Domino effect of failing banks, role of inflation, and critique of Austrian economics

[John_James]

@FlyingAxe

Some “fad” is started (through new discoveries, economic conditions, or the government’s policies), and a bubble happens when people over-invest in the fad. What makes it easier for people to over-invest is the presence of “easy money” – new currency that is pumped into the economy (by the government’s monetary policies, influx of gold and silver from new easy sources, etc.). Had new money not been pumped into the economy, the “craze” of over-investment would not have happened?

More or less. Have a look here for more on this. (In particular, this one and this one. The first one is a short summary. The second one is just excellent. I highly recommend taking the time to view it.)

So, when my cousin says that “many different factors contribute to bubbles, from psychological to political and economic”, he means that there are many different kinds of “fads” – for instance, the current “fad” of the housing bubble was caused by the government’s politics (he admits that; he also says there was excessive leverage).

For one thing, “excessive leverage” and overinvestment are two sides of the same coin…the inflation coin. (And of course by “inflation”, I mean inflation. Read what Mises had to say about how the word has been perverted.)

For a brief summary of how the current crisis went down, see here. For more info, see here.

The “fad” of tulipmania was caused by something else.

I’m not sure what you mean by this. Ultimately the culprit of tulipmania was increases in the money supply.

But his mistake is that he does not realize that the fads are allowed to proliferate into over- (and mal-investment) through increase in money supply.

I guess you could say that. It really depends on how you’re defining “fad”.

I have another question. I had a discussion with another relative of mine about politics and after a while she acquesced to the concept of malinvestment causing the boom and bust, but her argument was that Bush tax cuts made the problem of malinvestment worse. She further suggested that by taxation, one can “suck out” all the “easy money” out of the market. Moral arguments aside, why is she wrong?

She is wrong. This is nothing more than a central planning argument that is somewhat in line with chartalism or Modern Monetary Theory. For more on this, see here, and here. (There are links provided in those threads as well.) Basically the notion is nonsense. It essentially says that an economy can be micromanaged into prosperity. Central planning doesn’t work, it has never worked, and until someone gets supernatural powers that allows him to know what people want better than they do themselves, it will never work.

Is it because the malinvestment in modern times happens in a form of investing in a wrong kind of industries: capital vs. consumer, as per Austrian theory?

As opposed to what? How would malinvestment in historical times be different?

What I am trying to figure out is qualitative vs. quantitive aspects of the malinvestment: i.e., investing in wrong industries vs. being able to over-invest too easily because of all the new “easy money”. Am I correct that both of these components exist nowadays? (While, for example, in the case of tulipmania, perhaps only the quantitative one existed? Otherwise, how did the qualitative component happen then?)

I don’t know what you mean by this.

@FlyingAxe

In other words, to reiterate my second question (re: second relative): what’s the difference between saying “there is too much new currency pumped in by the government/Cortez” and “the rich people are too rich”?

One is saying “the people in control of the money supply are stealing from everyone else, and as if that weren’t bad enough, the distortive effects it creates will lead to catastrophic consequences.” The other says “I’m jealous because other people have more stuff than I do. They should have less.”

Obviously, there are ethical differences, and I understand that the rich people’s savings are backed up by real products and services that they traded for the money they saved up, but in terms of making over-investment easy, what is the difference? Why is it that “rich people who are too rich” won’t tend to over-invest their saved up money?

Because they’re afraid of losing it. The only reason people made such bad bets during the boom was because they didn’t see a downside. Depending on which gambler we’re talking about, either they were under the impression their investment was more sound than it was (because the market was giving false signals thanks to government intervention and money creation), or they were under the impression it didn’t matter because the government had their back (again, thanks to government intervention and regulation).

I think you might be getting a bit lost in the terms “malinvestment” and “overinvestment”. Pay attention to this video and it will help you understand greatly.