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Key Lesson #18: Booms and busts are due to fiat money

Us: One critical observation of Austrian Economics is that wherever there was no government or government impacts in the economy were low, there were no large cycles of boom and bust in it. In other words, the natural tendency of the economy is to grow smoothly with small and  short jumps and falls here and there. Therefore, there must be a link between government and big economic crisis. The link was eventually found: fiat money. The process works as follows. Government wishes to “stimulate” the economy and orders the Central Bank to print money. In so doing and because there is now more money, interest rates drop. Low interest rates transmit the wrong information to entrepreneurs. The message in this information is simply that economic risks are very low. Also, many people now find borrowing easy to do, so there is more purchasing power in the economy. Therefore, entrepreneurs borrow and invest in new manufacturing enterprises. People borrow and spend assuming they will be able to pay back the loan at those low interest rates. Banks must loan more because since interest rates are now low, they must make more loans to keep profitable. People now spend on speculative investments such as the stock market or real estate creating bubbles. They do so because the price of these assets seems to be going up and up with no limit. 

Eventually and to some degree all the following bad things happen. People runs out of money (they can’t borrow any longer) and speculative prices cannot be sustained; bubbles burst (stock exchange and real estate), prices collapse. Companies that invested in manufacturing find out that people are not buying their products and cannot pay back the loans; they go broke. People lose their jobs, savings and houses. Or, inflation starts to go up a great deal because of all the newly printed money. Central Banks knowing that high inflation is not good for the economy, decrease printing, interest rates to up, people can’t pay back the loans and the economy collapses. The only thing Central Banks can do, is to keep printing. When they do this, interest rates drop even more, fueling more spending. Eventually, interest rates reach zero and there are no more takers. The economy collapses. Then, if Central Banks do not intervene to make things worse, all these speculative and miscalculated investments are liquidated and the normal economy restarts again.

There is another way of looking at boom-bust cycles. In the Key Lesson #14 we explained that Capital has a complex structure. The parts of is structure are exquisitely interlinked and balanced with each other. When Central Banks print, some elements in this structure are boosted and others are depressed. They go out of synch with what consumers really want.  Eventually, this lack of synchronicity gets so bad that all these elements stop producing profits. When this happens, the entire structure collapses.

Them: There are many explanations out there as to why boom-bust cycles happen. Most dismiss government has anything to do with it. Some, however, go  as far as recognizing that yes indeed, creating money out of thin air is the cause. But then they back down and say that the problem is not that untold amounts of money were created, but that the “management” of that money was not the correct one. With just the “correct” management, busts can be avoided. They have been trying to find those “correct” management techniques and values for over 100 years by now, and failing miserably. The problem is, of course, that these magic conditions do not exist. Funny money was already spent in goods and services, based on unreasonable assumptions of profits. This money cannot be “un-spent”. The only known economic process that can correct these mis-spending problems is liquidation. And since all the members of an economic system are dependent of each other, if one fails the other fail. Voila! A crisis. In the end, this is a simple question of common sense.  Either you believe that borrowing up to your eyebrows and spending like a drunken sailor is bad for your economic future or you do not. If you do, you must then recognize that whoever makes your borrowing possible is to be blamed. In this case, it is squarely the government by printing money and lowering interest rates.


Key Lesson #19: Governments are guilty

Us: All the previous key lessons necessarily arrive to the same conclusion. All the major economic problems are simply due to government intervention through Central Banks. The solution is therefore obvious. Remove all Central Banks. However, the threat of re-introducing Central Banks will always be there for as long as governments exist. Therefore, the only real solution is to get rid of all governments.

Them: Governments are the source of power we need to implement the economic policies our theories say that we should be implementing. Without governments there is no Central Banking. Without Central Banks, imposing those policies is not possible. Therefore, we support governments. Did you notice the difference? We are all about letting people do, they are all about imposing behaviors and choices on people. This is not a coincidence, it is by design. And so, you must make a choice, which design do you prefer?



There is a long tradition of criticizing Austrian Economics by other economic theories. Many critics attack the logic and some attack by comparison with actual economic statistics.


Logic attacks

These attacks attempt to demonstrate that somewhere Austrian Economics got its thinking wrong. They attempt to demonstrate that if Austrian Economics is correct, then we should be seeing things in the market that we don’t see, or conversely, we should not be seeing things that we do see.

All these attacks are eventually all proven wrong. Typically either the attacker does not understand Austrian Economics and makes assumptions that are not part of the theory, or makes economic assumptions that are simply not true or demands that the theory proves things that it simply did not set up to prove.


Data attacks

These attacks attempt to demonstrate that Austrian Economics is wrong because “empirical data” (i.e. economic statistics) seems to be saying something else.

Again, attackers either do not understand Austrian Economics, or make assumptions that are not there or their data is not applicable (it is conveniently interpreted under a different theory) or they simply have personal issues and reach whichever conclusions they want.

Again, eventually, all these attacks are shown to be groundless.

The truth is that not a single attack has survived the test of time. There is no such thing as a final, conclusive attack that can prove a single critical item in the Austrian Economic theory wrong. No such animal.

Conversely, the other theories have been failing miserably the test of time. None of their critical promises have been achieved, even though they had 100+ years’ worth of worldwide experimentation. Not one. In every new cycle things go from bad to worse.


Austrian Economics theory is not perfect

This theory is not perfect, not by any stretch of the imagination. We know that and it is because we know this that we welcome any and all criticisms. It is trough fire that diamonds are forged.

However, having said that, we must also note that all the other competing theories are far, far worse. While criticizing relatively minor details of the Austrian Economic theory, the other ones have gigantic gaps between their theories and actual world events.

Austrian Economics is only vastly superior when compared to other economic theories. It is not vastly superior in absolute terms. We don’t claim to have the whole truth. We only claim that we have a better model of the truth.



Over the last lessons, we looked at the theory behind Austrian Economics. However, you may have noticed that all explanations have common sense interpretations and real-life implications. This is not by mistake or coincidence, but by design. Austrian Economics is all about how people think and act. It is all about human behavior. Is this mandate that keeps the theory firmly grounded in real life and away from purely mathematical and/or statistical interpretations. Austrian Economics is the only theory that actually bothers taking the time to look at what individuals do and why they do it, one person at the time. Is it then surprising to find that it is quite accurate and choke full of common sense? Of course not.

In the end, we do not prefer Austrian Economics over everything else because it is neat, but because it works in the real life. It is a theory that represents what people want, not what governments want. It is a theory that defends your point of view, not the point of view of grandiose “society” builders. It is a theory for the average person which improves everybody’s life, one life at the time. What else can you ask?

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

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