11
Jul
2014
Murphy Potpourri
Since I’ve been traveling so much, I’ve been remiss in keeping you up to speed with my machine-like output:
==> First Derivatives Are a Tough Knut for Krugman to Crack.
==> Tom Woods and I jerk-shame our libertarian peers.
==> Economic growth isn’t just about technology, it’s also about saving and investment.
Bob,
Regarding this line in your last post:
“Obviously, if and when we have floating ocean cities and Martian colonies, such success will be due to breakthroughs that make it cheaper to build such projects than how we would do it today, if we had to.”
So, ultimately, it does come back down to technology, doesn’t it? I mean you’re right that savings and investment definitely does play a role, and that throwing a bunch of scientists in the jungle wouldn’t result in a replication of modern civilization within a few weeks.
But it would seem to me that overall, technological advancement plays a greater role in progress than brute force savings does. I mean, it’s not as if back in 1850, there was this guy who knew how to build an airplane, but just didn’t have enough money yet, or that the Wright Brothers were just the first people to save enough money in order to build such a device.
If we ever do have colonies on Mars, it will be due to technology making it affordable to have them *without* having to forego a bunch of other more highly desirable things, will it not?
I’m also reminded of this shirt, created by Ryan North of “Dinosaur Comics” to help anyone who might somehow end up stuck in the distant past…
http://www.topatoco.com/graphics/qw-cheatsheet-print-zoom.jpg
Obviously if you took a bunch of nuclear physicists, biochemists, and neurosurgeons and stuck them in the jungle, they’d struggle. But if you had subject matter experts from all the different stages of production (farming, mining, construction, logistics, transportation, engineering, etc.) they might do better than you might think…
Sorry for the multiple posts, but I find this subject really fascinating…
After thinking about it some, I think the idea of martian colonies is a poor analogy, specifically because we *do* in fact have the technology to achieve that, just not the resources to make it economical to do so.
If you go back far enough in time, virtually all of modern technology will have a point where it *wasn’t* a matter of resources at all, but a matter of not having the technology. In the 18th century, the predominant viewpoint was that flight was impossible. It wasn’t a matter of “We know how we could achieve this, but it’s too expensive.” People simply didn’t think it could be done.
Now, you could theorize that if the governments of the world in the 18th century got together and confiscated all global wealth and forcibly re-directed 100% of human effort towards figuring out how to make an airplane, they would have been able to discover it much sooner than 1903. And in hindsight (now that we know that flight is indeed possible), yes, that is entirely possible.
But we are biased by this hindsight. So I’d prefer an analogy of say, faster than light travel. As it stands now, our current understanding of physics suggests this is likely impossible. It’s possible new breakthroughs could one day prove this false. It’s also possible that if world governments confiscated all wealth and re-directed all resources towards discovering a method of FTL travel, they might find one.
Then again, they might not. It might be impossible, regardless of the resources and effort spent looking for a way. We will only know after the fact. Any invention or discover theoretically could have been discovered sooner if more resources would have been consumed in the attempts to discover it. But then we get into counter-factuals…
“In the 18th century, the predominant viewpoint was that flight was impossible.”
Hadn’t they seen birds? Unike FTL, which theory says is impossible, flight clearly is possible, because birds and bees do it all the time. Although fleas, educated or otherwise, only jump. As far as we know now, FTL will never be invented, not because we couldn’t figure out how to do the possible, but because it is not possible.
Fair point. My general point was that “as far as we know now” can change. We learn new things, which challenge our previous assumptions.
IF we some day discover some ridiculously expensive method of FTL travel, at that point in time, it will be easy to say “Well we could launch an expedition to Alpha Centauri, if only we had more savings”
But at this point right now, it’s not a question of savings. Similarly, for the ancient Greeks, having nuclear power plants wasn’t just a question of their not having saved enough gold and iron. There was a real, legitimate knowledge gap.
If we took a bunch of nuclear physicists and stranded them on a desert island, no, it’s not very likely they’ll have a reactor up and running in a week. But I’d say that group of people is far more likely to produce a reactor than taking a bunch of ancient Greeks and giving them an overwhelming supply of metal, plastic, uranium, or what have you.
Matt,
the thing is we always have more technology than we have savings. It’s not that Africans don’t have a clue as to how a tractor can be used to grow crops more productively. They even know how to build one. But they don’t have the savings to afford building one.
People at Ford have the technology to build Ferrari-style supercars. But they wouldn’t sell a million of them every year.
Even today we have the technology to go to Mars. But considering the benefits, the costs outweigh them.
(Obviously the costs outweighed even the benefits of bringing a few rocks from the Moon but that’s government for ya).
So yeah, technology is important. But in real life it’s never the bottle-neck.
In human action terms, you choose the action that has the most value for you. Technology (=knowledge) is what guides you as to evaluating what the highest ranking need is and as to what the best means to achieving it is.
If we swap all people from Ethiopia with all the people from USA (keeping the total population magically constant), would this then still not lead to Ethiopia suddenly becoming a developed country?
Meaning it won’t be churning out higher order goods because it lacks capital?
