Both me and David the OP have explained how it occurs.
Ixtellor
I think you should re-read what David said, because it certainly does not imply a general rise in the price level, only price increases in particular areas of the economy.
Unless Ixtellor is claiming that the entire economy can experience a supply shock outside of money and credit supply.
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You may be right about temporal priority but this is standard temporal misallocation in that producers will get signals, from a market blinded by monetary inflation, to increase producers goods because of the increase in consumer buying.
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It can. But assuming a fixed money supply, some goods can no longer be consumed, hence demand for them will fall, and so will their prices. There is only so much money chasing so many goods.
Can’t supply decrease to meet the same equilibrium price? A company that is good about inventory control could just compensate in supply and maintain the price…?
What is the Austrian answer?
Last night, instead of doing my normal academic reading, I read a lot about malinvestment and the Austrian business cycle and a few questions occured to me, which you are free to ignore.
- What about hedge funds and short sellers? They have an investment in malinvestment and intend to profit by it. What austrian market forces will prevent them from continuing the process? The cycle blames the Fed for tampering with interest rates which lead to the malinvestment, but there are other actors that also want low interest rates, even if they know the rates are artificial and will lead to a bust. And in an AnCap or Austrian society, with no barriers to entering the short selling sectors, I dont’ see why they wouldn’t continue to perpetuate the cycle.
I think you will answer consumers, but if consumers can get 10%+ returns by encouraging malinvestment isn’t that a lot of incentive or demand for short selling services/investments? Or you might argue, its more free thus less more moral, to which I have no rebuttal other than your then talking semantics. Same result different path.
- There is no mention I can see to political forces that influence Fed decisions. The Fed is made out to be the ultimate bad guy, but frequently the Fed is basically cowardly to go forward with a particular plan because they have all of Wall Street screaming for easy money and growth policies. Could you not just argue that the Fed needs to more perfect the MS, and listen less to political concerns and stick to its prescribed guns?
If the Fed was near perfect at maintaing equilibrium MS, would Austrian’s still object to it, for reasons other than ‘freedom’?
Ixtellor
P.S. David’s definition on malinvestment was as good or better than any I found, so Kudos.
With what money will it be bought? EIther the price drops or the good is simply no longer consumed, absent Ms inflation.
Thanks! Even I didn’t think it was that good 
It’s not just low interest rates - which are not malum in se. It’s interest rates that don’t coincide with general time preferences, that encourage the divergence that leads to the bust.
The question about hedge funds, and I don’t want to be perceived as ignoring the question, is probably outside the scope of this discussion. Hedge funds are often (always?) heavily leveraged, and since the debt they lever isn’t backed by any real product, this contributes to the problem because they really do have nothing to lose. I have a hard time conceptualizing some of these things without fiat money.
Every short seller needs a long buyer…
Short-selling is not my area of expertise, but it is also a levered position if I’m not mistaken, without going into detail on something I know very little about (Robert P. Murphy has articles here about this sort of thing and its function w/r to markets), IMO people engaging in these activities don’t necessarily have an interest in “malinvestment” per se, they have an interest in ascertaining the true value of equity shares, which may in many instances involve recognizing when and where resources have been unprofitably or sub-optimally allocated, or identifying entrepreneurial error. Entrepreneurial error happens all the time, and nobody presumes it will disappear in the absence of a money monopoly.
I may not have made it explicit, but “malinvestment” is not simple “entrepreneurial error,” so more precisely: All malinvestment is entrepreneurial error, but not all entrepreneurial error is malinvestment. (Note to self for future blogging: this could be shown as a Venn Diagram.)
I was responding to this statement.
But assuming a fixed money supply, some goods can no longer be consumed, hence demand for them will fall, and so will their prices
If MS is constant, he said demand would fall and their prices would as well. But a decrease or shift in supply could maintain an equilibrium price. Producers reacting as consumers reacting could result in the same price. I wonder if there was an Austrian explanation for why this could not or would not occur.
Ixtellor
P.S. I created a fancy supply and demand chart with shifting demand and supply and the corresponding equilibrium price, but dont’ have the expertise to “paste” it here for some reason. Again, I blame this antiquated forum code and not my self.
You may recall a certain, defunct nation whose govt had totalitarian control of its economy. Yet, curiously enough, its no longer with us. I wonder if that’s a coincidence. I wonder if Plato’s philosopher-kings were merely coincidental with the intellectual context of that nation’s founders. I wonder if the 1776 publications of The Wealth of Nations and The Declaration of Independence were coincidental with the Enlightenment’s respect for independent judgment and the need to politically protect it from those whose revelations from the supernatural command them to command others with supernatural perfection. BTW, Plato, who discovered that reasoning is hierarchical, knew that economics is logically dependent upon politics, not an independent body of knowledge. Every claim in economics, no matter how narrow and technical, is an application of some, particular politics. The Marxist-Keynsian claim that capitalism is contradictory is an application of the political claim that that irrational individuals must be forcibly controlled by a rational state whose philosopher-kings have a mystical revelation of supernatural perfection. These days, of course, the philosopher-kings are Kantian subjectivists and prefer to talk in mathematical tongues about intuitions and a consensus of those initiated into the transpolitical wonders of monetary inflation and how eating cakes causes them to be baked.
