On Malinvestment, How? and Why?

Economics Economics Questions
121

I’m not at all sold on the “free banking” argument. I tolerate it because I don’t think it will work, and will result in something like 100% reserve banking, but that’s not a topic I wish to discuss in this forum :slight_smile:

But in a nutshell, yes, if you give up some consumption now and rather than consume, invest in productive assets, your patience will be rewarded. Sure, some investments will turn out to be unprofitable, but these are micro phenomena, not macro/systemic phenomena.

Hmmm. The fed is like inflating by the trillions. But it isn’t making its way into the economy yet, instead being used basically to prop up the balance sheets of banks which are in distress/default. The fed is doing everything it can to keep rates between 0-25 bp which is simply not sustainable. But the Fed is buying trillions in commercial paper and treasuries and junk mortgage securities, they’re urging us to reduce the national debt. These policies/goals basically contradict one another…

Meanwhile, people are doing everything they can to pay off debt. We’re not really saving, per se, but we’re trying very hard to get out of the debt burden as a precautionary measure. With that in mind, I think it’s true that spending on consumption has been greatly reduced - we know that people are paying off debt, and we also know that one in five of us is unemployed or chronically underemployed. That adds up to less consumption. But I don’t think the tradeoff towards the future/investment is occurring, either.

In the past, we borrowed from the future to finance the present. Presently, we’re paying for the past. It’s a tough pill to swallow.

Presumably yes, there is a “least bad” monetary policy, but I couldn’t tell you what that is. I suspect that any measure they take will have some substantial (and unanticipated) negative consequences.

122

Suppose that the total amount of money in the economy is $100. And let me put myself into the picture. I am a pauper who has no money. Now the Fed prints a fresh $100 note and gives it to me(lets say under some welfare scheme). Roughly speaking, now I basically have 50% of the purchasing power in the economy. I have the ‘power’ to redistribute resources according to my preferences. So,lets say I spend my money on buying honey. And this gives a great boost to the honey industry. Honey producers start employing more people(bid away from other sectors of the economy) and make honey for my demand.

All this seems perfectly fine, no? Where is the boom happening here?

123

But you haven’t produced anything. In this example, the market shifts from serving productive consumers to unproductive consumers.

At the expense of other industries built upon a productive consumer base.

People will see a “boom” because consumption has temporarily gone up. This boom is unsustainable because you can not keep borrowing money forever and then the honey industry will collapse. Though, If you could keep borrowing money forever, this is just a form of wealth redistribution and obviously the economy will be permanently weakened if you continue to buy honey by leaching other people’s value with your printed money.

When I started reading your example, I thought it was a supporting clarification of the OP’s answer. You layed out so obviously how monetary expansion hurts the economy.

124

Well, yes, I’ve used the money to consume.

You call it ‘at the expense of other industries’, because I’ve spent counterfeit money to bid those resources towards me?

Okay, now, in the real world interest rates are lowered and new money created to fund investment projects. So low interest rates actually increase the per capita capital of the economy, isn’t it?

125

And you aren’t actually generating any real wealth to back up your consumption…

Yes. If you don’t produce wealth and then use fiat money that has recently been printed, you leach wealth from producers.

I can’t really tell what you’re saying here due to grammar problems. I’ll do my best.

Not in real terms. Sure, if you pump an extra hundred dollars into the economy the GDP will be boosted, but only because of inflation. You having money you didn’t earn sends a false signal to everyone that they need to produce your honey. When they find out you can’t actually generate the wealth to keep paying for the honey, they will have to scale back their investments.

So there is a temporary boom when people are like “holy crap this person is willing to pay big bucks for lots of honey!” and then a bust when they realize you’re full of it and have to go back to serving productive consumers.

126

You ain’t getting this. Ignore the case where I use the new money to consume honey. Just think that I am a entrepreneur who is interested in making business. So I am being given 50% of the purchasing power of the economy to do business. I take the money and build Capital equipments. So the economy has more Capital resources now, right?