Higher order goods need more roundabout methods and procedures and without the availability of capital goods it won’t be possible even though the knowledge is there?
Then the only way to become developed is to have more savings and investments, leading to more capital goods and as a result increasing productivity?
Yes to all the questions. Americans are rich because they have factories, not because they have knowledge. If they moved to Ethiopia, the same people would be much, much poorer.
That’s why Americans are now getting poorer: because they are losing capital (physical capital, i.e. tools). What good is it to know how to wield a hammer if you don’t have the hammer?
Knowledge (technology) can be transferred very easily and for free. But capital (which comes from savings) cannot. Technology is like a recipe: once someone discovers it, it’s free for everybody. But you still need to have the eggs, flour and chocolate to make the cake.
The comparison between modern Americans and modern Ethiopians is far different from my comparison of modern Americans and 17th century Americans.
Advances in global communication has shrank the knowledge-gap between countries to virtually nothing.
But my point above stands. The reason that George Washington didn’t have a nuclear reactor isn’t because he simply didn’t have enough gold saved up to buy one.
“The reason that George Washington didn’t have a nuclear reactor isn’t because he simply didn’t have enough gold saved up to buy one.”
True, yes. You have to have both, but you always have more technology at any point in time. We have the technology today to feed and accomodate and give a car to every person on the planet but we don’t have enough physical stuff.
Again, you won’t bring Africa out of poverty by telling them : “use tractors, dummy!”
No to each question. America is rich because Americans have an individualist tradition of respecting knowledge and taking chances beyond mere survival.
Americans are wealthy and their wealth is growing because knowledge and attitude are much more important than tools.
Transferring technology leaves more time and space for new advances. You don’t need eggs, flower, and chocolate to make the cake, only a box of ingredients or, even better, a grocery store that sells cake.
“a box of ingredients” is the same thing as “eggs, flour and chocolate”. And it’s the same as “a grocery store that sells cake” which merely pushes the problem one step backwards. In that case the store, or the baker, must have the ingredients. And because the baker and the store will get paid AFTER they spend money on the ingredients, you need to have a way to finance it – which is savings.
The Chinese or the Japanese do not have an individualist tradition, but they have / have had a lot of savings and when they did, they produced far greater growth than the US. I don’t know if Americans’ wealth is growing (I wouldn’t say so) but it certainly is not even close to the growth rate in China. Why? Because of savings and investment.
Americans had huge growth in the past. Americans are still the best when it comes to technology (even today). But their economy is far from being the fastest growing, quite the opposite.
So I am afraid you’re wrong.
You’re kidding, right? Growth rate in China? If you have $1 and it becomes $2 the growth rate is 100%. That is somehow superior to having $100 and growing to $110, a growth rate of “only” 10%, i.e. 900% more than the “greater” growth rate 100%? The math is not that difficult.
Not kidding, no. It indeed is superior by virtue of 100% being more than 10%. Yes, the Chinese are poorer today but that’s not the fault of today’s Chinese, you have to blame the past generations. Similarly, Americans are rich because of the past generations. To judge the performance of current generation, you must look at the growth, not the absolute level. In the 50’s or 20’s the US were the richest AND the fastest growing.
And it goes back to savings/investment. The US had it, they grew. Now they don’t so they don’t.
Tony Stark was able to build his Iron Man suit in a cave…with a box of scraps Case closed.
Knowledge: 1
S&I: 0
Someone had to save those scraps; scraps aren’t original factors of production.
The metal was extracted from somewhere. They weren’t digging it. The electricity, rockets, bullets, computer, computer software, micro chips, and a host of other capital goods were already in place. A lot was provided by the bad guys so that Stark could build unimpeded.
Knowledge does help find new and roundabout ways to use the same capital goods into higher order products, but knowledge cannot overcome a dearth of capital goods, at least in the short run. Once back in civilization, with more capital goods available, many more, better, and improved Iron Man suits were made.
In your Mises Canada post you say
“However, at the same time we shouldn’t ignore the role of savings and investment, even holding technical know-how constant. A major reason we have a higher standard of living than our grandparents did, is that people have (on average) saved and invested over the last century.”
Obviously you need savings to accumulate capital, but if technological knowledge stayed the same , and time preference didn’t fall – wouldn’t you reach a point where all savings just went on capital replacement ?
I agree with Matt that in the long run technology drives growth – savings is just a necessary condition for it to take place.
On the Krugam/Wicksell thing:
I think as interpreted by the fed the Wicksellian rate is not the one that generates 0% inflation, but the one that generates the target rate of inflation (2%).
As we are below the target rate I’m going to have to score this one to Krugman.
“Wicksellian analysis is an older tradition; it argues that there is at any given time a “natural” rate of interest in the sense that keeping rates below that level leads to inflation, keeping them above it leads to deflation.”
Inflation causes lower rate instead of the lower rate causing inflation. True? (Inflation = increase in stack of money)
I think Wicksell argues that at too low a rate of interest there will too much borrowing and too little savings, causing the money supply to increase and inflation to ensue.
Later economists have modified this slightly to have the interest rate reflecting “expected” inflation. This allows an equilibrium rate of interest with inflation >0.
