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

462 Money, Bank Credit, and Economic Cyclescontinuously rising prices to be used as collateral for new loanrequests in a vicious circle which feeds on continual, speculativestock market booms, and which does not come to an endas long as credit expansion lasts. As Fritz Machlup explains:If it were not for the elasticity of bank credit, which has oftenbeen regarded as such a good thing, the boom in securityvalues could not last for any length of time. In the absenceof inflationary credit the funds available for lending to thepublic for security purchases would soon be exhausted. 62Therefore (and this is perhaps one of the most importantconclusions we can reach at this point) uninterrupted stockmarket growth never indicates favorable economic conditions.Quite the contrary: all such growth provides the mostunmistakable sign of credit expansion unbacked by real savings,expansion which feeds an artificial boom that will invariablyculminate in a severe stock market crisis.By the same token, as Hayek has shown, the significant capitalgains acquired on the stock market during the expansionstage, to the extent economic agents consider them an additionto their wealth and spend them on the purchase of consumergoods and services, imply substantial consumption of capital,an event which will ultimately make society poorer. 63Even when, analytically speaking, it is perfectly easy toidentify the processes which tend to reverse the investmentprojects undertaken in error as a result of credit expansion, itis impossible to determine in advance exactly when and under62 Machlup, The Stock Market, Credit and Capital Formation, p. 92. Thisbook by Machlup is essential to understanding the cycle’s influence onthe stock market.63 Stock Exchange profits made during such periods of capitalappreciation in terms of money, which do not correspond toany proportional increase of capital beyond the amountwhich is required to reproduce the equivalent of currentincome, are not income, and their use for consumption purposesmust lead to a destruction of capital. (F.A. Hayek, “TheMaintenance of Capital,” Economica 2 [August 1934])This article appears as chapter 3 of Profits, Interest and Investment, pp.83–134. The above excerpt is found on p. 133.