Case study in Boom/Bust economics–China’s empty cities

Posted on August 22, 2013 by

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The Austrian theory of the business cycle is often misunderstood as an overinvestment theory–where too much investment causes a boom, which must be corrected by a bust.  Prominent economists such as Paul Krugman characterize it this way,

Call it the overinvestment theory of recessions, or “liquidationism,” or just call it the “hangover theory.” It is the idea that slumps are the price we pay for booms, that the suffering the economy experiences during a recession is a necessary punishment for the excesses of the previous expansion.

Of course, this is NOT the Austrian theory; rather the Austrian theory is one of malinvestment–the wrong kind of investment, not overinvestment, or too much investment.  The is classically underway yet again by foolish stimulative policies in China, which has created perhaps the world’s greatest real estate bubble.  This piece from 60 minutes will tell you more about the Austrian business cycle theory than any economist ever could.  As you watch (about 12 minutes), notice the displaced people who are having their homes torn down to build housing that is unaffordable–its not that housing isn’t needed, but the government policies are enabling the wrong kind of housing.  This is the essence of malinvestment.  Capital is misallocated away from true consumer preferences toward something either favored by the government directly or indirectly enabled by manipulation of the interest rate.

China Bubble

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