Most here are familiar with the ABC theory and how it works. Artifically low interest rates induce unsustainable investment projects. The recession is the liquidation of those projects.
Here’s the aspect that’s puzzled me and often made it difficult to grasp the current situation as well as it could be grasped.
A lot of the loans provided are consumption loans. I’m not sure of the break down but loans for consumption and investment are comparable. My question is how this is integrated into a full business cycle theory?
I’ve read de Soto and he’s the only one I’ve found to give explicit attention to this. But his analysis is short. It basically entails that consumption loans are often for the purchase of durable consumer goods and durable consumer goods are of the same nature as capital goods, ergo it results in the unsustainable lengthening of the prod. structure. This is ok, but I find it unsatisfactory. Does more durable consumer goods necessitate an increase in relatively removed capital goods for their production as well? Is there a better and systematic way durable consumer’s goods can be integrated into the prevailing theory?
And what about credit cards? Clearly they result in more consumption. Does this result in a shortened structure? Further, how much of the credit provided through credit cards is unbacked? I have no idea what the ratio is or what the law concerning it is but I’ve never read anything explicity written about it.
So what if consumer loans result in a relative increase in present consumption? Are events over the last decade an example of this? What does it mean for the cycle? Once again, de Soto briefly treats this but it’s not terribly clear.
I’m curious about all of these questions because of the peculiarities of our modern economy. There’s a ton of consumption which is financed by credit. And much of our economy is made up of “service” type jobs. Does a “service” economy generally have a shorter or longer structure? Do more “service” jobs result as technology progresses? or is it because inflation makes these types of jobs ostensibly profitable?
These are all questions and thoughts I’ve had and if anyone has any insight or references I’d really appreciate it. Thanks.
There are two things that have occurred in this situation. A lot of houses got built and we consumed a lot of consumer goods. Those houses not being filled is problematic and so is the fact that our suppliers have had a difficult time keeping up with the demand and have raised the prices. Well, now the suppliers are building up a surplus because the higher prices have caused conservation. So the market is balancing out the prices as the supply increases.
During this time, though, Asia has been working hard and saving dollars. I just think they might spend them some day and throw a party of their own. Or they may lose trust in the dollar and try to convert their dollars into anything worthwhile in the United States. This will mean we haven’t seen the inflation truly yet. In fact, if you chart our currency with China’s over the last 2 years, they have been pushing down the value of the dollar relative to their currency. It is a consistent and intentional trend. They said their goal is 5 yuan to every dollar in a 5 year period. I don’t know what their plans are then, but they are halfway there.
Theoretically in an isolated economy this would mean the higher prices would force them into a period of time of saving and working hard to rebuild the resources that were spent to dangerous levels during consumption. It may even make for a backward trend in aggregate economic development when the tractor is breaking down while we are trying to save up again to invest in production. It will certainly mean massive unemployment while people in the retail and financial sectors retrain themselves for production jobs.
This paper may help.
By artificially lowering the rate of interest, people are less inclined to save and turn toward higher rates of consumption in proportion to their production. This includes taking consumption loans for some people. At the same time, there are investments at the lower orders of production. The structure of production is accelerated at both of its ends to do things beyond its capability. It cannot expand investment and consumption at the same time. It must shift resources from one to the other.
Both cause inflation. Consumer inflation will in turn drive up interest rates to retain real profit on loans. Thus, attempting to continue artificially low interest rates, so that pinched investors can take new loans to complete projects and start earning revenue requires accelerating, expanding credit, because at the same time, you are pushing savings rates further and further downward, possibly negative. Once there are virtually no real savings, investments are unsustainable. Credit and price inflation become much more closely related in relation to time. Continuing down this road will surely lead to hyperinflation.
Allowing a market correction sees all the resources employed in the early production stages moved towards the consumption side of production. Once production of consumer goods increases and inflation is tamed, interest rates can move down once savings rates increase, and investments can be properly planned and executed.
As for durable goods…I suppose creditors want something to repossess in case of default. I don’t see otherwise why credit wouldn’t be available for general purchases. Credit cards come to mind. I am not sure what you mean by “backed”. Backed by what? Credit cards are backed in the fact that someone might repo your stuff if you fail to pay. As for the balance on credit cards vs. the market value of credit card users’ property, I have no idea.