wage than the free market can provide, stupidly settle for a lower real wage if it is camouflaged in the form of a rise in the cost of living. As for idle capital goods, these may have been totally and hopelessly malinvested in a previous boom (or at some other time) and hopelessly lost to profitable production for a long time or forever. A credit expansion may appear to render submarginal capital profitable once more, but this too will be malinvestment , and the now greater error will be exposed when this boom is over. Thus, credit expansion generates the business cycle regardless of the existence of unemployed factors.
Credit expansion in the midst of unemployment will create more distortions and malinvestments, delay recovery from the preceding boom, and make a more grueling recovery necessary in the future.
While it is true that the unemployed factors are not now diverted from more valuable uses as employed factors would be (since they were speculatively idle or malinvested instead of employed), the other complementary factors will be diverted into working with them, and these factors will be malinvested and wasted. Moreover, all the other distorting effects of credit expansion will still follow, and a depression will be necessary to correct the new distortion.31
“Overinvestment” or Malinvestment?
The second misconception, given currency by Haberler in his famous Prosperity and Depression , calls the Misesian picture of the boom an “overinvestment” theory.32 Mises has brilliantly shown the error of this label. As Mises points out:
[A]dditional investment is only possible to the extent that there is an additional supply of capital goods available. . . . The boom itself does not result in a restriction but rather in an increase in consumption, it does not 31See Mises, Human Action, pp. 576–78. Professor Hayek, in his well-known (and excellent) exposition of the Austrian theory, had early shown how the theory fully applies to credit expansion amidst unemployed factors. Hayek, Prices and Production, pp. 96–99.
32Haberler, Prosperity and Depression, chap. 3.
The Positive Theory of the Cycle
31
procure more capital goods for new investment. The essence of the credit-expansion boom is not overinvestment, but investment in wrong lines, i.e., malinvestment
. . . on a scale for which the capital goods available do not suffice. Their projects are unrealizable on account of the insufficient supply of capital goods. . . . The unavoidable end of the credit expansion makes the faults committed visible. There are plants which cannot be utilized because the plants needed for the production of the complementary factors of production are lacking; plants the products of which cannot be sold because the consumers are more intent upon purchasing other goods which, however, are not produced in sufficient quantities.
The observer notices only the malinvestments which are visible and fails to recognize that these establishments are malinvestments only because of the fact that other plants—those required for the production of the complementary factors of productions and those required for the production of consumers’ goods more urgently demanded by the public—are lacking. . . . The whole entrepreneurial class is, as it were, in the position of a master-builder [who] . . . overestimates the quantity of the available supply [of materials] . . . oversizes the groundwork . . . and only discovers later . . . that he lacks the material needed for the completion of the structure.
It is obvious that our master-builder’s fault was not overinvestment, but an inappropriate [investment].33
Some critics have insisted that if the boom goes on long enough, these processes might finally be “completed.” But this takes the metaphor too literally. The point is that credit expansion distorts investment by directing too much of the available capital into the higher orders of production, leaving too little for lower 33Mises, Human
Credit expansion in the midst of unemployment will create more distortions and malinvestments, delay recovery from the preceding boom, and make a more grueling recovery necessary in the future.
While it is true that the unemployed factors are not now diverted from more valuable uses as employed factors would be (since they were speculatively idle or malinvested instead of employed), the other complementary factors will be diverted into working with them, and these factors will be malinvested and wasted. Moreover, all the other distorting effects of credit expansion will still follow, and a depression will be necessary to correct the new distortion.31
“Overinvestment” or Malinvestment?
The second misconception, given currency by Haberler in his famous Prosperity and Depression , calls the Misesian picture of the boom an “overinvestment” theory.32 Mises has brilliantly shown the error of this label. As Mises points out:
[A]dditional investment is only possible to the extent that there is an additional supply of capital goods available. . . . The boom itself does not result in a restriction but rather in an increase in consumption, it does not 31See Mises, Human Action, pp. 576–78. Professor Hayek, in his well-known (and excellent) exposition of the Austrian theory, had early shown how the theory fully applies to credit expansion amidst unemployed factors. Hayek, Prices and Production, pp. 96–99.
32Haberler, Prosperity and Depression, chap. 3.
The Positive Theory of the Cycle
31
procure more capital goods for new investment. The essence of the credit-expansion boom is not overinvestment, but investment in wrong lines, i.e., malinvestment
. . . on a scale for which the capital goods available do not suffice. Their projects are unrealizable on account of the insufficient supply of capital goods. . . . The unavoidable end of the credit expansion makes the faults committed visible. There are plants which cannot be utilized because the plants needed for the production of the complementary factors of production are lacking; plants the products of which cannot be sold because the consumers are more intent upon purchasing other goods which, however, are not produced in sufficient quantities.
The observer notices only the malinvestments which are visible and fails to recognize that these establishments are malinvestments only because of the fact that other plants—those required for the production of the complementary factors of productions and those required for the production of consumers’ goods more urgently demanded by the public—are lacking. . . . The whole entrepreneurial class is, as it were, in the position of a master-builder [who] . . . overestimates the quantity of the available supply [of materials] . . . oversizes the groundwork . . . and only discovers later . . . that he lacks the material needed for the completion of the structure.
It is obvious that our master-builder’s fault was not overinvestment, but an inappropriate [investment].33
Some critics have insisted that if the boom goes on long enough, these processes might finally be “completed.” But this takes the metaphor too literally. The point is that credit expansion distorts investment by directing too much of the available capital into the higher orders of production, leaving too little for lower 33Mises, Human
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