Some thoughts on the Austrian business cycle

Austrians see no problem with speculation-driven expansion of capital, assuming the increase in capital leads to more overall investment overall, meaning greater production.

But you believe government-driven expansion of capital (through the Fed and Fractional Reserve banking) leads to malinvestment and thus, the business cycle.

This seems contradictory, doesn't it? In both cases, investors aren't investing because they think their investments are worthwhile. They're investing either because:

a) They have more money

or

b) They think "the other guys" are going to copy his investment strategy, leading to a snowball effect that drives up the value of the investment

To be consistent, you'd have to believe either both forms of capital expansion lead to malinvestment or both forms of capital expansion don't lead to malinvestment. I strongly suspect the latter, based upon the fact that I've heard Forbes magazine used to run a fund in which they tossed a dart at a newspaper and randomly invested in the stock the dart landed on, and the fund was still surprisingly profitable.

 If random investment in stock is profitable, then I can't see how ANY expansion in capital could cause a rise in overall malinvestment.

Nathyn:

Austrians see no problem with speculation-driven expansion of capital, assuming the increase in capital leads to more overall investment overall, meaning greater production.

But you believe government-driven expansion of capital (through the Fed and Fractional Reserve banking) leads to malinvestment and thus, the business cycle.

This seems contradictory, doesn't it? In both cases, investors aren't investing because they think their investments are worthwhile.

I disagree with your assessment of the investment motive.  Investor will not invest their capital because "they have more money".  They invest because they think that they will profit.  The fact that they have more money allows them to invest more.  This is not creating money, except to the extent that there may be margin.  The money circulating in the market is the transfering of existing funds among investors first of all, and secondly it doesn't get into the public easily as investors generally re-invest profits. 

There is some snowball effect but overall this levels out and makes no long term difference at all in the long run advance in stock prices.  Stock is just another asset to be bought and sold.  The vast majority of funds in the market do not make it out of the market into the economy anyway, so the bubbles in the market, spectulative or not, are a symptom of a rise in M, not a cause.

 Governments cannot expand capital. Only saving can achieve that. What governments expand are claims to capital, which inevitably must correct back to the actual supply of capital.

Nathyn:

 In a commodity based, non inflationary system, speculators would only fulfil their natural function of hurrying the market to equilibrium.  It is only the unlimited credit provided to the speculators by the expansionary monetary system that allows speculators to function in the current destructive manner.  The current speculators are only taking advantage of the largesse provided by the Federal Reserve.  Ultimately, the Federal Reserve is SOLELY responsible for the situation.  Revert to a commodity based, 100% reserve banking system, and speculation will revert to its natural and proper function.

Stranger:

 Governments cannot expand capital. Only saving can achieve that. What governments expand are claims to capital, which inevitably must correct back to the actual supply of capital.

 

Quite right.  I should have said "funds".  (In reality: Federal Reserve Accounting Unit DeviceS")

Nathyn:

Austrians see no problem with speculation-driven expansion of capital

Hold on there... You know someone is biased when they speak for all of a particular group.

  

Nathyn:

assuming the increase in capital leads to more overall investment overall, meaning greater production.

This is a wildly loaded statement.

"Assuming the increase in capital."

 Who says capital increases? What makes capital increase? What is capital?

"Leads to more overall investment meaning greater production."

Where is this apart of ABCT?

 

Nathyn:

But you believe government-driven expansion of capital (through the Fed and Fractional Reserve banking) leads to malinvestment and thus, the business cycle.

What?!?

Capital is not expanded through the fed.

Liquidity/Dollars are expanded through the Fed, which the Fed loans out or gives away on frivolous projects that drain the real pool of capital.

First understand what Austrians mean by capital, then come back, or better yet, go to class and slap your idiot professor in the face a few times.

 

Nathyn:

This seems contradictory, doesn't it? In both cases, investors aren't investing because they think their investments are worthwhile. They're investing either because:

a) They have more money

When do private investors just invest because, "they have more money?"

That's not investment, buddy, that's charity.

Nathyn:

b) They think "the other guys" are going to copy his investment strategy, leading to a snowball effect that drives up the value of the investment

Never happens ending in an economy wide bust. You're not addressing one of Rothbard's requirements to be talking about business cycles. Why do economies as a WHOLE faulter? Not, why does one guy invest heavily in stock, just to pull out after tricking others to pump up the price a little more.

 

Also, take a book from your precious Neoclassicals; Rational expectations.  

Nathyn:

To be consistent

First you need to be consistent.

Nathyn:

you'd have to believe either both forms of capital expansion lead to malinvestment or both forms of capital expansion don't lead to malinvestment. I strongly suspect the latter, based upon the fact that I've heard Forbes magazine used to run a fund in which they tossed a dart at a newspaper and randomly invested in the stock the dart landed on, and the fund was still surprisingly profitable.

 If random investment in stock is profitable, then I can't see how ANY expansion in capital could cause a rise in overall malinvestment.

 

 

Because it isn't a rise in capital.

Nathyn... You wouldn't by chance be receiving your education in a state financed school... Would you? 

Correction: It was the Wallstreet Journal, I believe. Not Forbes.

Also, in this thread I'd like to simply discuss analytical economics, not get distracted by normative economics. politics, or Libertarian philosophy.

If you respond, please respond in large blocks, not quoting me roughly a few sentences at a time, because it makes it very tedious to respond to, to dig through the maze of quotes.

And no personal attacks.

Donald Lingerfelt:

Nathyn:

Austrians see no problem with speculation-driven expansion of capital, assuming the increase in capital leads to more overall investment overall, meaning greater production.

