Reply To: Some ABCT questions


If a central bank lowers interest rates by increasing the money supply, let’s say I own an oil company and now I invest in purchasing more drilling equipment (a capital good) in order to drill and produce more oil. Why is that a misallocation because the funds were not saved first? Isn’t that something that we needed/wanted in society, that would have been built lets say in two years anyway and we just built it in advance?
(Emphasis added)

First it’s worth remembering that money is a medium exchange used to represent resources; it is not, actually, the other resources itself. Thus the problem with tinkering with the money supply – either by printing more, or artificially suppressing interest rates (which is usually done by the former means, but can be done by fiat), which leads people to think there is more of it than there really is. The point is that such artificial methods distort the usual price signals.

Note that ABCT does not claim to know which investments are malinvestments. Now people using ABCT can make a SWAG, informed by other data, as to what the malinvestments might be, but the theory in-and-of-itself doesn’t say “such and such an investment is going to be a malinvestment.”

So you cannot know for sure that the drilling equipment itself will have been a malinvestment. under normal market circumstances, you may have evaluated (as an entrepreneur) that it’s an investment you can’t afford to make at that time, or you may not have.

Note also that ABCT does not claim that only malinvestments will be affected by the market dislocations resulting from artificially low interest rates (or the cycle of fractional reserve banking itself).

The other thing your question implicitly forgets is that we live in a world of scarcity; under perfect circumstances, society as a whole may need/could use more of almost any good – energy, for example. (Note that this is important to remember: in public policy debates, people will often assert that there are “unmet needs” in, say, public education or public health, as if this is a trump in arguing for greater budgets. But scarce resources implies that there are always needs/wants that are unmet, that go unfulfilled. It’s a matter of prioritizing these under the resource constraints; and yes, this includes time-delays awaiting more resource availability).

So it’s not even a question of whether the additional drilling equipment would be, in some general sense, good to have. Just as in the master builder analogy it’s not a question of whether a bigger house would be nicer to have than a smaller house: it’s the fact that the resources implied by the market signal that artificially low interest rates do not actually exist (see also “money doesn’t grow on trees” – real investable resources do not expand simply because someone adds more numbers in a computer implying that they do).

So for example you’ll see a lot of nice buildings that, individually, may be very good buildings – but which aren’t filled because the demand for commercial buildings isn’t as high as people thought. Or you’ll see house construction (and price) simultaneously soar, but then crash, with housing developments going unfilled do to demand actually be insufficient (at a price that justified the initial investments made on the basis of artificially low interest rates), even though it is obvious that “society” “certainly needs” nice new homes. Or you’ll see investments in “green technology” be complete boondogles, even though in a perfect world – we shouldn’t be ideological about this – it would be nice if we had affordable low-emissions/efficient, low-polluting vehicles, energy, power plants, and the like. But the investments (whether made directly through fiscal subsidy or indirectly through low interest rates enticing people into thinking it is worthwhile to go into those fields) are failures on the market because their is insufficient demand for them at the price point that would justify the investment.

Artificually low interest rates imply greater demand than actually exists – both for present consumption (if interest rates are low, people will save less and consume more in the present) and investment (if interest rates are low, people will want to borrow more to invest in long-term projects) – than actually exists. Keynsians and other equilibrium-model/simplified-model economists take this implication of higher demand to mean (or create) actual higher demand. But ABCT, essentially, shows that this is an illusion.