Just as important as saying what the business cycle is, saying what it is not.  It is not something determined by statistics.  Statisticians will make you think economics can be determined by viewing statistics, all statistics are historical, and drawing a graph to view those statistics is pointless.  In the words of Mises: graphs are for undergraduates.  The business cycle is categorically different from business fluctuations.  The business cycle is not caused by animal spirits, greed, or speculators—every person on earth is a speculator—unless you know someone who can predict the future.  The business cycle can only be caused by artificially expanding credit.

Business fluctuations must be explained more in depth.  Now, the cicada fighting equipment market probably did well recently, but we don’t want to stimulate idle cicada resources until next time they come around.  A speculator is just someone who is anticipating the future.  Unless you know the future, you are a speculator.  They may be someone taking advantage of distortions in the market.  This can lead to large profits for them.  This is actually beneficial.  The artificial boom would go on longer without them.

Present goods are worth more than future goods.  So, interest is the premium you pay to get a future good in the present.  If you loan someone money, it can be thought of as a reward for waiting, or a low time preference as economists call it.  This isn’t determined by looking at statistics or a chart.  This is what interest is.  So, now we are in position to outline the business cycle.  Don’t let anyone tell you this is a theory.  They are just trying to bite you with stolen teeth.  This is an explanation.

Entrepreneurs are very skilled at predicting future demand.  They pay the cost now with the expectation of profits in the future.  I say expectation because it can be a loss.  Nobody tries to lose money.   It would seem a small portion make a mistake in predicting future demand, but they all make mistakes at the same time.  Why is there a cluster of errors?  Why do some industries suffer more than others?  This does not happen on the free market. 

Busts are triggered by artificial credit expansion.  Some money is consumed, some will be used at a later date—saved or invested.  The more save or invested, the lower the interest rates will be.  A low interest rate signals to entrepreneurs people will consume at a later date.  So, when the interest rate is low, entrepreneurs will invest in capital goods, like a factory or hotel.  What if people aren’t saving for the future.  The interest rates will be high.  What if the interest rates are artificially lower?

Interest rates are artificially low so the entrepreneurs think people are saving for the future.  So, the factory or hotel will not have enough resources to be completed.  Say, they are completed and yield a profit.  These profits are illusory.  In real life, more than one person engages in a long term project.  Most will think capital goods are the place to be.  Capital goods will be developed when consumer goods would be if credit wasn’t artificially expanded.  This doesn’t mean there is over investment, it is investment in the wrong areas, malinvestment.  This is a waste of resources.

As one can see, this is not a period of genuine good business.  The profits are illusory—they do not accurately reflect time preferences.  This malinvestment must be liquidated—the dreaded bust.  Now, no one likes a bust, but is necessary to cure the economy.  This is the cluster of errors.  The ratios between consumer and capital goods must be reestablished.  If credit is expanded to create a boom, can’t this just go on forever?

Say credit is continually expanded, there will be a flight to real values which will cause a crack up boom.  For example, one may buy a piano without ever playing it because it has real value and can be sold at a later date.  This will increase demand in the piano market, that is the crack up boom.  Any longer, the currency will breakdown.  Essentially, this is a currency catastrophe. 

References

Ludwig von Mises; Human Action

Murray Rothbard; Austrian School Business Cycle Theory