But you believe government-driven expansion of capital (through the Fed and Fractional Reserve banking) leads to malinvestment and thus, the business cycle.

This seems contradictory, doesn't it? In both cases, investors aren't investing because they think their investments are worthwhile.

I disagree with your assessment of the investment motive.  Investor will not invest their capital because "they have more money".  They invest because they think that they will profit.  The fact that they have more money allows them to invest more.  This is not creating money, except to the extent that there may be margin.  The money circulating in the market is the transfering of existing funds among investors first of all, and secondly it doesn't get into the public easily as investors generally re-invest profits.

There is some snowball effect but overall this levels out and makes no long term difference at all in the long run advance in stock prices.  Stock is just another asset to be bought and sold.  The vast majority of funds in the market do not make it out of the market into the economy anyway, so the bubbles in the market, spectulative or not, are a symptom of a rise in M, not a cause.

When I said, "because they have more money," I was speaking about investors as a whole, not individual investors, based upon the marginal propensity to consume\save. Of course, individual investors will only invest if it's profitable when given more money, but investors as a whole will increase investment if they're just simply given more money because for every dollar anyone is given, they will save more and spend less.

Just so I make sure I'm understanding you, you say that an increase in capital by raising interest rates is only a marginal increase, because when investors put the additional money into investments, they simply get an increased return equal to the marginal increase in the money supply. Correct?

If this is true, I don't understand how there can be an increase in malinvestment. If investors are given more money (even if it's just a marginal increase) and they're investing for profit, where's the malinvestment? It's the malinvestment which causes the short-run fall in production and rise in unemployment associated with a recession, right?

What you say suggests that at any given point in time there is a fixed demand for capital, the same as with goods and labor on a microeconomic scale. And so you treat the financial market like the goods and labor markets. I.E., if the government tried to raise or lower the price of apples, there'd be either a shortage or a wasted surplus. And if the government had either a minimum or maximum wage for labor, there'd be higher unemployment, either way, but for different reasons.

But with capital, how can there be a "wasted surplus"? Because we aren't all employed, we all have limitless desires, and we aren't in a technological utopia, the potential for increased investment to increase production seems limitless.

"It's not a real increase in investment!" is not a rebuttal to this, because whether or not it's a real or marginal increase depends on whether or not central bank-driven expansion of capital leads to increased production, and thus a real return investors, and a real increase in the money supply.

Nathyn:

If this is true, I don't understand how there can be an increase in malinvestment. If investors are given more money (even if it's just a marginal increase) and they're investing for profit, where's the malinvestment? It's the malinvestment which causes the short-run fall in production and rise in unemployment associated with a recession, right?

[...] 

"It's not a real increase in investment!" is not a rebuttal to this, because whether or not it's a real or marginal increase depends on whether or not central bank-driven expansion of capital leads to increased production, and thus a real return investors, and a real increase in the money supply.

 

You do not understand the difference between capital, capital goods and finance.

All that the government can do is counterfeit claims to capital, which results in investors initiating production on more capital goods than there is actual capital to complete. 

 

Stranger:

Nathyn:

If this is true, I don't understand how there can be an increase in malinvestment. If investors are given more money (even if it's just a marginal increase) and they're investing for profit, where's the malinvestment? It's the malinvestment which causes the short-run fall in production and rise in unemployment associated with a recession, right?

[...]

"It's not a real increase in investment!" is not a rebuttal to this, because whether or not it's a real or marginal increase depends on whether or not central bank-driven expansion of capital leads to increased production, and thus a real return investors, and a real increase in the money supply.

You do not understand the difference between capital, capital goods and finance.

Of course I do. What a horrible accusation to make!

Capital is any wealth used in production. Capital goods are actual goods used in production, like machines. Finance (often called "investment capital") is capital in monetary form.

Nathyn:

Of course I do. What a horrible accusation to make!

Capital is any wealth used in production. Capital goods are actual goods used in production, like machines. Finance (often called "investment capital") is capital in monetary form.

 

From these definitions, how does it follow that government or speculators expand capital? 

Nathyn:

If investors are given more money (even if it's just a marginal increase) and they're investing for profit, where's the malinvestment?

According To ABCT, if the money supply is increased,  interest rates will fall below the natural rate of  interest, which is set by the consumer's time preference. This induces greater investment in the higher orders of production (think enterprises with projects which will take a long time to come to fruition) than would otherwise be the case. Addidtionally, it induces the consumer to consume more. You therefore have a combination of malinvestment in early stage goods and overconsumption. This boom can only be sustained by ever increasing injections of money. Eventually it leads to a bust, which is the market's answer to correcting the malinvestment that occurred during the boom.

  I think the malinvestment label applies to the unsustainable booms created by the central bank's loose monetary stance.  Sure the banker's motive is profit and the central bank only wanted to avoid a recession following the 9/11 attacks.   So Greenspan inflated bank reserves and a lot of this new bank credit went to the housing sector, creating new jobs.  Speculators motive is also profit and the easy credit from the bank's allowed them to bid up the prices of homes.   But all these jobs will be liquidated because the boom will eventually turn into a bust once the very same central bank tightens the money spigot, this time to reverse the effect of their last monetary stance.

 

   

The whole episode begins and ends with the central bank's monetary policy. 

 

 

 

 

Stranger:

All that the government can do is counterfeit claims to capital, which results in investors initiating production on more capital goods than there is actual capital to complete.

You're invoking Say's law, right?

