Some basic questions from a beginner

Economics Economics Questions
1

Hi there. I’ve been listening to a lot of lectures from here, aswell as reading every daily article for about a month, but I really don’t feel quite ready to head into big debates just yet. I understand almost everything that’s being proposed, and so I’d really need to clear a few things up!

First of all: How is it that saving becomes equated with investing so frequently?
Why would more saving lead to more investment?

Why is it that entrepreneurs choose to invest in capital goods when they think consumption is going down, instead of just not doing nothing with their money?

Basically: Why would less consumption lead to more investment in capital goods, instead of more saving in the bank accounts by the entrepreneurs? An example would be nice. :slight_smile:

Also, concerning deflation. Would it not be hard to lend money with goods (as security) constantly dropping in value?
Why would banks want goods which won’t retain their value (cars, houses, whatever), as security?

Some easily-understood answers would be great! Thanks. :slight_smile:

/ Eli

2

I’m not an expert in anyway, but I think I might be able to give you something of an answer to these questions:

  1. For saving to return interest, it must be lent out. Loans are taken in large part to invest. As saving increases, the price of a loan (the interest rate) falls, as the basic law of supply would indicate (higher supply, all else equal, means lower price).

  2. Entrepreneurs invest in capital goods instead of “doing nothing” because although demand is currently low, they expect it to rise in the future. Investment in capital thus has the possibility of high rates of return. And, as noted in #1, the only way to get interest is to loan out your savings.

  3. In a period of rapid deflation, I think your analysis might hold. But outside of confiscatory deflation (that is, the government steals your money and destroys it to induce deflation), I don’t think deflation would be rapid enough for what you are saying to hold. Assumably, free market deflation would also be somewhat uniform, so while things might drop in nominal price, their real value would probably be maintained. But, you do bring up a good point and banks might operate differently under a deflationary circumstance. Perhaps they would demand the borrower himself as collateral, that is, if the debt is not paid, the borrower can be forced into labor to pay back the bank (likely to be contracted out, a la debtor’s prison or garnished wages rather than being directly employed by the bank which probably has no use for most people).

3

Ah, right. Thanks for the answers. So this basically presupposes that savers will lend money out, instead of just keeping it in the bank vaults where it does nothing?

About the entrepreneurs… They start to switch investments from consumer goods to capital goods because they look at the interest rate and think people are saving more. But do the entrepreneurs really not know that most interest rates are artificial today?
Also, do the entrepreneurs invest in capital goods because they expect people to start “making use” of those goods, or because they just need to spend it on something? As in… Do they invest because they anticipate more sales, or do they invest to get the cost of production lowered?

What about this scenario… So business is just rolling along just fine, until one day the entrepreneur sees interest rates falling. Now, he thinks that people will be consuming a lot less of his consumer goods since they will be saving more. So, for the entrepreneur, spending the same amount of money on the production as before probably wouldn’t be profitable. Now what does he do? Does he invest in capital goods instead of consumer goods?
If so, isn’t this quite bad, seeing as if consumption would go back to its normal rate (before interest changes), the entrepreneur could have just cut back on spending a bit, and then re-hired workers when that time comes?
So: Why doesn’t the entrepreneur just fire a few workers, and lend the “extra money” out like a normal consumer, instead of spending that money that’s going away from the consumer goods market on capital goods?

Is it because the entrepreneur anticipates that people will be ‘as willing’ or ‘more willing’ than before to purchase his goods, and investment in capital goods would yield him greater profits once consumption/saving goes back to normal? Is it because he now has “spare money” that isn’t being used in the capital goods market, and is now able to spend it on lowering production costs (something he didn’t have the funds to do before)?

I’m guessing these are all the same questions really, and I hope you get what I mean.
Clarification would be greatly appreciated! :slight_smile:

/ Eli

4

An additional point, which came from Murray N. Rothbard: just because the economy itself is sinking doesn’t imply that every industry, or firm, is going under too. In a period of general deflation, capitalists will move to the areas of the economy where cost-prices are either keeping pace or dropping relative to receipt-prices. This combination means that the margins are either staying the same or increasing: such a pattern signals that scarce resources are needed in those niches.

