Whenever economic activity stagnates or declines, they quickly lower their interest rates and expand their credits. But when business seems to improve, they hesitate and vacillate in removing the rate cuts. The consequence is a permanent addition to liquidity. According to calculations of the German central bank, between the end of 1997 and September 2006 the stock of world money nearly doubled, but nominal economic production rose only by some 60 percent. Such an imbalance is bound to either cause consumer prices to rise or create price bubbles in stock, loan, or real estate markets. When they finally burst they are likely to inflict many personal losses and force businesses to repair and readjust.
Every week we may hear and read about new corporate mergers and acquisitions. Flush with cash, private equity firms are ever ready for more dealmaking, bidding for and acquiring another company. The merger and acquisition boom is buoying stock prices across the board, which is benefitting most investors. Moreover, as some corporations are being taken private and others are engaged in stock buybacks, thereby reducing the overall supply of corporate shares, the stock market is enjoying an extraordinary boom which many investors hope will never end.
Some economists are scoffing at such optimism; they like to point at the bursting of the bubble in 1929 which led to the Great Depression of the 1930s. They also remember the bursting of the Japanese bubble in the early 1990s, which kept the Japanese economy depressed for nearly a decade. And they cannot forget War II and postwar monetary policies which, by the beginning of the 1970s, had flooded the world with U.S. dollars. Some countries finally removed their currency ties to the dollar, and the oil-exporting countries cut their supplies of oil, which caused raw-material prices to soar. In the early 1980s, it took major Federal Reserve restraint to restore some measure of stability and several years for business to repair some damage and allow the American economy to expand again. At the present, government planners and central bankers are making the same mistakes all over again. They all seem to like low interest rates, thereby rendering capital less expensive. When real interest rates are depressed, as has been the case all over Europe and in the United States early in the present decade, the economy loses a sense of direction, which may allow even unproductive producers to remain in business. In the long run, without the guidance of true market rates of interest, economies lose efficiency and productivity.
In a free economy, interest rates play a role similar to those played by prices and wages. They all spring from the peoples choices and value judgments, giving rise to demand and supply and guiding producers in their decisions. The market rate of interest is a gross rate usually consisting of three distinctive components: the pure rate, the depreciation rate, and the debtors risk premium. The pure rate is the very core stemming from mans very nature which forces him to view economic phenomena in the passage of time. He ascribes a lower value to future goods and conditions than to present provisions; the difference is the pure rate. The depreciation component appears whenever government or its central bank inflates, thereby depreciating the currency; the rate of currency depreciation determines the size of the component. The debtors risk premium, finally, reflects the reliability and trustworthiness of the debtor.
Central bankers rarely pay attention to the market rate. Their policies are guided by popular doctrines calling for stimulation of national employment and income. They seem to be unaware that all rates other than market rates give false signals to producers and consumers alike; they cause maladjustments. Rates that are lower than market rates promptly increase the demand for credit. With all recent rates below the market rate it cannot be surprising that total American debt has surged by several trillion dollars. Last year, household debt alone rose by more than one trillion dollars. The federal government itself has been adding more than two billion every day. The Federal Reserve System, together with some 7,900 commercial banks, provided the funds; and foreign central banks and commercial banks invested their dollar earnings in nearly one-half of the federal governments debt.
Such credit expansion, unsupported by genuine savings and capital formation, generates illusionary gains making people believe that they are more prosperous than they actually are. Stock and real estate prices soar, tempting people to spend their gains, improve their homes and build mansions. Actually, they all– businessmen and stockbrokers, executives and workers– may consume their material substance. But no matter how low the Federal Reserve may set its rate, the boom is bound to come to an end as soon as the maladjustments inflict losses on business. As more and more businesses face difficulties or even fail, the readjustment begins, forcing them to respond to the actual conditions of the market.