You argue the government cannot increase production through increasing aggregate demand, because it is the market which determines the supply of available capital. And so any increase in aggregate demand will simply result in a general disequilibrium that's only corrected through a decline in production.

This is true in the case of capital goods. If the government were to set a price ceiling or floor on any given capital good (such as aluminum bolts), there would end up being a shortage or wasted surplus, just as with any other good.

This is not necessarily true in the case of investment capital, however. Let us assume that in the absence of regulation, banks are naturally full-reserve (a reasonable assumption, right?). Under full reserve banking, every dollar represents a claim on some tangible asset. But the reverse is not true. There are many valuable assets which are not captured by the monetary system. If the dollar is pegged to the value of gold, every dollar represents a claim on some tangible amount of gold. Any non-gold assets are not represented by the monetary system at all, creating a limitation on the available amount of capital.

When fractional reserve banking is established, dollars can be issued proportionally up to and (unfortunately) even over the value of all tangible assets in the economy. Moderate increases in the money supply should therefore be real increases, because they represent real assets -- both gold tangible assets and non-gold tangible assets. It is only when the money supply is increased above the value of all tangible assets that the increase is strictly marginal, not when the money supply is increased above the value of all tangible gold assets or whatever backing it is you use.

Stranger:

Nathyn:

Of course I do. What a horrible accusation to make!

Capital is any wealth used in production. Capital goods are actual goods used in production, like machines. Finance (often called "investment capital") is capital in monetary form.

From these definitions, how does it follow that government or speculators expand capital?

See my remarks above and below in this post.

Regarding speculation, I'm starting to suspect that there is no expansion, because any money they withdraw from bank accounts to spend on stocks doesn't increase the money supply. In fact, it decreases M1 and M2.

leonidia:

Nathyn:

If investors are given more money (even if it's just a marginal increase) and they're investing for profit, where's the malinvestment?

According To ABCT, if the money supply is increased,  interest rates will fall below the natural rate of  interest, which is set by the consumer's time preference. This induces greater investment in the higher orders of production (think enterprises with projects which will take a long time to come to fruition) than would otherwise be the case. Addidtionally, it induces the consumer to consume more. You therefore have a combination of malinvestment in early stage goods and overconsumption. This boom can only be sustained by ever increasing injections of money. Eventually it leads to a bust, which is the market's answer to correcting the malinvestment that occurred during the boom.

Why should a fall in the interest rate increase mostly the rate of investment in long-term projects? Does that mean that a rise in the interest-rate, above the natural rate, should increase mostly the rate of investment in short-term projects? Also, if this boom-and-bust is a cycle that regularly occurs, it seems to me that investors should anticipate that and thus avoid losing money in failed long-term projects by investing in mostly short-term projects.

Furthermore, if the interest rate goes up, I should think that would cause consumers to save more, not consume more. Because if interest rates on savings go up (obviously) and the prices of consumer goods don't change, as the production of consumer goods is a short-term project and you said above that that a nominal increase in the money supply would cause an increase in investment of mostly long-term projects.

Nathyn:

Why should a fall in the interest rate increase mostly the rate of investment in long-term projects?

Absent monetary inflation, a lower interest rate signifies that consumers are more prepared to forgo consumption now for greater consumption in the future. They have a lower time preference.  It sends a signal to investors that projects which would previously have been unprofitable because they would have taken too long to come to fruition, can now be undertaken profitably.  The lower interest rate lowers price differentials, flattening the structure of production and extending it further towards higher (earlier) stages. Prices thus rise in the earlier stages, shifting resources to this area.  Artificially lowering interest rates does the same thing, but without the consumer's time preference having changed and without a concomitant reduction of consumption, the seeds are sown for an eventual bust. 

Nathyn:

Does that mean that a rise in the interest-rate, above the natural rate, should increase mostly the rate of investment in short-term projects?

Whether it occurs as a result of increased time preference, monetary deflation caused by a credit contraction, or central bank monetary policy, a rise in interest rates shifts resources away from the earlier stages to later stages. 

Nathyn:

Also, if this boom-and-bust is a cycle that regularly occurs, it seems to me that investors should anticipate that and thus avoid losing money in failed long-term projects by investing in mostly short-term projects.

No one can predict with certainty when the bust will come since the timing of the bust is dependent on so many variables, not the least of which is central bank policy. If higher prices and greater profits can be made in the earlier stages it is inevitable that investors will shift resources to these areas. To the extent that business cycles are predictable, the best entrepreneurs will exit immediately before the bust occurs.

Nathyn:

Of course I do. What a horrible accusation to make!

Capital is any wealth used in production. Capital goods are actual goods used in production, like machines. Finance (often called "investment capital") is capital in monetary form.

 

 

NO NO NO NO NO NO! 

Monetary "capital" is a representative of real capital, or as Frank Shostak and I put it, real pool of fundings.

Credit expansion by the banking sector - i.e. inflation in the money supply - represents no real capital gain, it merely injects unbacked dollars into the economy. What is the effect of this? The money created from nothing sets in motion a trading of  nothing for something, that is it diminishes the real pool of funding or the capital used in production away from backed credit, and into unbacked finances.

Nathyn: This is not necessarily true in the case of investment capital, however. Let us assume that in the absence of regulation, banks are naturally full-reserve (a reasonable assumption, right?). Under full reserve banking, every dollar represents a claim on some tangible asset. But the reverse is not true. There are many valuable assets which are not captured by the monetary system. If the dollar is pegged to the value of gold, every dollar represents a claim on some tangible amount of gold. Any non-gold assets are not represented by the monetary system at all, creating a limitation on the available amount of capital.

