According to the Austrian Business Cycle Theory proposed by the Austrian School of Economics, Central banks artificially increase the money supply through expansionary monetary policies, which lowers market interest rates. This in turn causes market rates to deviate from the natural rates determined by the market. This phenomenon leads to the cycle of economic prosperity and recession.
In a gold standard system where money is based on gold, assuming there is no central bank, an increase in the supply of gold would also result in a decrease in market interest rates. This would lead to a deviation in market rates. Consequently, this would trigger the cycle of prosperity and recession. This means that even in a gold standard system without a central bank, boom-bust cycles could potentially occur.
According to the perspective of Robert Murphy, a prominent American economist, even in the scenario of commodity money and 100% reserve free banking, the process of new currency entering the loan market and distorting interest rates could lead to unsustainable prosperity.
It is important to note, as per Murphy’s view, that an increase in the supply of gold could also trigger the cycle of prosperity and recession. However, the Mises Economics argues that in practice, the impact of this theoretical possibility is minimal.
Renowned American economist Murray Rothbard disagrees with this notion. He believes that an increase in the supply of gold cannot trigger the cycle of economic prosperity and recession. He argues that the key reason behind the boom-bust cycle lies in the expansionary monetary policies of central banks that initiate the embezzlement of currency supply out of thin air. According to Rothbard, in his seminal work “Man, Economy, and State”, currency inflation does not include the increase in the money supply. Although these increases can have effects similar to raising commodity prices, they differ significantly in other effects.
Rothbard emphasizes that the initiation of the cycle of prosperity and recession is primarily due to the human-made, inflationary increase in the money supply. This increase leads to the transfer of wealth from wealth creators to non-wealth creators and their projects, causing economic prosperity and recession cycles.
One of the primary factors contributing to inflation is the expansion of credit by commercial banks. The expansionary monetary policy of central banks facilitates this credit expansion, resulting in false economic prosperity or economic inflation. When limited savings are pressured by the illusion of economic prosperity, banks start accumulating bad assets. Eventually, banks are forced to slow down the rate of artificial credit expansion. Under the pressure of rising prices, central banks typically implement a contractionary monetary policy. Investments relying on artificial loose money cannot survive in a money contraction, leading to economic recession.
The fraudulent behavior of increasing the money supply through inflation initiates the cycle of economic prosperity and recession. This artificial expansion of money and credit is also a cause of price inflation.
Miners mine gold because there is a market for it. Gold contributes to individual subjective well-being. In this sense, gold is a part of wealth.
Over time, people discovered that gold, traditionally used for making jewelry, holds significant attractiveness as an exchange medium. Therefore, countries may start attributing greater exchange value to gold than before. Therefore, an increase in the supply of gold equates to an increase in wealth, which differs from the inherent artificiality of inflation. When gold producers exchange gold for goods, they engage in barter, exchanging wealth for wealth. New gold in the system needs to be produced and/or exchanged.
In contrast, the issuance of unsupported receipts as an exchange medium lacks gold backing. These receipts function as counterfeit money, leading to increased consumption at the expense of production or savings. This unsecured legal tender initiates the process of creating something out of nothing, distorting price and production structures, thus resulting in the cycle of economic prosperity and recession.
Once these certificates are used to exchange goods and services, it lays the foundation for widespread fraudulent activities. By increasing purchasing and investment signals, this results in artificial economic prosperity. Once this process slows down or stops completely, the flow of wealth to various activities generated by currency inflation halts. Consequently, these activities come under pressure, leading to economic recession. Without the inflation of money and credit transferring wealth to these activities, they would struggle. Without loose money, these activities cannot survive or continue at their current pace.
In conclusion, while inflation-induced increases in the money supply and the supply of gold may cause changes in price relationships and market interest rates, an increase in the supply of gold alone does not spark the boom-bust cycle. Fundamentally, the cycle of prosperity and recession is generated by the artificial expansion of money supply through human interventions.
If the variation in interest rates is due to an increase in the supply of gold – which is an increase in wealth – then the cycle of prosperity and recession would not arise. However, the Cantillon Effect would likely come into play. An increase in the supply of gold leads to changes in prices and market interest rates, which could provoke fluctuations in economic activities. Nonetheless, the boom-bust cycle is not related to market fluctuations but rather to the monetary policy of currency inflation.
The cycle of economic prosperity and recession stems from embezzlement. This cycle refers to the transfer of wealth from genuine wealth creators to holders of artificially created currency. In a free-market economy, change is constant with no stability, but this does not equate to the chaos caused by monetary interventionism.
The crucial factor giving rise to the cycle of prosperity and recession is the inflationary growth of the money supply. An increase in the money supply triggers barter, changing price relationships, wealth transitions, and distortion of capital structures.
In contrast, an increase in the supply of gold is different. A rise in the supply of gold constitutes an increase in wealth and production supply. This increase does not lead to the exchange of “nothing” for “something.”
Unlike activities that do not create wealth and are unsustainable, activities that genuinely create wealth can sustain themselves without the expansion of money and credit through currency inflation channeling wealth to them through fraudulent means. Artificially increasing the money supply, rather than the supply of gold, poses a threat to the cycle of prosperity and recession.
This article is sourced from the Mises Institute website, based in Alabama.
Author Bio:
Dr. Frank Shostak is an affiliated scholar at the Mises Institute in Alabama. He founded the consultancy firm “Applied Austrian School Economics,” providing in-depth assessments and reports on financial markets and the global economy. He has taught at the University of Pretoria in South Africa and the Witwatersrand University School of Business.