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Key Lesson #15: Interest rate and profits

Us: Interest rates and profits are determined by two elements: supply and demand and time preference. Profits are obtained through the creation and sale of products. Interest rates are obtained through the lending of money (a product). Therefore, they both should be determined by the same elements. The higher the demand, the higher the price I will be able to sell my product at and the higher the interest rate I will be able to loan my money at. If the demand is there, the sooner I can sell a product, the higher the price I can ask, and the higher the interest I can demand. This is quite simple and obvious.

Them: classic economic theory says that interest rates are the reward for the productive use of capital. Keynesians disagree, for them, interest rates are the balance between the demand and supply of interest. As you can see, both theories fail to consider the effects of time as a minimum, and fail to consider that capital is not an amorphous stock. Actually, for both theories, these two elements are irrelevant.  In other words, reality is what they say it is and nothing more!


Key Lesson #16: Inflation is caused by fiat money

Us: the price of goods and services depends to a large degree to the amount of money in circulation. Since money is simply the means of exchange, the more of these means are there, the more people will ask for their goods and services. Therefore, any increase in the amount of money that is not met by demand, will increase prices. This means that if banks print money and that money leaves banks’ volts, prices will go up. This is nothing new or revolutionary. Governments and empires have been doing it since the beginning of the human written history. In old times, they would quietly replace gold or silver in coins with copper. Voila! More coins in circulation. Nowdays banks do the same with computers. Click a few buttons in a Central Bank and voila! fresh credit in circulation!

Them: Keynesians say: let’s assume that we have a nearly full employment level and then, let’s assume that demand for goods and services increases globally. In those conditions, we will have inflation. Funny isn’t it? You though that all these decades with record unemployment we had inflation. Well, you were mistaken. According to Keynes, what you experience did not exist!!! Monetarism (an evolution of Keynesianism)  agrees that inflation is simply too much money chasing too few goods. However, their solution is to have Central Banks print “just enough” money to create “price stability”… whatever that may mean. And, of course, we know how successful Central Banks were at achieving this goal. We owe our utopian economic situation to them!


Key Lesson #17: Communism and socialism are economically flawed

Us: we have already touched this topic in previous lessons, so we will only summarize it here. In a free market, prices reflect information, more precisely, people preferences. Manufacturers use these preferences to decide what to make and what not to make. Therefore, only products and services that people will want get produced (give or take). In economic terms, resources get allocated efficiently. In a communist system, there are no prices because there is no free market. Therefore, it is impossible to know what is that people prefer. Therefore, it is impossible to know what to produce. In economic terms, resources are allocated very inefficiently. By intervening in markets and subsidizing partially or completely certain goods and services, they are destroying price information with the same effects.

Them: Keynesians believe that this may or may not be true. The role of the government is to “stimulate” the economy in slowdowns. This stimulus introduces new “wealth” or “money” in the economy, allowing it to recover faster. The only problem with this is that these “stimulus” not only distort prices, but they create inflation, which further distorts prices. Both make the market even more inefficient.  Socialists and communists on the other hand, live in a parallel universe where a solution to this problem will be found, eventually, with some sort of magic process or technology. They have been trying to do just that since the USSR was created and failing miserably. Any time now… for sure….

Note: please see the Glossary if you are unfamiliar with certain words.

Continue to Austrian Economics In Theory - Part 9


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