Which episode of the Tom Woods show is mentioned in the post on Mises.ca? The link goes to a page with all episodes.
On a mobile device it does, but on a computer the episode in question starts playing. It’s July 7, the episode on affordable health care in the age of Obamacare.
The existence of “artificially low interest rates” (from a Wicksellian erspective) do not even require rising prices in the first derivative sense.
Central banks can inflate money in the loan market which could depress interest rates while past bank credit is defaulted on which reduces the aggregate money supply and volume of spending thus keeping a lid on prices.
Or, even if we assume aggregate money supply and volume of spending are not falling, or even increading, it still could be the case that alongside the “artificially low interest rates” real production is expanding by so much that it outpaces money and spending which results in falling prices.
There is no single constant connection between interest rates and prices.
“Or, even if we assume aggregate money supply and volume of spending are not falling, or even increasing, it still could be the case that alongside the “artificially low interest rates” real production is expanding by so much that it outpaces money and spending which results in falling prices.”
Does this rise in production cause a greater demand for money?
Can we deduce from your example that people’s time preferences have changed?
Raja:
“Does this rise in production cause a greater demand for money?”
If you assume people have a particular maximum desire for wealth and will hoard cash if more goods are available at lower prices, then yes it could. But I think you would agree that the desire for additional wealth is practically infinite. More goods at lower prices doesn’t imply lower spending.
“Can we deduce from your example that people’s time preferences have changed?”
I don’t think it is necessarily so. It could. Production can continually increase with a sufficiently high savings and investment to consumption ratio that remains fixed. More real capital is itself an additional driver of increases in production apart from changes in the investment to consumption ratio.
On bitcoin and Peter Schiff: I love the guy, he is surprisingly good even with the nuanced details even though the only Austrian he ever read was Bastiat (or rather more likely, the Hazlitt version) and his own dad. But I just feel he is dead wrong on bitcoin. Or at least on the arguments against it. And I would love someone to take him up on it. I know he interrupts and yells at people who disagree with him but still.
His position is that gold is money because bottom line is you can get gold teeth or make jewellery out of it while you cannot do it with bitcoin. Now I understand this sounds like the beginning of Mises’ regression theorem but Mises himself explained that that’s only how a money is BORN. Every good has an “intrinsic” or a use value and an exchange value. A good money is such which has a huge exchange value (although at some point in the past it had to have some use value, too). But once it takes off, the use value is unimportant. Bitcoin definitely took off for some reason. So the only thing to answer to confirm its status as money is : is it accepted as a medium of exchange generally enough? Probably not, but that’s a completely different argument than what Schiff is making.
I mean look at USD: it’s got no intrinsic value but it’s had exchange value for centuries now – has it been in a bubble the whole time? Or is USD really not a money? I don’t think so. Bad money, maybe, but it is money.
And there are also some arguments of Schiff’s that are even stranger, such as that bitcoin can supposedly be divided into fractions of bitcoin but unlike gold (where you get half an ounce, a tenth of an ounce, etc.) these fractions are still “one bitcoin”. I don’t see how that can be true but I’m not an expert.
I was going to sit this one out because I end up talking too much, but I think I can moderate myself better, going forward, and this issue really irks me.
Now I understand this sounds like the beginning of Mises’ regression theorem but Mises himself explained that that’s only how a money is BORN. Every good has an “intrinsic” or a use value and an exchange value. A good money is such which has a huge exchange value (although at some point in the past it had to have some use value, too). But once it takes off, the use value is unimportant.
It is unimportant how a money is born, if all that is required for something to become money is that people widely trade it.
Why do I need to know how a money is born if I can just look at people exchanging it and point to the price? There is nothing helpful that is learned by knowing how or when a money came to become money, if there is no connection to use-value.
Also, money isn’t useful if there isn’t a connection to use-value – that is, if either the money isn’t a good, or the money substitute doesn’t represent a good.
The reason is that, if you wanted to, you could arbitrarily trade with anyone using anything at all, and you would technically be engaging in indirect exchange.
It could be a handful of dirt, and it would still qualify.
Try to keep in mind that the whole point of trading is to acquire something you value more for something you value less. If the money used to make the trade doesn’t mean anything, then you can’t know whether you’re being ripped off (like if you buy an overpriced house the real price of which is revealed during a crash – assuming the government doesn’t bail out crashing businesses), or whether you’re benefitting from fraud (like when the Fed props up *your* bank).
Money has to represent the subjective values of the parties to the transaction *for* the goods that are sold and bought with it, in order for it to serve the purpose of indirect exchange.
Also, since the Austrian school shows that the supply of money doesn’t matter, large changes in the supply, strictly speaking, shouldn’t matter, either.
Under sound money – commodity money – large changes would make it difficult to make long term plans, but the wildly fluctuating prices which would result from those changes would be telling you something real about the subjective preferences of others.
That’s not the case with “money” that isn’t a commodity.
It’s not enough that people widely trade it.
Consider that America prints the world’s reserve currency. Yes, we are benefitting from laissez-faire activity to the extent that individuals are getting away with it; But think about what would happen if other countries stopped using the FRN.