My point is, society is made to forcefully save.

127

Okay i’ll ignore the example you gave.

Yes… but the capital resources do not come out of nowhere. You’ve shifted economic resources from whatever they were doing before into capital resources. But the economy has already proven that it doesn’t need capital resources because they weren’t being built before → i.e. there is already a more profitable alternative in the market.

What? No. Low interest rates discourage saving… [8-)]

128

Right.

You must understand what makes these new roundabout projects appear unprofitable. It’s the higher interest rates that show up once savers reassert their consumption-savings ratio. I will try to tell you whole story in a moment.

It doesn’t matter. There is fiat money to make people do what they really don’t want to. When the central bank doubles money supply(from $100 to $200) and gives half(that is $100) the new amount of money supply to me, so that I can invest it in my business, society is made to forcefully save. I can use the extra purchasing power I now have to bid resources to my wishes.

Let me now try explaining what I think is the real problem with credit expansion. I would like to have your opinion.

Lets get to the same example. Initially the economy has a money supply of $100. Lets say people save 20% of their incomes, and the rest they spend on buying consumer goods. So right now the society’s savings is $20. The central bank now prints $80 and loans it out along with the $20. Now remember, the total money supply is $80(money consumers decide to spend on present goods) + $20(money that people voluntarily save) + $80(newly created bank money) = $180(total money supply).

So prior to the bank creating new money, 20% of purchasing power went into investment purposes. After bank creating new money, 55% of purchasing power went into investment purposes. In short, people are forced to save more than they wish.

Assuming that investment prospects for businessmen are constant, now lets look at the loan market. Prior to new money being created, the loan market(with loans worth $20) clears at the interest rate of 10%. At this moment, businesses that promise a return over 10% will be undertaken.

After credit expansion, the loan market(with loans worth $100) clears at a lower interest rate of 5%. So now the business environment is simply superb. Businesses undertake any project that promises them a return over 5% itself.

Okay, and now businessmen take out loans and invest it in business projects that promise anything just over 5%. The lent money($100) percolates into the economy(like when businessmen pay their workers etc.); and this is when people reassert their original consumption-savings ratio, which is 80 for present consumption and 20 for savings. So in real terms, of the total money supply which is $180, $144 goes into present consumption and $36 into savings.

Contrast this with the previous ratio between consumption and savings: $80 into consumption and $100 into savings(Remember, of the $100 that has gone into savings only $20 was voluntary savings, $80 was forced saving as new bank money).

How does this affect the loan market? Assuming constant investment prospects in the business world, interest rates will be higher now, because of lower amount of available savings.(Note: savings have decreased from $100 in the previous round of bidding in the loan market to $36 in the present round)

Now do you see the problem? Interest rates rise, and many projects which looked profitable under low interest rates now turn into mailinvestments. They are no longer profitable in the present high interest rate regime. The bust arrives!

Your comments are welcome!

129

No! No! No!

The problem is that the economy doesn’t have “more capital resources now”, they’ll eventually have “more capital resources” in the future, but the only way this comes to pass is because you stole from the present

Now, people are generally willing to forgo the present in favor of the future, if they receive a return (interest) for the risk and time. Your counterfeit money offers neither.

130

Yes, right. When credit is expanded and businessmen invest this money, the economy’s capital capacity increases.

I do not by any means support counterfeiting of money, and the resultant credit-fed boom which is unsustainable, for reasons I’ve explained.

131

Why “you” and why “your wishes”? Don’t other people matter? Don’t other people deserve equity and fairness? Your purchasing power is de facto theft. Deal with it.

Charming. I still say it’s not saving, it’s the illusion of saving. Those who receive the money first benefit the most, and so on. But many people don’t receive the money ever, or are injured when the new money steals resources away from them, etc. You’ve got to understand this, don’t you?

You are neglecting the other half of the equation: people save less when rates are lower. Which means they demand more now. And this demand can’t be met without existing capital and productive factors (which don’t yet exist), which means prices rise so that the consumer markets clear.