{ 17 comments }
I have followed and used the concept of economic liquidity in my stock market analysis since the late 1970s. I always looked at two things driving stock markets, earnings and valuation. Valuation alway seemed to be a function of monetary policy as things like real MZM growth were leading-concurrent indicators of the stock market PE and frequently played a much larger role in stock market changes then earnings. But now we have everyone discussing liquidity driving markets when the US stock market PE is falling as earnings are growing faster then the stock market.
So if this is a liquidity driven market why is the market PE falling? The current analysis of liquidity just does not fit with the concept of liquidity that I have used very successfully for decades.
There are two inflations. Money inflation mostly effects people who loan money and helps those who borrow money.
Work hour inflation hurts those who work for wages and those who consume a large percentage of their assets for daily living. They must work longer to maintain consumption at a steady rate. It doesn’t hurt multimillionaires who live off interest money and stock trades.
spencer,
I think the high PE’s have something to do with companies using all the liquidity to buy back shares instead of making capital expenditures.
IMHO, the real problem isn’t money (read inflation) flooding the markets, or the interest rates, those are symptoms. The real problem is that all new capital in the economy comes from the fed and not from savers. That power takes control away from the savers, and causes harm for the same reason any central planned economy causes harm.
Housing is a classic example. Houses don’t generate new productivity and the wealth they create is inflation, in a rational economy I don’t think much capital would be loaned out for people to buy houses at all.
I have seen suggestions that the problem is a glut of savings, especially in third world countries. What do you think?
inflation, the problem of too much money chasing fewer goods, at the beginning, will tend to increase the prices of the goods some producers are making therefore, increasing their profits.
however, little they know that their depreciation cost (something they don’t have to pay for right know) is increasing at an equal or higher amount than their prices, the unpleasant surprise to them will come latter(ask GM or Ford). some, can even be making a lost when they think they are making a killing.(depends on the industry they are in).
that is the problem with inflation , nobody knows until it is too late. money is not neutral , remember?!. so,always keep in mind, inflation is a monetary phenomenon, how it affect prices is much more complex and mysterious than the plain and simple CPI number they want to sell us as “inflation”.
olmedo
re spencer: PEs may have been dropping, but I believe they still are far above average and present a yield below inflation (however measured) or UST yields. It would be interesting to see an analysis of past inflations and the effect on PEs. I would expect to see increased earnings as an effect of the inflation working through the economy (people buying more things).
“Housing is a classic example. Houses don’t generate new productivity and the wealth they create is inflation, in a rational economy I don’t think much capital would be loaned out for people to buy houses at all.”
This is the argument the fellow (Rich Dad, Poor Dad) makes on TV and it makes sense. A house is only an investment to a person who can’t defer gratification and plan ahead. I have a house free and clear because I am a worrying type of person and want to be able to grow veggies and chickens in the back yard if the stuff hits the fan. I would be dollars aheadf if I had rented for the last 50 years and put the difference in the stock market – or in rental housing.
There can be no such thing as a “glut of savings” – if we are talking about REAL savings, i.e. people choosing to save (rather than consume) part of their income. Even if people choose to save 99% of their income and live on only 1% (i.e. wildly restrict their present consumption) there would not (contrary to the school of Lord Keynes) be a problem.
As every student of the Austrian school knows, the problem comes when various other means (i.e. the complex games of credit expansion) are used to finance borrowing – on top of the borrowings that are financed by real savings.
As Murry Rothbard was fond of pointing out, it is the credit-money bubble games that are the cause of the boom-bust problem – not the amount that people choose to save.
That is why such words as “over saving” or “over investment” miss the point.
Hans F. Sennholz: “Whenever economic activity stagnates or declines,”
A praxelogical impossibility, by definition of action. If one chooses leisure over work, they by definition increase their wealth. Likewise if one chooses “economic activity” work over leisyre, they also by definition increase their wealth.
Hans F. Sennholz: “they quickly lower their interest rates and expand their credits.”
Only if by definition both parties increase their subjective wealth by so doing, by definition of trade.
Hans F. Sennholz: “The consequence is a permanent addition to liquidity.”