With commodity-money, if it stops being used as money, real prices can be readily discovered by simply using the next-widely-traded commodity, since the subjective preferences are represented by the goods for which people have a use-value.
Under our paper money system (for example; this would apply to bitcoins, as well), huge misallocations of resources have been made. Nobody really knows what the real price of things are, using paper money. When it crashes, it’s going to be a painful process to rediscover people’s actual preferences, and a massive restructuring of the capital structure will have to take place.
We are getting imports in return for paper that’s not so much as an IOU for anything.
Part of the reason we’re doing so well is that we’re robbing other countries – but not because of our laissez-faire activity. *WE* generally accept the FRN because we get to rob others with it.
“if all that is required for something to become money is that people widely trade it.”
I think the definition of money is not dependent on its origins, but is dependant of how widely it is traded. Something is money if it is “widely used” or “generally accepted within a country or socio-economic context”. So we can’t say something is not money because of how it started.
“Also, money isn’t useful if there isn’t a connection to use-value”
Why? I find it useful to swap goods and services for money, and so does everyone else as far as I can work out.
“The reason is that, if you wanted to, you could arbitrarily trade with anyone using anything at all, and you would technically be engaging in indirect exchange.”
This comes back to the definition – “generally accepted” or “widely used”. Somewhat vague terms, but very definitely not applying to handfuls of dirt. So yes, handfuls of dirt would be money if they were generally accepted as payment for goods and services. Since they are not, they are clearly not money. I would be engaged in indirect exchange, but not using money.
“Money has to represent the subjective values of the parties to the transaction *for* the goods that are sold and bought with it, in order for it to serve the purpose of indirect exchange.” That is so, and it seems to be what I call money does, and presumably what bitcoin does for those that use it. Why does this require commodity value?
“Try to keep in mind that the whole point of trading is to acquire something you value more for something you value less. If the money used to make the trade doesn’t mean anything, then you can’t know whether you’re being ripped off”
Money seems to serve this purpose for me – I presume for those that use bitcoin it also serves for them. That is because the money does mean something. I don’t see how gold would be any different because it has commodity value. If it lost its money value and was only used for industry and ornamentation, the value would be very different. I still wouldn’t know if I was being ripped off.
It may be that fiat money is unwise, but surely it cannot be said to not be money?
” I don’t see how gold would be any different because it has commodity value. If it lost its money value and was only used for industry and ornamentation, the value would be very different.”
Exactly! That’s what Peter Schiff doesn’t seem to understand.
Sorry, I couldn’t make sense of your post. I am not sure why you are replying to me, or even if you’re agreeing or disagreeing with me 🙂 I agree with many of your statements, disagree with some (e.g. “money isn’t useful if there isn’t a connection to use-value ” – not true, FRN is an example of a useful money with no use-value. Point is it has exchange value, “the supply of money doesn’t matter, large changes in the supply, strictly speaking, shouldn’t matter, either” – no,that doesn’t follow).
Any libertarian can (non-violently) criticize any other libertarian for any reason at any time, and the NAP is not violated. What you choose to criticize and why, are entirely up to you.
The NAP is more properly thought of as a truce… I promise not to initiate violence against you on strict condition that you also promise not to initiate violence against me.
NAP = Nicht-Angriffs-Pakt
Either serious government crackdown, or a published flaw in the algorithm, or a much better algorithm that attracts away the current Bitcoin users.
I dunno. Methods for intimidating innocent people have never been my area of expertise. I imagnie it would have something to do with tax, and with finding a way to block any legitimate businessmen from accepting bitcoin as payment. There is also the possibility that if governments can find a way to bypass the anonymity
I would also guess that cocaine dealers generally have a much higher risk tolerance (when it comes to potential government consequences) than your average nerdy bitcoin user.
So a smaller “crackdown” could have a much larger effect on bitcoin than it does on drug dealers, who are quite prepared to go to jail, engage in shoot-outs with the police, etc.
I’m told the rewards are pretty high in the cocaine trade, which might explain their willingness to take risks. That said there may be some overlap between people making trades the government disapproves of and people using crypto currency.
What if we didn’t have the knowledge of savings and investment being crucial to growth? Better make sure we bring out leading knowledgeable economists back in time too.
Anyway, I think this is ridiculously nitpicky. It’s one of those annoying chicken or the egg conversations. Yes, it’s nice and all that you emphasize the role S&I, but claiming that he’s wrong as a matter of fact is silly.
Mises would agree with your first statement.
“The natural sciences have achieved amazing results in the last two or three hundred years, and the practical utilization of these results has succeeded in improving the general standard of living to an unprecedented extent. But, say these critics, the social sciences have utterly failed in the task of rendering social conditions more satisfactory. They have not stamped out misery and starvation, economic crises and unemployment, war and tyranny. They are sterile and have contributed nothing to the promotion of happiness and human welfare.
These grumblers do not realize that the tremendous progress of technological methods of production and the resulting increase in wealth and welfare were feasible only through the pursuit of those liberal policies which were the practical application of the teachings of economics. It was the ideas of the classical economists that removed the checks imposed by age-old laws, customs, and prejudices upon technological improvement and freed the genius of reformers and innovators from the straitjackets) of the guilds, government tutelage, and social pressure of various kinds.”