 

Sigh. You misunderstand what one means when one says, "backed credit."

The situation has little to nothing to do with gold as a tangible object, it has to do with the real stock of capital at the time of the increase in the money supply.

 
As an aside: Every dollar does not represent a claim to a tangible asset, every dollar represents a potential claim to a tangible asset. Dollars created from nothing may represent a potential claim, but it does not mean that dollars change the actual stock of wealth within the economy, though they may appear to from the effect they have on the interest rates.

The central bank increases the money supply, the increase in the money supply is an increase from nothing, that increase from nothing now distorts the interest rate away from actual capital goods in the economy. The increase in the stock of money distorts the economy because it was created from a printing press, not from an increase in the stock of wealth.

 

If the stock of wealth perpetuates and represents real and sustainable growth, and fiat currency represents a distortion in the real wealth available for production, then the increase in fiat currency will distort the growth expected and thus the growth obtained.

 Fiat currency represents a distortion in real wealth because it originates from lenders who then distort interest rates. With artificially low interest rates, producers and other investors are fooled into  believing the economy possesses a higher stock of real wealth than it really does - because the newly created currency does not actually increase the real stock of wealth, but due to the appearance of real wealth creation from lower interest rates the indicators skew expectations - and so invest in otherwise unprofitable projects. 

Nathyn:

If this is true, I don't understand how there can be an increase in malinvestment. If investors are given more money (even if it's just a marginal increase) and they're investing for profit, where's the malinvestment?

Who is "given" more money? No one other than those the Fed give money directly to - a different topic of discussion.

There are several different ways to increase the stock of money, some of which are connected with eachother, but let us assume that the method used is  an artificial decrease in the credit supply by increases in the stock of money.

What does the interest rate appear to indicate to investors and entrepreneurs? The ratio between preferences for future goods to present goods. Through the course of decreasing the interest rate, ceteris paribus, the indicator for the production of future goods to present goods are significantly distorted out of their actual form.

Entrepreneurs basing their decisions off of available indicators, they are deceived into investing too heavily in one form of good when really it is the other good that deserves the attention.

Nathyn:

It's the malinvestment which causes the short-run fall in production and rise in unemployment associated with a recession, right?

What you say suggests that at any given point in time there is a fixed demand for capital, the same as with goods and labor on a microeconomic scale.

Not really. Merely an aggregate preference for present goods over future goods - consumer goods over capital goods.

Nathyn:

And so you treat the financial market like the goods and labor markets. I.E., if the government tried to raise or lower the price of apples, there'd be either a shortage or a wasted surplus. And if the government had either a minimum or maximum wage for labor, there'd be higher unemployment, either way, but for different reasons.

But with capital, how can there be a "wasted surplus"?

You're making the same mistakes Kruggsy made when he critiqued ABCT - amateurly as always.

 The question isn't about aggregate surplus or hangover theory, it's about specific malinvestments and aggregate manipulation. 

 

Nathyn:

"It's not a real increase in investment!" is not a rebuttal to this, because whether or not it's a real or marginal increase depends on whether or not central bank-driven expansion of capital leads to increased production, and thus a real return investors, and a real increase in the money supply.

 

I don't believe he was referencing "marginal," he was referencing unbacked.

Real wealth = Wealth in existence

Marginal wealth = Wealth by subjective preference (Is it even possible?)

Nominal wealth = Wealth given by the set amount of Dollars, Euros, Pounds, etc. 

Nathyn,

You obviously haven't read a lot concerning the ABCT.  There is a lot of information in this site on it.  I recommend all the lectures by Garrison especially, and the on line book "Prices and Production" by Hayek. 

Nathyn:

When fractional reserve banking is established, dollars can be issued proportionally up to and (unfortunately) even over the value of all tangible assets in the economy. Moderate increases in the money supply should therefore be real increases, because they represent real assets -- both gold tangible assets and non-gold tangible assets. It is only when the money supply is increased above the value of all tangible assets that the increase is strictly marginal, not when the money supply is increased above the value of all tangible gold assets or whatever backing it is you use.

The government cannot increase the quantity or capital by printing currency.  Currency is only a claim on capital, not the capital itself.  This is why more currency in circulation causes prices to rise: there are more claims to goods than there are goods tobe purchased.  To confuse capital goods with currency is a major error. 

Nathyn:

Why should a fall in the interest rate increase mostly the rate of investment in long-term projects? Does that mean that a rise in the interest-rate, above the natural rate, should increase mostly the rate of investment in short-term projects? Also, if this boom-and-bust is a cycle that regularly occurs, it seems to me that investors should anticipate that and thus avoid losing money in failed long-term projects by investing in mostly short-term projects.

Nathyn:

Regarding speculation, I'm starting to suspect that there is no expansion, because any money they withdraw from bank accounts to spend on stocks doesn't increase the money supply. In fact, it decreases M1 and M2.

Speculation does not decrease M1 or M2.  The currency deposited with a brokerage is still in circulation.  As with all investments, the buying power  is just transferred to others.  If the issuer/seller is selling to raise money for a project, then he spends it on that.  If he sells to be able to invest in a different instrument, then the recipient of those funds may use it for some purpose not unlike the origional seller.  Someone uses it to consume.

Nathyn:

Why should a fall in the interest rate increase mostly the rate of investment in long-term projects? Does that mean that a rise in the interest-rate, above the natural rate, should increase mostly the rate of investment in short-term projects? Also, if this boom-and-bust is a cycle that regularly occurs, it seems to me that investors should anticipate that and thus avoid losing money in failed long-term projects by investing in mostly short-term projects.

