Talk:Austrian business cycle theory/Archives/2010/May

unclear passage

"This new money then percolates downward from the business borrowers to the factors of production: to the landowners and capital owners who sold assets to the newly indebted entrepreneurs, and then to the other factors of production in wages, rent, and interest. Austrian economists conclude that, since time preferences have not changed, people will rush to reestablish the old proportions, and demand will shift back from the higher to the lower orders. In other words, depositors will tend to remove cash from the banking system and spend it (not save it), banks will then ask their borrowers for payment and interest rates and credit conditions will deteriorate."

Admittedly econ was my worst grade in college, but this passage is terribly unclear. The (borrowed) money percolates, so everyone--except the borrowers--has more money than he did before. It then states that "time preferences haven't changed" but says that demand "shifts back." If it hasn't changed in the first place, how is it changing "back"? and furthermore why is it changing now?

Then, because of this unclear "shift," "people" (does this refer to the borrowers/entrepreneurs or to the former capital owners/workers? it appears to be the latter) rush to "re-establish old proportions." This appears to refer to the proportion of money saved vs. money spent but it's not clear what the "old" and "new" proportions are. why are the "old" proportions the ones where they spend all their savings? it seems to me that if they were saving x% before, they will continue to save x%, if they are guided by "old proportions."

The final sentence has some seriously weird causation assumptions. 1. Depositors withdraw funds THEREFORE banks demand repayment of loans. Wouldnt the banks demand repayment of their loans no matter what? 2. Banks demand repayment of loans THEREFORE interest rates and credit market deteriorate. (side note: I assume "deteriorate" is used here in a standard sense to mean higher rates and tighter credit even though an Austrian would--I understand--view such a shift more as "natural and beneficial rectification" and "deterioration" would mean further cheap money Either way, the causation is unclear) Banks demanding repayment in itself couldn't affect interest rates or credit markets (tighter or looser) because everyone knew it was coming and therefore markets and rates would already reflect that. If you take out the middle bit, and say "Depositors withdraw funds THEREFORE banks reduce credit" that kind of makes sense, but not if depositors are withdrawing simply to spend. If they spend the money someone is accumulating it. If those people are the borrowing entrepreneurs, then the bank is recouping its investment, if its someone else, they must be saving it, otherwise there's just piles of cash sitting out in the economy somewhere.

Note: This is totally in good faith. I'm not some die-hard Keynesian coming in here trying to rant about how Austrian School are a bunch of loons and look at the holes in their arguments. I'm seriously trying to understand and also help clarify the article for future readers. Thanks -- Jieagles (talk) 02:12, 6 May 2010 (UTC)

All excellent points. It is unclear. Essentially the recipients of the new funds spend the money - but that does not "disappear" from the banking system. Obviously it goes into someone else's account so in aggregate the deposits don't "disappear" until a solvency crisis in the banks stop the game of musical chairs AND ONLY THEN does the liquidity crisis occur. The point is that the newly created money gets spent on stuff the borrowers didn't think it would get spent on - in Fisher's language, the velocity of money temporarily increases, then dramatically diminishes once a solvency crisis in the banks forces astute depositors to shift to gold or other tangible assets outside the banking system. The mechanisms are so subtle they are difficult to explain in simple terms. Money is created. It goes to people who want to spend it. It gets spent. Boom! The idiots who borrowed the money in the first place were misled by low interest rates - and they go bust (eventually). It often happens a couple of years after the lowering of interest rates and that's why there's a cluster of errors - everyone was an idiot at the same time. Then a few marginal banks get shaky balance sheets (the sucker banks who borrowed at the end of the cycle to shaky borrowers). THEN (and only then) do depositors rush to liquidate (out of the banking system). But how do you say this in simple terms? I'll give it a go... - $hady$hysterGeithner (talk) 03:07, 6 May 2010 (UTC)

Done. I hope everyone is happy now. - LostMyself (talk) 07:10, 6 May 2010 (UTC)

The latter part of the passage is much clearer and fits in much better with the other sources I have found. The first part (ie the part about "shifting back" and "old proportions" is still the same. What causes the shift from saving to spending? simply having more money? what does that have to do with "old proportions" or "time preferences NOT changing"? -- Jieagles (talk) 14:05, 6 May 2010 (UTC)

