http://econlog.econlib.org/archives/2010/09/rothbard_on_the.html
His two main points (which I think he stole from me) are:
The best response, so far, comes from andy:
"My main problem with the Austrian theory is that it presumes that businesses are highly myopic. An entrepreneur should be able to tell when the central bank is keeping interest rates too low. In that case, he should not say, "Oh, boy. Let me commit to long-term production based on these low interest rates." Instead, he should say, "I'd better be careful. These interest rates are artificially low." "
There are 2 problems with this objection: * Market price is both 'result' of market forces and 'incentive' to do some things. If government starts influencing the rate, you may know that this signal is wrong. But you do not have a better signal. It's like driving an airplane with totally non-sensical speedometer. The fact that you know that some information is wrong doesn't mean you know the correct information.
* The lower interest rate *means* that money is more available. The whole notion is based on the fact that prices do not change instantly. More money available means that more people have incentive to invest. However, if we assume good investors decide not to invest, the bad investors get the money.
One of the reasons market works is that it directs money from bad investors to the good investors. If the good investors know about the problem, they will refrain from investing - and the money can go to bad investors. If it still doesn't work, the Central bank WILL lower the interest rate further to make them invest.
It's a kind of prisoner dilemma.
"I'm not a fan of Murray Rothbard." -- David D. Friedman
At the interest rate available on the market, there are three types of projects: those that cannot be done at the current rate, those that can be done at the current rate and could be done if money were in a free market, and those that can be done at the current interest rate but cannot have been done if there were free market money. Everyone thinks their particular project is a good idea, that's why they pursue it. Those in the first group have a means to learn the truth. How is the world's smartest businessman supposed to differentiate between the last two? He doesn't know what the market rate would be, so he doesn't know if it would be high enough to knock out his project or not. Clearly, he thinks it's a good idea, and that people want the product.
One cannot assume entrepreneurs are abnormally stupid about low interest rates. - Arnold Kling
But one may assume that abnormally stupid entrepreneurs appear to do exceptionally well for a short time. Moreover, since discerning the natural rate of interest with anything othern than a well-functioning price system is nigh impossible, the longer the distortion persists and the greater profits "stupid" entrepreneurs make, the more people come to believe in the sustainability of their investments. The "smart" entrepreneurs appear to be stupid, as investors hastily turn to others who are offering higher returns. Even in the long run, it is unclear whether the "stupid" entreprenuers actually lose -- isn't the very smartest entrepreneur one who helps drive the boom but exists just before the crash?
Along the lines of Andy's response, when there are price ceilings on milk for instance, you get a shortage of milk. The criticism that Austrian economics assumes entrepreneurs must be stupid seems akin to saying that consumers must be stupid for buying more milk when the price is artificially lowered when they know there's going to be a shortage if they continue to buy as much as they are (assuming they all know basic econ). Like Andy is saying it's a prisoner's dilemma. I might know that in order for there not to be a shortage, we can all only get half a gallon a week, but since the price is artificially low, I have the incentive to buy as much milk as I can because if I don't, someone else will.
David Sherin:Along the lines of Andy's response, when there are price ceilings on milk for instance, you get a shortage of milk. The criticism that Austrian economics assumes entrepreneurs must be stupid seems akin to saying that consumers must be stupid for buying more milk when the price is artificially lowered when they know there's going to be a shortage if they continue to buy as much as they are (assuming they all know basic econ).
I've seen Austrians make this point before, and I still believe the analogy is faulty; this isn't just a simple price control.
Kling's point is made more clear when, in the voice of an irrational entrepreneur, he states, "Oh, boy. Let me commit to long-term production based on these low interest rates."
You purchasing artificially low-priced milk does create a shortage; however, artificially low interest rates, according to Austrians, creates a surplus of long-term production. Kling is asking a more pointed question: why would entrepreneurs invest in long-term production specifically if such investments were predictably doomed?
Because it's not guaranteed that all investments made during the period of a credit boom will be malinvestments? How many times do we have to revisit this topic?
Jonathan M. F. Catalán: Because it's not guaranteed that all investments made during the period of a credit boom will be malinvestments? How many times do we have to revisit this topic?
I think the better way to put it is that not all investments will prove unprofitable to everyone, certainly in the short term, but also for some in the long term.
Considering the opportunity costs involved in redirecting the structure of production onto a path that is not aligned with consumer preferences, I would avoid stating that since some investments do prove profitable (in the short term or long term), that not all are malivestments.
One important point that strangLoop is still not grasping is the non-neutrality of money in the long run. This prevents him from seeing that not all that has been done as a result of the boom will just have to go away into liquidation. The structure has been altered forever.
You're right. It should have been phrased: not all investment will result in a loss.
The "entrepreneurs aren't stupid" argument is, well, stupid. Businesses can't afford to wait around for rates to change before they can make an investment. Opportunities do not wait for Ben Bernanke to raise rates, sometimes you have to embark an a project NOW and that means acquiring financing at current levels. If you aren't growing, you aren't making money. Especially in an inflationary environment.
At any rate the whole argument is settled by the fact that if rates do rise the whole inverted pyramid of debt unwinds bigtime. We can even deduce a priori that interest rates would be higher than they are now if decided by market forces.
Moreover, the (up until recently) correlation between the stock market and the AUD/JPY carry trade is the purest example of ABCT I have seen in my short career as a market observer. Short JPY, buy AUD, buy stock. Pure interest-rate arbitrage, the trade doesn't even work unless the Yen is depreciating ie: the interest rates are low.
Jonathan M. F. Catalán:You're right. It should have been phrased: not all investment will result in a loss.
Conceivably, then, couldn't lower interest rates produce zero malinvestments? That is, would it be logically possible that all investments selected did not eventually result in a loss? Is that simply unlikely or strictly impossible?
"Kling is asking a more pointed question: why would entrepreneurs invest in long-term production specifically if such investments were predictably doomed?"
<= Because there is no such thing as a clear and cut sign that points and says 'this is a long-term production process that won't be profitable as soon as the interest rate goes up again'. Nor is there any way of making such a sign. That's why.
The idea is very simple: even given 'correct' prices, new and long term production processes are more risky than short term and not new production processes. If you give wrong inputs, it's only logical you'll expect more mistakes; not necessarily because of the 'long term', but maybe because of the higher risks.
The state is not the enemy. The idea of the state is.
"Conceivably, then, couldn't lower interest rates produce zero malinvestments? That is, would it be logically possible that all investments selected did not eventually result in a loss? Is that simply unlikely or strictly impossible"
That's like saying: 'what if we gave a class of students the wrong 'x = a random number'. It's logically conceivable they still have the right solution - because all made mistakes _given_ the information they had. Just not very likely.
Yup. I just realized that ABCT, even if true, doesn't necessarily lead to malinvestments, so I thought that was neat. (Unless both you and I are mistaken.)
What an embarassing post from Kling. It is sad that I as a layman can spot gaping holes in his argument in under 45 seconds.
Or maybe I am more awesome than I give myself credit for!
EDIT: Ha! Peter Klein crushes it out of the park in the comments.