Freedom, Liberty, Peace, Happiness and Prosperity

Freedom is the degree to which a thing can move without obstruction from other sources, while in itself not obstructing other things’ freedoms.

Liberty is directly derived from freedom. It is the concept of freedom applied to society. A society in which every individual is able to do what he wants with his body and his property while not infringing upon other people’s freedoms, that is their bodies and properties, can be called a society that has endorsed the concepts of liberty.

Since liberty, by that definition, requires absence of aggression from anyone against anyone, liberty cannot exist without peace. Peace is the indispensable precondition for liberty. Liberty can’t do without peace and peace can’t do without liberty.

Happiness is a subjective aim. It is that goal that every individual, with every action and every step he takes, seeks to attain. So long as one can pursue his desires in an unobstructed manner he becomes happier every step of the way. He might make false decisions once in a while, but this doesn’t in the slightest change the overall direction towards happiness. He will change course if he realizes that something doesn’t make him happy, seek advice with his fellow men, and get on the path he considers right again.

But when someone forces him down a path that he doesn’t approve of, it will be completely impossible for him to pursue happiness. Nobody can possibly tell someone else what it is that will make him happier. If one finds happiness in infringing upon other individuals’ liberties he has to understand that his lifestyle could not possibly be one that is applicable universally. For if he is to be allowed to infringe upon others’ freedoms, what keeps someone else from doing the same to him? Thus happiness, freedom, liberty and peace are inextricably linked.

At times one may seek material wealth and at times indulge in spiritual/intellectual activities. But before one gets to enjoy the delightful beauty of a Monet painting or the subtlety of a Kafka novel, he needs to provide for the means of bare subsistence for himself and his family. To blame capitalism for a lack of cultural or spiritual progress, or to blame it for negligence of the poor and the weak is thus an utter mistake. It is precisely in those countries that have later than others embarked upon a policy of destroying the accomplishments of the Age of Enlightenment and their corollary, free market capitalism, where people got to enjoy an abundance of art museums, opera houses, philosophical lectures, and the like. It is in those very countries where the vast lot of the poor and unemployed have been able to find employment in factories, behind desks and elsewhere and raise their standards of living beyond levels that a Croesus or the Medici would have envied them for. It is in those very countries where a dynamic market has provided for an ever rising supply of health care and pharmaceutical products to improve the lifes of the unfortunate, instead of casting them off a cliff. It is in those very countries where an indispensable network of churches and voluntary charities has been able to appeal to their affluent countrymen’s compassion and raise sums of money that dwarf all governmental welfare programs, quantitatively and most importantly qualitatively, in taking care of those few who were still falling through the cracks.

We are in the process of a complete destruction of all these accomplishments in the United States. We are returning to a state of mass poverty, pauperism, and militarism. But capitalism is not to blame for this unfortunate development. It is the rise of interventionism and the radical expansion of government intrusion that used to be unthinkable up to 100 years ago.

Prosperity is a direct outcome of the pursuit of happiness. To say that money or material wealth alone do not make one happy is to utter a rather pedestrian truism. There is no one thing in the universe that makes one attain a state of complete happiness. But every action voluntarily taken aims at getting closer to that state. It is what Thomas Jefferson had understood long before he chose his words for the Declaration of Independence:

We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness.

Government, by definition, is an obstacle to the pursuit of happiness. Its very essence consists in the infringement upon its subjects’ liberties through compulsory taxation. If it weren’t for this modus operandi, government would not pose such an obstacle.

If the past millennia have shown us one immutable economic law it is this: That governments always and everywhere grow and grow and grow in the long run, to the point of a complete and utter social collapse, only to start the cycle anew. The youngest and probably best example is that of the United States. Founded in 1776 as arguably the smallest government that has ever existed, it only took a few hundred years for it to turn into the biggest, most armed, most powerful, and most bellicose government in the whole world, along with a crushing public debt that will inevitably cause the demise of the current system within the coming decades.

These facts are not arcane or hidden. They are right before us. It doesn’t take the precision or smarts of a brain surgeon to grasp this. Quite the opposite: It takes really hard work and strenuous effort to ignore them and to delude yourself into believing anything else. The root causes for this deliberate self-delusion can be found in scar tissues from our childhoods and until one deals with one’s own personal childhood depredations and mental/physical abuses and corruption from authority figures, one is never going to accept such seemingly simple ideas.

