Business Cycle and Interest Rates

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    Tom Woods, I’ve heard you explain the business cycle. When you talk about the interest rates affecting the higher and lower stages of business, in a free market wouldn’t loan interest rates not change very much? In other words, wouldn’t the price of money find an equilibrium that wouldn’t change very much, similar to the price of most goods? Especially if the price is in competition with an entire country/world, and since money isn’t really something that can be produced cheaper and higher quality. This is assuming money was private and something like a gold standard. My main question is the drastic change you imply between the higher order stages increasing while the lower stages decrease, and resources are moved in a balance. What are some reasons the majority of people would save so much or spend so much at different periods, that would cause the interest rates to change so much, in order to have a real impact on the higher/lower stages?


    Interest rates don’t need to change significantly for the boom to be set in motion. They just need to be lower than they would be on the basis of people’s time preferences. The Fed sets the boom in motion by monetary inflation through credit expansion within a fractional-reserve banking system. When the Fed buys assets from banks and pays with reserves, then banks can create credit by issuing fiduciary media. Banks decide how to lend the funds they create across the different loan opportunities. Having exhausted these, other investors will alter their supply of credit to take advantage of arbitrage profit. As you point out, the end result is that interest rates throughout all possibilities are lower than otherwise.

    Interest rates, however, are not just earned on investment in financial assets, but also in physical assets. The rate of return on production and investment will be lower than otherwise also. But, in order for that to happen, buying prices of inputs must rise relative to selling prices of outputs. In other words, higher-stage prices must rise relative to lower-stage prices.

    People obtain more money to spend on goods from the monetary inflation set in motion by the Fed through the fractional-reserve banking system. The newly created money drives demands up disproportionately on higher-stage producer goods. Consider the following illustration. Credit creation leads to more auto loans. Increase demand by auto customers pushes up auto producers’ revenues. They increase their demand for inputs, including steel, and their demand for capital capacity, including auto factories. The additional demands for steel increase the revenues of steel producers who, in turn, increase their demand for iron ore. and their demand for steel mills. The resulting increase demand for iron ore is relatively greater than the increase demand for steel which is relatively greater than the increase demand for autos.

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