XX. INTEREST, CREDIT EXPANSION, AND THE TRADE CYCLE
6. The Gross Market Rate of Interest as Affected by Inflation and Credit Expansion
Whatever the ultimate effects of an inflationary or deflationary movement upon the height of the rate of originary interest may be, there is no correspondence between them and the temporary alterations which a cash-induced change in the money relation can bring about in the gross market rate of interest. If the inflow of money and money-substitutes into the market system or the outflow from it affects the loan market first, it temporarily disarranges the congruity between the gross market rates of interest and the rate of originary interest. The market rate rises or drops on account of the decrease or increase in the amount of money offered for lending, with no correlation to changes in the originary rate of interest which in the later course of events can possibly occur from the changes in the money relation. The market rate deviates from the height determined by [p. 551] that of the originary rate of interest, and forces come into operation which tend to adjust it anew to the ratio which corresponds to that of originary interest. It may happen that in the period of time which this adjustment requires, the height of originary interest varies, and this change can also be caused by the inflationary or deflationary process which brought about the deviation. Then the final rate of originary interest determining the final market rate toward which the readjustment tends is not the same rate which prevailed on the eve of the disarrangement. such an occurrence may affect the data of the process of adjustment, but it does not affect its essence.
The phenomenon to be dealt with is this: The rate of originary interest is determined by the discount of future goods as against present goods. It is essentially independent of the supply of money and money-substitutes, notwithstanding the fact that changes in the supply of money and money[substitutes can indirectly affect its height. But the gross market rate of interest can be affected by changes in the money relation. A readjustment must take place. What is the nature of the process which brings it about?
In this section we are concerned only with inflation and credit expansion. For the sake of simplicity we assume that the whole additional amount of money and money-substitutes flows into the loan market and reaches the rest of the market only via the loans granted. This corresponds precisely to the conditions of an expansion of circulation credit. Our scrutiny thus amounts to an analysis of the process caused by credit expansion.
In dealing with this analysis, we must refer again to the price premium. It has been mentioned already that at the very beginning of a credit expansion no positive price premium arises. a price premium cannot appear until the additional supply of money (in the broader sense) has already begun to affect the prices of commodities and services. but as long as credit expansion goes on and additional quantities of fiduciary media are hurled on the loan market, there continues a pressure upon the gross market rate of interest. The gross market rate would have to rise on account of the positive price premium which, with the progress of the expansionist process, would have to rise continually. but as credit expansion goes on, the gross market rate continues to lag behind the height at which it would cover both originary interest plus the positive price premium.
It is necessary to stress this point because it explodes the customary methods according to which people distinguish between what they consider low and high rates of interest. It is usual to take into account [p. 552] merely the arithmetical height of the rates or the trend which appears in their movement. public opinion has definite ideas about a "normal" rate, something between 3 and 5 per cent. When the market rate rises above this height or when the market rates--without regard to their arithmetical ratio--are rising above their previous height, people believe that they are right in speaking of high or rising interest rates. As against these errors, it is necessary to emphasize that under the conditions of a general rise in prices (drop in the monetary unit's purchasing power) the gross market rate of interest can be considered as unchanged with regard to conditions of a period of a by and large unchanging purchasing power only if it includes a by and large adequate positive price premium. In this sense, the German Reichsbank's discount rate of 90 per cent was, in the fall of 1923, a low rate--indeed a ridiculously low rate--as it considerably lagged behind the price premium and did not leave anything for the other components of the gross market rate of interest. Essentially the same phenomenon manifests itself in every instance of a prolonged credit expansion. Gross market rates of interest rise in the further course of every expansion, but they are nonetheless low as they do not correspond to the height required by the expected further general rise in prices.
