The Parasitic Cycle

[CoinCube]

The Parasitic Cycle: Finance Part II

Modern economics obscures the truth about the process of money creation. In Finance Part I: Understanding the Parasite we explored how money is actually created. Today we explore the devastating economic consequences that inevitably follow.

Banking is a very treacherous business because you don't realize it is risky until it is too late. It is like calm waters that deliver huge storms.

The modern industrial economy is characterized by cyclical boom and bust. Massive growth is followed by recurrent busts. With only minor hand waving we are told by most economists that this "business cycle" is caused by mysterious and natural periodic shifts in savings and consumption. Karl Marx noticed that before the Industrial Revolution, these cyclical boom and busts did not occur. Marx concluded that the cycles must therefore be an inherent feature of capitalism. Various schools of modern economic thought, regardless of their other disagreements have all agreed on this sacred scripture. The business cycle (we are told) must be rooted deep within the free-market economy a natural boom and bust if you will. These crashes seem to just… happen.

We must go further back in history to find a true counter to the modern narrative. David Hume and David Ricardo would not have agreed with current orthodoxy. Hume was the first to point out that another critical institution had developed and grown strong alongside the industrial system. This wondrous creation of wealth extraction creation is our fractional reserve banking system. Could this powerful institution be responsible for the cycles? Ludwig von Mises answered this question definitively in 1912 with his book Theory of Money and Credit.  

Mises saw that true cause of the recurrent boom and bust cycles was fractional reserve banking. Banks create money, but each loan they make creates more debt than money. To pay back these loans the interest due must in be drawn from the larger economy. This interest can only be paid via two mechanisms.

1) Someone somewhere in the economy must take out even more debt to pay the initial loan.

Or

2) Somewhere debt must go into default and its underlying collateral seized.

The bank's costs to create money are fixed at a low price by the central bank (not the free market). Central banks keep this rate at the lowest possible level that avoids significant inflation. It is "good for the economy" or so we are told. Debt requires ever more debt to sustain.

Credit creation makes it appear as if the supply of "saved funds" ready for investment has increased, for the effect is the same: the supply of funds for investment purposes increases, and the interest rate is lowered. Borrowers, in short, are misled by the bank inflation into believing that the supply of saved funds (the pool of "deferred" funds ready to be invested) is greater than it really is.

When interest rates are artificially low, entrepreneurs are led to believe the income they will receive in the future is sufficient to cover their near term investment costs. In an environment where the money supply is continually expanding via debt, entrepreneurs mistakenly conclude that investments are really available for long term projects when in fact the pool of available funds has come solely from artificial credit creation that can and will be contracted at will by the banking sector. Entrepreneurs see spending in the economy and assume consumer demand exists for their projects when in fact consumer demand is artificially and unsustainably elevated.

As bank credit percolates through the economy it moves downward from business borrowers to landowners and capital owners who sold assets to the newly indebted entrepreneurs, and finally onto other factors of production like wages, rent, and interest.

No punch bowl stays full forever. The artificial boom from artificial credit raises prices and if left unchecked runaway inflation. Banks cannot allow that. As inflation picks up the central bank overseer signals the end of the party. Interest rates are rise and the squeeze begins.

When banks start to squeeze (often in response to inflation) the party quickly ends and there is a critical economy wide liquidity shortage. By definition there is never enough money to pay off debt. Without sufficient new debt what existing liquidity exists must be redirected towards an ultimately unpayable debt. Assets must be sold and prices drop.  Investors suddenly find their projects are unsustainable; banks call in loans and then seize the underlying collateral capturing the work and effort of the investor.
Some investments made during the artificial monetary boom were inappropriate and "wrong" from the perspective of the long-term financial sustainability. Others should be sound but nevertheless fail due to the economic distortion and contraction triggered by sudden credit tightening.

The boom is revealed for what it is, a period of wasteful malinvestment, a "false boom" where the investments undertaken during the period of fiat money expansion are revealed to lead nowhere but to insolvency and unsustainability. Seizure of collateral and general price deflation or reduction in inflation ensues. The longer the false monetary boom goes on, the bigger and more speculative the borrowing, the more wasteful the errors committed and the longer and more severe will be the necessary bankruptcies, foreclosures and depression.

