Consider the operation of the time market in the unhampered market economy. People with higher time preferences borrow from people with lower time preferences. The level of the rate of interest clears the market so that the quantity demanded and quantity supplied of present money are the same. The present money is allocated across the time market into consumer loans, producer loans, and the capital structure so that no further arbitrage profit arises. Only that portion of present money lent into production goes to capital projects across the capital structure. Consumer loans do not build up the capital structure, but merely transfer consumption from lower time preference people to higher time preference people. For example, let’s say that the people making consumer loans reduce their demands for clothing while people who borrow increase their demands for cell phones. Then the capital structure supporting the production of clothing (spinning cloth, growing cotton, etc.) will shrink while the capital structure supporting the production of cell phones (producing chips, touch screens, etc.) will grow. The overall capital structure will not be built up. Capital production will merely shift from areas with smaller demands to areas will greater demands.
The business cycle is inter-temporal mal-investment. Central bank monetary inflation and credit expansion increase the supply of credit beyond what people’s time preferences dictate. The increase supply of credit is arbitraged into the different areas of the time market so that no additional profit in shifting it is possible. That portion of the new credit going into producer loans and the capital structure allows entrepreneurs to lengthen the capital structure by building up capital goods in the higher and intermediate stages of production. The build-up of the overall capital structure proves to be unsustainable because it fails to satisfy people’s time preferences. The build up of the capital structure supporting the areas of production stimulated by consumer loans (housing, autos, etc.) is part and parcel of the overall lengthening of the capital structure.