In analyzing the process of credit expansion, let us assume that the economic system's process of adjustment to the market data and of movement toward the establishment of final prices and interest rates is disturbed by the appearance of a new datum, namely, an additional quantity of fiduciary media offered on the loan market. At the gross market rate which prevailed on the eve of this disturbance, all those who were ready to borrow money at this rate, due allowance being made for the entrepreneurial component in each case, could borrow as much as they wanted. Additional loans can be placed only at a lower gross market rate. It does not matter whether this drop in the gross market rate expresses itself in an arithmetical drop in the percentage stipulated in the loan contracts. It could happen that the nominal interest rates remain unchanged and that the expansion manifests itself in the fact that at these rates loans are negotiated which would not have been made before on account of the height of the entrepreneurial component to be included. Such an outcome too amounts to a drop in gross market rates and brings about the same consequences.
A drop in the gross market rate of interest affects the entrepreneur's calculation concerning the chances of the profitability of projects considered. Along with the prices of the material factors of production, wage rates, and the anticipated future prices of the products, [p. 553] interest rates are items that enter into the planning businessman's calculation. The result of this calculation shows the businessman whether or not a definite project will pay. It shows him what investments can be made under the given state of the ratio in the public's valuation of future goods as against present goods. It brings his actions into agreement with this valuation. It prevents him from embarking upon projects the realization of which would be disapproved by the public because of the length of the waiting time they require. It forces him to employ the available stock of capital goods in such a way as to satisfy best the most urgent wants of the consumers.
But now the drop in interest rates falsifies the businessman's calculation. although the amount of capital goods available did not increase, the calculation employs figures which would be utilizable only if such an increase had taken place. The result of such calculations is therefore misleading. They make some projects appear profitable and realizable which a correct calculation, based on an interest rate not manipulated by credit expansion, would have shown as unrealizable. Entrepreneurs embark upon the execution of such projects. Business activities are stimulated. A boom begins.
The additional demand on the part of the expanding entrepreneurs tends to raise the prices of producers' goods and wage rates. With the rise in wage rates, the prices of consumers' goods rise too. Besides, the entrepreneurs are contributing a share to the rise in the prices of consumers' goods as they too, deluded by the illusory gains which their business accounts show, are ready to consume more. The general upswing in prices spreads optimism. If only the prices of producers' goods had risen and those of consumers' goods had not been affected, the entrepreneurs would have become embarrassed. They would have had doubts concerning the soundness of their plans, as the rise in costs of production would have upset their calculations. But they are reassured by the fact that the demand for consumers' goods is intensified and makes it possible to expand sales in spite of rising prices. Thus they are confident that production will pay, notwithstanding the higher costs it involves. They are resolved to go on.
Of course, in order to continue production on the enlarged scale brought about by the expansion of credit, all entrepreneurs, those who did expand their activities no less than those who produce only within the limits in which they produced previously, need additional funds as the costs of production are now higher. If the credit expansion consists merely in a single, not repeated injection of a definite [p. 554] amount of fiduciary media into the loan market and then ceases altogether, the boom must very soon stop. The entrepreneurs cannot procure the funds they need for the further conduct of their ventures. This gross market rate of interest rises because the increased demand for loans is not counterpoised by a corresponding increase in the quantity of money available for lending. Commodity prices drop because some entrepreneurs are selling inventories and others abstain from buying. The size of business activities shrinks again. The boom ends because the forces which brought it about are no longer in operation. The additional quantity of circulation credit has exhausted its operation upon prices and wage rates. Prices, wage rates, and the various individuals' cash holdings are adjusted to the new money relation; they move toward the final state which corresponds to this money relation, without being disturbed by further injections of additional fiduciary media. The rate of originary interest which is coordinated to this new structure of the market acts with full momentum upon the gross market rate of interest. The gross market rate is no longer subject to disturbing influences exercised by cash-induced changes in the supply of money (in the broader sense).
The main deficiency of all attempts to explain the boom--viz., the general tendency to expand production and of all prices to rise--without reference to changes in the supply of money or fiduciary media, is to be seen in the fact that they disregard this circumstance. A general rise in prices can only occur if there is either a drop in the supply of all commodities or an increase in the supply of money (in the broader sense). Let us, for the sake of argument, admit for the moment that the statements of these nonmonetary explanations of the boom and the trade cycle are correct. Prices advance and business activities expand although no increase in the supply of money has occurred. Then very soon a tendency toward a drop in prices must arise, the demand for loans must increase, the gross market rates of interest must rise, and the short-lived boom comes to an end. In fact, every nonmonetary trade-cycle doctrine tacitly assumes--or ought logically to assume--that credit expansion is an attendant phenomenon of the boom. It cannot help admitting that in the absence of such a credit expansion no boom could emerge and that the increase in the supply of money (in the broader sense) is a necessary condition of the general upward movement of prices. Thus on close inspection the statements of the nonmonetary explanations of cyclical fluctuations shrink to the assertion that credit expansion, while an indispensable [p. 555] requisite of the boom, is in itself alone not sufficient to bring it about and that some further conditions are required for its appearance.
