Austrians see no problem with speculation-driven expansion of capital, assuming the increase in capital leads to more overall investment overall, meaning greater production.
But you believe government-driven expansion of capital (through the Fed and Fractional Reserve banking) leads to malinvestment and thus, the business cycle.
This seems contradictory, doesn’t it? In both cases, investors aren’t investing because they think their investments are worthwhile. They’re investing either because:
a) They have more money
or
b) They think “the other guys” are going to copy his investment strategy, leading to a snowball effect that drives up the value of the investment
To be consistent, you’d have to believe either both forms of capital expansion lead to malinvestment or both forms of capital expansion don’t lead to malinvestment. I strongly suspect the latter, based upon the fact that I’ve heard Forbes magazine used to run a fund in which they tossed a dart at a newspaper and randomly invested in the stock the dart landed on, and the fund was still surprisingly profitable.
If random investment in stock is profitable, then I can’t see how ANY expansion in capital could cause a rise in overall malinvestment.
I disagree with your assessment of the investment motive. Investor will not invest their capital because “they have more money”. They invest because they think that they will profit. The fact that they have more money allows them to invest more. This is not creating money, except to the extent that there may be margin. The money circulating in the market is the transfering of existing funds among investors first of all, and secondly it doesn’t get into the public easily as investors generally re-invest profits.
There is some snowball effect but overall this levels out and makes no long term difference at all in the long run advance in stock prices. Stock is just another asset to be bought and sold. The vast majority of funds in the market do not make it out of the market into the economy anyway, so the bubbles in the market, spectulative or not, are a symptom of a rise in M, not a cause.
Governments cannot expand capital. Only saving can achieve that. What governments expand are claims to capital, which inevitably must correct back to the actual supply of capital.
In a commodity based, non inflationary system, speculators would only fulfil their natural function of hurrying the market to equilibrium. It is only the unlimited credit provided to the speculators by the expansionary monetary system that allows speculators to function in the current destructive manner. The current speculators are only taking advantage of the largesse provided by the Federal Reserve. Ultimately, the Federal Reserve is SOLELY responsible for the situation. Revert to a commodity based, 100% reserve banking system, and speculation will revert to its natural and proper function.
Hold on there… You know someone is biased when they speak for all of a particular group.
This is a wildly loaded statement.
“Assuming the increase in capital.”
Who says capital increases? What makes capital increase? What is capital?
“Leads to more overall investment meaning greater production.”
Where is this apart of ABCT?
What?!?
Capital is not expanded through the fed.
Liquidity/Dollars are expanded through the Fed, which the Fed loans out or gives away on frivolous projects that drain the real pool of capital.
First understand what Austrians mean by capital, then come back, or better yet, go to class and slap your idiot professor in the face a few times.
When do private investors just invest because, “they have more money?”
That’s not investment, buddy, that’s charity.
Never happens ending in an economy wide bust. You’re not addressing one of Rothbard’s requirements to be talking about business cycles. Why do economies as a WHOLE faulter? Not, why does one guy invest heavily in stock, just to pull out after tricking others to pump up the price a little more.
Also, take a book from your precious Neoclassicals; Rational expectations.
Correction: It was the Wallstreet Journal, I believe. Not Forbes.
Also, in this thread I’d like to simply discuss analytical economics, not get distracted by normative economics. politics, or Libertarian philosophy.
If you respond, please respond in large blocks, not quoting me roughly a few sentences at a time, because it makes it very tedious to respond to, to dig through the maze of quotes.
And no personal attacks.
When I said, “because they have more money,” I was speaking about investors as a whole, not individual investors, based upon the marginal propensity to consume\save. Of course, individual investors will only invest if it’s profitable when given more money, but investors as a whole will increase investment if they’re just simply given more money because for every dollar anyone is given, they will save more and spend less.
Just so I make sure I’m understanding you, you say that an increase in capital by raising interest rates is only a marginal increase, because when investors put the additional money into investments, they simply get an increased return equal to the marginal increase in the money supply. Correct?
If this is true, I don’t understand how there can be an increase in malinvestment. If investors are given more money (even if it’s just a marginal increase) and they’re investing for profit, where’s the malinvestment? It’s the malinvestment which causes the short-run fall in production and rise in unemployment associated with a recession, right?
What you say suggests that at any given point in time there is a fixed demand for capital, the same as with goods and labor on a microeconomic scale. And so you treat the financial market like the goods and labor markets. I.E., if the government tried to raise or lower the price of apples, there’d be either a shortage or a wasted surplus. And if the government had either a minimum or maximum wage for labor, there’d be higher unemployment, either way, but for different reasons.
But with capital, how can there be a “wasted surplus”? Because we aren’t all employed, we all have limitless desires, and we aren’t in a technological utopia, the potential for increased investment to increase production seems limitless.
“It’s not a real increase in investment!” is not a rebuttal to this, because whether or not it’s a real or marginal increase depends on whether or not central bank-driven expansion of capital leads to increased production, and thus a real return investors, and a real increase in the money supply.
You do not understand the difference between capital, capital goods and finance.
