As EconomistInTraining keeps insisting, what “price” is being distorted, and do you have evidence entrepreneurs rely solely on it?
As EconomistInTraining keeps insisting, what “price” is being distorted, and do you have evidence entrepreneurs rely solely on it?
The interest rate entrepreneurs borrow savings at. Whether or not entrepreneurs rely solely on it is irrelevant, but even you agree above that entrepreneurs do in fact rely on it (you agree that at lower rates of interest, entrepreneurs will borrow and invest more).
Indeed. But my case is even stronger than that. Even in a world where everyone accepted ABCT and was fully aware that five of the ten chairs on the other side of the field are probably “fake”, the ten entrepreneurs would have no other choice but to participate in the race. In a world with artificially low interest rates and flush with fake savings ‘not participating’ is tantamount to losing. Everyone is forced to run (take risks) even if they merely wanted to break even.
Z.
Do you have a game-theoretic basis for that conclusion?
For instance, I completely disagree that businessmen would engage in a race toward malinvestments.
Jonathan, you believe one single datum would entirely determine the long-term investments that entrepreneurs make?
z1235,
In a world with artificially low interest rates and flush with fake savings ‘not participating’ is tantamount to losing. Everyone is forced to run (take risks) even if they merely wanted to break even.
Why would an entrepreneur with X amount of accumulated capital lose by not investing, if he knew that the probabily of failing the investment is high? Not participating is not “tantamount to losing”; not participating means maintaining your present wealth.
Anyways, I am off to work. I will respond when I come back in four or so hours.
Jonathan, you believe one single datum would entirely determine the long-term investments that entrepreneurs make?
Neoclassical, please read what you are responding to.
I did!
You and I both agree that lower interest rates can generate more loans and hence more investment; the problem is that such a beginning does not immediately generate abnormally large amounts of irrational forecasts (i.e., malinvestments).
Wait a second: did you just make the same point I’ve been insisting upon? If “he knew that the probability of failing the investment is high,” then why would malinvestments be created?
Prove to me that business’s don’t use credit as a supplement of day-to-day operations and long-term expansion. I have my business CC in my hand right now. wink
Bingo, but more investment(credit) does not magically create new steel, new cows, new tractors, horses, cars, buildings, bricks, oil.
When everyone is taking out more loans, their purchasing power increases dramatically in relation to the existing supply of goods and services.
That’s because you have no idea how a businessman operates/thinks. I don’t need game-theory to reach that conclusion as I experience it in life-practice every day. If I’m oblivious to ABCT and the concept of “malinvestment” (as you portend to be) then the 1% loan is a green light for me to borrow and finally start my singing tong swim-wear line which otherwise would’ve been tough to launch with a 8% loan. If I’m aware of ABCT and malinvestments, I would still borrow (better yet, borrow as much as I could and lock in the 1% rate for as long as I could) and buy gold, land, or a business in anticipation of the inflation that it’s inevitably coming down the road. If you just sit on your hands with your cash “safely” tucked into your pockets, you lose.
So you can stomp with your feet all you want and refuse to participate in the race, but you’ll simply be run over by the rational racers and left in the dust. The amount of racers aware that some of the chairs at the end are fake is irrelevant as this outcome would be inevitable either way.
Z.
Jonathan,
You are thinking in aggregates and neglecting the wealth re-distributional effects of every boom-bust cycle. If 1% loans were freely available to anyone, how would a fixed amount of wealth be re-distributed between the ones that don’t borrow and the ones that do? Assets would be bid up in price so fast (as they have been over the last few decades) that anyone “not investing” or not participating would be left with evaporated purchasing power of their savings (currency).
Z.
Neoclassical,
You and I both agree that lower interest rates can generate more loans and hence more investment; the problem is that such a beginning does not immediately generate abnormally large amounts of irrational forecasts (i.e., malinvestments).
Why not?
Wait a second: did you just make the same point I’ve been insisting upon? If “he knew that the probability of failing the investment is high,” then why would malinvestments be created?
Wait a second: did you just forget about the past ten pages of debate we’ve been having between each other? Unlike z1235, I don’t believe that the entrepreneur can forecast the malinvestment, because of the nature of how the malinvestment is created.
Please, once again, see my main thesis (in relation to this thread) pinned here: Rational Expectations and Austrian Theory.
z12345,
You are thinking in aggregates and neglecting the wealth re-distributional effects of every boom-bust cycle. If 1% loans were freely available to anyone, how would a fixed amount of wealth be re-distributed between the ones that don’t borrow and the ones that do? Assets would be bid up in price so fast (as they have been over the last few decades) that anyone “not investing” or not participating would be left with evaporated purchasing power of their savings (currency).
Before I write my response, I find it ironic that you accuse me of thinking in aggregates, yet your entire thesis relies on the use of aggregates.
Actually (and I think there is sufficien empirical evidence to illustrate the point), general price inflation during the boom era is relatively low. Certaintly, all the non-entrepreneurs in this past thirty-year boom didn’t see their savings “evaporate”.
