‘..courage of the human race .. reason’

‘O Liberty! we have seen thee hunted from country to country, crushed by conquest, groaning under slavery, insulted in courts, banished from schools, laughed at in saloons, misunderstood in workshops, denounced in churches. It seems thou shouldst find in thought an inviolable refuge. But if thou art to surrender in this thy last asylum, what becomes of the hopes of ages, and the boasted courage of the human race?’

– Bastiat, Economic Harmonies, Book I (1850) (Pens for Hire, Cheap)

‘Recognizing that a lack of savings is the real barrier for development .. the search for profit is not necessarily always constructive but can even be destructive.’

‘Recognizing that a lack of savings is the real barrier for development, our attention is lead from Schumpeter’s approach to the Austrian Business Cycle Theory. As Mises and Hayek showed again and again, a boom driven by credit expansion with fiat money leads inevitably to malinvestments. But Schumpeter, enclosed in the static and absurd model of general equilibrium, where no profits are achievable, endorsed credit expansion by the banks as a means to foster innovation.

There is, of course, nothing wrong with relying on credit in order to provide for the application of an innovative project. The problem only appears when these credits are created out of thin air, thus inducing malinvestments.[11] It is easily imaginable that in an environment of monetary expansion, many innovative projects are fostered that are in fact not sustainable.

The clusters of innovative activities that Schumpeter considered the cause of inevitable depressions are thus in fact a symptom of the distortion of the market process that is introduced by fractional-reserve banks. The words Hayek used to describe such a situation fit well into the period of the dotcom and subprime bubbles:

Now the chief effect of inflation which makes it at first generally welcome to business is precisely that prices of products turn out to be higher in general than foreseen. It is this which produces the general state of euphoria, a false sense of wellbeing, in which everybody seems to prosper.[12]

Schumpeter is right, though, that one of the major characteristics of entrepreneurship and capitalism is the innovative capacity. Yet that is not what triggers the cycle. Another factor needs to be present. Theoretical research on the nature of entrepreneurship, e.g., by Baumol[13] and others, has pointed out that the search for profit is not necessarily always constructive but can even be destructive.

Such is the case when “bad” institutions guide entrepreneurial activities into areas where they create, not mutually beneficial situations, but zero-sum (or even negative-sum) games. An obvious example is the democratically legitimized redistribution of wealth, which opens the door for all kinds of rent-seeking projects.

Another example is the destructive effect that fractional-reserve banking has on entrepreneurial activities. Fractional-reserve banking violates property rights and misleads the normal innovative activities of entrepreneurs by providing incorrect price signals. As a result, innovative actions are channeled to unsustainable projects, which eventually have to be abandoned. Hence, it is not the creative and innovative character of entrepreneurs as such but the misguiding effects of fractional-reserve banking that ultimately cause ever-repeating business cycles.


..the Austrian attempt to explain current affairs is still marginalized in professional and public debates. We ought to consider the cautionary words of the once-proud philosopher Hypatia: “Should not reason alone be the judge?”‘

-Malte Tobias Kahler, Do Innovations Cause Business Cycles?, January 07, 2010