Yet, even in this restricted sense, the teachings of the nonmonetary doctrines are vain. It is evident that every expansion of credit must bring about the boom as described above. The boom-creating tendency of credit expansion can fail to come only if another factor simultaneously counterbalances its growth. If, for instance, while the banks expand credit, it is expected that the government will completely tax away the businessmen's "excess" profits or that it will stop the further progress of credit expansion as soon as "pump-priming" will have resulted in rising prices, no boom can develop. The entrepreneurs will abstain from expanding their ventures with the aid of the cheap credits offered by the banks because they cannot expect to increase their gains. It is necessary to mention this fact because it explains the failure of the New Deal's pump-priming measures and other events of the 'thirties.
The boom can last only as long as the credit expansion progresses at an ever-accelerated pace. The boom comes to an end as soon as additional quantities of fiduciary media are no longer thrown upon the loan market. But it could not last forever even if inflation and credit expansion were to go on endlessly. It would then encounter the barriers which prevent the boundless expansion of circulation credit. It would lead to the crack-up boom and the breakdown of the whole monetary system.
The essence of monetary theory is the cognition that cash-induced changes in the money relation affect the various prices, wage rates, and interest rates neither at the same time nor to the same extent. If this unevenness were absent, money would be neutral; changes in the money relation would not affect the structure of business, the size and direction of production in the various branches of industry, consumption, and the wealth and income of the various strata of the population. Then the gross market rate of interest too would not be affected--either temporarily or lastingly--by changes in the sphere of money and circulation credit. The fact that such changes can modify the rate of originary interest is caused by the changes which this unevenness brings about in the wealth and income of various individuals. The fact that, apart from these changes in the rate of originary interest, the gross market rate is temporarily affected is in itself a manifestation of this unevenness. If the additional quantity of money enters the economic system in such a way as to reach the loan market only at a date at which it has already made commodity prices and wage rates rise, these immediate temporary effects upon the [p. 556] gross market rate of interest will be either slight or entirely absent. The gross market rate of interest is the more violently affected, the sooner the inflowing additional supply of money or fiduciary media reaches the loan market.
When under the conditions of credit expansion the whole amount of the additional money substitutes is lent to business, production is expanded. The entrepreneurs embark either upon lateral expansion of production (viz., the expansion of production without lengthening the period of production in the individual industry) or upon longitudinal expansion (viz., the lengthening of the period of production). In either case, the additional plants require the investment of additional factors of production. But the amount of capital goods available for investment has not increased. Neither does credit expansion bring about a tendency toward a restriction of consumption. It is true, as has been pointed out above in dealing with forced saving, that in the further progress of the expansion a part of the population will be compelled to restrict its consumption. But it depends on the particular conditions of each instance of credit expansion whether this forced saving of some groups of the people will overcompensate the increase in consumption on the part of other groups and will thus result in a net increase in the total amount of saving in the whole market system. At any rate, the immediate consequence of credit expansion is a rise in consumption on the part of those wage earners whose wages have risen on account of the intensified demand for labor displayed by the expanding entrepreneurs. Let us for the sake of argument assume that the increased consumption of these wage earners favored by the inflation and the forced saving of other groups prejudiced by the inflation are equal in amount and that no change in the total amount of consumption has occurred. Then the situation is this: Production has been altered in such a way that the length of waiting time has been extended. But the demand for consumers' goods has not dropped so as to make the available supply last for a longer period. Of course, this fact results in a rise in the prices of consumers' goods and thus brings about the tendency toward forced saving. However, this rise in the prices of consumers' goods strengthens the tendency of business to expand. The entrepreneurs draw from the fact that demand and prices are rising the inference that it will pay to invest and to produce more. They go on and their intensified activities bring about a further rise in the prices of producers' goods, in wage rates, and thereby again in the prices of consumers' goods. Business booms as long as the banks are expanding credit more and more. [p. 557]
On the eve of the credit expansion all those production processes were in operation which, under the given state of the market data, were deemed profitable. The system was moving toward a state in which all those eager to earn wages would be employed and all nonconvertible factors of production would be employed to the extent that the demand of the consumers and the available supply of nonspecific material factors and of labor would permit. A further expansion of production is possible only if the amount of capital goods is increased by additional saving, i.e., by surpluses produced and not consumed. The characteristic mark of the credit-expansion boom is that such additional capital goods have not been made available. The capital goods required for the expansion of business activities must be withdrawn from other lines of production.
