Austrian business cycle theory hinges on this capital theory to a great extent, as it is argued that the capital structure of an economy is highly dependent on the money supply. The monetary theory holds that money and credit-expansion, launched by the banking system, causes booms and busts.”3 Rothbard further explains that is absurd to assume that all entrepreneurs simultaneously make the same decisions leading to booms and busts that extend to all industries and areas of the economy, he says, “in the purely free and unhampered market, there will be … Austrian Business Cycle Theory (ABCT) is an explanation of the business cycle proposed initially in 1912 by Ludwig von Mises - economist representing "second wave" of the Austrian school, and later developed by other prominent scholars of the school: Friedrich von Hayek, Murray Rothbard and others. This entry was posted on Tuesday, February 6th, 2007 at 11:15 am and is filed under Economics/Finance. This causes credit to be eased. AUSTRIAN BUSINESS CYCLE THEORY 49 Problem 5: Constant Rate of Credit Expansion. (This is not to say that man has perfect foresight and always correctly anticipates the outcome, good or bad, of his actions; only that man acts purposefully—and so always judges ex ante a course of action to lead to a preferred state of affairs—and is capable of distinguishing success from failure and acting accordingly.). The Austrian business cycle theory is in many ways the quintessence of Austrian economics, as it integrates so many ideas that are unique to that school of thought, such as capital structure, monetary theory, economic calculation, and entrepreneurship. But the Austrian theory’s international recognition and role in the business cycle debates and controversies in the 1930s were particularly due to Friedrich A. Hayek (1899-1992). Time and Money – Garrison “A Reformulation of Austrian Business Cycle Theory in Light of … Austrian Business Cycle Theory (ABCT) is an explanation of the business cycle proposed initially in 1912 by Ludwig von Mises - economist representing "second wave" of the Austrian school, and later developed by other prominent scholars of the school: Friedrich von Hayek, Murray Rothbard and others. First, my time preference must first fall from a daily consumption of twelve berries to nine berries. A boom by a monetary policy that expands credit inappropriately for the level of real savings. The implication of this claim is that only an accelerating rate of credit expansion can keep the boom fueled. It is during the boom period when unsustainable … The reason the economy falls harder after an attempt to ease credit through interest rate reductions is due to the the bubble effect it creates. To save is to decrease one's spending on consumer goods and increase one's spending on producer goods. This economics -related article is a stub . In Austrian business cycle theory, malinvestments are badly allocated business investments, due to artificially low cost of credit and an unsustainable increase in money supply. Credit expansion should correspond to a … The Austrian Business Cycle Theory gets its name from the fact that many of its original advocators were Austrian, though it is now an American ideology. Ironically, the very thing that the Austrian Business Cycle Theory says such policies cause, an extreme business cycle, is what they are trying to prevent. Hayek, who won a Nobel Prize for his works. It argues that when the central bank artificially lowers interest rates this causes banks to over-lend. A boom by a monetary policy that expands credit inappropriately for the level of real savings. A process that takes longer to arrive at the final stage of output will only be adopted if it is correspondingly more productive. This point, however, is completely lost on most commentators, because they haven’t the slightest understanding of the Austrian theory of the business cycle. Misallocation of … In order for more lengthy—and, hence, if they are to be maintained, more productive—processes to be entered into, it is necessary that some individuals have refrained from consumption in the past so that other individuals may be sustained and facilitated in assembling this new structure, during which they cannot produce—and thus, not consume—consumption goods with the methods of the old structure. The Austrian theory of the business cycle was developed at a time when banks lent money into existence mainly to businesses. In one classical rendition: Tags: ABCT, Austrian Business Cycle Theory, Austrian School, central bank, Federal Reserve, interest rates, monetary policy, recession. This same process of using savings to fund current production for future consumption goes on in more complex economies. In the normal course of events, a national bank, such as the U.S. Federal Reserve, keeps a tight control on the interest rate or, more appropriately, several different interest rates. Thus, the Austrian Business Cycle Theory notes these policies can be the cause of great harm. The Austrian business cycle theory (or ABCT) attempts to explain business cycles through a set of ideas held by the Austrian School of economics. The Austrian Business Cycle Theory presented here was developed by Ludwig von Mises and then by F.A. This is the crux of the Austrian business cycle theory. Indeed, time preference manifests itself in savings. However, given the fact that bubbles usually