All that the government can do is counterfeit claims to capital, which results in investors initiating production on more capital goods than there is actual capital to complete.
Of course I do. What a horrible accusation to make!
Capital is any wealth used in production. Capital goods are actual goods used in production, like machines. Finance (often called “investment capital”) is capital in monetary form.
According To ABCT, if the money supply is increased, interest rates will fall below the natural rate of interest, which is set by the consumer’s time preference. This induces greater investment in the higher orders of production (think enterprises with projects which will take a long time to come to fruition) than would otherwise be the case. Addidtionally, it induces the consumer to consume more. You therefore have a combination of malinvestment in early stage goods and overconsumption. This boom can only be sustained by ever increasing injections of money. Eventually it leads to a bust, which is the market’s answer to correcting the malinvestment that occurred during the boom.
I think the malinvestment label applies to the unsustainable booms created by the central bank’s loose monetary stance. Sure the banker’s motive is profit and the central bank only wanted to avoid a recession following the 9/11 attacks. So Greenspan inflated bank reserves and a lot of this new bank credit went to the housing sector, creating new jobs. Speculators motive is also profit and the easy credit from the bank’s allowed them to bid up the prices of homes. But all these jobs will be liquidated because the boom will eventually turn into a bust once the very same central bank tightens the money spigot, this time to reverse the effect of their last monetary stance.
The whole episode begins and ends with the central bank’s monetary policy.
You argue the government cannot increase production through increasing aggregate demand, because it is the market which determines the supply of available capital. And so any increase in aggregate demand will simply result in a general disequilibrium that’s only corrected through a decline in production.
This is true in the case of capital goods. If the government were to set a price ceiling or floor on any given capital good (such as aluminum bolts), there would end up being a shortage or wasted surplus, just as with any other good.
This is not necessarily true in the case of investment capital, however. Let us assume that in the absence of regulation, banks are naturally full-reserve (a reasonable assumption, right?). Under full reserve banking, every dollar represents a claim on some tangible asset. But the reverse is not true. There are many valuable assets which are not captured by the monetary system. If the dollar is pegged to the value of gold, every dollar represents a claim on some tangible amount of gold. Any non-gold assets are not represented by the monetary system at all, creating a limitation on the available amount of capital.
When fractional reserve banking is established, dollars can be issued proportionally up to and (unfortunately) even over the value of all tangible assets in the economy. Moderate increases in the money supply should therefore be real increases, because they represent real assets – both gold tangible assets and non-gold tangible assets. It is only when the money supply is increased above the value of all tangible assets that the increase is strictly marginal, not when the money supply is increased above the value of all tangible gold assets or whatever backing it is you use.
See my remarks above and below in this post.
Regarding speculation, I’m starting to suspect that there is no expansion, because any money they withdraw from bank accounts to spend on stocks doesn’t increase the money supply. In fact, it decreases M1 and M2.
Why should a fall in the interest rate increase mostly the rate of investment in long-term projects? Does that mean that a rise in the interest-rate, above the natural rate, should increase mostly the rate of investment in short-term projects? Also, if this boom-and-bust is a cycle that regularly occurs, it seems to me that investors should anticipate that and thus avoid losing money in failed long-term projects by investing in mostly short-term projects.
Furthermore, if the interest rate goes up, I should think that would cause consumers to save more, not consume more. Because if interest rates on savings go up (obviously) and the prices of consumer goods don’t change, as the production of consumer goods is a short-term project and you said above that that a nominal increase in the money supply would cause an increase in investment of mostly long-term projects.
Absent monetary inflation, a lower interest rate signifies that consumers are more prepared to forgo consumption now for greater consumption in the future. They have a lower time preference. It sends a signal to investors that projects which would previously have been unprofitable because they would have taken too long to come to fruition, can now be undertaken profitably. The lower interest rate lowers price differentials, flattening the structure of production and extending it further towards higher (earlier) stages. Prices thus rise in the earlier stages, shifting resources to this area. Artificially lowering interest rates does the same thing, but without the consumer’s time preference having changed and without a concomitant reduction of consumption, the seeds are sown for an eventual bust.
Whether it occurs as a result of increased time preference, monetary deflation caused by a credit contraction, or central bank monetary policy, a rise in interest rates shifts resources away from the earlier stages to later stages.
No one can predict with certainty when the bust will come since the timing of the bust is dependent on so many variables, not the least of which is central bank policy. If higher prices and greater profits can be made in the earlier stages it is inevitable that investors will shift resources to these areas. To the extent that business cycles are predictable, the best entrepreneurs will exit immediately before the bust occurs.
Monetary “capital” is a representative of real capital, or as Frank Shostak and I put it, real pool of fundings.
Credit expansion by the banking sector - i.e. inflation in the money supply - represents no real capital gain, it merely injects unbacked dollars into the economy. What is the effect of this? The money created from nothing sets in motion a trading of nothing for something, that is it diminishes the real pool of funding or the capital used in production away from backed credit, and into unbacked finances.
Sigh. You misunderstand what one means when one says, “backed credit.”