 

According to the ABCT, malinvestment occurs in the higher orders of producer goods because that is where the profit is.  Hayek called this more "round about production" meaning that since capital intensive goods are cheaper with lower interest rates, more profit can be had utilizing more capital intensive production methods.  Thus mining, tools, etc. are more profitable than labor intensive orders.  This reduces the cost of production overall, and expands the quantity of consumer goods.  Consumers are buying these goods because they have a reduced incentive to save, and there is less unemployment.  Eventually the extra money hits the street and causes price inflation, giving incentive for the central bank to raise interest rates.  This causes the inivetable bust.

You are correct about short term projects being where the money goes when interest rates rise above the natural rate.  Capital goods are now too expensive relative to labor, so money flows out from capital intensive to labor intensive stages of production, closer to final consumer goods.

Investors do anticipate the bust, the problem is that no one can predict when it will happen exactly.  There are always those that can better anticipate it than others and these are the better entrapeneurs that make the money lost by the losers.  The market collapse is caused by a majority of investors that all simultaneously decide to sell into the bust, so the collapse in the market is an investor driven event not really an economic one.  The economic bust is a correction of the malinvestment in production, where resources are transferred from higher orders of production to lower (read 'unemployment').  This causes  a rapid decrease in velocity of exchange and saving/regrouping. 

As to my previous explanation of velocity: I know Rothbard's opinion and to some extent I must agree with his assessment.  However, the formula for the price level is merely a tool to aid in the understanding of the events, not a realistic method of analysis.  It cannot be used to predict anything, as there is no way to quantify these variables.  Even using the AMS, the best that can be discovered is V at time intervals in the past.  I did not mean to imply anything else than that.

nathan states:

"if the government had either a minimum or maximum wage for labor, there'd be higher unemployment, either way, but for different reasons"

 this is only half right.  if the government sets a minimum wage above the market clearing price, a surplus of labour will result (unemployment).  the converse is true if there is a maximum rate imposed by the government below the market clearing rate, that is a shortage of labour will result as people withdraw their services.  

I'll respond in full, later. But for now, there's a few points I can quickly address.

Niccolò:

Nathyn:

Of course I do. What a horrible accusation to make!

Capital is any wealth used in production. Capital goods are actual goods used in production, like machines. Finance (often called "investment capital") is capital in monetary form.

 

NO NO NO NO NO NO!  Super Angry

Monetary "capital" is a representative of real capital, or as Frank Shostak and I put it, real pool of fundings.

I agree with you. When I said, "investment capital is capital in monetary form," I meant what you just said, that, except in specific circumstances(hyperinflation caused by the government printing money wildly, government tampering with the convertibility of gold, or full-reserve banks engaging in fraud), investment capital under both full and fractional reserve are bank notes which represent the value of claims on physical capital.

 

newson:

nathan states:

"if the government had either a minimum or maximum wage for labor, there'd be higher unemployment, either way, but for different reasons"

 this is only half right.  if the government sets a minimum wage above the market clearing price, a surplus of labour will result (unemployment).  the converse is true if there is a maximum rate imposed by the government below the market clearing rate, that is a shortage of labour will result as people withdraw their services.  

Yes. that's what I meant. A low minimum wage won't increase unemployment.

Donald Lingerfelt:

As to my previous explanation of velocity: I know Rothbard's opinion and to some extent I must agree with his assessment.  However, the formula for the price level is merely a tool to aid in the understanding of the events, not a realistic method of analysis.  It cannot be used to predict anything, as there is no way to quantify these variables.  Even using the AMS, the best that can be discovered is V at time intervals in the past.  I did not mean to imply anything else than that.

However, in two other posts in a different thread, you stated:

Donald Lingerfelt:

Velocity is a valid reason for price inflation and one of the problems with artifically low interest rates.

and

Donald Lingerfelt:

The velocity of exchange is the turover rate of currency.  If currency moves faster through society, this in itself will cause price inflation, even though the quantity of currency remains the same. Demand increases causing prices to rise.

But even if you accept the "equation of exchange" MV=PQ as valid (which I don't because P is indefinable), there is nothing here which tells you anything useful. If M is constant and V increases, it doesn't follow that P increases.  If two people live on a desert island, they can exchange the same goods every five seconds all day long, but the price of those goods doesn't have to change; all that changes in that case is Q. And what does that tell us? That the faster goods change hands, the more goods are exchanged!  So if the quantity of currency moves faster through society, this does not in itself cause price inflation. 

At best the equation of exchange is a trivial truism, but more often than not it is simply misleading.

Nathyn:

I agree with you. When I said, "investment capital is capital in monetary form," I meant what you just said, that, except in specific circumstances(hyperinflation caused by the government printing money wildly, government tampering with the convertibility of gold, or full-reserve banks engaging in fraud), investment capital under both full and fractional reserve are bank notes which represent the value of claims on physical capital.

 

 
They represent capital, and when the stock of capital is unchanged while interest rates decrease artificially without an equal change in time preference malinvestments occur. 

Nathyn:

But you believe government-driven expansion of capital (through the Fed and Fractional Reserve banking) leads to malinvestment and thus, the business cycle.

 

 

You miss the point.

The Fed pegs the interest rate below the market rate,  this makes demand for savings greater than the actual amount of savings. Simple economics tells us this will create a shortage, so to overcome this the Fed prints the difference.

Money has to enter the economy at certain points(its first transaction). If money enters the economy predominately at one point, as it does in the US, inflation is felt in these markets sooner than the rest of the economy. This creates inaccurate rates of changes which lead to a misallocation of resources, if the rate of money creation slows down the misallocations are exposed.