We may call p the total supply of capital goods available on the eve of the credit expansion, and g the total amount of consumers' goods which these p could, over a definite period of time, make available for consumption without prejudice to further production. Now the entrepreneurs, enticed by credit expansion, embark upon the production of an additional quantity of g3 of goods of the same kind which they already used to produce, and of a quantity of g4 of goods of a kind not produced by them before. For the production of g3 a supply of p3 of capital goods is needed, and for the production of g4 a supply of p4. But as, according to our assumptions, the amount of capital goods available has remained unaltered, the quantities p3 and p4 are lacking. It is precisely this fact that distinguishes the "artificial" boom created by credit expansion from a "normal" expansion of production which only the addition of p3 and p4 to p can bring about.
Let us call r that amount of capital goods which, out of the gross proceeds of production over a definite period of time, must be reinvested for the replacement of those parts of p used up in the process of production. If r is employed for such replacement, one will be in a position to turn out g again in the following period of time; if r is withheld from this employment, p will be reduced by r, and p - r will turn out in the following period of time only g - a. We may further assume that the economic system affected by credit expansion is a progressing system. It produced "normally," as it were, in the period of time preceding the credit expansion a surplus of capital goods p1 + p2. If no credit expansion had intervened, p1 would have been employed for the production of an additional quantity of g1 of the kind of goods produced previously, and p2 for the production of the supply of g2 of a kind of goods not produced before. The total [p. 558] amount of capital goods which are at the entrepreneurs' disposal and with regard to which they are free to make plans is r + p1 + p2. However, deluded by the cheap money, they act as if r + p1 + p2 + p3 + p4 were available and as if they were in a position to produce not only g + g1 + g2, but beyond this also g3 + g4. They outbid one another in competing for a share of a supply of capital goods which is insufficient for the realization of their overambitious plans.
The ensuing boom in the prices of producers' goods may at the beginning outrun the rise in the prices of consumer's goods. It may thus bring about a tendency toward a fall in the originary rate of interest. But with further progress of the expansionist movement the rise in the prices of the consumers' goods will outstrip the rise in the prices of producers' goods. The rise in wages and salaries and the additional gains of the capitalists, entrepreneurs, and farmers, although a great part of them is merely apparent, intensify the demand for consumers' goods. There is no need to enter into a scouting of the assertion of the advocates of credit expansion that the boom can, by means of forced saving, really increase the total supply of consumers' goods. At any rate, it is certain that the intensified demand for consumers' goods affects the market at a time when the additional investments are not yet in a position to turn out their products. The gulf between the prices of present goods and those of future goods widens again. A tendency toward a rise in the rate of originary interest is substituted for the tendency toward the opposite which may have come into operation at the earlier stages of the expansion.
