A lot of people are unclear on the concept of "malinvestment."
I'd like to start with an expanded version of a response I posted earlier in order to try and clarify the concept. Intelligent comments and constructive criticism appreciated.
Begin by considering two concepts:
The value of a prices, no pun intended, is that they provide signals to market participants: when, where, in what quantity, and towards what ends should investments be directed. 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, etc. Any interference with prices, therefore sends inaccurate signals to investors, entrepreneurs, consumers, borrowers, and lenders.
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.
New money, especially fiat money, typically manifests itself as demand for consumption goods. Keeping in mind that "consumption" is just a polite and roundabout way of saying that you're destroying something valuable, since this consumption wasn't matched with a previous investment in productivity, it's likely to be a net value destroyer.
What happens when new money is introduced, is that demand appears to have increased, manifested by higher prices. These prices tell people "make more stuff", this is how it works: People see a higher price being paid for certain goods, and this appears to indicate that there is perhaps profit to be made in that market. Responding to the apparent signal, they begin now to overwork their assets, or perhaps to invest in assets that will enable them to be more productive tomorrow.
What has not changed is the present productive capacity.
Prices rose, however, because of the money; the higher prices being merely reflections of the increased money supply, and not of any fundamental change in consumer preferences. This money eventually works its way through the system, and 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 match increase capacity to accommodate a phantom increase in demand. When this fact is eventually revealed, many investments are revealed as unprofitable and must be liquidated, and in either case we are worse off.
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. 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.
Without that previously accumulated capital, a boom/bust phase is inevitable.
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David Z
"The issue is always the same, the government or the market. There is no third solution."
Prashanth Perumal: What about this actually makes it an unsustainable boom? Or am I failing to find something obvious here?
What about this actually makes it an unsustainable boom? Or am I failing to find something obvious here?
Prices need to convey meaningful information about the relative availability of goods & services. By increasing the money supply (whether in the hands of a single individual or many), the resultant prices convey less-accurate information.
How do others in the economy respond?
etc.
Jon Irenicus:How would a general (economy-wide) rise in the price level take place then, without increasing the Ms?
Both me and David the OP have explained how it occurs.
Ixtellor
I think you should re-read what David said, because it certainly does not imply a general rise in the price level, only price increases in particular areas of the economy.
Freedom of markets is positively correlated with the degree of evolution in any society...
Unless Ixtellor is claiming that the entire economy can experience a supply shock outside of money and credit supply.
Check my blog, if you're a loser
Ixtellor:Are you stating, that the $168billion + doled out in amounts of $300/person had an impact on producer inflation prior to consumer inflation?
Loose the dogs of inflation! Bloat industry after industry! We're desperate!
You may be right about temporal priority but this is standard temporal misallocation in that producers will get signals, from a market blinded by monetary inflation, to increase producers goods because of the increase in consumer buying.
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Voters want more with less taxes?
WE inflate money, mimic lower interest rates and bail out losers.
YOU blame the boom-and-bust on capitalism. In the long run, our profits are offshore,
you're out of office and the voters have forgotten.
The only thing we have to fear is the science of economics. Call 1-800-FDR now!
It can. But assuming a fixed money supply, some goods can no longer be consumed, hence demand for them will fall, and so will their prices. There is only so much money chasing so many goods.
Jon Irenicus:But assuming a fixed money supply, some goods can no longer be consumed, hence demand for them will fall, and so will their prices
Can't supply decrease to meet the same equilibrium price? A company that is good about inventory control could just compensate in supply and maintain the price...?
What is the Austrian answer?
Last night, instead of doing my normal academic reading, I read a lot about malinvestment and the Austrian business cycle and a few questions occured to me, which you are free to ignore.
1) What about hedge funds and short sellers? They have an investment in malinvestment and intend to profit by it. What austrian market forces will prevent them from continuing the process? The cycle blames the Fed for tampering with interest rates which lead to the malinvestment, but there are other actors that also want low interest rates, even if they know the rates are artificial and will lead to a bust. And in an AnCap or Austrian society, with no barriers to entering the short selling sectors, I dont' see why they wouldn't continue to perpetuate the cycle.