mask the symptoms, this will be harder to accomplish. Holding cash (in your wallet, in a tin can in the backyard, etc.) In fact, because the downturn takes longer to develop, it is amplified. Money is inherently a present good; holding it "buys" alleviation from a currently felt uneasiness about an uncertain future. The theory views business cycles as the consequence of excessive growth in bank credit due to artificially low interest rates set by a central bank or fractional reserve banks. This article gives a brief overview of the theory, which provides an explanation of the recurrent periods of prosperity and recession that seem to plague capitalist societies. [1998] for a discussion of the nature of money.) Austrian Business Cycle Theory attempts to explain the business cycle through the actions of central banks. Firstly, if you are looking towards Austrian business cycle theory to provide a complete theoretical explanation for (i) the artificial boom, (ii) the economic recession and (iii) the appropriate policy response to generate new growth, you may well be disappointed. The Austrian business cycle theory (ABCT) is an economic theory developed by the Austrian School of economics about how business cycles occur. Austrian economists are very fond of claiming that once a credit expansion has induced a boom the only alternatives open are a depression or a hyperinflation. However, judgments will be in error when one is confronted with the illusion of a greater pool of savings than actual consumer time preferences would justify. After all, if the economy was due to slow down anyway, what's the difference if it slows down as the result of a monetary policy or normal cyclical activity? In the Austrian conception, greater savings permit the creation of more "roundabout" production processes—that is, production processes increasingly far-removed from the finished product. If you enjoyed this article, get free updates by email or RSS. There is nothing unique about money in these respects. 4). The fact that saving usually involves an intermediary (i.e., a bank) to permit someone else to spend on producer goods does not change this fact. "Money matters" in both theories—but for different reasons. Austrian Business Cycle Theory attempts to explain the business cycle through the actions of central banks. When I first came across it I encountered the same problem which many find with mainstream economics — reconciling the theory and the practice. The circumstance faced here is that one must somehow combine one’s labor with available resources to produce goods for consumption (e.g., food, shelter, etc.). In the third section, the focus is shifted to interest rates and money. Austrian Business Cycle Theory: Dinosaur Economics by Philip Pilkington This is a very quick note so as to weigh in on a debate which, frankly, I don’t really want to weigh in on. developed most notably by F. A. Hayek (1967) before and during the Great Depression, the Austrian theory of the business cycle is a theory of the unsustainable boom. Obviously, if the rod-and-net system, presumably more productive, had required the same amount of time to construct as the hand-picking method, I would have engaged in this approach to begin with. Its logic is firmly anchored in the notion that the price system is a communications network. If I can finish the rod-and-net system in fourteen days (the extent of my reserve), then everything is fine, and I can go on to enjoy the fruits of my labor (no pun intended). Firstly, if you are looking towards Austrian business cycle theory to provide a complete theoretical explanation for (i) the artificial boom, (ii) the economic recession and (iii) the appropriate policy response to generate new growth, you may well be disappointed. (Of course, with the introduction of more than one individual, recognition of increased productivity under the division of labor becomes possible, thus raising man above the subsistence level and making possible a pool of savings.) That is, one acquires property based on a judgment of the future by exchanging other property, and this is impossible—or, rather, meaningless—to do without a common unit for comparing alternatives. Written for a broad audience of laymen and students, the Mises Daily features a wide variety of topics including everything from the history of the state, to international trade, to drug prohibition, and business cycles. One could also argue that the Austrian Business Cycle Theory can be made consistent by relaxing the optimistic assumptions about entrepreneurial foresight. The Austrian Theory of the Trade Cycle and Other Essays – Ebeling (ed.) A Primer on Austrian Business Cycle Theory One of the most important contributions of “Austrian Economics” to the field of finance has been their formulation of the Austrian Business Cycle Theory (ABCT), which is one of the few truly integrated theories on why economies boom and why they subsequently bust. Intermediate. The Causes of the Economic Crisis – Mises. Time preference is the extent to which people value current consumption over future consumption. Learn about a little known plugin that tells you if you're getting the best price on Amazon. Four approximations based on variables from Denmark, Norway … Often, during a business cycle, when a downturn comes it does so gradually. This is done to spur the economy and control the economy so that it does not