“Liquidity” is a maldefined term. All “capital goods” are permanent additions. So are all “intellectual ideas”, from literature to music.
Hans F. Sennholz: “According to calculations of the German central bank, between the end of 1997 and September 2006 the stock of world money nearly doubled, but nominal economic production rose only by some 60 percent. Such an imbalance is bound to either cause consumer prices to rise or create price bubbles in stock, loan, or real estate markets.”
False. There can never be an “imbalance” from voluntary trading, no matter what the goods or services. If there’s more “money”, people may will exchange fewer goods and services for that “money”, just as if there’s more “goods and services”, people may well demand less/fewer “money” for those “goods and services”.
Hans F. Sennholz: “When they finally burst they are likely to inflict many personal losses and force businesses to repair and readjust.”
How’s the hoola hoop businesses today? Still hurting from a burst bubble?
Hans F. Sennholz: “Some economists are scoffing at such optimism; they like to point at the bursting of the bubble in 1929 which led to the Great Depression of the 1930s. They also remember the bursting of the Japanese bubble in the early 1990s, which kept the Japanese economy depressed for nearly a decade.”
All misdiagnoses, which did not properly account for violent restrictions on trade, and false measurements of “economic activity”.
Hans F. Sennholz: “In the early 1980s, it took major Federal Reserve restraint to restore some measure of stability and several years for business to repair some damage and allow the American economy to expand again.”
Economic activity “expands” with every action of every individual.
Hans F. Sennholz: “At the present, government planners and central bankers are making the same mistakes all over again. They all seem to like low interest rates, thereby rendering capital less expensive.”
Those that trade “capital” for other things like “money” are too stupid to voluntarily know what and what does not increase their subjective wealth , by definition of trade? It’s a miracle Austrians haven’t called for a benevolent government police agency to keep people from making trades which leave them worse off.
Hans F. Sennholz: “When real interest rates are depressed, as has been the case all over Europe and in the United States early in the present decade, the economy loses a sense of direction, which may allow even unproductive producers to remain in business.”
Real interest rates can never be “depressed”. “The economy” can never “lose a sense of direction”, by definition of action and trade. It’s also a praxelogical contradiction for “unproductive producers” to “remain in business”.
Hans F. Sennholz: “In the long run, without the guidance of true market rates of interest, economies lose efficiency and productivity.”
So too do economies “lose efficiency and productivity” from ever changing fickle subjective valuations. Would we be better off electing a Stalin to issue non-”wasteful” or non-”necessary” production orders?
Hans F. Sennholz: “The market rate of interest is a gross rate usually consisting of three distinctive components: the pure rate, the depreciation rate, and the debtors risk premium. The pure rate is the very core stemming from mans very nature which forces him to view economic phenomena in the passage of time. He ascribes a lower value to future goods and conditions than to present provisions; the difference is the pure rate.”
Thus, nobody would ever buy winter gloves in the fall, in anticipation of winter? Nobody would carry around an umbrella, unless it was actually raining?
Hans F. Sennholz: “The depreciation component appears whenever government or its central bank inflates, thereby depreciating the currency; the rate of currency depreciation determines the size of the component.”
So too does the “depreciation component” appear whenever more of anything is produced. Are the extreme environmentalist leftists correct that all human activity causes poverty for the anthropomorphic planet?
Hans F. Sennholz: “Central bankers rarely pay attention to the market rate.”
Why should they? They are violent thugs taking what they want to take. Nice of them to have learned from history that it’s not productive to sow your defeated enemies’ field with salt? We should be thankful they take as little as they do?
Hans F. Sennholz: “They seem to be unaware that all rates other than market rates give false signals to producers and consumers alike; they cause maladjustments.”
False signals are a praxelogical impossibility whenever and wherever voluntary trade is occurring. Thus, there can be no “maladjustment”.
Hans F. Sennholz: “Rates that are lower than market rates promptly increase the demand for credit. With all recent rates below the market rate it cannot be surprising that total American debt has surged by several trillion dollars.”