This tendency toward a rise in the rate of originary interest and the emergence of a positive price premium explain some characteristics of the boom. The banks are faced with an increased demand for loans and advances on the part of business. The entrepreneurs are prepared to borrow money at higher gross rates of interest. They go on borrowing in spite of the fact that banks charge more interest. Arithmetically, the gross rates of interest are rising above their height on the eve of the expansion. Nonetheless, they lag catallactically behind the height at which they would cover originary interest plus entrepreneurial component and price premium. The banks believe that they have done all that is needed to stop "unsound" speculation when they lend on more onerous terms. They think that those critics who blame them for fanning the flames of the boom-frenzy of the market are wrong. They fail to see that in injecting more and more fiduciary media into the market they are in fact kindling the boom. It is the continuous increase in the supply of the fiduciary media that produces, feeds, and accelerates the boom. The state of the gross [p. 559] market rates of interest is only an outgrowth of this increase. If one wants to know whether or not there is credit expansion, one must look at the state of the supply of fiduciary media, not at the arithmetical state of interest rates.
It is customary to describe the boom as overinvestment. However, additional investment is only possible to the extent that there is an additional supply of capital goods available. As, apart from forced saving, the boom itself does not result in a restriction but rather in an increase in consumption, it does not procure more capital goods for new investment. The essence of the credit-expansion boom is not overinvestment, but investment in wrong lines, i.e., malinvestment. The entrepreneurs employ the available supply of r + p1 + p2 as if they were in a position to employ a supply of r + p1 + p2 + p3 + p4. They embark upon an expansion of investment on a scale for which the capital goods available do not suffice. Their projects are unrealizable on account of the insufficient supply of capital goods. They must fail sooner or later. The unavoidable end of the credit expansion makes the faults committed visible. There are plants which cannot be utilized because the plants needed for the production of the complementary factories of production are lacking; plants the products of which cannot be sold because the consumers are more intent upon purchasing other goods which, however, are not produced in sufficient quantities; plants the construction of which cannot be continued and finished because it has become obvious that they will not pay.
The erroneous belief that the essential feature of the boom is overinvestment and not malinvestment is due to the habit of judging conditions merely according to what is perceptible and tangible. The observer notices only the malinvestments which are visible and fails to recognize that these establishments are malinvestments only be cause of the fact that other plants--those required for the production of the complementary factors of production and those required for the production of consumers' goods more urgently demanded by the public--are lacking. Technological conditions make it necessary to start an expansion of production by expanding first the size of the plants producing the goods of those orders which are farthest removed from the finished consumers' goods. In order to expand the production of shoes, clothes, motorcars, furniture, houses, one must begin with increasing the production of iron, steel, copper, and other such goods. In employing the supply of r + p1 + p2 which would suffice for the production of a + g1 + g2 as if it were r + p1 + p2 + p2 + p3 + p4 and would suffice for the production of
a + g1 + g2 + g3 + g4, [p. 560] one must first engage in increasing the output of those products and structures which for physical reasons are first required. The whole entrepreneurial class is, as it were, in the position of a master-builder whose task it is to erect a building out of a limited supply of building materials. If this man overestimates the quantity of the available supply, he drafts a plan for the execution of which the means at his disposal are not sufficient. He oversizes the groundwork and the foundations and only discovers later in the progress of the construction that he lacks the material needed for the completion of the structure. It is obvious that our master-builder's fault was not overinvestment, but an inappropriate employment of the means at his disposal.
It is no less erroneous to believe that the events which resulted in the crisis amounted to an undue conversion of "circulating" capital into "fixed" capital. The individual entrepreneur, when faced with the credit stringency of the crises, is right in regretting that he has expended too much for an expansion of his plant and for the purchase of durable equipment; he would have been in a better situation if the funds used for these purposes were still at his disposal for the current conduct of business. However, raw materials, primary commodities, half-finished manufactures and foodstuffs are not lacking at the turning point at which the upswing turns into the depression. On the contrary, the crisis is precisely characterized by the fact that these goods are offered in such quantities as to make their prices drop sharply.
The foregoing statements explain why an expansion in the production facilities and the production of the heavy industries, and in the production of durable producers' goods, is the most conspicuous mark of the boom. The editors of the financial and commercial chronicles were right when--for more than a hundred years--they looked upon production figures of these industries as well as of the construction trades as an index of business fluctuations. They were only mistaken in referring to an alleged overinvestment.
