kidmercury

We've talked about Austrian business cycle theory before, but in light of venture capitalist Peter Rip's recent post, I wanted to revisit the subject.

Rip says he believes "in the business cycle." Presumably he means that he believes markets go up and down, that there is a natural tide of sorts.

Myself, as well as the Austrian school of economics (who advocate commodity money, and is championed by folks like Peter Schiff and Ron Paul) views the business cycle as primarily the result of central banking policy. Basically, if we had commodity money and responsible government, there would be no business cycle. Here's the explanation:

1. Business people are trained to find opportunities and to manage risk.
2. Contrary to popular belief, astute business people are not a bunch of maniacs who suffer from "irrational exuberance." Savvy investors tend to be mild-mannered, calm, and display a mercenary-like attitude. You know how the conventional image of a business person is a risk-averse person who conforms to social standards (sort of like the opposite of me )? That's because astute business people are not reckless gamblers. In fact, the best business people tend to have the best understanding of risk/reward; that's a big part of what makes them successful.
3. At this point you may be saying, "But Kid Mercury, you're talking as though all business people are wonderful, brilliant people. This is simply not the case. What about all the foolish investments and reckless corporate behavior?" True, it does in fact exist. But the market prices fools out. In fact, that is what the market is currently trying to do via the destruction of wealth that happened in 2008 (and will likely continue to happen); it is pricing out all the false value.
4. At this point you may counter: "A ha! The fact that there is so much pricing out that needs to be done is proof that that the market is filled with fools!" Not so. According to Austrian business cycle theory, the reason why all these poor investments were made (think of all the terrible investments made in the initial dot com bubble) is because the money supply was excessively expanded via excessively low interest rates. This distorts analysis. For instance, back in the dot com bubble, CDNow was paying $40 to acquire customers when the lifetime value of the customer proved to be $25. Excessive expansion of the money supply distorted their analysis.
5. Excessive expansion of the money supply also fuels excessive speculation (i.e. dot com day traders, people who flipped houses) as well as scams involving lending (daytrading on ridiculous amounts of margin, giving home loans to people with bad credit for no money down).
6. The market, though, is very powerful, and will always try to revert the money supply back to a more appropriate level. Currently, the government is refusing to allow this happens. This means the taxpayer will pay for the losses, either via direct taxation or (more likely) through currency devaluation/higher prices.

And this is precisely why this crisis is going to be so bad. If the free market were left to its natural course, we'd have a very deep, but very short, recession (probably 2 years I'd say, though hard to guess). Instead, because the bubble is trying to be maintained, the bust will be that much bigger -- because the business cycle is an illusion to begin with. In fact, this collapse is not just the housing market trying to correct itself, but it's also the dot com bubble trying to correct itself as well, because a full deflation of that bubble was not allowed since the Fed lowered rates AGAIN back in 2003. This is why healthy technology companies like Apple and Google are experiencing massive declines in share price.

This time, though, there are no more bubbles to blow. The game is over; Treasury bonds seem to be the last one. And that's why this downturn is a game changer like one most people haven't seen in their lifetime.