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jmherbener
ParticipantThey used the housing market to identify the trigger setting off the financial crisis. This made sense in the recent boom-bust because the government’s fostering of mortgage backed securities channeled the credit expansion into housing. When the MBS market reached a peak it was an accurate indication of the unraveling of the entire financial boom.
ParticipantThe premise shared by both sides of your debate is incorrect. The physical aspects of human action are adjusted to satisfy preferences, not the other way around. We don’t change our preferences (e.g., increase consumption) to invigorate production or change our preferences (e.g., save and invest more) to stimulate economic growth, we arrange production to satisfy our preferences, including our time preferences. The economy is our concerted effort to arrange production in a division of labor to best satisfy our preferences. If our preferences shift toward consumption and away from saving, the market economy will shift production away from building up the capital structure to producing consumer goods more directly to give us what we prefer. If our preferences shift toward saving and away from consumption, the market economy will shift production toward building up the capital structure to give us what we prefer.
The problem of the boom and bust is that the monetary inflation and credit expansion of the boom generate a build up of the capital structure that does not satisfy our time preferences. During the bust (i.e., right now), the question is how to economize the transition of the distorted capital structure into the form that best satisfies our preferences. The basic answer is to let entrepreneurs alone to do their task. This task will be made easier if people lower their time preferences. By saving and investing more, they give entrepreneurs command over more resources to make the transition and less liquidation overall will need to be done if time preferences stay lower. The entrepreneurs’ task will be made more difficult if people increase their consumption because they will command fewer resources to make the transition and more liquidation will need to be done if time preferences stay higher.
The problem with the argument that consumption spending determines investment spending through the interconnectedness of production through the capital structure (instead of saving determining investment spending via time preferences) is that it ignores time. Mining company entrepreneurs must spend now to buy inputs to produce iron, then, steel companies must spend in the near future to buy the iron and other inputs, then, auto companies must spend in the later future to buy the steel and other inputs, then, consumers spend in the even later future to buy the autos. Obviously consumption today can only generate revenue in the future for producers. But, the goods must already have been produced to be bought and paid for by consumers. Therefore, producers must have saved and invested in the past to produce the goods sold today and must be saving and investing today to produce the goods which will be sold in the future. In a market economy the inter-temporal dimension of production is account for through the time market,
ParticipantDemand for credit has collapsed, which is not unusual during a bust. Both consumers and entrepreneurs take on too much debt during the boom and pay it down during the bust.
Interest rates move down if either demand declines or supply increases. You can tell the difference between the two cases because a decline in demand will reduce the quantity of the good traded (in this case present money lent) while an increase in supply will increase the quantity of the good traded. Since both the interest rate and the quantity of credit have declined, we know that demand for credit fell.,
The banks did an asset swap with the Fed during the crisis. They sold mortgage backed securities to the Fed in exchange for reserves (bank accounts at the Fed that pay interest). Reserves serve as the basis for issuing fiduciary media. Banks have, so far, been content to hold reserves and not issue more fiduciary media by creating new credit. This is in part because the prospects for the loans will not pay high enough interest rates to compensate them for putting risky assets back on their balance sheets. There is some evidence, however, that bank credit may be thawing, in which case we’ll get to see if Bernanke’s tools work to restrain monetary inflation.
ParticipantWhat industries are most affected vary from one cycle to the next. It depends on historical factors contingent to each cycle. It was radio in the 1920s, computers in the 1960s, dot.coms in the 1990s, housing in the 2000s. Historical work gives an account of the contingent factors.
Take a look at Tom Woods’s book, Meltdown.