Excerpt From: VonMises, Ludwig. “Human Action: A Treatise on Economics.” Ludwig Von Mises Institute. iBooks.
This material may be protected by copyright.
Maybe you can explain how a high real interest rate encourages investment.
Investment is impossible if everyone consumes equal to what they produce. Interest rates are the incentive to encourage people to produce more than they consume and search for opportunities to take advantage of the investment.
At zero interest rates, no one has an incentive to do this.
I’m not sure I agree that “Interest rates are the incentive to encourage people to produce more than they consume”. If they can produce future goods that they hope to sell at a profit, then they they have an incentive no matter what the interest rate is. In fact if they can borrow money to finance this production at 0% they will be more likely to think they can make a profit.
The problem would be that at 0% interest rate no one would have an incentive to save – but that may not be much of a problem in a recession where there is plenty of saving going on even at low rates.
Tel, your argument would only begin to make sense if increased real investment was currently impossible because there was a lack of available real resources (such as wood, metal, etc).
Is that what you believe is the case?
Not a lack of real resources per se, but a sufficiently high allocation of real resources devoted to consumption such that capital production cannot more than make up for it.
are you saying that increased real investment is currently impossible because too many real resources are currently being devoted to consumption?
Well, it is certainly true that the resources that go into consumer goods physically cannot also go into capital goods at the same time.
If people don’t produce greater material value than they consume then investment is simply impossible, regardless of how many trees you have growing, or ore in the ground. You can squabble for a limited time over who gets to consume the existing capital stock, but you won’t get new capital stock without productive surplus.
Metal doesn’t make itself, nor does any business just run itself. You need people, and skills, and incentives.
Say’s Law hasn’t gone away… no production => no economy.
Tel, I understand that you need real savings for real investment.
In other words you need real resources which can be used for investment, rather than used for consumption.
If there are no available real resources then you can’t increase real investment.
If all available resources are being used for consumption then they will not be available for use in investment, and increased investment will not be possible.
In this situation, a higher interest rate might incentivize people to consume less. This would mean that there would then be resources available which could be used for investment instead.
I’m not sure why you think higher interest rates would bring about increased investment, outside of this situation.
Which is why I asked whether you believe that there is currently a lack of available real resources, which is making increased investment impossible as a result.
Philippe:
Interest rates are an effect of the ratio between investment and consumption. If you posit higher interest rates, then you are talking about the effect of a relative reduction in investment and relative increase in consumption.
That would mean even lower capital investment in real terms.
It is tricky to think of interest rates being a seeming passive effect instead of an active cause, given that prevailing interest rates are purposefully influenced by central banks, and given that should interest rates double or triple tomorrow, then all else equal that might encourage you and others to invest more and consume less. But all else is not equal. While higher rates may encourage you to invest more, it is in an environment that increased them in the first place, i.e. changed investment.
Please take the above as referring to long run trends, and not short term fluctuations stemming from changes in liquidity preference, risk estimations, and other more obvious and talked about determinants of interest rates.
if the central bank was to triple the short term money rate of interest tomorrow, that might lead people to consume less, but I don’t see why it would lead people to invest more, given current conditions, as borrowing to invest would become more expensive, and there would also be a reduction in demand for the products of investment.
Philippe:
If rates go up, that means business are offering a higher rate on debt.
Wouldn’t lending to businesses be an “investment”?
“If rates go up, that means business are offering a higher rate on debt.”
If a bank starts charging you more to borrow, that doesn’t necessarily mean that you are offering to pay more to borrow, it just means that if you want to borrow, you have to pay more.
Generally it seems obvious that people will want to borrow more when real interest rates are low, and will want to borrow less when real interest rates are high, as borrowing is more expensive in the latter case.
An excessive demand for borrowing could drive interest rates up, but raising interest rates in itself will not cause demand for borrowing to increase.
If the Fed were to significantly raise the short term rate now, there’s no reason, as far as I can see, why this would lead to a greater demand to borrow for investment.
“Wouldn’t lending to businesses be an “investment”?”
If I lend my money to a business, that is a form of investment. However, real investment means producing real things which generate a real return over time which can then pay me a real return on my loan. There’s a difference between real investment and purely financial investment. The latter simply means buying financial assets, which doesn’t necessarily result in actual production of real things.
There’s a difference between real investment and purely financial investment. The latter simply means buying financial assets, which doesn’t necessarily result in actual production of real things.
Believe it or not, this is MF’s whole point.
Austrians say that printing money results in “purely financial investment” that doesn’t result in the actual production of real things.
The purely financial investments we call “malinvestments” because the investments are not made in accordance with consumer preferences.
Entrepreneurs are misled by the artificially low interest rates into making the wrong investments.
These must necessarily go bust.
And printing money to prop them up merely gives these failing businesses the ability to steal via the Cantillon Effect.
Philippe:
“If a bank starts charging you more to borrow, that doesn’t necessarily mean that you are offering to pay more to borrow, it just means that if you want to borrow, you have to pay more.”
