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The problem with ABCT

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aervew Posted: Fri, Jun 8 2012 7:01 PM

 

 
The problem with ABCT and bubbles is, it doesnt explain why LOW ORDER capital industries are often in bubbles.
 
Dotcom bubble: dotcoms are a relatively fast return companies. mostly they dealt directly to consumers, like pet product seller pets.com, amazon.com etc.
tulips: also fast return, give their return in the few months it takes to grow.
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Sure it does.

@1:21

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1999–Winter 2000: The Height of Madness
 
Between 1950 and 1992, the personal savings rate had never gone above 10.9 per cent and never fallen below 7.5 per cent, except in three isolated years. But, between 1992 and 2000, it plummeted from 8.7 per cent to -0.12 per cent. …
[B]y 2000, households’ outstanding debt as a proportion of personal disposable income reached the all-time high of 97 per cent, up from an average of 80 per cent during the second half of the 1980s.
 
During what we will roughly designate as “the boom,” from June 1995 to March 2000, MZM grew 52 percent, well ahead of real GDP growth of 22 percent (Rogers 2002) for the same period. The interest rate on 10-year Treasuries declined from 6.91 percent to 4.53 percent in October 1998, before beginning to rise again. Rates peaked in early 2000, roughly corresponding to the end of the boom. Corporate Aaa bond yields declined from 8.46 percent at the beginning of 1995 to 6.22 percent in at the end of 1998. (All data but Rogers from FRED.)
By late 1999, production of business equipment was up 74 percent and construction up 35 percent over 1992, while production of consumption goods had risen only 18 percent. Among manufacturing goods, durable good production had risen 76 percent while nondurable good production had risen just 13 percent (Federal Reserve 2000). “Annual borrowing by nonfinancial corporations as a percentage of nonfinancial corporate GDP darted from 3.4 per cent in 1994 … to a previously unparalleled 9.9 per cent in the first half of 2000. … As a result, by the first half of 2000, nonfinancial corporate borrowing on an annual basis had more than quadrupled with respect to 1994 and nonfinancial corporate debt as a proportion of nonfinancial corporate GDP had reached 85 per cent, the highest level ever” (Brenner 2002, p. 192).
Even as low interest rates spurred investment in certain capital goods, they led to a collapse in savings. The personal savings rate declined from an already low 2.1 percent (compared to a long-term trend of between 7 percent and 11 percent, as described above) in 1997 to -1.5 percent by 1999 (Bureau of Economic Analysis 1999). Consumers were increasingly leveraged, especially on their homes. “In 1989, about 7 percent of new mortgages had less than a 10 percent down payment, according to Graham Fisher & Co., an investment research firm. By 1999, that was more than 50 percent” (Priest 2001).
 
Spring 2000: The Tide Turns
 
The increase [in apartment rents] from $920 per month in the fall of 1995 to $2,080 in the spring of 2000 squeezed San Franciscans. … The rise in rents presumably reflected an increase in demand for housing, stemming from the influx of wealthy dot-commers. (Huffman 2001)
 
The people needed to staff dot-com companies were also rapidly becoming more expensive. As the boom peaked, Audi (2000) reported: “So many San Francisco lawyers were leaving good jobs in big firms to work for start-up Web companies that to compete, some firms doubled the starting pay to $150,000.”
Kuo (2001, p. 46) tells of how, within weeks of being hired in the summer of 1998, Value America executive Glenda Dorchak demanded, and received, “a lot more stock … a significant raise in pay,” and a promotion.
Covin (2002) noted: “In the late 90s, there was a sudden increase in programmer salaries as a result of the dot-com boom. Programmers who were earning $45,000 in 1995 were making well over $100,000 by the year 2000.”

The Japanese silver mining industry was also expanding at the same time, but without the benefit of the mercury-amalgam process. The Dutch East India Company had a virtual monopoly on trade with Japan and of course access to their precious metals production from 1611 through the end of the century. Del Mar (1969b, pp. 307–8) points out that, "from 1624 to 1853 the Dutch were the only Europeans permitted to trade with Japan," managing "to obtain about one-half of the total exports of the precious metals from Japan." Flynn (1983, pp. 162, 164) indicates that:

American output of bullion, in conjunction with the output of Central European and Japanese mines, increased the world's supply of silver sufficiently to slowly drive its market value downward. That is, there was price inflation in the sixteenth century. American and non-American mines produced such an enormous quantity of silver that its market value dropped to a level below the cost of producing it in a growing number of European mines.