The primary cause of business cycles is monetary inflation and credit expansion generated by a government supported money and banking system characterized by central banks and fractional-reserve commercial banks. Yes, the entire capital structure is distorted by monetary inflation and credit expansion. At the height of the bust, 15 million people were unemployed. the majority of them did not have jobs building houses before the bust. BLS data show that employment in construction and extraction occupations was around 5% of all employment in the U.S. in 2011.
http://www.bls.gov/cps/cpsaat09.pdf
Census Bureau data show that new single family house construction is only around 1/5 of total construction spending in the economy and total construction is a small part of overall production.
https://www.census.gov/construction/c30/pdf/privsahist.pdf
Housing construction is a small fraction of all production in the economy. Housing was a conspicuous, but not major, part of the recent boom-bust. In every cycle, the press draws our attention to a signature industry. By doing so, it draws our attention away from the more important aspects of the cycle.
ParticipantKirzner wrote no general treatise on economics. Instead, his writings tend to be topical. His most well-known work, for example, is on entrepreneurship. So, unless you have an deeper interest in the topics he addresses, Kirzner isn’t the best source for being introduced to Austrian economics.
Joe Salerno discusses Kirzner in the context of the Austrian school:
ParticipantHere are a few articles on Greenspan that try to explain his views.
ParticipantNot exactly. The argument is that banks create credit out of thin air by issuing fiduciary media. If all the created credit went to mortgages, it would push mortgage interest rates down while other interest rates would stay the same. But then banks would earn more profit from additional fiduciary media issue by lending it into other loans types of loans. So banks arbitrage the create credit across all types of loans according to people preferences (and state interventions).
If all the created credit went into mortgages, then the capital structure would not be built up. Instead it would be expanded in those parts that support housing and would be shrunk in those parts that support other consumer goods.
The primary distortion of the business cycle called “lengthening the capital structure” comes about through producer loans and present money lent directly into the capital structure. The secondary distortion of the business cycle occurs in shifting production toward certain consumer goods bought on credit and away from other consumer goods. These two distortions are intertwined during the business cycle.
Because the effects in these consumer goods industries are secondary, the government’s efforts to boost their demand to boom time levels, even if it could be done, will not restore the economy to normalcy.
ParticipantConsider the operation of the time market in the unhampered market economy. People with higher time preferences borrow from people with lower time preferences. The level of the rate of interest clears the market so that the quantity demanded and quantity supplied of present money are the same. The present money is allocated across the time market into consumer loans, producer loans, and the capital structure so that no further arbitrage profit arises. Only that portion of present money lent into production goes to capital projects across the capital structure. Consumer loans do not build up the capital structure, but merely transfer consumption from lower time preference people to higher time preference people. For example, let’s say that the people making consumer loans reduce their demands for clothing while people who borrow increase their demands for cell phones. Then the capital structure supporting the production of clothing (spinning cloth, growing cotton, etc.) will shrink while the capital structure supporting the production of cell phones (producing chips, touch screens, etc.) will grow. The overall capital structure will not be built up. Capital production will merely shift from areas with smaller demands to areas will greater demands.
The business cycle is inter-temporal mal-investment. Central bank monetary inflation and credit expansion increase the supply of credit beyond what people’s time preferences dictate. The increase supply of credit is arbitraged into the different areas of the time market so that no additional profit in shifting it is possible. That portion of the new credit going into producer loans and the capital structure allows entrepreneurs to lengthen the capital structure by building up capital goods in the higher and intermediate stages of production. The build-up of the overall capital structure proves to be unsustainable because it fails to satisfy people’s time preferences. The build up of the capital structure supporting the areas of production stimulated by consumer loans (housing, autos, etc.) is part and parcel of the overall lengthening of the capital structure.
ParticipantThe investor borrows by issuing overnight repos which he renews each day. He pays 10 basis points to borrow overnight money because the Fed has pushed the Fed Funds Rate to that level. He then invests the funds in T-bonds paying 200 basis points and earns 190 spread. If the bond price begins to fall (i.e., its interest rate begins to rise), he loses capital on his investment. So, he sells and then pays off his repos instead of renewing them.
Stockman calls this “carry trade” because the investor is aiming to earn the spread between interest rates but faces the possibility of losses from adverse movements in bond prices just as the carry trade in foreign exchange seeks to earn an interest rate spread but can suffer losses from adverse movements in exchange rates.
