We rightly associate a bubble activity with an expansionary monetary policy of the central bank. This type of policy gives rise to various undertakings that, in the absence of the expansionary monetary policy, would not have emerged. An expansionary monetary policy—through the lowering of the interest rates via increases in the money supply—diverts savings to various projects that emerged on the back of the expansionary policy.
For instance, various projects that—prior to the lowering of the interest rates—were not considered economically viable, are now considered economically feasible. Thus, prior to the artificial lowering of the interest rates, the calculation of the net present value of various projects was showing a negative figure. However, with the lowering of the interest rates, the calculated net present value of projects becomes positive.
In the unhampered market, monetary interest rates mirror individuals’ preferences towards consumption in the present versus the consumption in the future. Now, to stay alive, individuals must have a higher preference for present consumption versus future consumption. According to Mises,
He who wants to live to see the later day, must first of all care for the preservation of his life in the intermediate period. Survival and appeasement of vital needs are thus requirements for the satisfaction of any wants in the remoter future.
Whenever individuals decide to increase their future consumption versus the present consumption, this means that they have lowered their time preference. This will be manifested by the lowering of the market interest rates.
The lowering of the interest rates is accompanied by an increase in savings. The increase in savings will provide the means of sustenance to individuals that will be employed in the various stages of the production of the future consumer goods. On the other hand, the central bank’s artificial lowering of the interest rates by inflation of money and credit disregards individuals’ time preferences and private savings. Rather, the lowering of interest rates is due to the desire of policymakers to “stimulate” current and future economic conditions. But this lowering of the interest rates is not accompanied by the increase in individuals’ savings. Individuals’ social time preferences and private savings rate have not changed. This means that easy money and credit will be diverted to various projects that emerged on the back of the expansionary monetary policy. According to Richard von Strigl,
Let us assume that in some country production must be completely rebuilt. The only factors of production available to the population besides laborers are those factors of production provided by nature. Now, if production is to be carried out by a roundabout method, let us assume of one year’s duration, then it is self-evident that production can only begin if, in addition to these originary factors of production, a subsistence fund is available to the population which will secure their nourishment and any other needs for a period of one year…. The greater this fund, the longer is the roundabout factor of production that can be undertaken, and the greater the output will be.
It is clear that under these conditions the “correct” length of the roundabout method of production is determined by the size of the subsistence fund or the period of time for which this fund suffices.
Projects that have emerged as a result of the expansionary policy of the central bank might be of impressive nature, such as the artificial intelligence (AI) projects, however, these projects might not be affordable under unhampered market conditions. What determines the affordability of these projects is social time preference, private savings, and consumer demand for such goods.
Expansionary monetary policies via a central bank, which artificially expands money and credit, warps the structure of production, in part supporting malinvestment in activities that would not have emerged—at least at that time and to that extent—under a free market. Or we could say that there is a diversion of resources from wealth-generators towards non-wealth-generators as a result of the expansionary monetary policy of the central bank.
The extent of private saving constrains the affordability of the various impressive projects such as the AI. To disregard this reality through a course of inflation and credit expansion means uneven price inflation, currency devaluation, distortion of the price and production structure, malinvestment, boom-bust cycles, and economic impoverishment. Consequently, regardless of how impressive the various projects may be, what determines whether these projects are realistically viable is private savings, market interest rates, and market demand.
As things stand currently, private saving and capital investment are in trouble. The key reason is ever-growing government spending and the reckless monetary policy of the central bank. In addition to this, the imposition of tariffs shrinks the structure of production and restricts options. As a result, economic growth is likely to come under pressure (if it has not done so already).
The sharp decline in the momentum of money supply since February 2021 is starting to hurt various activities that emerged on the back of the massive increases in the money supply momentum between August 2019 to February 2021. It is likely that the effect from this massive inflationary increase is still dominating the economic scene. As time goes by, however, the effect from the massive decline in the momentum of money supply on economic activity is expected to assert itself.
As a result, various bubbles are likely to crumble. The reason is because the easy money and credit to them will eventually weaken on account of the decline in the money supply momentum. Consequently, various bubble activities are not going to survive or will at least have to retrench.
The truth is social time preference, private saving, and capital investment may not be sufficient to support the expansion of various AI companies under a free market, for example. Consequently, assessing these activities in terms of their possible strength in the months to come is futile. The issue here is not how good these activities are but whether they represent malinvestments and are misallocated, unaffordable activities that emerged—in whole or in part—due to expansionary monetary policy. Now, were the central bank to aggressively lower the interest rates and increase the money supply even more, this will only make things much worse.
It is possible that banks’ inflationary lending will crumble in the months ahead. As a result, the growth rate in the money supply is likely to follow suit. This is expected to put more pressure on bubble activities.
The central bank’s likely expansionary monetary policy, coupled with an aggressive expansionary fiscal policy, is going to deepen the economic crisis by weakening the wealth-generation process. What is required to mitigate the crisis is to reduce (or eliminate) the central bank’s tampering with financial markets and to severely curtail government spending. This will arrest the market distortions and allow for a painful return to reality (or closer to it) in prices and production.
The suggestion that the replacement of the income tax with tariffs will mitigate the possible economic crisis is unlikely to work given the uptrend in government outlays. The effective tax hinges on government outlays. Hence, the higher the outlays the higher is the effective tax. Increasing government spending requires a further diversion of savings towards government activities. This, however, weakens wealth-generators thereby weakening economic growth.
Conclusion
Bubble activities are associated with an expansionary monetary policy of the central bank. This type of policy gives rise to various undertakings that, in the absence of the expansionary monetary policy of the central bank, would not have emerged. Various projects that have emerged on the back of the expansionary policy of the central bank might be impressive, however, given the shrinking size of private saving available for capital investment, these projects are not affordable. Regardless of how impressive these projects are, they are bubble activities and, therefore, are likely to burst. Furthermore, the misallocation of resources emerges not only because producers—on account of the central bank’s policies—are ignoring the consumers’ market preferences, but also because of the decline in genuine private savings.
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