If a bank IS charging a higher interest rate, then that means borrowers are at the same time offering a higher rate. Some borrowere will drop out, others might be borrowing for the first time.
Exchanges imply two offers and two acceptances.
Banks do not set a rate that collapses borrowings to zero.
“Generally it seems obvious that people will want to borrow more when real interest rates are low, and will want to borrow less when real interest rates are high, as borrowing is more expensive in the latter case.”
But what about lenders? Wouldn’t they want to lend more when real rates are high, and want to lend less when real rates are low?
You have to think of both borrowers and lenders. Yes, you might predominantly be a lender, but not everyone else is.
“An excessive demand for borrowing could drive interest rates up, but raising interest rates in itself will not cause demand for borrowing to increase.”
Neither will an “excess demand for borrowing” in itself cause borrowing to go up.
We also have to take into account suppliers of loans and their intentions.
“If the Fed were to significantly raise the short term rate now, there’s no reason, as far as I can see, why this would lead to a greater demand to borrow for investment.”
Lending to businesses IS an investment, is it not? If the context is higher interest rates, then that means debt investment pays higher returns.
“If I lend my money to a business, that is a form of investment. However, real investment means producing real things which generate a real return over time which can then pay me a real return on my loan. There’s a difference between real investment and purely financial investment. The latter simply means buying financial assets, which doesn’t necessarily result in actual production of real things.”
But lending money to a producer must earn a return, and the producer wouls have to produce things for sale in order to pay the loan back. But to produce goods, the producer would have to invest in the production of those goods rather than declare a large dividend and increasing their own consumption. A business might do that, but it cannot keep doing that because lenders would soon learn that this company cannot cover their loans with earnings.
you seem to be quibbling over pointless things.
The question is whether there would be more real investment if the central bank raised the short term rate of interest, say tomorrow.
That seems unlikely given that raising the rate of interest would make borrowing to invest more expensive. A higher interest rate is also likely to incentivize people to spend less and to want to save more.
You haven’t explained why you think the central bank raising the short term rate would lead to more investment.
I’ll reply at the bottom where there’s more space.
Philippe:
“you seem to be quibbling over pointless things.”
Not sure if that was meant for me?
“The question is whether there would be more real investment if the central bank raised the short term rate of interest, say tomorrow.”
OK, there might be more or there might be less. It depends on other factors, like what caused the rates to rise. If they rose because of inflation increasing, then that might not lead to any reduction, because revenues and profit rates would be higher, and so the additional interest would be able to be paid off out of additional earnings.
But the question I would like to raise with you is WHICH SPECIFIC investments would be encouraged and discouraged, given an amount of aggregate investment.
“That seems unlikely given that raising the rate of interest would make borrowing to invest more expensive. A higher interest rate is also likely to incentivize people to spend less and to want to save more.”
Which would tend to do what to prices over time? Raise them? Keep them unchanged? Decrease them?
“If they rose because of inflation increasing, then that might not lead to any reduction, because revenues and profit rates would be higher, and so the additional interest would be able to be paid off out of additional earnings.”
Which is why central banks plan to raise short term rates only when they think economic conditions allow it, such as when inflation is higher. If they were to raise rates in the middle of a recession that would have the effect of reducing investment and consumption.
Philippe:
“Which is why central banks plan to raise short term rates only when they think economic conditions allow it, such as when inflation is higher.”
But the central bank is the cause of inflation.
You’re saying that the central bank will only raise rates if their previous inflation was sufficient to…raising rates.
That’s circular. You’re claiming the central bank should only act once the effects of its own past actions are such and such.
What about the actual market? You’re not talking about its recovery. You’re only talking about the results of past Fed actions.
“If they were to raise rates in the middle of a recession that would have the effect of reducing investment and consumption.”
Not if the rise in rates is caused by inflation. Then people would be earning higher incomes and be able to afford the higher rates. For a time…until the errors are once again revealed…
No, there’s nothing circular there. The definition of inflation I am using is the mainstream definition. Central banks will not raise short term rates at present if they think it will lead to a reduction in investment, consumption, and employment, thereby putting the economy back into recession. They will raise short term rates when they think economic conditions allow for it.
I won’t be responding to any more comments in this thread.
Philippe:
“No, there’s nothing circular there.”
There is, and by your comment it seems you don’t see why.
“The definition of inflation I am using is the mainstream definition.”
I know. But you do realize that central banks influence price inflation, right?
Saying that central banks will reduce monetary inflation once price inflation increases at a certain rate, is not taking into account any market recovery. It is a circular argument that goes back to the Fed. You are sayng that the Fed will only reduce its monetqry inflation once the effects of its past monetqry inflation cause today’s prices to rise at a particular sufficiently high rate.
That is not waiting for any market to recover, it is simply waiting for the effects of its own money printing.
“Central banks will not raise short term rates at present if they think it will lead to a reduction in investment, consumption, and employment, thereby putting the economy back into recession.”
Intentions and results are not always the same, especially for violence backed activity.
“They will raise short term rates when they think economic conditions allow for it.”
