no third solution

Blogging about liberty, anarchy, economics and politics

Pure Keynesian Nonsense

January 13th, 2009

Probably stumbled across this via Reddit|Economics.

Mosler’s Law states that,

There is no financial crisis so deep that a sufficiently large increase in public spending cannot deal with it.

Surely this is a joke, right?

I mean, it violates Say’s Law of Markets, runs contrary to Public Choice Theory, spits in the face of Hayek’s Knowledge Problem (although from a Macro POV), and completely ignores the destructive, long-run effects of inflation like teh dread Malinvestment.

I’m not sure which of Mosler’s arguments offend me the most: the overwhelming sense of entitlement, that governments justifiably appropriate and redistribute individual savings, or the notion that, in order for individuals to produce, the government must tax them first.

Stay tuned.

Say’s Law of Markets: The Case for Doing “Nothing”

January 9th, 2009

In Prosperity should be increased by stimulating production, not consumption, some commenters at reddit/Economics were confused by the Law of Markets, which was first proposed by French economist Jean Baptiste Say in the early 19th century. It is pretty clear to me that they see “Supply creates its own demand” and immediately try to square that with some backwards Labor theory of value, or they smuggle in the Keynesian “prices are rigid downwards” objection, or some combination of the two. One person even wanted to know why there wasn’t “painful unemployment” during an economic boom.

The rate of employment need not change at all (although it may certainly fluctuate) during a boom. During a boom, scarce resources are reallocated from industries where they were more-or-less optimally employed, towards the production of some other goods/services previously deemed unprofitable, which only appear profitable now in light of the distortions in the price system caused by inflation.

Inflation is the illusion of prosperity, and since it leads necessarily to malinvestment, its necessary consequence is not increased wealth, but eventually increased suffering brought about by the squandering of real goods and services during the boom. Of course, I chided them with lolspeak taunts of “oh noes ur doing it rong”.

In the interest of full disclosure, I should warn you that I am a fan of Say’s Law of Markets. I generally (ummm, always) agree per Mill, that an abundance of goods and services, rather than an abundance of money, which signifies prosperty (cf. here
here.), it is of paramount importance to recognize that such an abundance of goods and services can only arise through production at some historical time, or in other words, that in order to consume, production must first occur.

According to Peter Anderson, in Say’s Law in Context”

If individuals wish to procure a good they must give something in return that is also desirable to individuals. Therefore in order for one to be a consumer one must first be a producer of a good in which others find utility.

Simple enough, right? I’m not entirely convinced that the person posting the item knows fully the implications of the argument, “Prosperity should be increased by stimulating production, not consumption.”

But this is too vague. Intentionally or not, in certain contexts, it is completely wrong. Does the author mean “Production tends to increase where production is stimulated” or does he mean that “The proper way to create prosperity is by stimulating production”? They’re two very different statements. The former is closer to being an economic statement (i.e., without judgment) than the latter, although it could be interpreted in such a manner as to imply that the government should “do things to increase production.” Neither of these positions is a satisfactory treatment of Say’s Law.

The real argument is, “Prosperity increases where production is permitted.” Period.

Anderson says that, “Say’s Law cannot be separated from the Treatise as a whole and still be accurately understood”. I’ve never read Say’s Treatise, but I had some excellent professors in graduate school, who introduced me to these ideas, and taught us well. For that, I’m fortunate. When I allude to Say’s Law, I am not suggesting that the government should do X, Y or Z. I am suggesting that the government should allow, should tolerate, should permit people to produce value. This is the essence of Say’s Law, in context.

All that needs to be done is nothing! Let people produce wealth unimpeded, let them be free in order that they may propser.

Malinvestment: A Primer

December 24th, 2008

I’ve lately been occupied with a theory piece, on the idea of “malinvestment” which is central to the Austrian theory of business cycles. Malinvestment is a fairly complicated phenomenon, and many people have a hard time understanding the concept (i.e., it’s not “over-investment”), if they don’t dismiss it outright.

I’ve broken it into four topics:

I. What is malinvestment? A brief definition of the idea.
II. What causes malinvestment? Explaining what forces in the economy cause malinvestment.
III. How does malinvestment happen? Explaining the process by which malinvestment infects an economy, and is later discovered.
IV. Why does malinvestment cause a “bust”? Explaining why the “boom” phase is (and must be) followed by a “bust”.

The idea of “malinvestment” was put forth by Ludwig von Mises and Friedrich von Hayek. The theory has been refined by Mark Skousen (in his book, The Structure of Production) and Roger Garrison (in an excellent PowerPoint presentation on Sustainable and Unsustainable Growth.)

What follows is the revised version of a draft, titled “On Malinvestment, How? and Why?“, which I posted at forums asking for feedback & criticism. It was fairly well-received by the readers and moderators, alike, but I have taken some time to re-organize and fine-tune it, although I still consider it a work-in-progress, subject to future revision.