I think you will answer consumers, but if consumers can get 10%+ returns by encouraging malinvestment isn't that a lot of incentive or demand for short selling services/investments? Or you might argue, its more free thus less more moral, to which I have no rebuttal other than your then talking semantics. Same result different path.
2) There is no mention I can see to political forces that influence Fed decisions. The Fed is made out to be the ultimate bad guy, but frequently the Fed is basically cowardly to go forward with a particular plan because they have all of Wall Street screaming for easy money and growth policies. Could you not just argue that the Fed needs to more perfect the MS, and listen less to political concerns and stick to its prescribed guns?
If the Fed was near perfect at maintaing equilibrium MS, would Austrian's still object to it, for reasons other than 'freedom'?
P.S. David's definition on malinvestment was as good or better than any I found, so Kudos.
With what money will it be bought? EIther the price drops or the good is simply no longer consumed, absent Ms inflation.
Ixtellor:P.S. David's definition on malinvestment was as good or better than any I found, so Kudos.
Thanks! Even I didn't think it was that good :)
Ixtellor:The cycle blames the Fed for tampering with interest rates which lead to the malinvestment, but there are other actors that also want low interest rates, even if they know the rates are artificial and will lead to a bust. And in an AnCap or Austrian society,
It's not just low interest rates - which are not malum in se. It's interest rates that don't coincide with general time preferences, that encourage the divergence that leads to the bust.
The question about hedge funds, and I don't want to be perceived as ignoring the question, is probably outside the scope of this discussion. Hedge funds are often (always?) heavily leveraged, and since the debt they lever isn't backed by any real product, this contributes to the problem because they really do have nothing to lose. I have a hard time conceptualizing some of these things without fiat money.
Ixtellor:isn't that a lot of incentive or demand for short selling services/investments?
Every short seller needs a long buyer...
Short-selling is not my area of expertise, but it is also a levered position if I'm not mistaken, without going into detail on something I know very little about (Robert P. Murphy has articles here about this sort of thing and its function w/r to markets), IMO people engaging in these activities don't necessarily have an interest in "malinvestment" per se, they have an interest in ascertaining the true value of equity shares, which may in many instances involve recognizing when and where resources have been unprofitably or sub-optimally allocated, or identifying entrepreneurial error. Entrepreneurial error happens all the time, and nobody presumes it will disappear in the absence of a money monopoly.
I may not have made it explicit, but "malinvestment" is not simple "entrepreneurial error," so more precisely: All malinvestment is entrepreneurial error, but not all entrepreneurial error is malinvestment. (Note to self for future blogging: this could be shown as a Venn Diagram.)
I was responding to this statement.
But assuming a fixed money supply, some goods can no longer be consumed, hence demand for them will fall, and so will their prices
Jon Irenicus:With what money will it be bought? EIther the price drops or the good is simply no longer consumed, absent Ms inflation
If MS is constant, he said demand would fall and their prices would as well. But a decrease or shift in supply could maintain an equilibrium price. Producers reacting as consumers reacting could result in the same price. I wonder if there was an Austrian explanation for why this could not or would not occur.
P.S. I created a fancy supply and demand chart with shifting demand and supply and the corresponding equilibrium price, but dont' have the expertise to "paste" it here for some reason. Again, I blame this antiquated forum code and not my self.
Ixtellor: There is no mention I can see to political forces that influence Fed decisions. The Fed is made out to be the ultimate bad guy, but frequently the Fed is basically cowardly to go forward with a particular plan because they have all of Wall Street screaming for easy money and growth policies. Could you not just argue that the Fed needs to more perfect the MS, and listen less to political concerns and stick to its prescribed guns?