For those who have understood the truth behind the concepts outlined above, it is obvious that there can only be one proper solution: The elimination of that institution commonly referred to as government, aka voluntaryism.

But all these realizations are worth nothing if the people who are subject to the government’s depredations and propaganda are not educated accordingly. In today’s world there is an overwhelming, though fading, compliance on the part of the public with the depredations of interventionism. It is thus my intention to spread the word about these truths wherever I can. Anyone who agrees should, if it doesn’t cause him major discomfort, do the same. It is in conversations in bars and restaurants, in the announcements in the news media, in town halls and on public squares, in quick chats with neighbors and friends where public opinion is formed.

Without an educated public, all the concepts that stand behind liberty and peace are meaningless. It is thus the duty of every one of us to take the word to those around us and show them the right way towards a better world.

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Consumer Spending Update, Savings Update & Other Data

Consumption on Non-Durable Goods Down:

Savings Up:

Savings Rate Up, it was obviously unsustainable below 0:

Personal Income Peaking:

All in line with an ongoing consumer credit contraction. All in line with phase 8 of the bunsiness cycle. Be prepared for much worse.

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Welcome to Krugmanland

The science of economics is still young and full of clueless pundits. A perfect example is Nobel Price winner Paul Krugman and this article about fiscal stimuli:

I’ve been on the warpath over Germany’s refusal to play a constructive role in European fiscal stimulus. But what does the math look like? Here’s a simple analysis — well, simple by economists’ standards — of the reason coordination is so important for the EU.

We start from the proposition that Europe is, or soon will be, in a position where interest rates are up against the zero lower bound. This means both that fiscal policy is the only game in town, and that we can use ordinary multiplier analysis.

OK, I hope Krugman understands that interest rates are low because we are in phase 8 of the business cycle. That phase where people finally realize that too much has been consumed, while not enough has been saved so as to make available enough factors of production that produce those consumer goods. I hope he realizes that in order to accomplish the objectives of economic policy, viz. the maximization of every one’s well being in society, the government needs to do what is possibly can to let the market return to the state that the consumers are asking for in their value preferences and time preferences expressed in the form of interest rates and prices, respectively. We shall examine whether or not his recommendations even remotely accomplish this objective.

Let m be the share of a marginal euro spent on imports — either for an individual county, or for the EU as a whole (I’ll explain in a minute). I’ll assume that m is the same for government spending and for domestic demand. Let c be the marginal propensity to consume. And let t be the share of an increase in GDP that accrues to the government in increased taxes or reduced transfers.

Consider the effects of an increase in government purchases dG. This will raise GDP directly, to the extent that it falls on domestic goods and services, and indirectly, as the rise in GDP induces a rise in consumer spending. We have:

dY = (1-m)dG + (1-m)(1-t)c dY

or dY/dG = (1-m)/[1 – (1-m)(1-t)c]

Without any further analysis or detail Krugman implies that an increase in the nominal GDP is the ultimate objective of economic policy. He doesn’t go into any detail whatsoever. He passes in silence all the flaws that come with this figure and he certainly doesn’t ponder for a second what a true GDP measure should look like.

But all these amateurish shortcomings taken aside, let’s examine what the formula above really tells us. The idea behind the GDP is to approximate the total sum of the prices paid for all consumer goods and factors of production produced inside the country and consumed or used subsequently. The GDP Y is defined as Y = I + C + G + X – M, where
I = Private Investment (purchases of factors of production by domestic non government individuals),
C = Private Consumption (purchases of consumer goods by domestic non government individuals),
G = Government Expenses (purchases of consumer goods and factors of production by domestic government individuals),
X = Exports (purchases of consumer goods and factors of production by foreigners),
M = Imports (purchases of consumer goods and factors of production that were produced abroad)

Now Krugman tries to quantify the effect of additional government purchases dG on Y. dG(1-m) is that portion of government expenses that falls upon domestic consumption by the government. But for some reason he commits the unfortunate blunder of adding to that a mystical (1-m)(1-t)c dY. Where does that come from? He doesn’t even attempt to explain it. He simply assumes that the additional government purchases for some obscure reason also lead to more consumer demand due to an increase of the GDP which is … due to the increase in government expenditure. This is complete utter amateurish kindergarten nonsense.