Or maybe credit is subjectively more valuable than in the past. Identity has no value to thieves?
Hans F. Sennholz: “Such credit expansion, unsupported by genuine savings and capital formation, generates illusionary gains making people believe that they are more prosperous than they actually are.”
Raise your hand if you knew Karl Marx wrote the Austrian Business Cycle Theory.
Hans F. Sennholz: “Stock and real estate prices soar, tempting people to spend their gains, improve their homes and build mansions”
People aren’t better off with gains, improved homes, and mansions?
Hans F. Sennholz: “But no matter how low the Federal Reserve may set its rate, the boom is bound to come to an end as soon as the maladjustments inflict losses on business.”
Nor matter how high credit card companies may set their rates, the boom is bound to come to an end as soon as changes in subjective valuations signal less of this, more of that.
Hans F. Sennholz: “As more and more businesses face difficulties or even fail, the readjustment begins, forcing them to respond to the actual conditions of the market.”
Circular reasoning, with assumed premises *and* assumed conclusion, with no explanation as to why people are “stupid” earlier, and “smarter” later, so as to begin “readjustment”. Yes, another glorious rtr sinking of the ABCT flagship. Talk about “malinvestment” of sending out the theory again and again … it’s no wonder the primary argument against the Federal Reserve and fiat money has failed.
http://au.us.biz.yahoo.com/seekingalpha/070521/36012_id.html?.v=1
I noticed the above article while perusing Drudge today. What I picked up on was the fact that China is ratcheting its reserve requirements up. That fact is not insignificant. Sadly, I think it will be far too little, far too late. I do agree with the author that China is headed for big trouble.
rtr states….Economic activity “expands” with every action of every individual.
is this economic expansion……”The federal government owns a tremendous amount of property, including land. It owns 84.5% of the land in Nevada, 69.1% of the land in Alaska, and 57.5% of the land in Utah. The sale of Nevada could generate a significant amount of revenue.”
http://mises.org/daily/2559
….”The most appropriate measure of the level of taxation is government spending. In seven years, from fiscal year 2001 to the proposed budget in fiscal year 2008, federal spending will increase from $1,863.2 billion to an estimated $2,901.9 billion, an increase of 55%. Actual spending in 2008 will probably top $3 trillion…..”
i mean if you steal enough money and dump it it sone place or a few places, something will happen…but i dont know if you can call that economic expansion.
rtr states….”Or maybe credit is subjectively more valuable than in the past. Identity has no value to thieves?”
If credit isunneled into wartime activities …….”For example, the current US war on Iraq is estimated to have cost roughly $346 billion from its inception in 2003 until the present.[18] During this time, the change in the Adjusted Monetary Base (MB), which is completely controlled by the Fed and represents the “seigniorage” or inflation tax that the government realizes from money creation, has been about $137 billion. But the rate of growth of MB has steadily declined from mid-2002 from 10 percent to below 5 percent currently. This is reflected in a decline in the rates of growth of broader monetary aggregates such as MZM, M2, and M3. Yet at the same time, US Federal Government debt has ballooned by nearly $2 trillion since March 2003, expanding the total debt accumulated since the inception of the American Republic by over 30 percent! How has this flood of new debt been financed if not by money creation?
The answer is by borrowing from foreigners. In March 2003, foreign investors held about $1,286.3 billion of Federal government debt. By June 2006, foreign investors were holding $2091.7 billion of the debt, an increase of $805.4 billion or over 40 percent of the increase of the total debt since March 2003.[19] In other words, foreigners have by and large financed the US imperialist adventure in Iraq, greatly mitigating the economic burden of the war borne by US taxpayers and consumers — at least until foreigners refuse to absorb any more US debt. At this point increased taxation and more rapid money creation must be resorted to in continuing to finance the war as well as the interest payments on the outstanding debt.” http://mises.org/daily/2405#4
This to me doesnt seem subjectivly more valuable. This seems reckless and deadly.