The entire case behind Austrian business cycle is that inflation will affect some goods relative to others. Therefore, new money will be bidded towards capital-goods, as these are made artificially cheaper by a new price ceiling (this new price ceiling being created by the lesser amount of interest that needs to be discounted from final profits).
So, the “wealth distribution” effect you’re talking about is really not as dramatic as you’d like to think. Furthermore, the areas in which the accumulated capital will be drawn from is not really owned by the investors themselves (indeed, they are the one increasing their demand for accumulated capital), and so with relatively low general price inflation I don’t see why a non-participating entrepreneur would “lose” during the boom period (certainly, my family didn’t, and they didn’t invest in the housing market).
Jonathan,
If you read my other posts in this thread you’ll find that I agree with this. I already criticized Neoclassical for confusing the “intelligence” (knowledge) of the complex adaptive system (economy) with the intelligence (knowledge) of the agents that comprise it. But just for this debate, I wanted to grant him the assumption and to show him that even if all agents were aware that they are in an ABCT boom (clearly impossible assumption) that wouldn’t stop them from participating in it, as every agent believes/hopes that they are the ones that will be able to get to their chair when the music stops before all the chairs are taken. I repeat, this is especially valid for a central bank + FRB system in which most of his empirical evidence is being collected.
You must be writing from another planet then, or using a different thesaurus. The value of $100 from thirty years ago has clearly “evaporated” today. You disdain aggregates yet keep referring to a “general” price inflation. Yes, “general” price inflation over any period can be “made” as low as desired for public consumption by conveniently excluding the assets/goods most affected by the latest sloshes of liquidity (ex-stocks, ex-real estate, ex-energy, ex-…, etc.)
I agree, but I repeat, this neglects the question as to who ultimately pays for the malinvestments. Without a central bank – and I would even say, without fractional reserve banking – everyone pays for their own mistakes (malinvestments). However, with a central bank and FRB, every boom/bust cycle splits the market agents into three groups: (1) non-participant losers, (2) participant losers, and (3) participant winners. Group (1) is clearly worse off after the cycle than it was before it. Group (2) could be worse or better off depending on when and how they got in. An entrepreneur borrowing at 1% to build a singing thong swim-wear factory and placing it as collateral (with no equity of his own) could still build it, sell enough thongs, reap profits for his LLC, and still be better off after going bust when the music stops – leaving the FDIC and FED (hence tax-payer) insured bank holding the bag. Group (3) is clearly better off, as they borrowed, started selling, and got out safely before the music stopped. Which group would a “rationally expectant” agent rather be a part of, and which group ultimately pays both for the malinvestments and the winner’s loot?
Let’s clarify that we’re talking about an economy with a central bank and FRB. I agree that these re-distributional effects would be orders of magnitude smaller or non-existent under a 100% reserve free market system. As for your family, if they’ve been conservatively and prudently been saving their capital (currency) under their mattress (no investments, no exposure to risk) over the last few decades, they’d be wiped off by now. Moreover, why do you think most western governments are up to their ears in debt, and what do you think that debt represents? I claim that this debt represents the accumulated losses of Group (1) that are paying for the malinvestments and wins of Groups (2) and (3). The central bank that created the 1% loans made your family liable for other agent’s losses and wins even if they did not participate in the race themselves.
Z.
z1235,
But just for this debate, I wanted to grant him the assumption and to show him that even if all agents were aware that they are in an ABCT boom (clearly impossible assumption) that wouldn’t stop them from participating in it, as every agent believes/hopes that they are the ones that will be able to get to their chair when the music stops before all the chairs are taken.
Entrepreneurs would still invest, but amount of entrepreneurs willing to invest would most likely decrease. There would be less malinvestment (as the bubble becomes more obvious, less entrepreneurs who are aware of the bubble invest).
You must be writing from another planet then, or using a different thesaurus. The value of $100 from thirty years ago has clearly “evaporated” today. You disdain aggregates yet keep referring to a “general” price inflation.
Between 2002 and present-day, the dollar has lost about 20% of its value. Yes, between 1980 and present-day, the dollar has lost about 70% of its value. First, savings are not static; they are lent out, and you gain interest on them, so the loss in savings is actually lower. Second, retaining a percentage of your total savings is still better than losing the entire value of your savings. Third, not all investment is malinvestment, so there’s no reason that entrepreneurs would simply invest along other lines if they knew that the chance of a profitable investment in another line was low.
Yes, “general” price inflation over any period can be “made” as low as desired for public consumption by conveniently excluding the assets/goods most affected by the latest sloshes of liquidity (ex-stocks, ex-real estate, ex-energy, ex-…, etc.)
If the entrepreneurs are not investment in the assets and capital-goods affected by the bubble, what does it matter? The value of their money relative to the goods they are demanding “erodes” much less.
However, with a central bank and FRB, every boom/bust cycle splits the market agents into three groups: (1) non-participant losers…Group (1) is clearly worse off after the cycle than it was before it
An entrepreneur who enters the general economy in 2002 and doesn’t invest in the housing sectors, and related markets, would not necessarily lose. You are creating a false dichotomy. “Group 1” is only worse off to the extent of the general price inflation (or the inflation of goods that are actually demanded by them; for example, if the price of fabreeze skyrockets, since I don’t necessarily buy fabreeze I don’t really lose), and this discounts rising wages and interest paid on savings. It also discounts those who invest along other lines, and into other capital-goods (in your example, entrepreneurs who decide to invest into something else rather than chairs).