Of course, the boom affects also the consumers' goods industries. They too invest more and expand their production capacity. However, the new plants and the new annexes added to the already existing plants are not always those for the products of which the demand of the public is most intense. They may well have agreed with the whole plan aiming at the production of r + g1 + g2 + g3 + g4. The failure of this oversized plan discloses their inappropriateness.
A sharp rise in commodity prices is not always an attending phenomenon of the boom. The increase of the quantity of fiduciary media certainly always has the potential effect of making prices rise. [p. 561] But it may happen that at the same time forces operating in the opposite direction are strong enough to keep the rise in prices within narrow limits or even to remove it entirely. The historical period in which the smooth working of the market economy was again and again interrupted through expansionist ventures was an epoch of continuous economic progress. The steady advance in the accumulation of new capital made technological improvement possible. Output per unit of input was increased and business filled the markets with increasing quantities of cheap goods. If the synchronous increase in the supply of money (in the broader sense) had been less plentiful than it really was, a tendency toward a drop in the prices of all commodities would have taken effect. As an actual historical event credit expansion was always embedded in an environment in which powerful factors were counteracting its tendency to raise prices. As a rule the resultant of the clash of opposites forces was a preponderance of those producing a rise in prices. But there were some exceptional instances too in which the upward movement of prices was only slight. The most remarkable example was provided by the American boom of 1926-29. 
The essential features of a credit expansion are not affected by such a particular constellation of the market data. What induces an entrepreneur to embark upon definite projects is neither high prices nor low prices as such, but a discrepancy between the costs of production, inclusive of interest on the capital required, and the anticipated prices of the products. A lowering of the gross market rate of interest as brought about by credit expansion always has the effect of making some projects appear profitable which did not appear so before. It actuates business to employ r + p1 + p2 as if it were r + p1 + p2 + p3 + p4. It necessarily brings about a structure of investment and production activities which is at variance with the real supply of capital goods and must finally collapse. That sometimes the price changes involved are laid against a background of a general tendency toward a rise in purchasing power and do not convert this tendency into its manifest opposite but only into something which may by and large be called price stability, modifies merely some accessories of the process.
However conditions may be, it is certain that no manipulations of the banks can provide the economic system with capital goods. What is needed for a sound expansion of production is additional capital goods, not money or fiduciary media. The credit expansion boom is built on the sands of banknotes and deposits. It must collapse.
The breakdown appears as soon as the banks become frightened [p. 562] by the accelerated pace of the boom and begin to abstain from further expansion of credit. The boom could continue only as long as the banks were ready to grant freely all those credits which business needed for the execution of its excessive projects, utterly disagreeing with the real state of the supply of factors of production and the valuations of the consumers. These illusory plans, suggested by the falsification of business calculation as brought about by the cheap money policy, can be pushed forward only if new credits can be obtained at gross market rates which are artificially lowered below the height they would reach at an unhampered loan market. It is this margin that gives them the deceptive appearance of profitability. The change in the banks' conduct does not create the crisis. It merely makes visible the havoc spread by the faults which business has committed in the boom period.
Neither could the boom last endlessly if the banks were to cling stubbornly to their expansionist policies. Any attempt to substitute additional fiduciary media for nonexisting capital goods (namely, the quantities p3 and p4) is doomed to failure. If the credit expansion is not stopped in time, the boom turns into the crack-up boom; the flight into real values begins, and the whole monetary system founders. However, as a rule, the banks in the past have not pushed things to extremes. They have become alarmed at a date when the final catastrophe was still far away. 
As soon as the afflux of additional fiduciary media comes to an end, the airy castle of the boom collapses. The entrepreneurs must restrict their activities because they lack the funds for their continuation on the exaggerated scale. Prices drop suddenly because these distressed firms try to obtain cash by throwing inventories on the market dirt cheap. Factories are closed, the continuation of construction projects in progress is halted, workers are discharged. As on the one hand many firms badly need money in order to avoid bankruptcy, and on the other hand no firm any longer enjoys confidence, the entrepreneurial component in the gross market rate of interest jumps to an excessive height. [p. 563]
Accidental institutional and psychological circumstances generally turn the outbreak of the crisis into a panic. The description of these awful events can be left to the historians. It is not the task of catallactic theory to depict in detail the calamities of panicky days and weeks and to dwell upon their sometimes grotesque aspects. Economics is not interested in what is accidental and conditioned by the individual historical circumstances of each instance. Its aim is, on the contrary, to distinguish what is essential and necessary from what is merely adventitious. It is not interested in the psychological aspects of the panic, but only in the fact that a credit-expansion boom must unavoidably lead to a process which everyday speech calls the depression. It must realize that the depression is in fact the process of readjustment, of putting production activities anew in agreement with the given state of the market data: the available supply of factors of production, the valuations of the consumers, and particularly also the state of originary interest as manifested in the public's valuations.