This point ain’t just theoretical, either. There were several expanding industries in the Great Depression. You may be shocked to learn that ad agencies were one of them. (Another, less shocking, was self-help: the Charles Atlas course was started in the Great Depression and became a huge success starting in that decade.)

5

Something to keep in mind is that an account where your money is merely stored is not the same as a normal savings account, where you earn interest. In the former case you actually have to pay for it to be stored, in the latter you gain interest and the money can be loaned out. This is how banking used to work, at least. See Hoppe’s paper on international banking in the reading list on praxeology.

On entrepreneurs, they, like everyone else, have no idea where the real interest rate lies, due to the Fed’s constant interventions with the interest rate. It is impossible to properly determine it at this stage.

6

As I see it, it’s not these goods which constantly lost value, it’s their prices that decrease while value of money increases. And btw deflation would likely be very slow, as Morty said.

7

There are a few theories on this, as far as I can tell. One is that while entrepenuers realize most interest rates are artificial to some extent, they don’t know how artificial they are. So they take a chance when the rate drops. Another is that entrepenuers recognize that the rates are artificial, but decide to ride the boom and just hope they make enough to survive the bust or try to sell before the bust occurs, at the peak of the boom. A third is that the idea that interest rates are a “signal” is sort of deceiving, because entrepenuers don’t think “the interest rate is low, so that means people are going to consume more later and are consuming less now” - it simply allows the entrepenuer to take on a project that they wanted to do regardless of “signals” but it was not affordable at the higher interest rate. Which of these it is, I don’t know, and it is probably a combination of these and others.

I imagine it is a bit of both. I guess it depends on how they invest. If they invest in building a new factory and expanding operations, it is probably the former, whereas if they just invest in capital goods which increase productivity, it might be more the latter. Of course, in both instances, they are really doing both. If they expand operations, that means a rising supply, which means a lower price. If they lower the price, that means more will be demanded and they will increase output to respond to the higher demand.

As I understand it, you don’t “invest” in consumer goods. You could stockpile them if you were a spectulator but that wouldn’t be investing, strictly speaking. Consumer goods are made to be consumed, so to say you “invested” in consumer goods is sort of confused, I think. Capital goods, on the other hand, are an investment, in that they aren’t consumed but rather are a way to increase production of something else.

But who is he going to lend to? Loans aren’t generally taken out to buy consumer goods, but rather to buy capital goods. Whether the individual entrepenuer is planning to buy capital equipment with the increased saving is not really the issue, someone is going to use it to invest in capital goods

I hope that helps and I hope someone more knowledgable than I can correct any mistakes I made.

8

I would just like to add at this point that you voice a common misconception about the way in which banks work. Look up Fractional Reserve Banking on wikipedia for a simple explanation of how you saving $1000 usually translates to about $9000 (varies by country) inexistant money being lent out, now you know where inflation, malinvestment, and a large portion of the boom-bust cycle comes from.

9

Indeed, that is the reason banks can provide interest for - ostensibly - providing warehouse services. As one poster pointed out earlier, if the banks didn’t lend out your money then you would have to pay some sort of fee for the bank to hold it for you.

10

Late to the party, but we’re on an area I teach, so I thought I’d chime in:

Remember what investing means in this context. For the ABCT, we have something called the market of loanable funds, which means all the money available for business to borrow, regardless of how the businessman acquires the money. So, investment doesn’t just mean buying stocks, it also can mean buying a CD, or just putting money in a savings account, so that the bank has the money to loan out to business. Ultimately, it just means that the businessman can get money at a lower interest rate. The only way to consume less and not do this is to stick money under your mattress. And what happens if you stick money under your mattress? Your drop in consumption puts downward pressure on interest rates, and in the future you’ll have more to spend than you otherwise would have - so even this behaves just like investment.

