What Causes Booms and Busts?
What is really to blame for the booms and busts of the economic cycle? Is it inherent in the nature of the free market, as Marx claimed? Or is there something else going on?
Professor Jeff Herbener answers this question in a lecture about Austrian economics at Liberty Classroom:
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I agree with Marx on this one, booms and busts are a feature of free markets (which government intervention can make bigger or smaller).
I listened to the lecture and found some things I don’t agree with.
In his discussion of stock market prices he assumes that all buyers and sellers in the market are basing their decisions on their assessment of the long term value of a stock. But in fact there are many momentum traders who assume prices will continue to move in the same direction. Enough such traders introduce instability causing bubbles and crashes based on changes in confidence rather than real changes in the long term outlook for a stock.
He dismisses problems caused by sticky wages and prices by noting these are produced in response to consumer preferences and thus (he claims) should go away if they start causing problems. But this assumes local optimizations will produce the global optimum which is often not the case.
Near the end he claims changes in consumer preference don’t matter because entrepreneurs can anticipate them. I believe some aspects of the future are unpredictable and cannot be forecast accurately in general. Of course some people will make lucky guesses but there is no reason to believe the average expectation will be accurate.
James B. Shearer (9c6bcc) — 11/26/2016 @ 8:55 am@Shearer: But in fact there are many momentum traders who assume prices will continue to move in the same direction.
Maybe there is a distinction made between a boom and a bubble?
When you get lots of people who have no interest in the long term value of an asset, and are just trying to flip it, I don’t know if that CAUSES a bubble but it certainly is highly correlated.
I know one guy who lost lots of money in the dot com bubble. As he said, “we all knew it was a bubble, we just didn’t think we were the suckers”.
The canonical historical examples: South Sea Bubble, Mississippi Bubble,Tulip Bubble.
In each of these cases the market was around for quite a few years before the bubble, which took place in a very short time, a matter of months.
Gabriel Hanna (9b1f4a) — 11/26/2016 @ 9:22 amIt’s related to the ‘Greater Fool’ theory: you’re a damn fool to buy an over priced stock, unless a greater fool will come along and pay you more.
ropelight (3d2fd8) — 11/26/2016 @ 10:29 amAll busts are a boom for someone. Money doesn’t disappear. Someone pocketed that money that they report as having just disappeared from the economy.
Jcurtis (609b31) — 11/26/2016 @ 4:34 pm4. Jcurtis (609b31) — 11/26/2016 @ 4:34 pm
Yes, it does, and plenty of money diappeared in the years 1929-1932, especially when banks failed.
Also in 1893, and then the discovery of gold in 1897 and 1898 made money appear.
Andrew Jackson destroyed money in 1837.
I would say that what causes booms and busts is increases or decreases in the real money supply. (now to some people the words “real money supply” might sound like an impossible term)
Sammy Finkelman (1190c5) — 11/26/2016 @ 7:07 pmThe South Sea Bubble, Mississippi Bubble, and Tulip Bubble where cases where money was first created, and then destroyed.
Sammy Finkelman (1190c5) — 11/26/2016 @ 7:09 pmAll busts are a boom for someone. Money doesn’t disappear. Someone pocketed that money that they report as having just disappeared from the economy.
I believe money can disappear. But in any case bubbles followed by busts can cause misallocation and waste of real resources. I believe the collapse of the housing bubble led in some cases to half built houses being abandoned (or even bulldozed) because it was no longer worth finishing them.
James B. Shearer (a99e7c) — 11/26/2016 @ 9:23 pm