Aside from your attacks on me for being ignorant of Austrianism, it turns out that I've actually been misunderstanding some Keynesian concepts too (I suspect others here have as well), possibly even throwing in some Monetarism, because that's what I've been taught.

Before I go any further, I plan to read:General Theory of Employment, Interest and Money by John Maynard Keynes, What Has Government Done to Our Money? by Murray Rothbard, and Monetary History of the United States 1867-1960 by Milton Friedman, so that I can grasp the basic arguments of each side.

 You might as well add Garisson's Time and Money to your list, where he sketches out a comparison between the competing views and fleshes out the Austrian capital-based macroeconomic view.

Inquisitor:

 You might as well add Garisson's Time and Money to your list, where he sketches out a comparison between the competing views and fleshes out the Austrian capital-based macroeconomic view.

 

Hmm. I didn't know Austrians had macroeconomic theories. I thought they saw the macro\micro distinction as unjustifiable because of their methodological individualism?

If praxeology dictates that the only economic assertions that can be made must be made about individuals, how can you have separate macro and microeconomic theories? After all, I thought that macroeconomics was born from the empirical observation that individual behavior on a small scale is very different from individual behavior on a large scale.

Austrians see no problem with speculation-driven expansion of capital, assuming the increase in capital leads to more overall investment overall, meaning greater production.

One sentence in and you are already incorrect.  Austrian economists qua economists do not make moral judgements, so in this sense, they do not see a problem with speculation-driven capital expansion.  However, neither do they support it.  As Mises said, the most important thing an economist can do is tell the government what it cannot do.  Austrians seek to understand and explain economic behavior.  Of course, each Austrian probably has an opinion on something, but inasmuch as he opines on subjective topics he is going outside the bounds of economics.

 Another inaccuracy in your post is implying that an increase in capital will lead to more overall investment.  In fact, things work precisely in the reverse.  Capital is increased because people invest in it, not the other way around.

 And finally, Austrians, assuming they set aside their economic objectivity, can certainly see a problem with expansion of capital.  If it is capital expanded because free market signals indicated it was a sound investment, then we see it as a good thing.  If it is capital expansion caused by misleading price signals, then it is a bad thing.

But you believe government-driven expansion of capital (through the Fed and Fractional Reserve banking) leads to malinvestment and thus, the business cycle.

Good enough.

This seems contradictory, doesn't it?

With the first sentence revealed as misleading, we no longer are bothered by this conclusion.

In both cases, investors aren't investing because they think their investments are worthwhile. They're investing either because:

a) They have more money

or

b) They think "the other guys" are going to copy his investment strategy, leading to a snowball effect that drives up the value of the investment

I'll be perfectly honest: I don't know how you arrived at this point.  At any rate, investors invest because they expect to make a profit in the future.  The discounted value of the future goods they can buy with the profits they expect to earn is worth more than the next item they would buy today.

Of course, some investors probably invest because for them it is a fun game to see how much money they can make.  In this case, investing itself becomes a consumer good.

To be consistent, you'd have to believe either both forms of capital expansion lead to malinvestment or both forms of capital expansion don't lead to malinvestment. I strongly suspect the latter, based upon the fact that I've heard Forbes magazine used to run a fund in which they tossed a dart at a newspaper and randomly invested in the stock the dart landed on, and the fund was still surprisingly profitable.

I understand the first sentence, at least, and below I'll explain why it is incorrect.  The next part loses me.

If random investment in stock is profitable, then I can't see how ANY expansion in capital could cause a rise in overall malinvestment.

Random investment in stocks is not necessarily profitable, which is why they advise you to spread your investments around rather than put all your eggs in one basket.  Investing your money in stocks is not the same as expanding your capital structure.  Onto an explanation of the ABCT.

A consumer good is any good that makes you happy, or, as economists put it, increases your utility.  DVD's, sporting events, massages, apples and automobiles are examples of consumer goods.  Capital goods are goods which aid in the production of other goods.  Tractors, hoses, automobiles (notice that a good can serve both functions) and even education are capital goods.  The more capital that is invested per worker, the more productive a worker will be, but in order to invest in capital someone must first save, that is, they must forego consumption in the present so that, instead of consumption for utility, a capital investment can be made.  In very simplistic terms, imagine a fisherman who catches and consumes three fish per day.  Then he decides to consume only two fish per day and save the other one.  After two days, he has saved two fish.  The next day, instead of fishing he builds a net, consuming the two fish that he had saved.  The day after that he catches five fish because of his net, allowing him to eat three and either trade the other two for something else or save them as well in preparation for embarking on another capital building project.

Since capital decays, it must constantly be maintained.  This requires constant savings so that the needed capital investments can be made.  If we want to expand the capital structure, even more savings is required.

Now, we must understand price.  The function of a price is to ration scarce resources.  A resource is said by economists to be scarce if there is more demand for it than supply of it.  Ipso facto, the good must be rationed.  When all relationships are voluntary - on the free market, in other words - goods are rationed by pricing them.  The price rises which discourages the least interested from purchasing while encouraging more production of that good.  The price will tend towards the market clearing rate, which is the rate at which there is a good for every buyer willing to pay the price.  An interest rate is also a price and works as a clearing function in the same way.

Now, savings are used to fund capital investment projects.  The interest rate is determined by the willingness of people to save and the desire for businesses to borrow to expand their capital structure.  Businesses use the interest rate as a guideline for whether or not it will be profitable to expand their capital structure, and people use the interest rate to decide whether or not they wish to save and consume more later or consume less now.