ParticipantHe explains the division of payments a few pages after the quote you give. On page 268, he shows that if there are five workers each to be paid at the end of five years when the steam engine is sold for $5,500 and the rate of interest if 0.05, then the payments would be.
1st worker who waits four years to be paid: $1,200
2nd worker who waits three years to be paid: $1,150
3rd worker who waits two years to be paid: $1,100
4th worker who waits one year to be paid: $1,050
5th worker who gets paid immediately: $1,000This division is necessary to make the total $5,500 with the rate of interest 0.05.
The present value of the 1st worker’s effort four years before completion of the steam engine is $1,000. That is $1,000(1.05)(1.05)(1.05)(1.05) = $1,215
The PV of the 2nd worker’s effort is $1,000(1.05)(1.05)1.05) = $1,157
For the 3rd worker $1,000(1.05)(1.05) = $1,102
The 4th $1,000(1.05) = $1050
The 5th $1,000
As B-B says, his figures do not compound the interest.
ParticipantIf a Fed generated monetary inflation and credit expansion had its effects only domestically, it would lower the dollar’s purchasing power in the U.S. and extend credit to less profitable investment projects in the U.S. Because dollar-denominated credit markets are worldwide, arbitrage opportunities would then arise. Investors could profit by extending credit to investment projects overseas that are still earning the higher pre-inflation rate of return. Because Fed monetary inflation has made the purchasing power of the dollar higher overseas, people can gain by spending dollars there and foreigners will hold the additional dollars until it purchasing power is the same in the U.S. as in foreign countries.
ParticipantThe question seems to rest on a false assumption, namely, that market prices must always favor the buyer. In other words, it presupposes that if this scenario happens, then there is a market failure. The market, however, is concerted effort. It’s the attempt of people to arrange a division of labor to economize production.
As to the scenario itself, an entrepreneur maximizes his revenue by asking the price at the mid-point of his demand curve (where demand is unit elastic). Any other price, either higher or lower, reduces his revenue. If entrepreneurs act together, this principle is true of their overall demand. With a given demand for the product, entrepreneurs would lose revenue when they restrict supply and begin to sell at the higher price.
Take a look at the lecture on Competition and Monopoly.
Of course, it could be the case that the unit elastic point of the joint demand for the entrepreneurs’ product is at a higher price than the unit elastic point of any of the entrepreneur’s demand when they do not act together. But in that case, they must sell less at the higher price to earn more revenue. In other words, they must not dump their supply on the market, but continue to restrict it to maintain the higher prices and larger revenue.
Take a look at Murray Rothbard on cartels in Man, Economy, and State.
ParticipantIntermediate capital goods become part of the output that is sold to the next stage of production. So, the entrepreneur does not retain possession of intermediate capital goods. When he sells his output, they go with it. But he retains ownership of his plant, equipment, improved land, and other assets. Even though some portion of them are used up in production (and he depreciates his asset values to account for that), he retains possession of them when he sells his output.
ParticipantInvestment counts only if it’s for assets held by the entrepreneur and used by him in production. If an auto company builds a new factory or buys new equipment, it’s included. But the tires, paint, steel, and all other intermediate capital goods the company buys are not included. Intermediate capital goods are not held by the company as final user, but pass to the next stage of production.
ParticipantThere is no such thing as stability of prices. The very concept is a chimera. As long as we change as human persons and change the world through our actions, prices will change.
Moreover, neither rising nor falling prices in general make it more or less difficult for entrepreneurs to estimate the prices relevant to their own production. If prices in general rose 2 percent per year or fell 2 percent per year, it would add no difficultly to entrepreneurial prediction.
Finally, money production in the market is regulated by profit, which is itself subject to entrepreneurial speculation. Prices in general, then, have as little volatility as possible. With the state inflating fiat paper money, waves of price changes are constantly rippling through the entire market. And if the monetary inflation is done through credit expansion, it generates the volatility called the boom-bust cycle.
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