You may recall a certain, defunct nation whose govt had totalitarian control of its economy. Yet, curiously enough, its no longer with us. I wonder if that's a coincidence. I wonder if Plato's philosopher-kings were merely coincidental with the intellectual context of that nation's founders. I wonder if the 1776 publications of _The Wealth of Nations_ and _The Declaration of Independence_ were coincidental with the Enlightenment's respect for independent judgment and the need to politically protect it from those whose revelations from the supernatural command them to command others with supernatural perfection. BTW, Plato, who discovered that reasoning is hierarchical, knew that economics is logically dependent upon politics, not an independent body of knowledge. Every claim in economics, no matter how narrow and technical, is an application of some, particular politics. The Marxist-Keynsian claim that capitalism is contradictory is an application of the political claim that that irrational individuals must be forcibly controlled by a rational state whose philosopher-kings have a mystical revelation of supernatural perfection. These days, of course, the philosopher-kings are Kantian subjectivists and prefer to talk in mathematical tongues about intuitions and a consensus of those initiated into the transpolitical wonders of monetary inflation and how eating cakes causes them to be baked.
Have you ever wondered why Federal Reserve Notes say ""This note is legal tender for all debts, public and private" on one side and "In God we trust" on the other? When US money was redeemable in gold, was it also genuflecting to the supernatural? Or was gold sufficient? I wonder...
Ixtellor:If MS is constant, he said demand would fall and their prices would as well.
If we all woke up tomorrow, and discovered that prices (across the board) had risen inexplicably from P to P' by a uniform 10%, a shift in supply isn't possible. It's too late. Prices include wages, however, so individuals will earn - moving forwards - 10% more. But their "stockpile" (i.e., cash holding, checkable deposits, etc.) are insufficient to make all of the purchases for which they had budgeted. Something has to give. There will be unsold inventory because those inventories were accumulated based on conditions that were expected to hold, but didn't. In order to liquidate those inventories, prices must fall.
david_z: If we all woke up tomorrow, and discovered that prices (across the board) had risen inexplicably from P to P' by a uniform 10%, a shift in supply isn't possible. It's too late. Prices include wages, however, so individuals will earn - moving forwards - 10% more. But their "stockpile" (i.e., cash holding, checkable deposits, etc.) are insufficient to make all of the purchases for which they had budgeted. Something has to give. There will be unsold inventory because those inventories were accumulated based on conditions that were expected to hold, but didn't. In order to liquidate those inventories, prices must fall.
Correct.
But you said "Demand will fall THEN prices will fall", but if supplies are super intellectual capitalists making good decisions, can then can't they reduce supply simultaneously with the fall in demand? ( I think the austrian argument is that pure competition causes the best capitalists to rise to the top, and those who are ineffficent to falter, so can you reach a state where those capitalist who survive and thrive, CAN accuratly predice declines in demand and make appropriate inventory and supply adjustments?")
I guess I was bothered by the absolutism again. So if you say something like "there are exceptions" then I am sated. If that is inaccurate and there are no exceptions, that its not possible for suppliers to predict aggregate wide falls in demand.. then I guess you are correct. And I expressely commented on inventories previously in that good capitalists predicing falling demand would make inventory adjustments far prior.
dude no austrian has ever mentioned pure competition except to laugh at neoclassicals that talk about it.
Where there is no property there is no justice; a proposition as certain as any demonstration in Euclid
Fools! not to see that what they madly desire would be a calamity to them as no hands but their own could bring
Ixtellor:But you said "Demand will fall THEN prices will fall", but if supplies are super intellectual capitalists making good decisions, can then can't they reduce supply simultaneously with the fall in demand?
It doesn't matter how super-intellectual the capitalist is, he can't go back in time.
Ixtellor:a state where those capitalist who survive and thrive, CAN accuratly predice declines in demand and make appropriate inventory and supply adjustments?
Sort of, but we've got to be careful when making class judgments. The reader's digest version would be that at any given point in time, those capitalists still in business have succeeded in the past, at satisfying consumers' demands. There's no value judgment about their future ability to predict and adapt. As any investment prospectus will tell you: "Past performance is not a guarantee of future results."
Ixtellor:If that is inaccurate and there are no exceptions, that its not possible for suppliers to predict aggregate wide falls in demand.
The Austrian position, IMO as it pertains to a decline in AD, would be that the fall in AD is evidence of previous distortions (typically +MS), the results of which were not accurately forecast. At that point, to suggest that the remedy for what ails us is more distortions, well, to use a tired analogy, is like telling the heroin addict that the "cure" for his addiction is more heroin.