Enter the Fed (cue Darth Vader theme music).  Let's say that the Fed purchases some securities, thus making available more money for banks to lend each other, thus driving down the interest rates.  Two things happen.  First, businesses see the reduction in the interest rate and notice that a whole host of capital projects just became profitable at the lower rate.  Second, people see the lower interest rate and decide that they prefer to save less money now since they will be getting back less money in the long term.

Do you see the problem beginning?  Before the rate of savings and the rate of borrowing was balanced out, and therefore the savings rate and consumption rate supported the capital investment rate.  But now, real savings is dipping down - and thus consumption is increasing - at the same time that businesses are demanding more loans for capital projects.  In other words, consumers are thinking short term and businessmen are thinking long term.

The economy starts to reshape itself around the artificial stimuli and bad investments are made.  The capital structure, specifically the structure of those industries which received the early injection of cheap credit, is expanded beyond what can be maintained by the true savings rate, and as the demand for capital increases capital goods soar in value.  Projects are begun, but it soon becomes apparent that they won't be finished.  With the housing debacle, we long ago started getting stories of projects that were delayed because of a lack of material.  Capital expansion outstripped what the savings rate could sustain.

Of course, a new injection of credit might keep things going, but it will only make the fall all the harder and eventually, with no let up in money creation, your currency will be rejected.  At some point, the Fed chooses to tighten credit.  The interest rate goes back up, and suddenly these new capital projects are revealed as bad investments.  There is a fire sale of capital goods which causes their prices to plummet, and the economy goes into a recession which is simply the liquidation of bad investments.  After the recession, the story might continue more peacefully, but of course the Fed always choose to inflate again, which leads us right back to where we were.

And so we see that investment in capital isn't useful in and of itself.  It must serve the purpose of making a profit, and the price signals of an economy will tell entrepreneurs if this will be the case.  There are good investments and there are bad investments.  By interfering with price signals, the government causes a cluster of bad investments to be made and these must eventually be liquidated.  We have no need to decry all investment as bad nor to praise all investment as good.  There are good and bad investments, and when government messes with the signals of an economy it becomes hard for entrepreneurs to know the difference.

nathyn states: 

"if the government had either a minimum or maximum wage for labor, there'd be higher unemployment, either way, but for different reasons"

and later, 

"A low minimum wage won't increase unemployment."

 

- neither of the above is right.  it's not the absolute lowness or highness of the government-mandated minimum wage, but rather where this rate is with respect to the market clearing price.  even setting a low rate may exclude many inexperienced or otherwise unproductive workers.  it's not possible to accurately quanitify a rate which would guarantee no unemployment, because the labour market is not homogeneous.

newson:

nathyn states:

"if the government had either a minimum or maximum wage for labor, there'd be higher unemployment, either way, but for different reasons"

and later,

"A low minimum wage won't increase unemployment."

 

- neither of the above is right.  it's not the absolute lowness or highness of the government-mandated minimum wage, but rather where this rate is with respect to the market clearing price.  even setting a low rate may exclude many inexperienced or otherwise unproductive workers.  it's not possible to accurately quanitify a rate which would guarantee no unemployment, because the labour market is not homogeneous.

I agree with you. Obviously, the effect depends on its difference from the natural wage and it would have different effects on different forms of labor.

When I say, "a high minimum wage increases unemployment, a low minimum wage has no effect," I mean, "a high minimum wage, with respect to the natural wage increases unemployment, a low minimum wage has no effect, with respect to the natural wage."

If the minimum wage is set ridiculously low, such that no employer in the world can be found to pay such a wage so low, such as 1 penny a day, yes, such a minimum wage would not increase unemployment.

To be more concise, frequently, core assumptions are left out of economic arguments and arguments, in general. In philosophy, this is called an "enthymeme." The common sense we bring with us to our arguments is called "existential import."

Surely, when you hear an actual economist use the term "capital" to refer interchangeably to both physical and financial capital (as Timothy Taylor himself acknowledges doing, in his lectures for TTC) , neither you nor anyone else should be rude enough to suggest that he sees no difference between the two.

Consider what I've said: What possible basis could I have for arguing that the government could and should try to peg the minimum wage to what they believe is the natural wage? It makes no sense at all. It's wholly incompatible with every economic school, even the heterodox ones. For you to make such a criticism insults my intelligence. 

Your pedantry has absolutely nothing to do with this discussion. It's distracting and extremely condescending. Please stop. And when you or Niccolo read something, give me the benefit of the doubt. Sheesh.

Now, is there anything in this above paragraph which is not completely, fully clear? Oh, and when I say, "clear," I mean "free from uncertainty or doubt." The text above is obviously not transparent, after all. Otherwise, you wouldn't be able to read it, right? Just making sure!!  

 nathyn says:

"if the government had either a minimum or maximum wage for labor, there'd be higher unemployment, either way, but for different reasons"

and later,

"A low minimum wage won't increase unemployment."

 

when making generalizations that are on the face of it wrong, people don't have to grant you any leeway.  the above statements are wrong, and therefore liable to be criticized.  i notice from your other posts many of your defences are prefaced by the "that's-what-i-meant-to-say line".   near enough is not good enough when expressing complex arguments, try harder and you'll avoid the pedants like me.  that is if you're not deliberately being cryptic.

newson:

 nathyn says:

"if the government had either a minimum or maximum wage for labor, there'd be higher unemployment, either way, but for different reasons"

and later,

"A low minimum wage won't increase unemployment."