132

Capital is a factor of production. It is not money, nor is it credit.

133

When people are forced to save more(through credit expansion), businessmen get more funds and are able to bid away factors of production from stages closer to consumption and use it in stages farther from consumption. In simple words, the per capita capital of the economy increases.

Whether these more round about projects are sustainable beyond a period of time is another story. The basic thing I want to say is, credit expansion does cause society to save more, forcefully.

134

Thats a pretty messed up concept of saving. You’re saying that investment = saving. Not exactly true because investments vary in their liquidity. Also, its not investment/saving by the people who earned the money, its by you who didnt produce anything. So everyone who did work has less savings, and you have more.

135

Dude, I am NOT justifying credit expansion. I am just looking at what happens when credit is expanded.

Right. Because interest rates will rise again when savers reassert their consumption-savings ratio. This will expose malinvestments.

Yes, right.

It doesn’t matter. Consumers have lesser purchasing power now. So they really can’t bid against businessmen who now have more purchasing power.

136

Yes, loan markets clear. Leave aside cases where banks get nervous and are more interested in holding reserves.

I am tired of this. I am not justifying credit expansion in any means. I am just seeing through the effects of credit expansion.

137

They’re not necessarily bidding for the same resources at once. He needs fuel and finds that the fuel market has cleared, so he pays a little “extra” to get fuel. He needs machinery, but there is none not already in use, so he pays “extra” to buy it from someone else. He needs to hire employees he finds that the labor market has already cleared, he must offer someone “extra” to lure them away from their current employ.

All this “extra” is fraudulent. It seems we agree on this. (In fact, I’m not sure that we disagree on any of this…) These individuals or companies benefit in the short run at everyone else’s expense.

Everything begins to cost more. But most people in most lines of work don’t get a raise or a bonus. The “extra” is cannibalized mostly. The rest of the non-institutional individuals have less purchasing power; a standard indifference curve being phase-shifted leftwards. They now buy less, even though their bank balances haven’t changed. Their consumption patterns change; where they previously bought a 34" television, maybe now only 27". Previously they bought meat from a deli, now from a grocery store, etc.

Now think of the businessman who bought the machinery from another, by paying a little “extra” with this new money. The other guy only sold it to him based on the then prevailing rates; he says, “I can do without a drill press for a few weeks if this guy will pay me an extra 10% over my cost, I’ll just order a new one and ramp up production when it arrives…” But by the time it arrives, prices for the rest of his inputs have risen enough (or more) that the “extra 10%” is now revealed as illusory: there is no “extra”!. So we see capital decumulation/destruction and resource misallocation, or, malinvestment in the Austrian vernacular.

138

Wealth redistribution is an effect of credit expansion. It is a worthwhile effect to consider because wealth is taken from productive sectors of the economy.

139

“When money is injected into the system, it causes prices to change without a corresponding change in time preference which would be necessary to meet the “demand” contrived by the inflation.”

are you saying this is what takes place now???

does say adding gold, via money gold given up to get gold ore and the its additional processing, somehow not affect time preferences or prices in the same way???

does the currenct central bank/commercial bank/ currency system affect prices in a noticibly different way???

140

“Excellent point! C/P, a higher interest rate encourages people to “save” or “invest”, if the rate is forced lower by credit expansion, then marginal lenders/savers are crowded out of the market.”

when prices are adjusted for inflation, Americans today spend “40% less on clothes, 20% less on food, more than 50% less on appliances, about 25% less on owning and maintaining a car” than they did during the early 1970s. Over that same period, Census Bureau tables show, US median household income rose by at least 18% in constant dollars…" true???

well…i assume credit expansion was taking place while the above price reductions were going on if the items mentioned above make up roughly 70 percent of the expenditures made by americans wouldnt that actually operate like a savings account..and not crowd them out of the market???

40 percent less on clothes over the years would be like having money saved? has the current system wiped out those gains in other areas that you can show???