Austrians see no problem with speculation-driven expansion of capital, assuming the increase in capital leads to more overall investment overall, meaning greater production.
One sentence in and you are already incorrect. Austrian economists qua economists do not make moral judgements, so in this sense, they do not see a problem with speculation-driven capital expansion. However, neither do they support it. As Mises said, the most important thing an economist can do is tell the government what it cannot do. Austrians seek to understand and explain economic behavior. Of course, each Austrian probably has an opinion on something, but inasmuch as he opines on subjective topics he is going outside the bounds of economics.
Another inaccuracy in your post is implying that an increase in capital will lead to more overall investment. In fact, things work precisely in the reverse. Capital is increased because people invest in it, not the other way around.
And finally, Austrians, assuming they set aside their economic objectivity, can certainly see a problem with expansion of capital. If it is capital expanded because free market signals indicated it was a sound investment, then we see it as a good thing. If it is capital expansion caused by misleading price signals, then it is a bad thing.
But you believe government-driven expansion of capital (through the Fed and Fractional Reserve banking) leads to malinvestment and thus, the business cycle.
Good enough.
This seems contradictory, doesn’t it?
With the first sentence revealed as misleading, we no longer are bothered by this conclusion.
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
I’ll be perfectly honest: I don’t know how you arrived at this point. At any rate, investors invest because they expect to make a profit in the future. The discounted value of the future goods they can buy with the profits they expect to earn is worth more than the next item they would buy today.
Of course, some investors probably invest because for them it is a fun game to see how much money they can make. In this case, investing itself becomes a consumer good.
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.
I understand the first sentence, at least, and below I’ll explain why it is incorrect. The next part loses me.
If random investment in stock is profitable, then I can’t see how ANY expansion in capital could cause a rise in overall malinvestment.
Random investment in stocks is not necessarily profitable, which is why they advise you to spread your investments around rather than put all your eggs in one basket. Investing your money in stocks is not the same as expanding your capital structure. Onto an explanation of the ABCT.
A consumer good is any good that makes you happy, or, as economists put it, increases your utility. DVD’s, sporting events, massages, apples and automobiles are examples of consumer goods. Capital goods are goods which aid in the production of other goods. Tractors, hoses, automobiles (notice that a good can serve both functions) and even education are capital goods. The more capital that is invested per worker, the more productive a worker will be, but in order to invest in capital someone must first save, that is, they must forego consumption in the present so that, instead of consumption for utility, a capital investment can be made. In very simplistic terms, imagine a fisherman who catches and consumes three fish per day. Then he decides to consume only two fish per day and save the other one. After two days, he has saved two fish. The next day, instead of fishing he builds a net, consuming the two fish that he had saved. The day after that he catches five fish because of his net, allowing him to eat three and either trade the other two for something else or save them as well in preparation for embarking on another capital building project.
Since capital decays, it must constantly be maintained. This requires constant savings so that the needed capital investments can be made. If we want to expand the capital structure, even more savings is required.
Now, we must understand price. The function of a price is to ration scarce resources. A resource is said by economists to be scarce if there is more demand for it than supply of it. Ipso facto, the good must be rationed. When all relationships are voluntary - on the free market, in other words - goods are rationed by pricing them. The price rises which discourages the least interested from purchasing while encouraging more production of that good. The price will tend towards the market clearing rate, which is the rate at which there is a good for every buyer willing to pay the price. An interest rate is also a price and works as a clearing function in the same way.
Now, savings are used to fund capital investment projects. The interest rate is determined by the willingness of people to save and the desire for businesses to borrow to expand their capital structure. Businesses use the interest rate as a guideline for whether or not it will be profitable to expand their capital structure, and people use the interest rate to decide whether or not they wish to save and consume more later or consume less now.
Enter the Fed (cue Darth Vader theme music). Let’s say that the Fed purchases some securities, thus making available more money for banks to lend each other, thus driving down the interest rates. Two things happen. First, businesses see the reduction in the interest rate and notice that a whole host of capital projects just became profitable at the lower rate. Second, people see the lower interest rate and decide that they prefer to save less money now since they will be getting back less money in the long term.
Do you see the problem beginning? Before the rate of savings and the rate of borrowing was balanced out, and therefore the savings rate and consumption rate supported the capital investment rate. But now, real savings is dipping down - and thus consumption is increasing - at the same time that businesses are demanding more loans for capital projects. In other words, consumers are thinking short term and businessmen are thinking long term.
The economy starts to reshape itself around the artificial stimuli and bad investments are made. The capital structure, specifically the structure of those industries which received the early injection of cheap credit, is expanded beyond what can be maintained by the true savings rate, and as the demand for capital increases capital goods soar in value. Projects are begun, but it soon becomes apparent that they won’t be finished. With the housing debacle, we long ago started getting stories of projects that were delayed because of a lack of material. Capital expansion outstripped what the savings rate could sustain.
Of course, a new injection of credit might keep things going, but it will only make the fall all the harder and eventually, with no let up in money creation, your currency will be rejected. At some point, the Fed chooses to tighten credit. The interest rate goes back up, and suddenly these new capital projects are revealed as bad investments. There is a fire sale of capital goods which causes their prices to plummet, and the economy goes into a recession which is simply the liquidation of bad investments. After the recession, the story might continue more peacefully, but of course the Fed always choose to inflate again, which leads us right back to where we were.
And so we see that investment in capital isn’t useful in and of itself. It must serve the purpose of making a profit, and the price signals of an economy will tell entrepreneurs if this will be the case. There are good investments and there are bad investments. By interfering with price signals, the government causes a cluster of bad investments to be made and these must eventually be liquidated. We have no need to decry all investment as bad nor to praise all investment as good. There are good and bad investments, and when government messes with the signals of an economy it becomes hard for entrepreneurs to know the difference.