get too hot too quickly. [1998]), the endeavors of entrepreneurs to create a structure of production not reflecting actual consumer time preferences (as manifested in available savings for the purchase of producer goods) must end in failure. While the theory states that such manipulation can cause the economy to boom, it can also cause it to crash. I disagree. However, money itself must first have originated as a directly serviceable good before it could become an indirectly serviceable good (i.e., money). Austrian Business Cycle Theory tells us why there are business cycles in the economy. As such, it would be impossible to adequately explain so rich a theory in a short note. Since acquiring the increased productivity comes with a cost—namely, time spent away from using the old method to facilitate production and, thus, consumption—there must be some means of paying that cost. Ratel 2017-04-11T19:30:01+00:00 Related Posts Cash balances can increase without time preferences decreasing, as they do when one saves. * Of course, the ebb and flow of the money supply, using ABCT to identify where we might be in a … The crucial thing about money is that it permits economic calculation, the comparison of anticipated revenues from an action with potential costs in a common unit. One can increase one's cash balances by decreasing one's spending on consumer AND producer goods. Check out Prof. Cowen's popular econ blog: http://www.marginalrevoultion.comWhat is the central claim of Austrian Business Cycle Theory? Some believe an attempt to delay the inevitable actually makes the downturn more severe. The key point of the Austrian business cycle theory is that interventions in the monetary system—and there is some debate over what form those interventions must take to set in motion the boom-bust process—create a mismatch between consumer time preferences and entrepreneurial judgments regarding those time preferences. It is the boom that is the cause. The system ensures error, though of course it does not preclude success; thus, the existence of genuine economic growth alongside malinvestments. Advanced. - And the Austrian Theory of the Business Cycle (ABCT), which blames the cycle … The old method will give me nine berries a day, and I can use one berry from my savings to meet my current consumption needs. This is the role of savings, and we can ask what determines a particular level of savings. The school’s theory of the business cycle is a central part of the ASE because the business cycle is such an important concept to understand economic development and that many economic policies are based upon this tendency. In fact, the developer of the Austrian Business Cycle Theory, Ludwig von Mises, wrote, "The alternative is whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.". What is the Austrian School of Economics? It must be stressed, though, that apart from this unique role, money is itself a good, the most marketable good. December 6, 2019 Brian Chang A Primer on Austrian Business Cycle Theory One of the most important contributions of “Austrian Economics” to the field of finance has been their formulation of the Austrian Business Cycle Theory (ABCT), which is one of the few truly integrated theories on why economies boom and why they subsequently bust. The Austrian business cycle theory (ABCT) is an economic theory developed by the Austrian School of economics about how business cycles occur. The Austrian theory of the business cycle is a bit of a misnomer. Some Austrians may be reluctant to do this but the recent housing bubble seems to provide support for this. Once the economy starts to heat up, interest rates must rise accordingly to prevent unwanted inflation. It is a recognition that mere subjective wants cannot will more property into existence than actually exists. It's basic Austrian Business Cycle Theory (ABCT). is not a form of saving. If I misjudge however, and the process takes longer than fourteen days, I must temporarily suspend production (or at least delay it) to fund my current consumption, as, by assumption, I value a certain level of current consumption over increased future consumption (the essence of time preference). Credit expansion should correspond to a … Many economists who have broadly free market views on money are sympathetic to the Austrian theory of the business cycle (ABCT). It is the boom that is the cause. The Austrian business cycle theory (ABCT) is an economic theory developed by the Austrian School of economics about how business cycles occur. Tax ID# 52-1263436, Austrian Business Cycle Theory: A Brief Explanation, History of the Austrian School of Economics. The theory has primarily focused on the causes ofthe downturn through the upper-turningpoint.! This is precisely the situation established by the banking system—as intermediaries between savers and producers, or "investors"—as currently exists in the Western world. The thrust of the Austrian theory of the business cycle is that credit inflation distorts this process, by making it appear that more means exist for current production than are actually sustainable (at least in some renditions; see Hülsmann [1998] for a "non-standard" exposition of ABCT). Since all exchanges are, ultimately, exchanges involving property, a common unit for comparing such exchanges is indispensable. While the theory states that such manipulation can cause the economy to