Krugman is an intelligent person. He must have missed something here. If he wants to figure out whether or not an increase in government expenses leads to an increase in GDP then how can he commit the blunder of assuming an increase of GDP in that very same formula. This is something that not even an elementary class student would get away with. If he wants to apply the questionable GDP formula to calculate the effect of government expenses on the well being of society he should at least do that right.

First of all one has to understand, as most people hopefully do, that dG does not simply grow out of nowhere. Additional dG will have to be funded out of additional taxes. Taxes are funded by taking money from private individuals. If money is taken from private individuals it will either reduce private consumption C or private investment I or both of them by precisely the amount spent. The basic culprit is that Krugman uses variables that are dependent upon each other in the same formula. When one starts calculating derivatives for such a formula one must take that into account. Thus the following calculation is the only correct one:

Y = G + (I + C ) + X – M
<=> dY = dG(1-m) + (dI + dC dG(1-m)) + dXdM
<=> dY/dG = 1-m + 0 + 0 – 1 + m + 0 – 0
<=> dY/dG = 1-1
<=> dY/dG = 0

Of course he has to resort to complicated and sophisticated looking mathematic formulas because if he were to explain his hideous theory in words it would break down immediately.  Even if we give Krugman the benefit of the doubt, the growth in GDP, if the government spends dG, would be exactly 0. This is the one and only correct way to calculate a change dY/dG if one understands basic elementary school mathematical concepts and if one applies simple logic and reason. Paul Krugman needs to come forward and apologize for his terrible blunder.

Even if an individual were to work and save 50% of his earnings in cash in his matress, he would not inflict the slightest harm upon his fellow men. All he does in working and saving is make available more productive capacity to everyone than he in return withdraws via consumption. By withdrawing his money and saving it for future consumption he steps back and voluntarily leaves factors of production or consumer goods available to others by not participating in the bidding process on the market. The prices for those goods would thus be lower than had he participated, but they still render the same benefit to the consumers. If the government steps in and buys the good in question, it does nothing but snatch it away from someone else and employ it in bureaucratic uses. The Trouble With Bureaucracy explains what will inevitably ensue. No one is helped in this process, only harm is inflicted.

Now, I know that a Keynesian such as Krugman would now object that the additional government expenses would not necessarily have to be funded out of taxes but rather via deficit spending. OK, let’s say the government borrows additional money from one of the participants on the market. Again, this would require that someone who would have loaned the money to someone else now loans it to the government in a credit transaction. The money will thus not be available to that marginal entrepreneur who would have borrowed it. Private investment is reduced while government expenses go up. From the kindergarten GDP formula’s point of view, the effect is 0. To those who understand bureaucracy, the effect is negative.

The diligent pseudo economist, who has meticulously studied all of Keynes’s shallow theories, will then reply: “But since we are approaching 0% interest rates, no one will lend the money, everyone will hoard it. We are in a liquidity trap!” Then we would have to reply that since we are in phase 8 of the business cycle, of course people are hoarding money. The reason being a reckless monetary and fiscal deficit spending policy. And the only way to get out of it is to swiftly abandon that policy and let phase 9, the correction, occur. But even that taken aside, what I said two paragraphs above, applies just as much in this case again. There is no way around this causality, no matter how much one tries to deny it.

Then the Keynesian will reply that the added government expenses could also be funded by having the government print money and buy goods on the market. And of course the response to that would have to be that in that case, money prices for the good purchased with the fiat money will go up and, again, will force the marginal consumer to forgo consumption of that good, while it is re-allocated to the government. The Keynesian would then reply that no one would have purchased the good if the government would not have purchased it. To that we would again have to explain to the Keynesian the basic concepts of he function of a price and that a good will be demanded at a certain price, so long as that price represents the involved parties’ value preferences. If it doesn’t then the seller needs to lower the price until it does.

But even if the price for the good was 0, what good does it do if the government prints money and gives it to someone who in return has produced a good that nobody needed? He will be the first to receive this money and bid up the prices of goods that would then not be available to other marginal consumers who would have bought it in exchange for money earned from useful labor. They will then abandon their operations which the consumers deemed useful and also begin producing that same useless good in order to obtain free money from the government. The business cycle will inevitably ensue.

