The Austrian theory of the business cycle gives a completely different account of booms and busts than you will find in the media or from the mouth of Ben Bernanke. The person who put the whole theory together is Ludwig von Mises. <i>The Illusion of Wealth</i> gives you the chance to assess his theory in his own words. In passages carefully selected by Robert Murphy, Mises explains economic calculation, prices, interest, capital, money, central banking and provides a detailed look at the mechanics of the cycle.
Mises's general idea is that cycles begin with loose credit provided by a banking system that is protected from facing the economic consequences of unsound lending by the existence of the central bank. The boom turns to bust when the resources to sustain it go missing.
In a market, banks want to lend; they are restrained by risk. Government guarantees encourage risky lending. Artificially low interest rates — always cheered by indebted governments — signal to borrowers that there are more savings in the system than really exist. Business in particular expands production in a way that is unsustainable. This loose money policy creates a boom — the illusion of wealth — that is not justified by economic fundamentals. The correction takes place when the illusion of wealth is revealed in the course of time, kicked off by tightening credit or when the boom times are tested by reality.
In the 1920s and the first half of the 1930s, Mises's view came to be almost commonplace in the English-speaking world, mentioned and discussed by the mainstream as the top contender. After World War II, the theory ended up being stamped out by the newfound faith in macroeconomic planning, with John Maynard Keynes as its leading profit.
Today, that faith in macroeconomic management is now at another low point, but the baseline assumption that business cycles have a psychological origin is still with us. As Robert Murphy explains in the introduction, the goal of this book is to provide the most coherent possible explanation of the entire theory from its roots to its conclusions.
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