Francis Walker (1968, p. 135) validates this view: "the astonishing production of silver at Potosi began to be felt. From 1570 to 1640 silver sank rapidly. Corn rose from about two oz. of silver the quarter, to six or eight oz."

Walker (1968, p. 135) goes on to quote David Hume:

By the most exact computations that have been formed all over Europe, after making allowance for the alterations in the numerary value, or the denomination, it is found that the prices of all things have risen three, four, times since the discovery of the West Indies.

The table in Figure 1 illustrates this large influx of precious metals into Europe. Bullion flowed from Spain to Amsterdam due to both trade and seizure of treasure.

Further evidence of an exceptionally large increase in the supply of money in the Netherlands is provided by an excerpt from a table of the total mint output of the South Netherlands, 1598–1789, which is displayed in Figure 2. These figures point to the explosive increase in the supply of money from 1630–38, the later part of which tulipmania took place (1634–37).

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I've actually just been asking the same question in this thread. I still haven't been able to figure out where the high/low order relation comes into play.

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I don't know why this is so controversial...

First order goods can be consumed on credit just like higher order capital goods.  Consumption of first order goods is still related to the term structure of interest rates being manipulated.

I don't see a reason why first order goods would be discluded from malinvestment.

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Exactly. The level of credit has the same affect on goods of all orders. But my impression is that the ABCT asserts that low interest rates increase the relative investment in high order goods:

From Wikipedia:

Borrowers, in short, are misled by the bank inflation into believing that the supply of saved funds (the pool of "deferred" funds ready to be invested) is greater than it really is. When the pool of "saved funds" increases, entrepreneurs invest in "longer process of production," i.e., the capital structure is lengthened, especially in the "higher orders", most remote from the consumer. Borrowers take their newly acquired funds and bid up the prices of capital and other producers' goods, which, in the theory, stimulates a shift of investment from consumer goods to capital goods industries.

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The level of credit has the same affect on goods of all orders. But my impression is that the ABCT asserts that low interest rates increase the relative investment in high order goods:

Sure, because it pushes the yield curve to the long end which makes it more affordable to invest in long term investment projects.  Consumables aren't among those. 

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Exactly. The level of credit has the same affect on goods of all orders.

Non sequitur.  Just because credit expansion may have some effect on all orders doesn't mean it has the same effect on all orders.

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Just because credit expansion may have some effect on all orders doesn't mean it has the same effect on all orders.

Or rather I should have phrased it, "The same effect from credit expansion will be the effect that is creating malinvestment in all orders."  You're right the proportion of effect will not be the same.

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Sure, because it pushes the yield curve to the long end which makes it more affordable to invest in long term investment projects.  Consumables aren't among those.

It also makes it more affordable to invest in short-term projects and buy consumables, does it not?

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It also makes it more affordable to invest in short-term projects and buy consumables, does it not?

Yeah.  Although, more credit would be diverted to where it looks the most profitable (artificailly, in the long term).  Low interest rates indicate high savings and this in general would cause people to increase consumption.  You see, it should provide some sort of bottom for consumer spending (when they run out of savings), but when phantom money from the central bank is feeding their credit lines nothing will stop first order goods from being effected by the lower interest rates.

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Aristippus:
Exactly. The level of credit has the same affect on goods of all orders.
Non sequitur.  Just because credit expansion may have some effect on all orders doesn't mean it has the same effect on all orders.

This.

Of course it's been brought up multiple times before...

Why does the interest rate affect higher and lower order goods disproportionately?

Consumers' time preference -- how does it affect interest rates?

 

Also see here.  Particularly here.

 

In the future you might actually learn something about what you're talking about before making claim about "problems" with it.  Or at least ask questions instead of making ignorant accusations.  (or how about just running a search?  I even created an entire post just listing the threads on interest rates.)

 

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For a new and more nuanced take on the ABCT see the underlying arguments in the Structure of Production by Guido Hulsmann. I've only read it once but it's rather interesting.

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Thanks for the links, John.

BTW, does anyone know of a source that compares and contrasts the ABCT with Minsky's Financial Instability Hypothesis? I'd be curious to see a concise list that gives the assumptions underlying each.

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