It is impossible to run away from the fact that government expenses will be wasteful and by necessity lower the people’s standard of living due to the irrefutable workings behind bureaucracy. The crucial shortcoming of applying the GDP formula is the blatant disregard of the fact that the government raises money violently and against the people’s value preferences before offering goods and thus faces the inability to calculate profit and loss.

Since governments are worried about debt, it’s also important to ask how much the budget deficit is increased by an increase in government spending. It’s not one-for-one, because higher spending leads to higher GDP and hence higher tax revenue. We have

dD = dGtdY

Now he continues with the false assumption that GDP is growing and happily concocts new formulas based on that. He doesn’t put into context the relevance of dD and, I have to assume, does not bother to view it in light of a corresponding reduction of private investment which would necessarily occur as I already pointed out above. He blithely assumes that magically a tdY appears out of nowhere and reduces the deficit. He then takes this flawed formula and incorporates it into his other flawed formula. Everything from hereon is based on sheer nonsense and requires no further comment:

A crucial number is “bang for euro”: the ratio of the increase in GDP to the increase in the deficit. After a bit of grinding, it can be shown to be

dY/dD = (1-m)/[1 – (1-t)(1-m)c – t(1-m)]

OK, some numbers. The average EU country spends about 40 percent of GDP on imports, and collects about 40 percent of GDP in taxes. Let me cut corners and assume that the marginal rates are the same as the average, and also assume that the marginal propensity to consume is 0.5. That is, for an average EU country, m = 0.4, t= 0.4, c = 0.5.

We can represent a coordinated fiscal policy by looking at the numbers for the EU as a whole. The only difference is that m falls to 0.13, because two-thirds of the imports of EU members are from other EU members.

And we get the following results:


Multiplier = 0.73
Bang per euro = 1.03


Multiplier = 1.18
Bang per euro = 2.23

The bang per euro is what matters: the tradeoff between increased debt and effective stimulus is MUCH better for the EU as a whole than it is for any one country.

You can play with these numbers, but I don’t think that conclusion is very sensitive to the details as long as you keep the large intra-EU trade effects in there. The lesson of this algebra is that there are very large intra-EU externalities in fiscal policy, making coordination really important. And that’s why German obstructionism is such a problem.

Krugman can’t escape the fact that his formula fails from start to finish. It sickens me that thousands of students are probably listening to him and employing his “logic” elsewhere. To anyone who still doubts my criticism, please consider the following: If the bang per Euro of deficit spending is 2.23 Euro, then why don’t we ask all European governments to spend 1,000 quadrillion Euros on deficit. This will create unprecedented wealth in Europe of 2,230 quadrillion. Then the governments can levy a tax of 1,000 quadrillion and pay off the debt. With 1,230 quadrillion Euro, this would leave Europe wealthier than ever before for years and years to come. Welcome to Krugmanland!

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Paulson Asks for Another Fix

Treasury Secretary Paulson asks for the remaining $350 billion:

Treasury Secretary Henry Paulson urged Congress to release the second half of the $700 billion financial rescue fund after the government exhausted the first $350 billion in less than three months.

Congress, which passed the Troubled Asset Relief Program on Oct. 3, “will need to release the remainder of the TARP to support financial market stability,” Paulson said today in a statement released in Washington.

The Treasury today agreed to lend $13.4 billion to General Motors Corp. and Chrysler LLC, after spending $335 billion mostly to increase bank capital. Lawmakers, who can vote against giving Paulson the remaining funds, have criticized the Bush administration for not using the rescue package to help stem foreclosures.

Paulson’s call for the other $350 billion may set off a debate in Congress, where some members have demanded more help for struggling homeowners. House Financial Services Committee Chairman Barney Frank said today he’s crafting legislation to unlock the unallocated money.

Today’s statement from Paulson wasn’t a formal request for the funds, a move President George W. Bush or his successor would have to make. Paulson intends to consult with Congress and President-elect Barack Obama’s staff on the strategy for officially requesting the next $350 billion, a Treasury official told reporters on a conference call. The official, who spoke on condition of anonymity, said he expected talks to begin soon.

