Why the essential business cycle is driven by innovation, not speculation.

Innovation from a more efficient process or discovery of raw resource (material/people).

Wealth sees that capex/training will increase to diminish short term profits so valuations decline.

Producers see long term profits will rise so borrow (now relatively cheaper than equity) to fund capex.

Interest rates rise.

Consumers see better return on saving so divert from (less essential) consumption to savings, that are lent to producers.

Reduced consumption leads to reduced production, leads to reduced employment.


Completion of capex.

Wealth sees only rising profits so valuations rise.

Improved process leads to greater profit so repayment of borrowings so interest rates fall.

Consumers reduce savings and increase consumption.

Increased production leads to increased employment in efficient processes.

Even in declining business cycle employing a more efficient process/resource will lead to increased profit/market share so will be undertaken.

If over the business cycle wealth valuations grow at a greater pace than production, this is an indication of excess money via an asset bubble, unless reversed consumers will spend this excess wealth creating consumer price inflation (higher prices for the same production). If valuations grow at a lesser pace this will lead to deflation.

Price stability leads to easier decision making. However removal of indication of benefit for substitution through price movement (including cost of money) leads to incorrect allocation of resources and sub optimal capacity (including labour) .i.e. a lower real GDP/head and greater wealth inequality.

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