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

Additional Considerations on the Theory of the Business Cycle 461In an economy which shows healthy, sustained growth,voluntary savings flow into the productive structure by tworoutes: either through the self-financing of companies, orthrough the stock market. Nevertheless the arrival of savingsvia the stock market is slow and gradual and does not involvestock market booms or euphoria. 61Only when the banking sector initiates a policy of creditexpansion unbacked by a prior increase in voluntary saving dostock market indexes show dramatic and sustained overallgrowth. In fact newly-created money in the form of bank loansreaches the stock market at once, starting a purely speculativeupward trend in market prices which generally affects mostsecurities to some extent. Prices may continue to mount as longas credit expansion is maintained at an accelerated rate. Creditexpansion not only causes a sharp, artificial relative drop ininterest rates, along with the upward movement in marketprices which inevitably follows. It also allows securities withissuance of bank deposits necessary for the financing of production projects.We are now in a position to grasp why this criticism is unjustified. Thereality is actually quite the opposite: banks’ ability to finance investmentprojects via credit expansion unbacked by real saving is precisely whatplaces banks in a position of prominence in many investment projects, tothe detriment of the stock market, which loses importance in the processof investment and in many instances becomes a secondary market which,throughout the cycle, follows the guidelines set by the banking sector.61 Only a sudden, improbable drop in society’s rate of time preferencewould allow stock-market indexes, in the absence of credit expansion, tojump to a new, consolidated level, from which point, at most, slow, gradualstock-market growth could take place. Thus continuously-prolongedstock-market booms and euphoria are invariably artificial and fed bycredit expansion. Moreover such episodes of euphoria encourage thepublic to postpone consumption for the short term and invest cash balancesin the stock market. Therefore while expectations of stock-marketbooms fed by credit expansion last, the crisis and recession can be temporarilypostponed. This is what happened at the end of the 1990s, beforethe severe stock-market adjustment of 2000–2001. See Philipp Bagus,“Asset Prices: An Austrian Perspective,” Procesos de Mercado 4, no. 2(Autumn, 2007): 57–93, and Edith Skriner, “Did Asset Prices Cause theCurrent Crisis?” in The First Great Recession of the 21st Century: CompetingExplanations, Óscar Dejuán, Eladio Febrero, Maria Cristina Marcuzzo, eds.(Cheltenham, U.K. and Northampton, Mass., U.S.A.: Edward Elgar, 2011).