In a free society where individuals are allowed to make choices by themselves so long as they don’t infringe upon their fellow men’s life, health, and property, entrepreneurs use natural resources, transform them and/or combine them with previously produced factors of production, and turn them into either consumer goods or other factors of production. They employ workers in the process who provide the production factor labor.
They exchange consumer goods on the market against money obtained from consumers. They exchange factors of production against money obtained from other entrepreneurs.
Factors of production, once completed at some point in the future, enable entrepreneurs to produce more consumer goods during the same amount of time. But while factors of production are being built, workers and natural resources are being used in processes that don’t turn out any consumer goods. It is thus necessary to only employ workers and resources in the production and maintenance of factors of production to the extent that during this process individuals in society are willing to not consume the full output of their labor, and hence generate savings.
On top of that, it is necessary to maintain the existing stock of productive factors, lest their wear and tear cause a decline in the output of consumer products. Thus a continuous level of savings needs to be maintained by individuals in society.
Interest rates on the market give entrepreneurs an indication of the market participants’ time preference, meaning how much immediate consumption people are willing to forgo in exchange for the prospect of more future consumption. In other words, interest rates give an indication as to how much people are ready to save and thus contribute to the maintenance and new developments of factors of production.
If the the government pursues a policy of business credit expansion, the interest rate indicator is manipulated by force, as opposed to voluntary individual time preferences. The interest rate drops below the level that represents those actual preferences. If mostly consumer loans are pushed, the consumption business cycle ensues:
The Consumption Business Cycle
The central bank and fractional reserve banks create new fiat money and make it available in credit transactions to individuals who intend to use the money for the purposes of consumption. Examples would be car loans and home loans which made the US economy align its productive factors accordingly over the past decades. It is likely, but not necessary that interest rates for such credit instruments will drop initially.
Some individuals may now enter into these new credit transactions and use the new money to consume goods that they wouldn’t have consumed before. But they didn’t do so by reducing their savings, nor did anybody else sacrifice consumption to make this money available. It was created out of nothing. No additional consumer goods have been produced.
The prices for the goods demanded will begin to increase. Entrepreneurs will respond by abandoning the production of some additional factors of production and turn out more consumer goods instead. So long as more credit is channeled into the system, prices will continue to increase while entrepreneurs try to catch up. Fractional reserve banks will begin to earn more interest revenue and expand their operations and resource usage.
Businesses that produce consumer goods will report higher profits, while profits for businesses producing factors of production and basic materials will lag behind. A myriad of consumer goods based businesses will spring up over time. The alignment for immediate consumption vs. more/better future consumption continues so long as individuals continue to be able to pay interest on the credit transactions performed and expect to be able to do so in future.
But as explained above, making interest payments and paying off debt is only possible in the long run if the workforce, as a whole over time, becomes more productive per unit of labor. But the opposite occurs. Productivity per labor unit will be lower than the additional consumer loans appeared to indicate, since in an unhampered system credit can only come out of savings (which means someone somewhere forgoes immediate consumption, making room for more factors of production). After a certain period, the amount of debt and interest payments will become higher than consumers can afford. In addition, due to lower interest rates, a lot of rather risky loans were made to individuals that would not have occurred in the unhampered state. Individuals will begin to default on their interest payments.
They start realizing that they need to consume less and save more in order to not have this happen again. Their demand for additional credit drops sharply. Their demand for money to pay off the debt and/or generate savings rises.
The fractional reserve banks will begin to slow down the creation of additional credit. They begin reporting losses on existing consumer debt.
As excess consumption comes to a halt consumer prices begin to fall, businesses aligned for the production of consumer goods will see declining profits, some will start reporting losses. They realize that they will have to abandon some projects since the demand for consumer goods starts to fall back to sustainable levels that match everyone’s time preference and expectations. The desire to consolidate one’s finances takes priority over everything else.
This is what is currently happening in the United States. The end of consumerism really means the end of capital consumption. It means that people realize that they need to save more and consume less, so as to provide for economic progress and more efficiency in the future, and to restore balance to the economy as a whole. It means that people have understood that too much of the existing capital stock has been consumed and has deteriorated.
This is the causality that the majority of pundits and economics professors that one can hear talk every evening on the news simply don’t understand. All their theories and policies are ignoring this one crucial fact: That Americans are done consuming for the foreseeable future. The end of consumerism isn’t just a temporary ditch. It is here and now and it won’t go a way for a long long time. It is a once in a lifetime occurrence. This is why it is so hard to grasp and to accept. But it is very simple to understand when one approaches it with sane common sense. How many more Starbucks branches do we need in the streets of New York? How many more gas guzzling cars should each family posess? Three, four, ten …? How many more different brands of detergents, shampoos, toothpastes, and consumer electronics products do we really need?
Now, it is important that the reader doesn’t get this wrong. I do not oppose consumption. In fact, the entire material wealth of a person is ultimately determined by how much he can consume. Consumption, present or future, is what all humans ultimately work for. But if, in an environment of government induced credit expansion, people consume more than is sustainable in the long run so long as the music still plays, they need to cut back for a certain period once the music stops playing. If we had never embarked on the disastrous path of credit expansion and government intervention, if all factors of production were allocated as efficiently and effectively as possible, if the government had confined its scope to the protection of each individual’s life, health, and property, we would today be able to consume a lot more than we currently can.
Unfortunately this is not the situation we are in here and now. We do not live in a perfect free world. We need to respond to the reality around us rather than deny it. It is time to cut back and restore sanity and balance. Individuals have realized this and are doing the right thing. The government has not understood this fact at all. It is trying to keep alive failed businesses that should release resources for more demanded projects. It is trying to make up for the “lack of consumption” in the private sector. All these attempts will fail miserably. All they will accomplish is to slow down the corrective phase and turn it into a decade of agony.