Hopefully lawmakers will look back and ponder whether or not this whole program has been working, or if it hasn’t rather been a complete utter failure. As noted before, the program won’t work, it will make things worse. No matter what Paulson claims to use it for, it will be squandered, executives will take out as much as they can, and everyone is going to act surprised when they find out.

Unfortunately, lawmakers are braindead at this point.

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The Business Cycle

Note: To find out more about the differences between the consumption business cycle and the production business cycle read my newer post The Business Cycle Revisited.

All causes, effects and basic workings behind the Business Cycle have already been outlined by the theory of Credit Expansion.

This article shall elaborate on the detailed workings during the business cycle, from start to finish, divide it into phases, and establish a checklist for each phase during the cycle.

Phase 1: The Unhampered Market

The initial phase is a market system unhampered by central bank intervention. Consumers demand consumer goods. Entrepreneurs obtain savings money from capitalists in credit transactions and buy and combine factors of production and pay workers in order to produce those consumer goods. If the factors were withdrawn from less important uses and employed in more important ones, and on top of that there is still money left after paying interest to the capitalists, the entrepreneur earns a profit. Everyone who has earned money in this transaction, workers, capitalists, and entrepreneurs will then use part of the money earned and act as consumers which brings us back to the beginning. But with part of what they earned they act as capitalists and save it up for future consumption. Thus, as a whole,  part of their labor is available to  contribute to a stock of goods that are not consumed but rather aid in the production process, factors of production, via savings and investment. The more the immediate wants are satisfied over time, the lower the people’s time preference for present goods, and thus the more will people save, and the more capital will be available which increases the future output of goods per unit of labor. The unhampered market system, as a tendency, continuously provides for a rising standard of living for everyone who is involved. The government limits its scope to protecting the individuals on the market against aggression. It funds this activity via a minimal tax. Interest rates fully reflect the market participants’ voluntary time preferences, prices reflect voluntary value preferences.


  • True GDP expands significantly
  • A continuous and slow decline of interest rates
  • A continuous and slow increase of the savings rate
  • A money supply growth of 3% or less
  • A continuous decline in the money prices of consumer goods

Phase 2: The Bank Credit Expansion

Now the central bank appears and prints additional fiat money. It goes out on the market and asks capitalists, or banks who act on the capitalists’ behalf, to sell the debt they hold at a price based on the interest payments and riskiness of the security. Capitalists won’t be interested in the exchange since they genuinely desire to hold the debt as a means of obtaining interest income. Hence the central bank needs to offer a higher price for the debt. As a result, the debt is sold at a higher price. It is sold to an institution that has not generated genuine savings but rather printed fiat money out of nothing.


  • Interest rates for the debt instrument types bought by the central bank begin falling a bit faster
  • Overall interest rates remain untouched
  • Banks accumulate excess reserves
  • True GDP keeps rising
  • The savings rate is still increasing

Phase 3: The Business Credit Expansion

The capitalists and banks whose debt has been bought by the central bank now hold cash again. They will thus loan out money again since their time preferences haven’t changed. But the entrepreneurs they previously loaned money to don’t need additional capital. Thus they will try to loan out money to others. They will try to find a borrower from whom they can expect the same interest rate as they were earning previously, or at least an interest rate that is only slightly lower. Since they realized a premium upon their previous sales of debt, they will still be able to earn more interest income per month if the interest rate for the total loan only drops marginally. Slowly the rate for loans on the broad market begins to drop. Bank profit from interest earnings begins to rise consistently. The central bank, again, buys up newly created debt from the capitalists which the capitalists, again, loan out. The activity is repeated.


  • Interest rates begin dropping faster across the board
  • Banks loan out excess reserves
  • Banks begin to report higher profits
  • The money supply growth rate accelerates beyond 3%
  • True GDP keeps rising
  • The savings rate keeps rising

Phase 4: Entrepreneurial Activity Expands

Would-be entrepreneurs, who up to now were unable to obtain loans from the capitalists, because interest rates indicated that not enough voluntary savings were available to bridge the temporary shortfall in consumption goods that comes with investment, are now under the impression that the market provides enough factors of production to complete the projects they had been planning. With the borrowed money, they will begin obtaining factors of production on the market.

