Promted by the excellent Hayek V Keynes vido rap, there was one idea in it that I have never quite got. Its the idea that bust reveals that the resources were too few?
Now I get mal investment, circus coming to town analogy and its implications and understand the possability that other capital assets may be run down due to the boom. But just missing the implications of the idea above, any interesting analogies or real life examples would be appreciated, or how the idea would be expreessed/measured in 2007, did we run out of commodity growth? skills? etc.
Thanks
Another analogy, possibly by Mises, is building a house. Suppose you have 10,000 bricks. You design a house which requires 10,000 bricks, build it and live happily ever after. But suppose someone tricked you into believing you had 12,000 bricks. So you design a house which requires 12,000 bricks and start building. At some point, you’re going to realise that you’re not going to be able to complete this project. There’s just not enough bricks for it. You’re going to have to destroy what you built so far and start again. All that time, energy and resource was wasted; the project was a malinvestment.
The Fed lowering the interest rate tricks entrepreneurs into believing there is more resources (savings/capital) to go around then there truly is. So entrepreneurs malinvest in projects which can never be completed, and one day will have to be liquidated. The day when it becomes apparent that there are too few resources to complete all the projects that have been started is the bust.
Continuing with the house-building analogy, by 2007 you’d used 8,000 of your bricks on your 12,000-brick house. Now you look at the pile of bricks and say ‘are you sure there’s 4,000 bricks left, it looks like less to me’. The Fed replies that actually there’s 15,000 bricks, so carry on, there’s plenty of bricks left for you to finish your house. So you carry on building your house. But its not true; the Fed can’t magic more bricks (capital) into existence. At some point, you’re going to run out of bricks; the sooner you realise it the better.
Thank you for that, clears it up nicely for me.