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question on malinvestment causes: qauntity, not quality of money matters?

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Dr.Atom posted on Wed, Dec 3 2008 10:15 AM

Fractional reserve coupled with fiat money leads to abundant and easy way to obtain credit which is turn leads to malinvestments.

It looks to me, and this is what I wanted to verify, that it's not the source of the money (good vs bad):
savings vs. bank credit, it's the *amount* of money/currency that would potentially cause misallocations of capital.

Since savings would provide a much lower rate of investment capital, the ventures funded would be more
error free and cautious only driven by sure need, while bank credit expansions cause the majority of ventures to be the risky ones, which compete or force competition with "good" ones and create the booms and busts as credit is withdrawn from both the good and bad ventures.

In other words, all would be well, if the society managed to keep capital availability to a minimum, which in turn would create a very low but steady and continuous growth (even though we might still not have had the internet,cell phones etc).


What would be the level of such "healthy" growth,if there is a number to be assigned?

thanks a lot!

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Dr.Atom:
Fractional reserve coupled with fiat money leads to abundant and easy way to obtain credit which is turn leads to malinvestments.

In practice, "Fractional reserve banking" can only occur under a fiat regime, due to Gresham's Law

Dr.Atom:
Since savings would provide a much lower rate of investment capital, the ventures funded would be more
error free and cautious only driven by sure need, while bank credit expansions cause the majority of ventures to be the risky ones, which compete or force competition with "good" ones and create the booms and busts as credit is withdrawn from both the good and bad ventures.

You are making a judgment call on the quality of loans that would be issued under full-reserves.  This is certainly part of the problem. 

I'm not entirely sure that savings would provide "a much lower rate of investment capital".  At any given instant in time, there exists only a quantity K of capital, in all the world.  The injection of money into the system doesn't change the amount of K in existence, it simply changes the prices which certain individuals are able to bid.  Those who sell into this new money may profit temporarily, others may find that they're actually depleting their own capital stock faster than they can sustain it.  (See Garrison's powerpoints on this, I think).

Dr.Atom:
In other words, all would be well, if the society managed to keep capital availability to a minimum, which in turn would create a very low but steady and continuous growth (even though we might still not have had the internet,cell phones etc).

Again, I'm not sure that I can follow you with the "minimum" requirement.  A "minimum" of any productive, economic good is always indicative of poverty, not plenty.  The free-market takeaway from all this is not that there is a particular level of available investment capital that is or would be correct, or optimal, but rather that the correct/optimal amount of investment can only occur where risk and time horizons match borrowers and lenders, interest rates are purely market-generated phenomena, etc.

Re: the internet, cell phones, etc... --- Think of how productive people could've been over the past century, if so much of their productive capacity hadn't been squandered in the boom years?  squandered on world wars?  squandered on bailouts?  Etc.

============================

David Z

"The issue is always the same, the government or the market.  There is no third solution."

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Dr.Atom:
does this clarify the question?

No.


Rothbard demonstrates that it doesn't matter how much money there is in an economy, prices will adjust accordingly.  You seem to be confusing "capital" and money.  They are not interchangeable. 

The Austrian school doesn't claim that there would never be any capital misdirected (i.e., towards unprofitable production), rathter it argues that fiat money encourages such misdirections.

============================

David Z

"The issue is always the same, the government or the market.  There is no third solution."

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I need to write this part down before I forget it ...

When money is injected into the system, it causes prices to change without a corresponding change in time preference which would be necessary to meet the "demand" contrived by the inflation.  The takeaway here is that if time preferences haven't changed, fiat injections cause a disconnect between prices and time preference.

It requires previously accumulated capital (higher order goods) to facilitate the production of more consumer products (lower order goods) without depleting the existing capital stock. 

Without that previously accumulated capital, a boom/bust phase is inevitable.

 

============================

David Z

"The issue is always the same, the government or the market.  There is no third solution."