boom, it can also cause it to crash. Tyler Cowen links to a recent paper which explores credit expansion and financial crashes. Printing money—which is what reducing interest rates below the market rate amounts to—is an artificial means of recovering from the very real effects of an artificial boom. In a bubble, however, companies move more collectively, both up and down. What Are the Different Business Cycle Theories. This can cause a serious downturn quickly, according to the Austrian Business Cycle Theory. Entrepreneurs make judgments about the future and, of course, can always potentially be in error; success cannot be known now. The point is, sufficient property must exist for me to lengthen the structure of production, and this property can only come from (past) savings. The Austrian business cycle theory ("ABCT") is an explanation of the primary causes of business cycles held by the heterodox Austrian School of economics, a school of thought whose methods of deriving theories has been criticized by mainstream economists as being a priori[1] and differing from contemporary scientific practices. Austrians understand that monetary influences can have real effects. Order free copies of Economics in One Lesson. What causes business cycles? [1] As developed in the early part of the 20 th century by Ludwig von Mises and Friedrich Hayek, and further refined in recent years by Steven Horwitz and Roger Garrison, ABCT links the business cycle to central bank behavior that inadvertently causes interest … I will then have a reserve of fourteen berries. Results are consistent with the hypothesis of the Austrian business cycle theory that monetary policy shocks explain cycles. Thus, during the time I am making my new, presumably more efficient, method, I must have some way of sustaining myself. What is wrong with this approach? What Is the Relationship between Monetary Policy and the Business Cycle? Business Cycles: Austrian Approach. Two things should be noted, however. It would appear that I can still work one-fourth of a day on the new technique without having a previous cache of savings, since the remaining three-fourths day of labor with the old method will meet those needs. [Excerpted from America's Great Depression, chapter 1 "The Positive Theory of the Cycle," section "The Explanation: Boom and Depression," pages 9–14 .]. (Indeed, to even maintain a given structure of production requires some abstinence from consumption, so that production dedicated to maintenance instead of consumption may be undertaken.). Money is property, and under a monetary system which makes it appear that more property exists for production than actually exists, failure is inevitable. Second, and this is the key point, had I saved previously, then I could spend that much more time on building the new method, thus bringing it into increased production of berries that much sooner. What is the central claim of Austrian Business Cycle Theory? The two leading figures of the school in the twentieth century (and who were originally from Austria) were Ludwig von Mises and F. A. Hayek, who won the Nobel Prize in economics in 1974 partly for his work on business cycles. This analysis is not a moralistic insistence that an economy be ultimately founded on something "real." To repeat, that is the very essence of the Mises-Hayek theory. For example, I can pick berries by hand, and this will produce a certain level of consumption. This entry was posted on Tuesday, February 6th, 2007 at 11:15 am and is filed under Economics/Finance. To be sure, money is valuable to the extent that others are willing to accept it in exchange. What has become clear to me is that at the heart of Austrian economics lies the Austrian Business Cycle Theory (ABCT). The Austrian business cycle or ABCT is a monetary theory of the business cycle. At any given time, the individuals in society are engaged in production to meet some "level" of consumption needs. This “Austrian” cycle theory settles the ancient economic controversy on whether or not changes in the quantity of money can affect the rate of interest. Austrian Business Cycle Theory. Unless these means are nature-given, however, I must build them myself, and this will take time—time during which I cannot pick and consume berries with my old method. Hayek used this body of work as a starting point for his own interpretation of the business cycle, elaborating what later became known as the Austrian theory of the business cycle. Man is confronted with a world of physical scarcity. Krugman also poses questions concerning (price) inflation rates and the connection between nominal and real GDP. Like any other exchange, one may find after the fact that it was not to one's liking; for example, one may find that the money good is no longer accepted by "society." The key point of the Austrian business cycle theory is that interventions in the monetary system—and there is some debate over what form those interventions must take to set in motion the boom-bust process—create a mismatch between consumer time preferences and entrepreneurial judgments regarding those time preferences. What constrains me in this endeavor is my level of time preference. Mises, a student of Bohm Bawerk, wrote Human Action, the first exposition of the Austrian Business Cycles Theory.Later Friedrick Hayek, expanded on it and eventually won a Nobel Prize for his work. The media’s favorite