The chief effect credit expansion exerts on the productive structure is ultimately that it discoordinates the behavior of the different economic agents.

Indeed entrepreneurs rush to lengthen and widen the productive stages and make them more capital-intensive, while the remaining economic agents are unwilling to cooperate by sacrificing their consumption and raising their overall voluntary saving.

This maladjustment or discoordination, which stems from a systematic attack on the process of social interaction (the privilege governments grant banks, allowing them to use a fractional reserve on demand deposits), invariably triggers a crisis process that eventually corrects the entrepreneurial mistakes committed.

Nevertheless the process takes time, and inevitably, by its end, serious errors will have been made that will have become irreversible.

The errors consist of launching and attempting to complete a series of investment projects which entail a lengthening and widening of the capital goods structure, projects which nonetheless cannot come to fruition, due to a lack of real saved resources.

Moreover once resources and original factors of production have been transformed into capital goods, these goods become non-convertible to a certain extent.

In other words, many capital goods will lose all of their value once it becomes clear there is no demand for them, they were manufactured in error and they should never have been produced.

It will be possible to continue using others, but only after spending a large amount of money redesigning them. The production of yet others may reach completion, but given that the capital goods structure requires that the goods be complementary, they may never be operated if the necessary complementary resources are not produced.

Finally, it is conceivable that certain capital goods may be remodeled at a relatively low cost, though such goods are undoubtedly in the minority.1

Hence a widespread malinvestment of society’s scarce productive resources takes place, and a loss of many of its scarce capital goods follows.

This loss derives from the distorted information which, during a certain period of time, entrepreneurs received in the form of easier credit terms and relatively lower interest rates.2

Many investment processes may also be left half-completed, as their promoters abandon them upon realizing they cannot continue to obtain the new financial resources necessary to complete them, or though they may be able to continue to secure loans, they recognize that the investment processes lack economic viability.

In short the widespread malinvestment expresses itself in the following ways: many capital goods remain unused, many investment processes cannot be completed, and capital goods produced are used in a manner not originally foreseen.

A large portion of society’s scarce resources has been squandered, and as a result, society becomes poorer in general and the standard of living drops, in relative terms.

Many economists have misunderstood the fact that a significant number of the errors committed manifest themselves as completed capital goods which, nonetheless, cannot be used, due to the absence of the complementary capital goods or working capital necessary.

Indeed many see this phenomenon of “idle capacity” as clear proof of a necessity to boost overall consumption with the purpose of putting into operation an idle capacity which has been developed but is not yet used.

They do not realize that, as Hayek indicates,3 the existence of “idle capacity” in many production processes (but especially in those furthest from consumption, such as high technology, construction, and capital goods industries in general) in no way constitutes proof of oversaving and insufficient consumption.

Quite the opposite is true: it is a symptom of the fact that we cannot completely use fixed capital produced in error, because the immediate demand for consumer goods and services is so urgent that we cannot allow ourselves the luxury of producing the complementary capital goods nor the working capital necessary to take advantage of such idle capacity.

In short the crisis is provoked by a relative excess of consumption, i.e., a relative shortage of saving, which does not permit the completion of the processes initiated, nor the production of the complementary capital goods or working capital necessary to maintain the ongoing investment processes and to employ the capital goods which, for whatever reason, entrepreneurs were able to finish during the expansion process.


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