 

when making generalizations that are on the face of it wrong, people don't have to grant you any leeway.  the above statements are wrong, and therefore liable to be criticized.  i notice from your other posts many of your defences are prefaced by the "that's-what-i-meant-to-say line".   near enough is not good enough when expressing complex arguments, try harder and you'll avoid the pedants like me.  that is if you're not deliberately being cryptic.

 

I'm not being anymore deliberately cryptic than anyone else. You're being condescending. I've said, "I agree," several times now because of the several straw mans I've faced.

"The minimum wage causes unemployment" doesn't need to be any further picked apart. Anyone who makes that claim is going to acknowledge it depends on the natural wage and that it affects people differently.

I did a quick search to find if any Austrians have made the same generalization which is on the surface false, if you take them so literally. And surprise! Look what I found:

 http://www.mises.org/story/633

People in general are capable of managing their own affairs but are utterly incapable of managing the affairs of millions of their fellow citizens and are even less capable of running a global empire. For example, the war on poverty institutionalizes poverty, the war on drugs leads to the use of more dangerous drugs, urban "renewal" causes homelessness, the FDA kills people by depriving them of medicine, the war on racism increases racial tensions, the minimum wage causes unemployment, and on and on and on.

Obviously, though, it would be insulting for you to tell the author above, "But if the natural wage is higher, there's no unemployment!"

Of course he knows that and so do I. Both of us were being concise.

Now, cut it out.

Nathyn:

Austrians see no problem with speculation-driven expansion of capital, assuming the increase in capital leads to more overall investment overall, meaning greater production.

But you believe government-driven expansion of capital (through the Fed and Fractional Reserve banking) leads to malinvestment and thus, the business cycle.

This seems contradictory, doesn't it? In both cases, investors aren't investing because they think their investments are worthwhile.

You've got to consider how they know investing will yield a gain. Interest is the price of borrowing money, and prices coordinate actions within an economy. The rate of interest coordinates futures actions and planning, so setting this price interferes with this signal, and has similar effects to other forms of price-setting. Too high a price means under-investment, while too low a price yields over-investment.

I'd suggesting reading Garrison:

http://www.auburn.edu/~garriro/strigl.htm 

nathyn says:

"if the government had either a minimum or maximum wage for labor, there'd be higher unemployment, either way, but for different reasons"

and later,

"A low minimum wage won't increase unemployment."

mr ostrowski,  (http://www.mises.org/story/633) actually says  "the minimum wage causes unemployment". cast your eyes up a couple of lines and compare what you wrote, and what ostrowski says, and you'll notice they are two completely different assertions.  only ostrowski's is correct.  by the way, you never got around to explaining how maximum wage is going to increase unemployment. i'm intrigued.

Nathyn:

Hmm. I didn't know Austrians had macroeconomic theories. I thought they saw the macro\micro distinction as unjustifiable because of their methodological individualism?

I suppose it makes it easier for Garisson to communicate with non-Austrian economists. It is perfectly possible to classify much of what Austrians do as macroeconomics.

If praxeology dictates that the only economic assertions that can be made must be made about individuals, how can you have separate macro and microeconomic theories? After all, I thought that macroeconomics was born from the empirical observation that individual behavior on a small scale is very different from individual behavior on a large scale.

Most macroeconomics is as distant from reality as can be. I am not sure what 'empirical' observations it is based off. Macroeconomics is based on predictive power, not how closely it matches reality.

Nathyn:

Before I go any further, I plan to read:General Theory of Employment, Interest and Money by John Maynard Keynes, What Has Government Done to Our Money? by Murray Rothbard, and Monetary History of the United States 1867-1960 by Milton Friedman, so that I can grasp the basic arguments of each side.

If you are going to read "General theory.." then you must read Hazlit's "The Failure of the New Economics", which is the Austrian's rebuttal.  It's excellent.

leonidia:

But even if you accept the "equation of exchange" MV=PQ as valid (which I don't because P is indefinable), there is nothing here which tells you anything useful. If M is constant and V increases, it doesn't follow that P increases. 

 

Sorry, I totally disagree.  If V increases, demand must increase which causes the tendancy for prices to rise.  Your example of a binary economy doesn't apply to the situation. 

 Actually Hazlitt's The Failure of New Economics (IIRC) is a more comprehensive refutation of Keynes. I believe Hutt and Hayek also dissected many of his theories.

Inquisitor:

 Actually Hazlitt's The Failure of New Economics (IIRC) is a more comprehensive refutation of Keynes. I believe Hutt and Hayek also dissected many of his theories.

That's what I said.  Of course all the Austrians have written theory opposing Keynes' views.

As astute as many of the people who post on here are, (and I have seen some great answers) you really need to understand the complete theory of Austrian Economics before you will understand how the details fit in.  For example, if you were going to build a house, there is a logical progression of steps you would follow in it's construction.  IE, lay the foundation, build the frame, finish the house inside and outside, and only then would you furnish the house. 

 I have noticed from your questions that you are attending to the details (what kind of curtains, what color paint, where to put the couch -to continue the metaphor) when you have not done the work that should come first, build your foundation, and the rest will make much more sense.  It takes time, so you really need to determine if it is worth the effort to you.  If you are not an econ major, it may not be.  Because as with all other things in life your time is scarce and you need to allocate it well.  Like I said in another post, it has taken me three years and I still have more ahead of me than behind, possibly another decade to understand things as well as I would like.  I understand that you want to know it all now, I am very much the same way, but the truth is that it takes a long time, people spend their entire lives trying to answer these questions, don't expect to learn it all during your intro to Macro class.  Good luck.