Money, Bank Credit, and Economic Cycles - The Ludwig von Mises ...

368 Money, Bank Credit, and Economic Cyclesbring in less profit, an accounting result of a rise in costs morerapid than the corresponding increase in income. These twofactors produce the following combined effect: it graduallybecomes evident throughout the productive structure that theaccounting profits generated in the stages closest to consumption arehigher in relative terms than the accounting profits earned in thestages furthest from it. This prompts entrepreneurs to rethinktheir investments and even to doubt their soundness. It compelsthem to again consider the need to reverse their initialinvestment of resources by withdrawing them from more capital-intensiveprojects which have barely gotten off the groundand returning them to the stages closest to consumption. 774. The “Ricardo Effect.”In addition, the more-than-proportional rise in the price ofconsumer goods with respect to the increase in original-factorincome begins to drive down (in relative terms) the realincome of these factors, particularly wages. This real reduction77 Sooner or later, then, the increase in the demand for consumers’goods will lead to an increase of their prices and ofthe profits made on the production of consumers’ goods. Butonce prices begin to rise, the additional demand for fundswill no longer be confined to the purposes of new additionalinvestment intended to satisfy the new demand. At first—andthis is a point of importance which is often overlooked—onlythe prices of consumers’ goods, and of such other goods ascan rapidly be turned into consumers’ goods, will rise, andconsequently profits also will increase only in the late stagesof production. . . . [T]he prices of consumers’ goods wouldalways keep a step ahead of the prices of factors. That is, solong as any part of the additional income thus created is spent onconsumers’ goods (i.e., unless all of it is saved), the prices of consumers’goods must rise permanently in relation to those of the variouskinds of input. And this, as will by now be evident, cannotbe lastingly without effect on the relative prices of the variouskinds of input and on the methods of production that willappear profitable. (Hayek, The Pure Theory of Capital, pp.377–78; italics added)In an environment of increasing productivity (such as the one experiencedduring the period from 1995 to 2005), the (unit) prices of consumergoods will not rise significantly, yet the (monetary) amount companiesclosest to consumption bring in in sales and total profits will soar.