Why do you save money? Spending money now means that you will have more money to spend in the future. Future spending vs. present spending changes not just the when, but the how of your spending. You put off current consumption for greater consumption in the future. So, instead of buying ice now, you’ll buy a refrigerator later - that is, a more expensive, more capital-intensive good. So when savings are up and consumption is down, businessmen had better be shifting resources to more round-about methods of production, which requires shifting labor to earlier stages and buying capital goods.

You later clarified this question to the Bryan Caplan problem with the ABCT - namely, if the Austrians get it, why don’t businessmen, when they have so much more on the line? A simplistic, although not entirely false, answer would be “they went to business school and had common sense driven out of them.” And, in fact, there are some entrepreneurs who see more clearly what is happening and tend to do better. On the other hand, just because the boom is artificial doesn’t mean you can’t make money off of it - or be left behind if you don’t. Were businessmen wrong to devote resources to building houses when interest rates were low (originally)? Clearly not. Another point is that the idea of “interest rate signalling” is Hayekian baggage which a Misesian wouldn’t really want. More than a signal, the low interest rate just is an opportunity to borrow more money at low rates. Also, just because the government is screwing with the money supply doesn’t mean that there isn’t real savings.

Careful there. It’s true that the monetary value of goods falls during deflation - but does that mean that the value of the good drops? The monetary price establishes a ratio - say a car is $1000, and a pizza is $10 - the important fact is the 100/1 car/pizza ratio. So there’s a period of deflation and the prices are $100 and $1 - but the value of the car has not dropped, since the ratio is the same.

So, I loan you $1000, and lean your car as collateral. You fail to pay, and now I take the car which is worth only $100. However, if I had taken the car initially, I could have traded it for 100 pizzas - and I still can. So what have I lost? Now, this is different from inflation, which doesn’t happen equally across the economy, because natural deflation - that is, when no one screws with the money supply - does happen evenly across all goods.

Besides, assume it did make it harder to give loans. Then interest rates would go up - and? As long as no one is screwing with the market, there’s no reason to favor one interest rate over another, and there’s no a priori correct allocation of goods and money.

11

Thanks for all the answers, makes quite a lot more sense now. :slight_smile:

I’m a tad interested; how would other schools of thought usually answer these questions?
Are there any “viable” or “somewhat decent” theories, other than the Austrian one? And what do they really fail in, what do they usually “miss” in their analyses?

But, if I had kept the money (and not lent them out), I would still have $1,000 in my pocket, and thus a 1,000/1 car/pizza ratio after deflation.
So I’d still have made a big loss… Or?
I mean, if the person was able to repay, I’d have gotten $1,000, but now instead I got this lousy car only worth $100…

Edit:
About the interest rates going up… I’ve heard this objection quite a bit: “It would be bad for the economy if i’s harder for people to loan money (high interest rate), and that coupled with deflation makes for a terrible economic system you’re proposing there…”

What would be a good short answer to all of this (without the need to go into the very basics of Austrian economics and hold a 30 minute lecture)? :slight_smile:
Would less consumption and more saving only lead to workers being shifted from the consumers goods production, into the capital one, and not much more?

12

That’s probably why the banks (used to) demand significantly more collateral than the value of the loan. I would expect, in a period of anticipated deflation, the collateral/loan ratio would rise and the offering of uncollateralized loans would drop.

13

The basic assumption there is that more capital investment is better than less. But why should we assume that? It is the same sort of fallacy that is made when people decry “non-durable” goods and think that everything should last as long as possible. It is saying that our great, wise planners know better what we want than we do.

But what you can also offer is that with a sound money policy our growth will be continual, so long as the government doesn’t increase in size. We might not have a few years of unsustainably high rates of “growth” (which is really mostly wasteful), followed by an inevitable bust.

14

Investment is simply the result of low time preference. Consumption is simply the result of high time preference. All Homo sapiens require a minimal level of consumption to survive. Therefore, poor people would invest less.