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Central Banks And Its Role In “Boom and Bust” Creation

Updated on December 28, 2011

A rebuilt economic engine of tomorrow should strive to avoid business cycles but the truth is that, under a fiat based monetary system, they may be inevitable. What’s a business cycle? A business cycle represents an abnormal and non-repeating up-and-down movement of business activity that takes place around a generally rising trend. In thirty some odd years, we’ve seen this cycle adjust to the oil trend of the late 70s, the trend of late 90s and the real estate sub-prime trend of the early 2000s. Occurring around long-term growth trends, the business cycle typically involves shifts, overtime, between periods of relatively rapid economic growth (expansion & boom), and periods of sharp stagnate declination (contraction & bust).

If the business cycle lives up to its name, our economy should begin to see long-term growth. The problem with business cycle dictum in a kamikaze economy is that the cycle can end up reversing itself. Instead of “boom-bust­-boom-bust,” we could begin to see “boom-bust-bust-bust-boom.” In other words, the cycle could get so distorted that we began to see very long-term periods of economic contractions. To avoid this type of scenario, Americans will have to adjust its way of thinking.

In reference to this way of thinking, what causes these cyclical shifts, within the forces of the business cycle, is the kind of erratic market behavior that perpetuate the idea that U.S. investors are like jack rabbits. A jack rabbit investor is someone who gets excited at the possibility of making “quick money,” so they start jumping or throwing monies at anything that could be even remotely promising. They jump on the type of trends, bandwagons and fades that are caused by a central banking inflationary induced business cycle. Almost like a natural high, these same investors began to think that the “sky’s the limit” and become stoic to the probable consequences of their actions.

The cyclical boom was like this: it was a “feeding frenzy” of a magnitude 9 earthquake. As a complete irrational bonanza, the boom proved that investing off of pure impulse was a macroeconomic “no-no” at the highest level. However, the implications of all this impulse investing came to an inevitable bust which then caused our economic engine to start backfiring. What created the cyclical boom? Ask any economist, and they should go along with the international consensus that the Fed— through egregious monetary policy, may have instigated the entire thing.

How can the Fed influence the business cycle with interest rates? The average textbook explanation of “big gov’s” influence on the business cycle hasn’t changed: the notion that when the Fed raises interest rates, it makes borrowing more costly for businesses and consumers; therefore, they borrow, invest and spend less is pretty much the explanation in nutshell. On the other hand, lowering interest rates has the opposite effect—whereby doing so, it entices businesses and consumers to borrow, invest and spend more.

Are cyclical booms false? Followers of economist Milton Friedman believed that for the most part, excluding very large supply shocks, business decline is a result of monetary phenomena; therefore, the business boom had to be false. When you think about it, if you have a bad situation after a good, then the good wasn’t really supposed to happen anyways. Why aspire to reach Mount Everest, only to fall off a cliff right after reaching the summit? Conventional wisdom says, “you can ‘holla’ all you want, but you’ll eventually stop.”

In other words, whenever there’s a boom going on, history has shown that it’s probably false. In order for a boom to happen, there have to an initial spark that gets the flames going. In the case of the, the internet as an economic portal was that spark. It seemed every one wanted to get in on the action—including “big gov” himself. With this said, one could make the argument that the cause of the boom was government itself. And to be quite frank, if Alan Greenspan wanted to put out the flames, all he had to do was take a page out of his predecessor’s book: in order to combat inflation, Fed Chairman, Paul Volker, raised interest rates to nearly double-digit levels in the 1970s.

Whenever government thinks that it’s a good idea to facilitate market actions within the business cycle, an expansionary boom will be the end result. In this irregular economic environment, irrational behavior gets turned a blind eye for the sake of the frenzy: bankers start buying up Versace business suits, cars started getting sportier, restaurants begin fusing international cuisines—it becomes an economic euphoria like none other. Alan Greenspan called this bizarre economic euphoria, “irrational exuberance.” But you want to know what it really was: macroeconomic pandemonium. The Austrian Business Cycle Theory describes the business cycle boom and bust as follows:

The nation’s monetary authorities should have tightened policy earlier and more aggressively during the 1996–1999 period. A tighter monetary policy might have helped to keep the investment boom from becoming so extended. As a consequence, the downward forces of adjustment that followed when the boom ended would not have been so intense. Also, the allocation of capital might have been improved. After all, with hindsight, it is pretty obvious that billions of dollars of investment spending in sectors such as telecom were wasted.

Is it true that hindsight is always 20/20? If it is then the economics of the 21st century will have to steer clear of booms in the business cycle. Why is this? Because the business cycle says that a bust always follows; which puts the economy back to square one. What should be the government’s role in all this? The government should just do its job—which consist of spotting situations like these and abruptly eliminating them. If they see a situation where there’s a contraction in the economy, open market operations becomes justified. After all, the job of the Federal Reserve is to foster economic growth, not hinder it. A Federal Reserve System that plays overseer is better than one that jump, head first, into a volatile situation, thus making matters worse. The Fed is finding out the hard way that misallocating resources—especially within a macroeconomic framework—isn’t a joke. To be exact, playing around with an engine’s life blood can and will lead to irrevocable engine damage.


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