These data, however, are no longer identical with those that prevailed on the eve of the expansionist process. A good many things have changed. Forced saving and, to an even greater extent, regular voluntary saving may have provided new capital goods which were not totally squandered through malinvestment and overconsumption as induced by the boom. Changes in the wealth and income of various individuals and groups of individuals have been brought about by the unevenness inherent in every inflationary movement. Apart from any causal relation to the credit expansion, population may have changed with regard to figures and the characteristics of the individuals comprising them; technological knowledge may have advanced, demand for certain goods may have been altered. The final state to the establishment of which the market tends is no longer the same toward which it tended before the disturbances created by the credit expansion.
Some of the investments made in the boom period appear, when appraised with the sober judgment of the readjustment period, no longer dimmed by the illusions of the upswing, as absolutely hopeless failures. They must simply be abandoned because the current means required for their further exploitation cannot be recovered in selling their products; this "circulating" capital is more ungently needed in other branches of want-satisfaction; the proof is that it can be employed in a more profitable way in other fields. Other malinvestments offer somewhat more favorable chances. It is, of course, true that one would not have embarked upon putting capital goods into them if one had correctly calculated. The inconvertible investments made on their behalf are certainly wasted. But as they are inconvertible, a fait accompli, they present further action with [p. 564] a new problem. If the proceeds which the sale of their products promises are expected to exceed the costs of current operation, it is profitable to carry on. Although the prices which the buying public is prepared to allow for their products are not high enough to make the whole of the inconvertible investment profitable, they are sufficient to make a fraction, however small, of the investment profitable. The rest of the investment must be considered as expenditure without any offset, as capital squandered and lost.
If one looks at this outcome from the point of view of the consumers, the result is, of course, the same. The consumers would be better off if the illusions created by the easy-money policy had not enticed the entrepreneurs to waste scarce capital goods by investing them for the satisfaction of less urgent needs and thereby withholding them from lines of production in which they would have satisfied more urgent needs. but as things are now, they cannot but put up with what is irrevocable. They must for the time being renounce certain amenities which they could have enjoyed if the boom had not engendered malinvestment. but, on the other hand, they can find partial compensation in the fact that some enjoyments are now available to them which would have been beyond their reach if the smooth course of economics activities had not been disturbed by the orgies of the boom. It is slight compensation only, as their demand for those other things which they do not get because of inappropriate employment of capital goods is more intense than their demand for these "substitutes," as it were. But it is the only choice left to them as conditions and data are now.
The final outcome of the credit expansion is general impoverishment. Some people may have increased their wealth; they did not let their reasoning be obfuscated by the mass hysteria, and took advantage in time of the opportunities offered by the mobility of the individual investor. Other individuals and groups of individuals may have been favored, without any initiative of their own, by the mere time lag between the rise in the prices of the goods they sell and those they buy. But the immense majority must foot the bill for the malinvestments and the overconsumption of the boom episode.
One must guard oneself against a misinterpretation of this term impoverishment. It does not necessarily mean impoverishment when compared with the conditions that prevailed on the eve of the credit expansion. Whether or not an impoverishment in this sense takes place depends on the particular data of each case; it cannot be predicated apodictically by catallactics. What catallactics has in mind when asserting that impoverishment is an unavoidable outgrowth of credit [p. 565] expansion is impoverishment as compared with the state of affairs which would have developed in the absence of credit expansion and the boom. The characteristic mark of economic history under capitalism is unceasing economic progress, a steady increase in the quantity of capital goods available, and a continuous trend toward an improvement in the general standard of living. The pace of this progress is so rapid that, in the course of a boom period, it may well outstrip the synchronous losses caused by malinvestment and overconsumption. Then the economic system as a whole is more prosperous at the end of the boom than it was at its very beginning; it appears impoverished only when compared with the potentialities which existed for a still better state of satisfaction.