Have you ever wondered why Federal Reserve Notes say "“This note is legal tender for all debts, public and private” on one side and “In God we trust” on the other? When US money was redeemable in gold, was it also genuflecting to the supernatural? Or was gold sufficient? I wonder…
If we all woke up tomorrow, and discovered that prices (across the board) had risen inexplicably from P to P’ by a uniform 10%, a shift in supply isn’t possible. It’s too late. Prices include wages, however, so individuals will earn - moving forwards - 10% more. But their “stockpile” (i.e., cash holding, checkable deposits, etc.) are insufficient to make all of the purchases for which they had budgeted. Something has to give. There will be unsold inventory because those inventories were accumulated based on conditions that were expected to hold, but didn’t. In order to liquidate those inventories, prices must fall.
Correct.
But you said “Demand will fall THEN prices will fall”, but if supplies are super intellectual capitalists making good decisions, can then can’t they reduce supply simultaneously with the fall in demand? ( I think the austrian argument is that pure competition causes the best capitalists to rise to the top, and those who are ineffficent to falter, so can you reach a state where those capitalist who survive and thrive, CAN accuratly predice declines in demand and make appropriate inventory and supply adjustments?")
I guess I was bothered by the absolutism again. So if you say something like “there are exceptions” then I am sated. If that is inaccurate and there are no exceptions, that its not possible for suppliers to predict aggregate wide falls in demand.. then I guess you are correct. And I expressely commented on inventories previously in that good capitalists predicing falling demand would make inventory adjustments far prior.
Ixtellor
dude no austrian has ever mentioned pure competition except to laugh at neoclassicals that talk about it.
It doesn’t matter how super-intellectual the capitalist is, he can’t go back in time.
Sort of, but we’ve got to be careful when making class judgments. The reader’s digest version would be that at any given point in time, those capitalists still in business have succeeded in the past, at satisfying consumers’ demands. There’s no value judgment about their future ability to predict and adapt. As any investment prospectus will tell you: “Past performance is not a guarantee of future results.”
The Austrian position, IMO as it pertains to a decline in AD, would be that the fall in AD is evidence of previous distortions (typically +MS), the results of which were not accurately forecast. At that point, to suggest that the remedy for what ails us is more distortions, well, to use a tired analogy, is like telling the heroin addict that the “cure” for his addiction is more heroin.
What I didn’t articulate is the lag affect. The decline in demand and the shift in price are not simultaneously. The ‘information’ of less demand occurs first, and in many instances will not see subsequent falls in price for long periods. So if a savvy supplier has accuratly forcasted falling demand and cut back inventories, I don’t see why the shifts could not occur simultaneously before the lag drop in price. I am thinking in the micro and admit at the macro level this would be highly improbably.
And now I will be greatly confused because we were talking about inflation, but for you inflation = increased MS, so does your position, which I quoted a few posts back, also apply to the micro level or are you strictly speaking at the macro level? Furthermore, is it possible that my scenario of supply being reduced prior to price deflation occur at the macrolevel in any circumstance? If you answer NO, to this second portion then I guess you “win” as I think its soo improbable as to be impossible, but you are speaking about “perfect competition world” AKA Austrian theory, where the probabilities would shift and you might just answer “YES” that it is possible, thus… I forget what my point was.
Ixtellor
I think we’re not clear any longer, let me try to reiterate mt previous point:
- Yesterday, we accumulated inventories for future distribution and sale. In the case of individuals, we have money stockpiled for future consumption.
- Today, we all realize that all prices rose (I’m discussing your question about what happens if all prices were to rise, a situation which I believe to be implausible, but I’m working with it) in a more-or-less uniform manner.
Now, there are two things of which we can be certain:
- The amount of inventories did not change.
- The amount of money did not change.
From which it follows that previous levels of consumption can not be accommodated given the now higher prices, and a greater amount (than forecasted) of existing inventories can not be sold at the prevailing prices.
Today, the businesses can make adjustments which will affect tomorrow, and they will, because A) their replacement costs are now higher and B) they have more carry-over inventory. Today the individuals can exercise new consumption preferences, but in order to eat the same quality and quantity of food, he has less money to spend on movie tickets, video games, sporting events, etc.
But it seems that you’re asking not about the above situation, but rather: What if the reason prices rose, is because businesses accurately predicted that consumers would spend less on present consumption, and therefore decreased the supply available for sale?
But businesses can’t just raise prices like that. Reducing output doesn’t give you carte blanche to raise prices, unless you’re a monopoly. Some businesses would be more able than others to accommodate a reduction in demand without substantially raising prices. These businesses survive, and others do not.
You really need to read up on Austrian theory. Austrians are against perfect competition except as a useful theoretical device, which they call the “evenly rotating economy”, used to distinguish interest from money. Otherwise, they hold to dynamic, disequilibrium models and maintain that equilibrium is never reached, even if there is a tendency towards it (by entrepreneurial activity.) They would certainly not hold to anything like the ERE when the interest rate is being held down and the tendency towards equilibrium deliberately averted, even if they were willing to extend its applicability beyond conceptual clarification.
printing more money or lowering interest rates does not always increase the money supply. It is harder to expand the money supply during poor economic periods because member banks may sit on what they have instead of taking out a risky loan.
Furthermore inflation=the general rise in prices because inflation is caused by more then just an expansion in the money supply. For example population during the early stages of capitalism were perhaps one of the causes for the great inflations of that era.
Umm what?