Economic conditions that they themselves effect,and you don’t seem to see any destructive effects of non-market, violent intervention.
“I won’t be responding to any more comments in this thread.”
OK.
Please don’t delete me for not being relevant!
Anyway, I think I had a pretty revealing argument with LK here:
socialdemocracy21stcentury.blogspot.com/2014/07/what-is-vulgar-internet-austrianism.html
This is the old market clearing prices debate, so I understand if I may get zapped. Its just more proof that LK is arguing against a caricature.
Yes, its amazing how quickly LK and other Post-Keynsians bloggers resort to abuse in the comments of their own blogs. It seems they can’t even answer simple requests for clarifications on their views without throwing in some random name-calling.
If you want to read an amusing comments section on a Post-Keynsian blog see the following:
http://fixingtheeconomists.wordpress.com/2014/07/12/stock-market-crash/#comments
In regards to Tom Woods’ story, I think he’s technically right, but making a big deal out of a bunch of nothing. Seems like a “pick your battles” situation to me. Like, yeah, it’s technically a real jerk thing to press all the buttons on an elevator, and that sort of behavior shouldn’t just be excused with “boys will be boys.”
But at the same time, if the worst thing that ever happens to you by a group of teenage boys is that they force you to wait an extra five minutes for the elevator, that’s not really so bad, all things considered. Getting that outraged over something like this makes me wonder how Tom might respond to being a victim of actual theft or violence. Let’s hope we never find out!
Short and simple answer is because resources are not homogeneous. We have a complex, many tiered production process (and we need that in order to maintain our technology) so a bottleneck at any stage in the process is going to rapidly and nonlinearly devalue the entire production chain.
To elaborate, if you want to regard labour as a resource, then a worker is “consuming” his own labour by converting work hours into leisure hours. In order to bust his buns going to work every day, he would need to expect to get at least as much in return as the effort put in (allowing for subjective values). Return must be not in money (which is an intermediary) but in something useful to this person (what you can buy with money).
Suppose 20 hours per week is enough to live on, what is the return for working 50 hours a week? Some may decide to get a mortgage and buy a house, in which case they are probably paying about 3.5% in the USA and maybe 5% or more in Australia. The incentive to work a bit extra is paying off the mortgage which is an effective return on investment of 3.5% tax free.
What about the situation where this worker either already owns a house or doesn’t want to get deeply in debt to buy one? Sticking money into a savings account doesn’t earn much, and you get taxed on it, and inflation imposes yet another effective tax. Earning more than you need to live on is a waste of time, so now you have a guy working only 20 hours a week. Economists will say, “don’t worry, we have idle resources!” The worker in question says, “I see no value in working any harder.”
Suppose there are plenty of minerals under the ground, more idle resources huh? But those guys working 20 hour weeks are the guys digging up those minerals, and the guys processing those minerals, and all of that is happening only at a very slow rate. Doesn’t matter how large the mineral deposits are, you can have a whole continent of idle resources, ain’t going to increase production.
You can’t meaningfully aggregate human labour as a resource (including a variety of useful skills) with natural resources (also various) to get one big lump sum, then conclude that the existence of idle resources implies we can ignore the supply side. Human labour is a resource available to each individual human, who then may or may not choose to put that resource to work in the economy. Low interest rates (and let’s face it, outright destruction of savings), work to discourage participation.
In a way this is quite a logical outcome, as society becomes more advanced it provides for human needs more effectively, thus the marginal return on more investment diminishes. People already have all of what they need, and most of what they want in material goods so more leisure time is the next most useful thing after that. Poverty in the USA generally means being overweight. Even poor people have air conditioning, and smartphones and flat screen TVs, so cranking up production to get them a bigger house, with two A/C and three TV sets and a smartphone that runs a tiny bit faster is not delivering much utility. It certainly isn’t delivering utility to the highly skilled people who generally get all of that stuff sooner.
Saving for the future has two sides to it: time preference is part of it (am I willing to wait for a deferred reward?) but also the physical system imposes a constraint on what investment can do (is there any point in waiting for a deferred reward?)
Then there’s the intermediation between saver and borrower which is also kind of broken right now (can I find someone willing to promise me a deferred reward, and do I trust them to keep their promise?)
MF would be proud, don’t worry about the details, look at the length!
No doubt someone will throw out the obvious criticism that an agile and dynamic Capitalist system should route around bottlenecks, and discover new and interesting products to offer people, thus encouraging greater participation. Maybe that’s true, but our current system has a lot of regulatory constraints preventing such adaptation. Even with those constraints removed, it may not happen quickly.
As I hinted above, I think we currently collectively have a massive trust problem, and our leadership has a complete lack of credibility. In such a situation, you certainly don’t want to be investing effort now in the hope of getting a fair deal someday.
so I guess you don’t believe in the austrian business cycle theory, then? When the central bank lowers the short term rate this causes investment and consumption to fall?
It increases investment in production processes which do not conform to consumer preferences; And it causes consumption of capital.
Another way of saying this is that it causes investments in the wrong things, assuming the goal is to make profits without violating individuals’ rights.
“production processes which do not conform to consumer preferences”
If those production processes didn’t conform to consumer preferences then people wouldn’t buy the resulting products.