The intense clarity of your thinking and your desire to get to the heart of this "theory" (explanation) of business cycles is impressive. I feel obliged to help you out as a fellow traveller in fiat money world. I've changed the text slightly to clarify. "Rush to re-establish their old proportions" is an awkward expression, but is correct. Let's think about a live case. A farmer is offered $10 million for his land by a property developer, stimulated to develop by the low interest rates. The farmer is rich! He used to have $100,000 in the bank, now he's got $10 million. But he doesn't want to keep $10 million in the bank because he knows interest rates are low and money is losing value. So he "rushes" to re-establish his old proportion (his old cash balance). Given his net wealth, perhaps he re-establishes it at $300,000 average balance, but whatever it is he gets out of cash. He spends the money and perhaps invests in more land or does something else with it - but a reasonable proportion of it is consumed (spent on non-capital items). Certainly very little of it stays in his account earning 2% interest. And none of it is saved up to buy one of the condos that the developer is developing. The developer will have to rely on another sucke... sorry "investor" to get into debt when he offloads the development. He won't be able to rely on the farmer to buy the condo because the farmer hasn't been saving up to buy a condo. He hasn't been saving up at all. He doesn't want to save. He will "rush" back to re-allocate his portfolio between cash/deposits/assets/consumption the way he had them before, at prevailing interest rates of 2%. Perhaps the developer thought farmers like this one would buy his condos (after all interest rates are only 2%!). But this is a big mistake.

Basically it means the people who are recipients of the new money continue their old spending habits at prevailing interest rates. Instead of returning money to the bank and deferring consumption, saving it up for a car or a house (a capital item) they spend it (at prevailing interest rates) on whatever they've been spending their money on (consumption items). Who wants to save with interest rates on term deposits "fixed" by the central planners at 2%? This pushes up the velocity of money (in Fisher's language) until the capital investment/borrowing stops when the borrowers who borrowed to build houses or car factories realise that the low interest rates were not because people were deferring consumption and saving up to buy their new stuff (houses, cars) but were low simply because of the manipulation of the rate by the central price fixing authority (the central bank). Like any intrusion in the market (rent controls, price controls) this creates massive distortions in resource allocation - this time skewing production towards capital goods industries temporarily, until reality dawns that the whole thing was a "hoax" (to use Robert K. Landis's term in his brilliant paper on this subject). You should perhaps read this paper before asking any further questions. It's referenced in the article and really does a great job of teasing out the implications of the theory in a broader sense. He is a brilliant writer and perhaps I can't match the quality of his expression (he also has more space to write so perhaps that's the reason his piece reads so well). - $$$MakeMore$$$ (talk) 00:26, 7 May 2010 (UTC)

OK, I've really made the effort to explain time preference and its relationship to the interest rate. I tried to keep it as succinct as possible. I'm exhausted by the effort to condense Landis's (and von Mises's) work so I'm going to have a little lie down now. Mises took about 450 pages to expain this in his Theory of Money and Credit. If you say you're still not satisfied with this explanation, I am going to go off and shoot myself, because that's the best I can do. - $$$MakeMore$$$ (talk) 03:00, 7 May 2010 (UTC)

Thanks. That was actually a very clear and succinct explanation and a helpful link. Excepting the lead, which is, I think very good, the rest of the article, especially the "Assertions" section, remains a difficult read and a bit haphazard in its organization. I think the inclusion of a scenario such as the one in your above explanation could result in an improved article. This would require some significant reworking if someone felt inclined to undertake such a task. (an based on your comments, especially below, you might have a bit too strong a POV to undertake it yourself). In any event, thanks again. -- Jieagles (talk) 02:52, 11 May 2010 (UTC)

Smart money is on User:KarmaIsKing fabricating a discussion by himself with different accounts again. BigK HeX (talk) 08:35, 7 May 2010 (UTC)

Do a geolocation on Jieagles. You may be surprised by what you find. Then again Daleks tend to kill indiscriminately, so perhaps you'll ban him too, just to be on the safe side? And Jieagles - there's another thing you should understand about Keynesians. They're not "scientists" so much as zealot-propagandists. Regardless of the scorn they have for Austrian anti-empiricism, they have a desire to "purge" Austrians on sight rather than debate the substance. Note: This attack (and my banning) is occurring on the Austrian talk page when I am genuinely trying to explain ABCT to you (which you can clearly see above), not on the Keynesian talk page where I'm saying something like "Keynes was a shallow, superficial gay shyster who loved counterfeiting for the State because it got him into more parties" (which I admit would justify me being banned - but I've never said that on any WP page. All I've done is focus on AS and ABCT). Keynesian zealots know no boundaries in their brutal, relentless attacks on the few Austrian hold-outs who stand against fiat money and central banking. Ex...Term...In...Ate! Ex...Term...In...Ate! Ex...Term...In...Ate! - $$$MakeMore$$$ (talk) 08:49, 7 May 2010 (UTC)

The other guy's status would have little bearing here. We all know YOUR status, and that's what really matters. BigK HeX (talk) 10:09, 7 May 2010 (UTC)