As we have seen, an increase in the supply of money benefits the early receivers, that is, the government, the banks, and their favored debtors or contractors, at no point is this more true than at the bottom of the business cycle when asset prices are artificially depressed and only favored borrowers are allowed to borrow. It is at the bottom that favored insiders can still borrow allowing assets to be purchased at depressed prices.

In any economy not on a 100% percent commodity or cryptocurrency standard, the money supply is thus used as a vehicle for wealth extraction. Monetary inflation and the inevitable resulting parasitic cycle erroneously referred to as the "business cycle" is the method by which the banking system, and favored political groups are able to partially expropriate the wealth of other groups in society. Those empowered to control the money supply issue new money to their own economic advantage and at the expense of the remainder of the population. The parasitic cycle is a direct result of fractional reserve banking. The creation of new money is limited only by the top down imposed cost set by the central bank. This value is not set by individuals optimizing their economic savings decisions but a single top down controller, a controller who's charter mandates it to act in the best interest of its member banks.

The empirical evidence is strongly on the side of the view that deviations from full employment are often the result of spending shocks. Monetary policy, in particular, appears to have played a crucial role in causing business cycles in the United States since World War II. For example, the severe recessions of both the early 1970s and the early 1980s were directly attributable to decisions by the Federal Reserve to raise interest rates. On the expansionary side, the inflationary booms of the mid-1960s and the late 1970s were both at least partly due to monetary ease and low interest rates. The role of money in causing business cycles is even stronger if one considers the era before World War II. Many of the worst prewar depressions, including the recessions of 1908, 1921, and the Great Depression 1930s, were to a large extent the result of monetary contraction and high real interest rates.

Figure 1: Unemployment Rate and Recessions

Once inflation is safely tamed and another cycle of assets seized, the central bank signals the start of the next "boom" and low rates are initiated once more with the goal of "helping reduce the unemployment" caused by the "business cycle". However, the parasitic cycle is self-limiting. It only works if banks can identify individuals with collateral to harvest lend to. Eventually those people run out of assets to seize. The highly productive learn to avoid debt whenever possible and thus partially opt out of the game.

Once the parasitic cycle has run its course banks need a way to forcibly harvest the wealth of those who opt out of the system. To succeed they need a more efficient suction mechanism. Specifically they need powerful centralized government and taxation powers. Stay tuned for Finance Part III.

Finance Part I: Understanding the Parasite
Finance Part II: The Parasitic Cycle
Finance Part III: Divide, Conquer, Enslave

References:
Murray N. Rothbard, Economic Depressions: Their Cause and Cure
https://mises.org/daily/3127
Ludwig von Mises Institute, Austrian Business Cycle Theory
http://wiki.mises.org/wiki/Austrian_Business_Cycle_Theory#cite_note-6
Christina D. Romer, Business Cycles
http://www.econlib.org/library/Enc/BusinessCycles.html

[1714307913]

1714307913

[1714307913]

1714307913

[1714307913]

1714307913

[1714307913]

1714307913

[bobdutica]

I enjoyed this article.
After the U.S. Dollar almost collapsed in 1978, Hollywood made a movie on the theme of financial collapse: Rollover, starring Jane Fonda and Chris Kristofferson. I watched it recently to see the hollywood interpretation of financial collapse. It was ok to provide a flavor of collapse caused by bankers for the general public, put a little bit of a disappointment for anyone with a moderate amount of knowledge about the banking system. Fortunately, by raising interest rates to around 20% the collapse was avoided, so we don't have to worry about a sequel to "Rollover".

[q119108]

It's a nice article. It explains the nature of Money clearly.

[iamnotback]

Karl Marx noticed that before the Industrial Revolution, these cyclical boom and busts did not occur.

That is not true. Agriculture suffered busts due to the cyclic calamities, droughts, etc of mother nature.

The Bible even speaks about the 7 fat years followed by 7 lean years.

Once the parasitic cycle has run its course banks need a way to forcibly harvest the wealth of those who opt out of the system. To succeed they need a more efficient suction mechanism. Specifically they need powerful centralized government and taxation powers

And we have recently noted how gold can no longer serve that opt-out release valve, but crypto-currency does.

[CoinCube]

Karl Marx noticed that before the Industrial Revolution, these cyclical boom and busts did not occur.

That is not true. Agriculture suffered busts due to the cyclic calamities, droughts, etc of mother nature.

Here is my source material for that sentence.