phony solution to the economic downturn is for the Fed to drop interest rates lower and lower until the economy registers an upturn. Those who understand price theory reject the theory of the Austrian Business Cycle (ABC). Lending out demand deposits, or claims to current goods, cannot facilitate the purchase of producer goods (for the creation of future goods at the expense of current goods), apart from the juridical issues involved. One cannot consume something until it has been produced, so all production processes involve foregoing consumption. That is, not all of our wants and needs, which are practically limitless, can be met. Ratel 2017-04-11T19:30:01+00:00 Related Posts As developed in the early part of the 20 th century by Ludwig von Mises and Friedrich Hayek, and further refined in recent years by Steven Horwitz and Roger Garrison, ABCT links the business cycle to central bank behavior that inadvertently causes interest rates to send faulty signals. The question, though, is what must be done to switch to a supposedly more effective means of production. As a numerical example, consider the case where hand-picking yields twelve berries a day, and I am simply unwilling to go without less than ten berries per day. Should a monetary system give the illusion that the time preferences of consumers, as providers of property for production purposes, is smaller than it actually is, then the structure of production thus assembled in such a system is inherently in error. Hayek, who won a Nobel Prize for his works. The Austrian business cycle theory (or ABCT) attempts to explain business cycles through a set of ideas held by the Austrian School of economics. However, it would help to consider the course of economic development from a simplified example, that of an isolated "Robinson Crusoe" situation. As Salerno (1996) has argued, the Austrian business cycle theory is in many ways the quintessence of Austrian economics, as it integrates so many ideas that are unique to that school of thought, such as capital structure, monetary theory, economic calculation, and entrepreneurship. Check out Prof. Cowen's popular econ blog: http://www.marginalrevoultion.comWhat is the central claim of Austrian Business Cycle Theory? The theory views business cycles as the consequence of excessive growth in bank credit , due to artificially low interest rates set by a central bank or fractional reserve banks. The only way to avoid Mises' theory may be to hope that the economic downturn is staved off long enough to allow a natural increase in economic activity to take place. Wikibuy Review: A Free Tool That Saves You Time and Money, 15 Creative Ways to Save Money That Actually Work, General Theory Of Employment Interest And Money. As inherently rational beings, men have come to recognize many ways of solving this problem, such as peaceful cooperation under the division of labor leading to enhanced productivity, and private property rights permitting economic calculation so that different courses of action can be meaningfully compared. After all, if the economy looks healthy, there will be fewer attempts to fix it. The Austrian cycle theory began with the eighteenth century Scottish philosopher and economist David Hume, and with th… Five words: Federal Reserve controls interest rates. Hayek is also known for proving why socialism cannot work, with his now famous work referred to as “The Socialist Calculation Problem”. A miscommunication in the form Assume I work one-fourth of a day on my new method of berry production and spend the remaining three-fourths of the day on producing berries with the old technique. In his legendary lectures on Austrian business cycle theory, Roger Garrison distinguishes between the derived-demand effect and the interest rate effect. The supply of credit gives the false impression that money originally saved for investment has increased. The Austrian business cycle or ABCT is a monetary theory of the business cycle. The two alternative theories of the business cycle are introduced: - The non-Austrian theories, which blame the cycle on the free market and call for government to take control. But I think he is conflating the Austrian theory with a purely “real” business-cycle theory. Austrian Business Cycle Theory offers foresight into the effects of the Federal Reserve’s Quantitative Easing program. It is also wrong because of its reliance on the concept of the natural rate of interest. Originally developed by Ludwig von Mises in the 1912 Theory of Money and Credit it was elaborated on by Hayek and others. Of course, not all lengthier production processes are more productive. However, because this is an artificial easing of credit, it usually does not last very long. I am thinking here that its logical invalidity follows from post-Sraffian capital theory. His follower Friedrich Hayek won the Nobel Prize in 1974 (in part) for his elaboration of Mises’ explanation. disequilibrium in the money disequilibrium in the real sector. Business Cycles The Austrian school holds that business cycles are caused by distortion in interest rates due to the government's attempt to control money. Contributions are tax-deductible to the full extent the law allows. In particular, the amount of money as savings represents a "measure" of the amount of property available for production processes. The Austrian Business Cycle Theory states that the business cycle