At the 2020 World Economic Forum in Davos, Bob Prince, co-chief investment officer at Bridgewater Associates, attracted attention when he suggested in a news interview that the boom and bust cycle as we have come to know it in the last decades may have ended. This viewpoint may well have been encouraged by the fact that the latest economic upswing (“boom”) has been going for around a decade and that an end is not in sight as suggested by incoming macro- and microeconomic data.
But would that not reject the key insight of the Austrian business cycle theory (ABCT), which says that a boom, brought about by artificially lowered market interest rates and injections of new credit and money produced “out of thin air,” must eventually end in a bust? In what follows, I will remind us of the key message of the ABCT and outline the “special conditions” which must be taken into account if the ABCT is applied to real-world developments. Against this backdrop, we can then form a view about how the next crisis might look.
What the ABCT Says
The ABCT is actually a “theory of crisis,” and it explains the broader consequences if and when central banks, in close cooperation with commercial banks, increase the amount of money in the economy through credit expansion—that is, an increase in bank lending that is not backed by real savings. The increase in the circulation of credit supply initially lowers the market interest rate below its “natural level,” or, “the originary interest rate level,” to use the Austrian school’s term.
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