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Business cycles: Why crises happen

An economic crisis may appear to be about financial scams, or profligate spending, but their main cause is too little savings and too much debt. Recognizing the nature of the crisis leads one to also appreciate gold and silver as real money.

Published: 13-02-2013 00:00

Business cycles: Why crises happen

What is covered

The theory about economic ups and downs has been developed over centuries. First of all, the boom-bust cycle should not be confused with singular occurrences such as a discovery of a valuable resource that enriches a community, or of famines due to acts of god. Actually, the boom-bust cycle, or business cycle, pertains only to those phenomena that occur in a ‘cyclical’ manner, wherein the boom is followed by a bust as a matter of course.

History of theory

Even 200 years ago, a monetary or financial explanation was given for business cycles. It was supposed that excess credit results in price increases and excess redemption of certificates in gold. In order to stop the gold supply from vanishing in a country, banks bring up interest rates and make it harder to borrow money. People lose their easy access to credit. This also allows prices to drop once more.

But it was really in the 20th century that the theory was consistently applied to other economic happenings, in particular, employment and productivity. Austrian Ludwig von Mises, who in 1912 presented his business cycle theory, likened it to a builder who overestimates the size of a house, of which he has too few bricks to complete.

Fellow Austrian Friedrich von Hayek, building on Mises’ theory, emphasized the tradeoff between the level of investment, and the level of consumption. According to Hayek, it is the actual amount of savings, that determines the sustainability of an economy. Excess credit will only result in increased spending in certain sectors, to the disadvantage of other sectors. But eventually, consumer and investor preferences will manifest themselves. This may result in prices falling for certain items, and in people losing their jobs. The bust is a period of unemployment before workers and equipment are maintained once more according to the amount of savings in the economy.

Practical application

What good is this knowledge of how economies work? For one thing, we are able to appreciate the monetary nature of the crises that happen, that is, manipulation of the money supply leads to economic downturns before things can get better. We also see how cycles, by definition, have the inevitable bust after a boom.

With this knowledge, we can dismiss some economists’ claims that issuing more debt, beyond saving levels, can somehow be done to achieve perpetual prosperity, or that this debt problem can be solved by more debt.

For practical purposes, one knows better than to place their money on unsustainable projects, including bonds and most stocks. And, in anticipation of a country’s financial situation getting worse, one has the knowledge to invest in precious metals instead, to preserve their savings.

In a bust, as people withdraw money from once-promising ventures, the savings rate eventually picks up once more. And because currencies depreciate in an inflationary environment, people would prefer to put savings where their purchasing power is maintained. This is where gold and silver come in handy.

Things to come

The current world situation has not been remedied, and ventures based on excess credit won’t last. But as people learn to save more, borrow less and spend less, we can expect a real recovery to take place, as well as for demand for gold and silver to rise.