The Alleged Absence of Depressions Under Totalitarian Management
Many socialist authors emphasize that the recurrence of economic crises and business depressions is a phenomenon inherent in the capitalist mode of production. On the other hand, they say, a socialist system is safe against this evil.
As has already become obvious and will be shown later again, the cyclical fluctuations of business are not an occurrence originating in the sphere of the unhampered market, but a product of government interference with business conditions designed to lower the rate of interest below the height at which the free market would have fixed it. At this point we have only to deal with the alleged stability as secured by socialist planning.
It is essential to realize that what makes the economic crisis emerge is the democratic process of the market. The consumers disapprove of the employment of the factors of production as effected by the entrepreneurs. They manifest their disapprobation by their conduct in buying and abstention from buying. The entrepreneurs, misled by the illusions of the artificially lowered gross market rate of interest, have failed to invest in those lines in which the most urgent needs of the public would have been satisfied in the best possible way. As soon as the credit expansion comes to an end, these faults become manifest. The attitudes of the consumers force the businessmen to adjust their activities anew to the best possible want-satisfaction. It is this process of liquidation of the faults committed in the boom and of readjustment to the wishes of the consumers which is called the depression.
But in a socialist economy it is only the government's value judgments that count, and the people are deprived of any means of making their own value judgments prevail. A dictator does not bother about whether or not the masses approve of his decision concerning how [p. 566] much to devote for current consumption and how much for additional investment. If the dictator invests more and thus curtails the means available for current consumption, the people must eat less and hold their tongues. No crisis emerges because the subjects have no opportunity to utter their dissatisfaction. Where there is no business at all, business can be neither good nor bad. There may be starvation and famine, but no depression in the sense in which this term is used in dealing with the problems of a market economy. Where the individuals are not free to choose, they cannot protest against the methods applied by those directing the course of production activities.
It is no answer to this to object that public opinion in the capitalist countries favors the policy of cheap money. The masses are misled by the assertions of the pseudo-experts that cheap money can make them prosperous at no expense whatever. They do not realize that investment can be expanded only to the extent that more capital is accumulated by saving. They are deceived by the fairy tales of monetary cranks. Yet what counts in reality is not fairy tales, but people's conduct. If men are not prepared to save more by cutting down their current consumption, the means for a substantial expansion of investment are lacking. l'hcse means cannot be provided by printing banknotes and by credit on the bank books.
It is a common phenomenon that the individual in his capacity as a voter virtually contradicts his conduct on the market. Thus, for instance, he may vote for measures which will raise the price of one commodity or of all commodities, while as a buyer he wants to see these prices low. Such conflicts arise out of ignorance and error. As human nature is, they can happen. But in a social organization in which the individual is neither a voter nor a buyer, or in which voting and buying are merely a sham, they are absent.
 About the "long-wave" fluctuations, see below, p. 575.
 Cf. G.v. Haberler, Prosperity and Depression (new ed. League of Nations' Report, Geneva, 1939), p. 7.
 Cf. M.N. Rothbard, America's Great Depression (Princeton, 1963).
 One should not fall prety to the illusion that these changes in the credit policies of the
banks were caused by the bankers' and the monetary authorities' insight into the unavoidable consequences of
a continued credit expansion. What induced the turn in the banks' conduct was certain institutional
conditions to be dealt with further below, on pp. 796-797. Among the champions of economics some private bankers
were prominent; in particular, the elaboration of the early form of the theory of business fluctuations, the Currency Theory,
was for the most part an achievement of the British bankers. But the management of the central banks and the conduct
of the various governments' monetary policies was as a rule entrusted to men who did not find any fault with
boundless credit expansion and took offense at every criticism of their expansionist ventures.
 Cf. below, pp. 793-795.
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