The situation has little to nothing to do with gold as a tangible object, it has to do with the real stock of capital at the time of the increase in the money supply.
As an aside: Every dollar does not represent a claim to a tangible asset, every dollar represents a potential claim to a tangible asset. Dollars created from nothing may represent a potential claim, but it does not mean that dollars change the actual stock of wealth within the economy, though they may appear to from the effect they have on the interest rates.
The central bank increases the money supply, the increase in the money supply is an increase from nothing, that increase from nothing now distorts the interest rate away from actual capital goods in the economy. The increase in the stock of money distorts the economy because it was created from a printing press, not from an increase in the stock of wealth.
If the stock of wealth perpetuates and represents real and sustainable growth, and fiat currency represents a distortion in the real wealth available for production, then the increase in fiat currency will distort the growth expected and thus the growth obtained.
Fiat currency represents a distortion in real wealth because it originates from lenders who then distort interest rates. With artificially low interest rates, producers and other investors are fooled into believing the economy possesses a higher stock of real wealth than it really does - because the newly created currency does not actually increase the real stock of wealth, but due to the appearance of real wealth creation from lower interest rates the indicators skew expectations - and so invest in otherwise unprofitable projects.
Who is “given” more money? No one other than those the Fed give money directly to - a different topic of discussion.
There are several different ways to increase the stock of money, some of which are connected with eachother, but let us assume that the method used is an artificial decrease in the credit supply by increases in the stock of money.
What does the interest rate appear to indicate to investors and entrepreneurs? The ratio between preferences for future goods to present goods. Through the course of decreasing the interest rate, ceteris paribus, the indicator for the production of future goods to present goods are significantly distorted out of their actual form.
Entrepreneurs basing their decisions off of available indicators, they are deceived into investing too heavily in one form of good when really it is the other good that deserves the attention.
Not really. Merely an aggregate preference for present goods over future goods - consumer goods over capital goods.
You’re making the same mistakes Kruggsy made when he critiqued ABCT - amateurly as always.
The question isn’t about aggregate surplus or hangover theory, it’s about specific malinvestments and aggregate manipulation.
I don’t believe he was referencing “marginal,” he was referencing unbacked.
Real wealth = Wealth in existence
Marginal wealth = Wealth by subjective preference (Is it even possible?)
Nominal wealth = Wealth given by the set amount of Dollars, Euros, Pounds, etc.
You obviously haven’t read a lot concerning the ABCT. There is a lot of information in this site on it. I recommend all the lectures by Garrison especially, and the on line book “Prices and Production” by Hayek.
The government cannot increase the quantity or capital by printing currency. Currency is only a claim on capital, not the capital itself. This is why more currency in circulation causes prices to rise: there are more claims to goods than there are goods tobe purchased. To confuse capital goods with currency is a major error.
Speculation does not decrease M1 or M2. The currency deposited with a brokerage is still in circulation. As with all investments, the buying power is just transferred to others. If the issuer/seller is selling to raise money for a project, then he spends it on that. If he sells to be able to invest in a different instrument, then the recipient of those funds may use it for some purpose not unlike the origional seller. Someone uses it to consume.
According to the ABCT, malinvestment occurs in the higher orders of producer goods because that is where the profit is. Hayek called this more “round about production” meaning that since capital intensive goods are cheaper with lower interest rates, more profit can be had utilizing more capital intensive production methods. Thus mining, tools, etc. are more profitable than labor intensive orders. This reduces the cost of production overall, and expands the quantity of consumer goods. Consumers are buying these goods because they have a reduced incentive to save, and there is less unemployment. Eventually the extra money hits the street and causes price inflation, giving incentive for the central bank to raise interest rates. This causes the inivetable bust.
You are correct about short term projects being where the money goes when interest rates rise above the natural rate. Capital goods are now too expensive relative to labor, so money flows out from capital intensive to labor intensive stages of production, closer to final consumer goods.
Investors do anticipate the bust, the problem is that no one can predict when it will happen exactly. There are always those that can better anticipate it than others and these are the better entrapeneurs that make the money lost by the losers. The market collapse is caused by a majority of investors that all simultaneously decide to sell into the bust, so the collapse in the market is an investor driven event not really an economic one. The economic bust is a correction of the malinvestment in production, where resources are transferred from higher orders of production to lower (read ‘unemployment’). This causes a rapid decrease in velocity of exchange and saving/regrouping.
As to my previous explanation of velocity: I know Rothbard’s opinion and to some extent I must agree with his assessment. However, the formula for the price level is merely a tool to aid in the understanding of the events, not a realistic method of analysis. It cannot be used to predict anything, as there is no way to quantify these variables. Even using the AMS, the best that can be discovered is V at time intervals in the past. I did not mean to imply anything else than that.
“if the government had either a minimum or maximum wage for labor, there’d be higher unemployment, either way, but for different reasons”
this is only half right. if the government sets a minimum wage above the market clearing price, a surplus of labour will result (unemployment). the converse is true if there is a maximum rate imposed by the government below the market clearing rate, that is a shortage of labour will result as people withdraw their services.