“it causes consumption of capital.”
How?
“it causes investments in the wrong things”
Why are they the wrong things?
“assuming the goal is to make profits without violating individuals’ rights”
It’s funny how you guys always start out with economicky-sounding arguments, and then end up justifying them by appealing to libertarian ethical/political ideology. You guys constantly conflate economic and political arguments. How does a low interest rate “violate individual rights”?
Hang on a moment, you define aggregrate terms like “ïnvestment” and price inflation, then you happily accept that the government can tweak the factors that go into the measurement, and conclude this “proves” that government interference is helping the economy.
That’s very much just ending up appealing to socilaist ideology with an economicly sounding hat on.
Why are they the right things?
no I don’t do those things and no it is not an appeal to socialist ideology.
Yes you do do those things and yes it is an appeal to socialist ideology.
“Why are they the right things?”
I didn’t assert that they are ‘the right things’. guest asserted that they are the wrong things.
There’s a few other factors not mentioned above. In Australia the current business overdraft interest rate is about 8%, while the “official” reserve bank rate has been at 2.5% for more than a year. Normal people can’t borrow money at 2.5% only the banks can borrow at that rate. The Australian government borrows at about 3.5% and mortgage holders borrow at between 5% and 6%.
Because the government can borrow cheaper than regular people (and much cheaper than business) the flow of new money goes to the politically connected, often also to institutions well placed in the financial industry.
Let’s consider the student loan situation in the USA… the lenders have been told that everything is 100% government backed. Because of this perceived absence of risk, lenders offer buckets of money to students. So look at all that “investment” driven by low interest loans. Investment in human capital, must be bloody brilliant! Thing is, while money has been pooring into student loans, the universities have merely been jacking up their fees. This so called “investment” is not supported by new physical resources, it depends instead on a “Cantillon Effect” where the price of education is rising faster than other prices. The most it can do is transfer resources bout of other parts of the economy and into the university system (for example, now the well paid university can bid up the prices of other resources, that will not be available to the business needing to borrow at overdraft rates).
Austrian economics does not believe in the concept of aggregate investment — you cannot sensibly add up a school, a coal mine, and a data center to get a total, you can only add up the dollar values but values are subjective and prices in the above situation are not natural anymore.
Thus, it doesn’t really make sense to say that low interest rates either raise or lower investment on the whole. Firstly we don’t have a single interest rate available to all parties in the economy, and secondly the Cantillon Effect distorts prices to the point where adding up the values isn’t useful, but even if prices were not distorted values would still be subjective.
So what are we left with? For a given resource either government gets to decide where it goes, or private business gets to decide… but the same resource cannot do both. More decisions made by government necessarily must mean less decisions made by agreement amongst private parties.
This is the root cause of mal-investment which gives the appearance of lots of economic activity, but not real economic activity, just diversion of resources away from satisfying private desires over to political interest groups.
“Because the government can borrow cheaper than regular people (and much cheaper than business) the flow of new money goes to the politically connected”
No, it doesn’t necessarily mean that.
“often also to institutions well placed in the financial industry.”
Complete non sequitur. “Because the government can borrow cheaper than regular people the flow of new money goes… to institutions well placed in the financial industry”.
“This so called “investment” is not supported by new physical resources, it depends instead on a “Cantillon Effect” where the price of education is rising faster than other prices.”
More pseudo-economics. You’re now confusing monopolistic or oligopolistic pricing power with ‘cantillon effects’. Econ 101 fail.
The American higher education and funding system is ridiculous. You only need to look at other countries to see that it is perfectly possible to have a higher education system which doesn’t place its students in massive debt.
“Thus, it doesn’t really make sense to say that low interest rates either raise or lower investment on the whole.”
What a load of crap. You really don’t know anything about how investment figures are arrived at do, you.
“More decisions made by government necessarily must mean less decisions made by agreement amongst private parties.”
Not necessarily.
Errr, the government does not have a monopoly position in the market for borrowers, nor does it get cheap loans because of any pricing power. Government prints money and lends to itself at a low price.
What do you think it means when you hear people talk about the central bank setting interest rates?
Observation of reality fail.
if you can keep raising prices without demand reducing or competitition kicking in to bring them back in then you have pricing power.. that has nothing to do with ‘cantillon effects’.
It doesn’t preclude them.
You didn even grasp the basic concepts I was explaining. Demonstrate how you get the sum total value of a school, a coal mine and a data center in a way that is objective and universal.
Go!
A note on “monopolistic or oligopolistic pricing power”:
This so-called power is derived from consumers’ own preferences.
It is only because consumers value something so highly that businesses are able to sell them at high prices.
Price-gouging helps everyone, because real information about consumer preferences are transmitted by the prices.
It lets some (not all) other entrepreneurs know that they can make money by supplying those goods at a lower price.
(Unless the government gets in the way with Anti Trust laws to punish “cutthroat pricing”.)
Consequently, the supply of that good increases while the marginal utility of a unit of that good falls.
A fall in marginal utility means that the good will have to sell at a lower price, all other things being equal.
No government needed.