I. What is Malinvestment?

A simple, working definition would be something like, “Malinvestment is the systematic allocation of productive factors (i.e., land, labor, capital) towards the production of goods or services for which insufficient demand exists.” It is not “overinvestment“, nor is it “underinvestment.” It may very well be just the right amount, it’s just not allocated appropriately. Malinvestment is at its core an examination of inflation and its effects on the economy:

  1. Inflation causes resources to be allocated towards, and consumed (i.e., destroyed) by the production of goods and/or services that people ultimately don’t want. To the extent that this occurs, it represents a real diminution of material wealth.
  2. Inflation creates an incentive to spend more and invest/save less than that ratio which would be in accord with their true time preference. To the extent that this occurs, values are “realized” or “fulfilled” sooner than would be optimal, this too represents a real sacrifice of (future) well-being.

II. What causes Malinvestment?

Malinvestment occurs when, as Rothbard put it, a central bank has “tampered with the moorings” of the economy, when the price mechanism has been violated by inflation; discouraging investment (which increases our future productivity) and simultaneously encouraging more immediate consumption, inflation destroys an economy from within.

In order to understand the problem, it is necessary to understand that an interest rate is fundamentally an inter-temporal price: present goods in terms of future goods, and also that consumption is not merely the satisfaction of needs, but also as the destruction of previously accumulated wealth; that which is consumed is no longer available to satisfy other needs. In order to optimize the satisfaction of human wants, its necessary for prices to (as accurately as possible) reflect genuine conditions.

The function of price is to provide signals to market participants: when, where, in what quantity, and towards what ends should resources be allocated. These signals are valuable information that market participants use in directing the resources at their disposal, whether they be cash, credit, finished products, works-in-progress, labor, etc. Interference with prices, therefore sends inaccurate signals to investors, entrepreneurs, consumers, borrowers, and lenders. Inflation is an interference with the price system, since it makes available to certain parties more money, and depresses the rate of return on investments/savings.

When new money is introduced, what causes the existing ratio of prices to change, as a result? Someone, somewhere in the economy receives the new money before anyone else, and before the increase in MS is known. This actor then has at his disposal more money than he would otherwise have. Competing for scarce resources with others, who do not have the benefit of this new money, he bids up the prices, and takes them from where, in an unfettered market, they would be more optimally allocated.

Prices just began to rise, and they did not rise uniformly. Everyone else is playing catch-up. Non-institutional investors are always the losers.

III. How does Malinvestment happen?

When new money is introduced, demand appears to have increased, as manifested by higher prices. These prices tell people “make more stuff.” Seeing a higher price being paid for certain goods, it appears that a profit to may be made in that market. Responding to the signal, people begin now to overwork their assets, or perhaps to invest in assets that will enable them to be more productive tomorrow. New money typically manifests itself in two distinct manners:

  1. First, money enters the system through the banks, who create the money ex nihilo and distribute to businesses in the form of loans (debt money), which spend it on higher-order capital goods, lengthening the structure of production. Longer time-horizon projects are more interest-rate sensitive than short-term projects. All else being equal, a lower interest rate (caused by more money in circulation, will encourage production processes that are more roundabout, take longer to complete, etc.
  2. A secondary effect of the new money is demand for consumption goods, is not due to the new money being spent, but rather the new money’s effects on the structure of interest rates. All else being equal, a higher interest rate is an incentive to “save” or “invest”. Iif the rate is forced lower by credit expansion, then marginal lenders/savers are crowded out of the market. It follows that the artificially low interest rates due to inflation cause a diminution in real investment (i.e., deferred consumption), and consumption rises.

Malinvestment occurs because businesses are investing in more capital goods at the same time that consumers (e.g., employees now with higher wages, or businesses with more purchasing power) are demanding more consumption goods. The consumer demand initially appears greater, as evidenced by the higher prices caused by more money competing for the same amount of existing goods/services, which apparently justifies undertaking the new investments in longer, roundabout processes. The only time longer, more roundabout processes ought to be undertaken is when consumption is deferred for the future. Otherwise, what we have is businesses embarking on longer-term projects, even as consumers are spending their money on more immediate consumption.

IV. Why Does Malinvestment Cause a “Bust”

Higher prices being generally reflections of the increased money supply, and not of any fundamental change in consumer preferences (if the latter is the case, the former makes it more difficult to ascertain), inflation is rising prices due to a rising money supply. As new money eventually works its way through the system, people discover that they over-utilized their productive assets yesterday (and therefore can’t produce as much today) or that they invested in assets in an attempt to increase capacity to accommodate a phantom increase in demand.

When these facts are eventually revealed, many investments are shown as unprofitable and must be liquidated, and in either case we are made worse off.

It requires previously accumulated capital (higher order goods, not pure debt obligations) to facilitate the production of more consumer products (lower order goods) without depleting the existing capital stock. In order to have more today, it is imperative to have invested in productivity, made some sacrifice towards that end, yesterday. This process does not work in reverse, so since the consumption fueling the “demand” stimulated by inflation wasn’t matched with a previous investment in productivity, it’s likely to be a net value destroyer; remember that “consumption” is just a polite and roundabout way of saying that something valuable is being destroyed/consumed.

If economic growth is not financed by previously accumulated capital, but instead mortgaged by future productivity, the systemic boom/bust phase to which we are accustomed is a necessary consequence.

no third solution

Blogging about liberty, anarchy, economics and politics