors revealing the false economies

Basically by tinkering with interest rates the central bank is unwittingly tinkering with a complex three dimensional but rationally organized heterogeneous structure of capital that it knows nothing about.

As a result, it produces the business cycle…and reduces growth to fits and starts.

This is because the Fed (or government) cannot produce or create or stimulate growth.

Only rational and prudent investment in capital formation sustains economic growth while the Fed’s intervention impairs the signals that entrepreneurs and other economic actors rely on to make rational decisions.  Not only does the policy fool them about the availability of savings for investment in earlier stages of the structure, it fools them into consuming some of their present capital (by falsifying profits).

All this private capital wasted and abused by a policy intent on inflating the money value of wealth and consumption just in order to help powerful elites get re-elected and Wall Street to fleece the public.

If the policy continues to be abused eventually there will be no capital, and no growth.

Unfortunately, due to the state of government finance, everywhere, the policy will likely be abused for the foreseeable future, and we are doomed to continued attacks on the capital foundation.

The booms will last for as long as the planners can falsify the factors and get away with all this.

But they are costly distractions from growth, and not growth on steroids.

What you are seeing played out is an enormously dishonest recovery story.  Don’t buy into it.


Courtesy of

Ed Bugos is a mining analyst, investment banking professional, and senior analyst at The Dollar Vigilante (an online guide to surviving the dollar crash), with more than 20 years experience in the investment business advising clients on portfolio and trading strategies.

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