Economic Depressions: Their Cause and Cure
https://mises.org/library/economic-depressions-their-cause-and-cure

The currently fashionable attitude toward the business cycle stems, actually, from Karl Marx. Marx saw that, before the Industrial Revolution in approximately the late 18th century, there were no regularly recurring booms and depressions. There would be a sudden economic crisis whenever some king made war or confiscated the property of his subject; but there was no sign of the peculiarly modern phenomena of general and fairly regular swings in business fortunes, of expansions and contractions. Since these cycles also appeared on the scene at about the same time as modern industry, Marx concluded that business cycles were an inherent feature of the capitalist market economy. All the various current schools of economic thought, regardless of their other differences and the different causes that they attribute to the cycle, agree on this vital point: that these business cycles originate somewhere deep within the free-market economy.

[iamnotback]

...There would be a sudden economic crisis whenever some king made war or confiscated the property of his subject...

The economic realities that cause the busts of liquidity are probably the underlying stress that drive kings to make war or confiscate.

Those collapses of overexpansion of liquidity are also evident in Roman times.

But what else would you expect from leftist, Marxists who lie to support their agenda.

I am too sleepy (sleepless in airport waiting for 1am flight with a stopover, ugh) to fully research my objections. Yet I am confident that the 8.6 year business cycle didn't begin in the 19th century. Armstrong has documented as far back as Mesopotamia I think (remember a blog of his on this topic).

Edit: https://www.armstrongeconomics.com/research/monetary-history-of-the-world/historical-outline-origins-of-money/money-and-the-evolution-of-banking/

The invention of banking preceded that of coinage by several thousand years. Banking appears to have originated in Ancient Mesopotamia. Receipts in the form of clay tablets were used to record transfers between parties. Among some of the earliest recorded laws (Code of Hammurabi), pertain to the regulation of the banking industry in Mesopotamia.

The development of banking in Mesopotamia is quite interesting. It illustrates that all the modern practices such as deposits, interest, loans and letters of credit existed from the time of the first great civilizations on earth. In effect, these clay tablets were the forerunner of our more modern paper money systems that emerged in China by 900 AD and in Western culture by the 18th century. The distinction appears to be that these clay tablets were more of a bank draft or money order issued by the private sector rather than by the state. In that respect, they were a function of the banking system that facilitated the development of an officially sanctioned form of standardized monetary system.

Egyptian sources also show that a vibrant banking industry emerged whereby the state provided warehouses in which farmers deposited their grain. In turn, the farmer would receive a “deposit receipt” reflecting how much wealth was held by the bank in question. Such written receipts eventually became used as a general method of making payment of debts to third
parties during the Ptolemy era including trade, taxes and donations to the gods.

...

Throughout the monetary history of the world, leverage has provided through the means of credit the boom and the bust effect within the economy. With it, the business cycle inevitably over-expands and over-contracts aid largely by credit.

...

Kondratieff’s work was compelling and contributed greatly to the Austrian School of Economics that first began to develop the concept of a business cycle. While the general central principle of the Austrian Business Cycle Theory is concerned with a period of sustained low interest rates and excessive credit creation results in a volatile and unstable imbalance between saving and investment. Within this context, the theory supposes that the business cycle unfolds whereby low interest rates tend to stimulate borrowing from the banking sector and this then results in the expansion of the money supply that causes an unsustainable credit ­source boom that leads to a diminished opportunity for investment by competition. Therefore, at the top, this causes speculative misallocation of resources that manifests into a bubble-top. The decline unfolds as a “credit-crunch” creating the speculative bust and recession. This contraction in credit shrinks the money-supply complete the cycle to return to its prior state.


This theory is merely an observation of a single slice of the complex dynamic adaptive system that constitutes the economy. It is not correct for interest rates will rise during the bull cycle phase. There is no empirical evidence that supports the theory from a quantitative formulae perspective. In other words, the real true operation of interest rates is that people will continue to borrow even when rates rise depending upon their expectations of profits. It is not the simplistic direction of interest rates nor is it an easily defined sustained level of what is low or high. The problem is merely attempting to reduce the entire complex system to a single and simplistic cause and effect.

...

The issue of INTENSITY seemed to revolve around periods of 51.6 years, which was in reality a group of 6 individual business cycles of 8.6 years in length. Back testing into ancient history seemed to reveal that the business cycle concept was alive and well during the Greek Empire as well as Rome and all others that followed. It was a natural step to see if one could project into the future and determine if its validity would still hold up.

...