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Can Expectations Undo the Validity of the Mises’s Business Cycle Theory?
CAN EXPECTATIONS UNDO THE VALIDITY OF THE MISES’S BUSINESS CYCLE THEORY?
According to Ludwig von Mises’s Austrian Business Cycle Theory (ABCT), the artificial lowering of interest rates by the central bank leads to a misallocation of resources due to the fact that businesses undertake various capital projects that prior to the lowering of interest rates weren’t considered viable. This misallocation of resources is commonly described as an economic boom.
Once the central bank reverses its stance this sets in motion an economic bust. It follows then that the artificial lowering of interest rates sets a trap for businessmen by luring them into unsustainable business activities that are revealed as such once the central bank tightens its interest rate stance.
Critics of the ABCT maintain that there is no justification that businessmen should fall prey repeatedly to an artificial lowering of interest rates. Businessmen are likely to learn from experience, the critics argue, and not fall into the trap produced by an artificial lowering of interest rates. Consequently, correct expectations will undo or neutralize the whole process of the boom-bust cycle that is set in motion by the artificial lowering of interest rates.[1] Hence critics are questioning the validity of the ABCT.
Even Mises himself had conceded that it is possible that some time in the future businessmen will stop responding to loose monetary policy thereby preventing the setting in motion of the boom-bust cycle. In his reply to Lachmann he wrote,
It may be that businessmen will in the future react to credit expansion in another manner than they did in the past. It may be that they will avoid using for an expansion of their operations the easy money available, because they will keep in mind the inevitable end of the boom. Some signs forebode such a change. But it is too early to make a positive statement.[2]
Do Expectations Matter?
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Central Bank Reserves – The Rise of the Yuan
QUESTION: Mr. Armstrong; I understand that your model shows that China will become the dominant economy post-2032. The IMF added the yuan to their SDR basket. Are central banks starting to use the yuan in reserves in a major way yet?
KD
ANSWER: Yes. The ECB (European Central Bank) converted a half-billion euros to yuan. So that is not what you would call major. This is a first step in the true internationalization of the yuan. The Bundesbank has also converted a small portion of their reserves. So it is starting. Reports that China was selling off US debt are false. The U.S. debt to China is $1.2 trillion as of October 2017. That’s 19% of the $6.3 trillion in Treasury bills, notes, and bonds held by foreign countries. The rest of the $20 trillion national debt is owned by either the American people or by the U.S. government itself. What China and most governments have been doing is reducing their holding in maturity from 10 years down to 5 years or less.
Despite what everyone may believe, the ECB reserves rank only number 30 on the list among central banks with just 75.1 billion. China has the biggest reserves of all followed still by Japan. Other than Switzerland, no European country ranks in the top ten. This is a reflection of their status in world trade as well. It only follows reason that the Chinese yuan will become a wider used reserve currency as it also dominates trade.