Since no additional savings and thus factors of production have been added to the market, the prices for factors of production will rise slowly. The factors are withdrawn from other occupations where they were obtained for less money, but were fulfilling demands based on true market data. Salaries for employees in these new production lines will go up.

However, the overall market is not yet fully permeated by this new activity. Lots of the previous operations remain active. The overall mood is positive. The new entrepreneurs are convinced their projects will be successful. The employees withdrawn from other occupations are happy about the raise in salary. They have not begun spending this new money yet. Prices for consumer goods have not begun to rise yet so it appears as though their real income rises. Their example catches others people’s attention. They, too, begin looking for new occupations. The ensuing reduction of the supply of consumer goods will not immediately be reflected in market data. The prospect of new and better goods in the future entices the majority. The central bank keeps on buying up additional debt.


  • The ratio of entrepreneurs to workers on the market increases
  • The money supply grows more sharply
  • Interest rates bottom
  • Prices for factors of production slowly start to rise more noticeably
  • Stock prices begin to rise more sharply
  • Talk about new industries and businesses in the media increases
  • Business sentiment turns more optimistic than before

Phase 5: The Credit Acceleration

The perpetuation of the central bank’s purchases now impels capitalists to make riskier loans than before. The ability to load loans off at the central bank at a premium reduces the relevance of risk assessment. A broad market for risky loans emerges, the junk bond market. The rise in the price of factors of production is starting to become more obvious on their main market, the stock market. Especially the markets for risky loans and stocks and for loans and stocks for projects that yield output in the farther future will suddenly appear much more lucrative to capitalists.

Entrepreneurs believe that the goods to be produced in these projects will meet a demand and that enough basic consumption goods are available at a low enough price to justify expenditures for the new future products. Profit expectations of the new enterprises appear reasonable.  As a result stock prices continue to rise. More capitalists will enter this market and realize gains. Established businesses will also begin changing their strategy and embark upon riskier and longer term projects.

It is not possible to determine from the outset which projects will be boosted more than others. If the government, for example, encourages home ownership via corresponding legislation and pushes home loans by itself, and if the central bank buys mortgage backed securities, it is rather likely that lending for the purpose of home ownership will increase and a housing bubble will ensue. But it is important to understand that such a housing bubble would only be one part of an overall reallocation of resources.

New would-be capitalists appearing on the market, who would usually have saved money and thus generated capital by abstaining from consumption no longer see their time preference reflected in the lower interest rates. Instead they will be compelled to buy stocks or houses as a means of wealth generation which at this point appears far more lucrative than loaning out money for less risky and shorter term projects. In addition they will be impelled to consume part of what they would have usually saved. Capital consumption as outlined in Savings and Investment ensues.

The number of resources withdrawn from the production of current basic consumer goods increases. Their employment in long term and risky projects increases. Meanwhile the true availability of savings has decreased. Production of basic consumer goods is neglected more and more as a result.

The additional money loaned and spent in salaries now visibly hits the market for consumer goods. The recipients of the money don’t save as much as the low interest rates indicated. And of the money they do save, part is diverted to risky or long term stocks. Due to higher consumption and less production, prices for basic consumer goods begin to rise slowly. The central bank begins to slow down its purchases of debt.

The entrepreneurs have gotten used to the easy access to credit. The overall sentiment will still be positive toward debt. Entrepreneurs will demand new credit once some of the initial loans are paid off. The lack of additional debt purchases from the central bank, coupled with the ever more prevalent shortage of savings will now cause interest rates to rise. Entrepreneurs will borrow money for more risky and longer term projects.


  • The junk bond market becomes more popular
  • Loans are being repackaged and sold at premiums
  • Profit expectations are revised higher
  • The savings rate peaks
  • The stock market soars
  • The money supply growth rate peaks
  • Interest rates rise
  • Prices of factors of production increase sharply
  • Prices for consumer goods begin rising slowly
  • True GDP peaks

Phase 6: The Credit Boom

Overall sentiment is very positive toward the projects that have been embarked upon. Factors of production are still priced based on the initial earnings expectations, meaning the expectation that their output would meet an expected demand. But the rise in consumer prices is no longer negligible. The raise in salaries is more and more put into relation with prices for consumer goods. Credit transactions will now take into consideration a significantly lower level of purchasing power, adding a premium to the interest. Interest rates begin rising more sharply. The rise of the prices of factors of production impels people to obtain them solely for the purpose of realizing a price gain and as a hedge against rising prices. Stock prices soar at an unusually high pace. Consumer prices rise more sharply. The central bank halts the credit expansion.