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Dr.Atom:
Fractional reserve coupled with fiat money leads to abundant and easy way to obtain credit which is turn leads to malinvestments.

In practice, "Fractional reserve banking" can only occur under a fiat regime, due to Gresham's Law

Dr.Atom:
Since savings would provide a much lower rate of investment capital, the ventures funded would be more
error free and cautious only driven by sure need, while bank credit expansions cause the majority of ventures to be the risky ones, which compete or force competition with "good" ones and create the booms and busts as credit is withdrawn from both the good and bad ventures.

You are making a judgment call on the quality of loans that would be issued under full-reserves.  This is certainly part of the problem. 

I'm not entirely sure that savings would provide "a much lower rate of investment capital".  At any given instant in time, there exists only a quantity K of capital, in all the world.  The injection of money into the system doesn't change the amount of K in existence, it simply changes the prices which certain individuals are able to bid.  Those who sell into this new money may profit temporarily, others may find that they're actually depleting their own capital stock faster than they can sustain it.  (See Garrison's powerpoints on this, I think).

Dr.Atom:
In other words, all would be well, if the society managed to keep capital availability to a minimum, which in turn would create a very low but steady and continuous growth (even though we might still not have had the internet,cell phones etc).

Again, I'm not sure that I can follow you with the "minimum" requirement.  A "minimum" of any productive, economic good is always indicative of poverty, not plenty.  The free-market takeaway from all this is not that there is a particular level of available investment capital that is or would be correct, or optimal, but rather that the correct/optimal amount of investment can only occur where risk and time horizons match borrowers and lenders, interest rates are purely market-generated phenomena, etc.

Re: the internet, cell phones, etc... --- Think of how productive people could've been over the past century, if so much of their productive capacity hadn't been squandered in the boom years?  squandered on world wars?  squandered on bailouts?  Etc.

============================

David Z

"The issue is always the same, the government or the market.  There is no third solution."

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my question is actually very simple, without demand deposits being used for credit , just this much money would not be available to invest = (all deposits) x 100

So, much much less money would be available in the credit market system, a hugely smaller amount !

Thus, the austrian school would claim, that in this case there will be no mal-investments.. why? Apparently, due to so much less money available for credit.

Forgetting about the people's time preference, that would only define investable capital that remains, and I am not considering that capital since it's present in the current system as well (CDs, stocks, bonds bought with savings, etc)

does this clarify the question?

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Dr.Atom:
does this clarify the question?

No.


Rothbard demonstrates that it doesn't matter how much money there is in an economy, prices will adjust accordingly.  You seem to be confusing "capital" and money.  They are not interchangeable. 

The Austrian school doesn't claim that there would never be any capital misdirected (i.e., towards unprofitable production), rathter it argues that fiat money encourages such misdirections.

============================

David Z

"The issue is always the same, the government or the market.  There is no third solution."

  • | Post Points: 25
Top 150 Contributor
Male
573 Posts
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Verified by Dr.Atom

I need to write this part down before I forget it ...

When money is injected into the system, it causes prices to change without a corresponding change in time preference which would be necessary to meet the "demand" contrived by the inflation.  The takeaway here is that if time preferences haven't changed, fiat injections cause a disconnect between prices and time preference.

It requires previously accumulated capital (higher order goods) to facilitate the production of more consumer products (lower order goods) without depleting the existing capital stock. 

Without that previously accumulated capital, a boom/bust phase is inevitable.

 

============================

David Z

"The issue is always the same, the government or the market.  There is no third solution."

  • | Post Points: 25
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david_z:
In practice, "Fractional reserve banking" can only occur under a fiat regime, due to Gresham's Law

Seems pure nonsense. Why would that be?

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David Z replied on Thu, Dec 18 2008 10:39 AM

The condition which must hold, for Gresham's Law to apply, is that government must make the bad money legally equivalent to good money. Then, per Gresham, bad money drives out good money.

Unbacked money, debt money, is bad money.

============================

David Z

"The issue is always the same, the government or the market.  There is no third solution."

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