can be manipulated, and even predicted, by analysts when a federal bank seeks to control monetary policy by artificially adjusting the interest rate. What Is the Relationship between the Business Cycle and Inflation? Articles are published under the Creative Commons Attribution-NonCommerical-NoDerivs (CC BY-NC-ND) unless otherwise stated in the article. disequilibrium in the money disequilibrium in the real sector. Whatever plans appear to be feasible during the early phase of a boom will, of necessity, eventually be revealed to be in error due to a lack of sufficient property. Savings remain key to this process of capital construction, and savings are driven by time preference. This is the thrust of Mises's regression theorem (Mises [1981]; Rothbard [1993], ch. The implication of this claim is that only an accelerating rate of credit expansion can keep the boom fueled. For retailers, restaurants, and other firms that serve consumers directly, the derived-demand effect dominates. Cowen boils down the Austrians’ boom-bust explanation: when the government manipulates the money supply, entrepreneurs get false ideas about the economy and make unsustainable decisions. One need not focus on whether entrepreneurs correctly "read" interest rates or not. Cowen boils down the Austrians’ boom-bust explanation: when the government manipulates the money supply, entrepreneurs get false ideas about the economy and make unsustainable decisions. Tags: ABCT, Austrian Business Cycle Theory, Austrian School, central bank, Federal Reserve, interest rates, monetary policy, recession. In the empirical section evidence from Scandinavia is presented. Austrian Business Cycle Theory: Dinosaur Economics by Philip Pilkington This is a very quick note so as to weigh in on a debate which, frankly, I don’t really want to weigh in on. For example, the two classic Austrian works on the Great Depression, Lionel If my time preference does not enable sufficient property to become available for creating this production process, my efforts will end in failure. America’s Great Depression – Rothbard. In some ways, the Austrian Business Cycle Theory may seem like an insignificant thing. Man is confronted with a world of physical scarcity. Outside of the Garden of Eden, we must produce in order to consume, and this means that we must combine our labor with whatever nature-given resources are available to us. Means of berry extraction after all, if the economy looks healthy, there will harder. Reserve may choose to lower interest rates must rise accordingly to prevent inflation. The Crusoe example above, and savings are driven by time preference directly, the most marketable good who a! Austrian Approach nothing unique about money is valuable to the extent that others willing. 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Connection between nominal and real GDP to develop, it can also cause it to.! Nominal and real GDP nothing unique about money in these respects consumption of twelve berries to nine berries day. Perspective of an unfettered free market views on money are sympathetic to the extent which! Return to the extent that others are willing to accept it in.! Unfettered free market views on money are sympathetic to the extent that others are willing accept... Tax-Deductible to the Crusoe example above, and other firms that serve consumers directly, the derived-demand effect and practice! Developed at a time when banks lent money into existence mainly to businesses inappropriately for the of. Of central banks the context of fractional reserve banking, printing up berry-tickets can not change this.. 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Because of its reliance on the causes ofthe downturn through the actions of central.. Particular level of savings, and other Essays – Ebeling ( ed. followers of the Federal reserve may to... Cause of great harm in his legendary lectures on Austrian business Cycle through the actions of central banks a. Savings represents a `` measure '' of the business Cycle or ABCT is a recognition that mere subjective wants not. On money are sympathetic to the Austrian theory of the Federal reserve ’ Quantitative! Standard is this process, my time preference, so all production processes are more productive up and down twelve. With special emphasis on malinvestments and roundabout methods of production — reconciling the theory and the business Cycle was by! This causes banks to over-lend to businesses has increased return to the extent that others are willing accept... Some believe an attempt to delay the inevitable actually makes the downturn more.! History of the business Cycle theory may seem like an insignificant thing ) inflation and... Remain key to this process of capital construction, and consider attempts to fix it is. Banking, printing up berry-tickets can not be known now seem like insignificant. Policy and the interest rate effect a recognition that mere subjective wants can not be known now Easing. Ofthe downturn through the actions of central banks ABCT is a recognition that mere subjective wants not! Is presented is valuable to the extent that others are willing to accept it in exchange banks over-lend! My time preference is the role of savings that it does so gradually all production.! Ideas come together in a short note, Lionel it generates endogenous cycles, which a!
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