  • A euphoria emerges on the stock market, stock prices skyrocket
  • The money supply growth continues declining
  • Consumer prices rise more sharply
  • Interest rates rise further
  • The savings rate declines sharply
  • Stock prices peak
  • True GDP falls

Phase 7: The Credit Peak

Interest rates for loans keep rising sharply. The prices for factors of production increase which drives up cost for the new operations. The products they might at this point be launching are not the highest priority for the consumers. Due to a lack of immediate consumption products vis a vis  consumer demand, the prices for other consumer products begin rising sharply. Thus consumers need to cut back on extra consumption and confine their expenditures to basic consumer goods which are now more expensive. Thus revenue for the new operations falls. Rising prices and falling revenue will affect the profit of these operations. They will start to have problems paying interest to the capitalists and banks.

One by one, new businesses that produce less basic and more extra goods will begin defaulting on their loans and revise their earnings expectations down. First the riskiest ones, then the less risky ones. The capitalists will no longer extend additional credit. The market data now shows the capitalists and entrepreneurs what the true value and time preferences of the consumers are. Stock prices begin to fall, consumers refuse to change their consumption behavior while prices for basic consumer goods and commodities soar.

Resources need to be released from their current occupations. Since people will not immediately find new occupations, a rise in unemployment ensues.


  • Stock prices decline
  • Interest rates peak
  • Consumers complain about high prices for basic goods, such as gasoline or food
  • Business defaults increase
  • Commodity prices soar
  • Business sentiment turns less positive
  • The money supply growth keeps slowing down
  • Unemployment increases
  • True GDP continues to fall

Phase 8: The Credit Crunch

A general realization that the consumption demands were not in line with the actual amount of basic consumer goods available ensues. People will first of all begin consuming less, especially those who have been temporarily released from their occupation. Now the prices of consumer goods will reverse their gains begin falling sharply as well. The same realization reaches those people who are still occupied in more useful lines of production.

They will consume less and save more. More savings will be available. At the same time, as entrepreneurs still one by one liquidate their current failed operations, no additional credit is demanded. Existing loans are paid off or foreclosed upon. Businesses and consumers now rather want to consolidate their finances and save money so as to make available more productive factors for the production of basic consumption goods to get back to the level before the credit expansion began. A lot of money will initially be parked in very low risk debt securities, such as Treasuries. Their interest rates will begin falling first. Other debt securities will follow. The recipients of the money prefer to hold the cash until they are able to identify entrepreneurs who plan to produce more basic goods. Cash gains in preference to other goods.

The overall sentiment turns negative. Profit expectations are again revised down by the capitalists. They begin selling more of their stocks, factors of production are released from their current occupation and return to prices that truly reflect their usefulness to the consumers.


  • Stock prices crash
  • Commodity and consumer prices fall
  • The savings rate increases
  • Loan foreclosures increase significantly
  • Interest rates fall
  • Business sentiment turns negative
  • The number of bankruptcies increases
  • Unemployment increases
  • True GDP continues to fall

Phase 9: The Correction

Unless the government tries to counteract the processes that lead to a correction, in particular the liquidation of unprofitable operations, or attempts to perpetuate the process of credit expansion, prices will quickly return to levels where they represent voluntary value preferences. Otherwise the correction will also occur, but it will take much longer. Individuals have cut back on their consumption in order to save up money. The increase in savings lowers the rate of interest and thus indicates to entrepreneurs that a sufficient level of productive factors is available. Entrepreneurs identify operations that are profitable and obtain funds from the capitalists. They begin employing factors of production in these operations. The market returns to the unhampered state, albeit at a level of output and a standard of living that is lower than where it was before the credit expansion was started.


  • Stock prices bottom out
  • Interest rates bottom out
  • Consumer and commodity prices rise back to a certain level and then continue their slow long term decline
  • Unemployment declines
  • True GDP begins to rise again
  • Interest rates rise back to a certain level and then continue their slow long term decline

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