Does a Boom Have to go Bust?

The Austrian Business Cycle Theory teaches us that when we have an artificial boom, usually caused by a central bank, a correction must follow.  The artificial boom is a misallocation of resources that will eventually be corrected when the rate of increase of the money supply goes down.  The actual money supply does not actually have to decrease as the bust can come just from a slowdown in the monetary inflation.

To answer the question of this post, there are a couple of scenarios to deal with.  First, if there is a boom that is not caused by an increase in money and credit, then there doesn’t have to be a bust and there probably won’t be.  The boom would probably look nothing like what we are accustomed to in our modern world of inflation.  Most of 19th century America was a boom, but it didn’t mean huge gains in the stock market or real estate market.  In fact, consumer prices actually when down gradually during this time. (I am not counting the problems during and after Lincoln’s war.)

19th century America was far from perfect.  Even aside from slavery and the war, it was still not a completely free market economy.  But it was one of the closest things we have seen in history and it meant an increase in the living standard for the average American.  A boom in a free market economy means that living standards are rising.  Life is getting easier for the average person.

The next question is: Is it possible to have an artificial boom without a bust?  The question certainly seems relevant to our situation today.  In an article earlier this week, Robert Murphy discusses the fact that we will have to experience a bust in our current situation.  I basically agree with everything he says, except I would like to clarify one thing from his article.

In an earlier part of his article, Murphy says, “According to the Mises-Hayek theory, the preceding boom makes the corrective bust inevitable.  The goal, therefore, is not to keep the boom going, but to avoid it in the first place, rendering the bust unnecessary.”

I completely agree with the latter part of that quotation.  The boom phase is actually the bad part where mistakes are being made.  It is a misallocation of resources.  The bust phase is more painful, but it is actually trying to correct the previous mistakes.  If there was no artificial boom in the first place, then a bust wouldn’t be necessary.

But what about the statement that the preceding boom makes the corrective bust inevitable.  I agree with this in a sense, but only with clarification.  As long as the bust does not necessarily mean negative growth, then I agree with this.  The previous mistakes are going to be corrected by the market.  But just because there is an artificial boom, it doesn’t necessarily mean negative growth sometime ahead.  It could simply mean less growth than what would have otherwise happened.

To use an extreme example, let’s say the Fed expanded the money supply by $1 million.  In a $15 trillion economy, this is literally a drop in the ocean.  Conceivably, it could cause some kind of a misallocation of resources on the margin in some insignificant way.  Maybe the price of a particular good was one cent higher because of this monetary expansion.  But it would be absurd to think that this would cause any kind of noticeable bust.  Perhaps resources would realign themselves in the same insignificant way that they were misallocated, but it wouldn’t cause negative growth for sure.

Even if the Fed’s expansion were bigger, it would still be a race between the free market and the artificial tampering of the money supply.  The damage done by the Fed’s monetary inflation might be overcome with technology, investment, and growth.  In today’s situation, that scenario seems unlikely due to the unprecedented monetary inflation by the Fed, along with the huge government debt.  Technically it would still be possible to avoid negative growth if there is some huge technological discovery that can overcome the previous damage done, but it would have to be something really big.

A good analogy for this is price inflation.  Just because the Fed prints money (or creates it on a computer) doesn’t mean that there has to be a rise in prices for everything.  The electronics industry is a good example of this.  Television, cell phones, and computers get cheaper despite monetary inflation.  Technology in these areas is actually more powerful than the Fed’s damaging inflation.  However, prices would have gone down even more if it hadn’t been for the Fed’s monetary inflation.

In conclusion, the Fed’s tampering with the money supply means that resources are being misallocated.  With a slowdown in the growth of money, the free market will try to correct this misallocation and try to realign resources to their best uses.  The market it always trying to do this regardless of the central bank’s policies.

An artificial boom will make things worse than they otherwise would have been.  You can call the correction a bust, but it doesn’t necessarily mean negative growth.  Technology can overcome this, but it doesn’t seem likely in our current scenario where the government and the Fed have intervened in an unprecedented manner.