Which group would a “rationally expectant” agent rather be a part of, and which group ultimately pays both for the malinvestments and the winner’s loot?
But the probability of being a winner can be extremely low, in which case the entrepreneur may decide not to risk it. This is true empirically, as the bubble begins to reach its climax. The government, of course, incentivizes continued investment by removing moral hazard, which partly accounts for why the bubble reached to such great extents.
I think the confusion here is that you are talking about investment in general. But, not all investment is malinvestment. Just because you accept a loan with an artificially low rate of interest doesn’t mean that the capital-goods you’re bidding that loan towards are being subject to a bubble. So, you can rationally accept a loan with a very low rate of interest, but if you know a certain sector of capital-goods are extremely scarce and subject to high demand (i.e. the bubble) and you know that probability of reaping profit is relatively low, then it may not be rational to invest along those lines of production.
Let’s clarify that we’re talking about an economy with a central bank and FRB.
This is what I’m talking about, yes.
As for your family, if they’ve been conservatively and prudently been saving their capital (currency) under their mattress (no investments, no exposure to risk) over the last few decades, they’d be wiped off by now.
Then it would be rational to save through another form, or invest along other lines, but it’s not necessarily rational to invest amongst lines that you know the probability of reaping a reward is low.
Moreover, why do you think most western governments are up to their ears in debt, and what do you think that debt represents? I claim that this debt represents the accumulated losses of Group (1) that are paying for the malinvestments and wins of Groups (2) and (3).
First of all, this is entirely unrelated to the discussion. Second of all, “group 1” would only be paying for malinvestment if the costs were socialized by the government (which occurs in some cases, but not in all). In this case, “group 2” and “group 3” would also be paying, as the inflation/taxes affect society as a whole. Third of all, the amount of government debt tends to rise with a drop in productivity, which is why so many Keynesians support stimulus to increase productivity. An increase in productivity would cause the deficit to shrink.
Why Ludwig von Mises is still one of my favorite economists:
It may be that businessmen will in the future react to credit expansion in another manner than they did in the past. It may be that they will avoid using for an expansion of their operations the easy money available, because they will keep in mind the inevitable end of the boom. Some signs forebode such a change. But it is too early to make a positive statement.
Neclassical,
re: Mises quote.
But Mises never rejected the time structure of production, which is key to understanding what is really happening in ABCT. You are looking narrowly at the interest rate and how entrepreneurs may reject taking on new debt due to the threat of the bust.
You ignore the time structure of production, and how signals work within the market.
There is more going on in ABCT than what you are critiquing.
Someone told me there was a bubble discussion taking place…
I really don’t see why this approach is so profound. You truly don’t know what we mean, when we say there was a housing bubble that popped?
It’s one thing to challenge people to come up with a precise definition that captures our intuition; but it’s another to pretend as if we’re dealing with an empty concept, just because we might not be able to give necessary and sufficient conditions. (For an analogy, it’s hard to define exactly what constitutes “furniture,” but most of us wouldn’t say, “I don’t even know what you mean by that term.”)
So: an asset bubble occurs when something’s market price is not supported by the “fundamentals,” and (less obvious) when its speculative price increase is due to incorrect forecasts about future price increases. So for example, if speculators think there is going to be war with Iran next month, and that the spot price of oil will shoot up to $300 / barrel, then they would start buying oil right now like crazy. (They would either buy physical oil and stockpile it, or they would buy futures.)
People who didn’t forecast war would be baffled. They would see that daily production of oil (i.e. how many barrels were pumped and delivered) greatly exceeded daily consumption. Some might say, “Oil is in a bubble.” But then when war broke out, people would say, “Ah, those wily speculators saw this coming. Go markets!”
So there was something similar in housing. Using any measure you want–such as straight-up house prices, or house prices relative to income, or house prices adjusted for rental rates, or house prices adjusted for interest rates and rental rates, etc.–house prices were rising at high levels in the early to mid-2000s. A tell-tale sign that there was a speculative demand–as opposed to a population influx or a simple shift in preferences to live in bigger houses–was that the ratio of owner-occupied units fell during this period. I.e. more and more of the housing stock was owned by landlords, either to rent or to “flip” after the price had (hopefully) risen.
At this stage, a lot of people were calling “Bubble!” This isn’t an ex post claim of victory; in this article I list many Austrians who called the housing bubble while it was in progress.
So it could have turned out that this speculative boom in housing was justified, if (say) the barriers to immigration were lowered and the “fundamental” demand for housing went way up in 2007. But as it was, house prices crashed, and just about everyone (except Eugene Fama) said, “What the heck were we thinking?!”
====
Incidentally folks, just a little plug for the anarchy course that starts up Tuesday night. Details here. If you like to argue, c’mon and join us. Grayson and I will be running several different discussion threads on various topics, ranging from introductory issues to advanced readings.
You know your audience!
Thanks for taking the time to reply to this discussion Bob.