Of course taxation and theft do not increase subjective wealth. But is economic activity. The individuals who run the State, choose violent means rather than free market means upon which to make a living. That’s still an economic choice. It’s one which results in immediate net poverty, lower net wealth. But it still remains irrefutable that voluntary trade transactions only occur because they increase subjective wealth for both parties to the exchange.
Thus, no business can malinvest in any activity whatsoever due to an increase of money or credit, any more than due to an increase or decrease of any other thing. Why bandy about with false theories when the definition of trade proves that wealth is created with voluntary transactions? That’s the *only* reason trade occurs. People don’t trade things for “credit” unless that “credit” is subjectively more valuable than those things which are traded in exchange for it.
i guess.
but this…rtr “Of course taxation and theft do not increase subjective wealth. But is economic activity. The individuals who run the State, choose violent means rather than free market means upon which to make a living. That’s still an economic choice.”
‘Forcing’ a steel girder up on a building with a crane seems to be an economic choice. forcing someone else to pay for it doesnt seem ‘economic’ to me. that seems anti-economic. the oppposite of trade and exchange.
In being a tad crass, a scenario where a robbery could amount to exchange whereby both parties come better off might look like this (as inspired by rtr?):
A robber with a gun demands Joe hands over his money or risks death. Joe complies and hands over the money. The robber is happier cause he got what he wanted – money. Joe is ‘happier’ because he got what he wanted – to keep his life.
Right, it’s still an economic choice to prefer a lesser violence than a greater violence. All choices, all actions are economic, by definition of one form of action being chosen as opposed to another form of action. Economics is a “disinterested” science.
Violence is not trade. Trade increases the subjective wealth of both parties to exchange. The one who is robbed is not voluntarily turning over his money, is not subjectively wealthier after the robber takes his money by threat of violence. He is certainly better off to be alive rather than dead, by definition of his choosing to hand over the money rather than be killed. It’s an error to maintain both are subjectively wealthier from the transferance of the victim’s money to the robber. Clearly the victim is worse off. Clearly that is not voluntary trade.
I take it all those “in the know”, realize the ABCT is irrecoverably sunk.
rtr No we are not.
rtr(Hans F. Sennholz: “Whenever economic activity stagnates or declines,”
A praxelogical impossibility, by definition of action. If one chooses leisure over work, they by definition increase their wealth. Likewise if one chooses “economic activity” work over leisyre, they also by definition increase their wealth.)
rtr, Why the pointing out of something outside your arguement? If the words economic activity are replaced with the word production, which has the same meaning as orginally intened. I know that doing this seems a bit hypocritcal but I am tired of wadeing through a half page of useless arguements to find the one that is relevant to the situation.
rtr(Hans F. Sennholz: “they quickly lower their interest rates and expand their credits.”
Only if by definition both parties increase their subjective wealth by so doing, by definition of trade.)
rtr, We are talking about the big picture. Not just one incedent. The only reason that the banks accept this printed money is that they benefit by being one of the first in line to accept the money. They know they will benefit because the government will force acception of its money by legal tender laws. (rtr I am sure you are for the reapelment of legal tender laws, and you might be also like the idea of no taxes on gold and silver)
rtr(Hans F. Sennholz: “Some economists are scoffing at such optimism; they like to point at the bursting of the bubble in 1929 which led to the Great Depression of the 1930s. They also remember the bursting of the Japanese bubble in the early 1990s, which kept the Japanese economy depressed for nearly a decade.”
All misdiagnoses, which did not properly account for violent restrictions on trade, and false measurements of “economic activity”.)
Again if you put the word production in for econ activity… Also violent restrictions on trade have been the norm and not the exeption in history. While these were contributing factors they were not the cause of the collapse.
rtr(Hans F. Sennholz: “At the present, government planners and central bankers are making the same mistakes all over again. They all seem to like low interest rates, thereby rendering capital less expensive.”
Those that trade “capital” for other things like “money” are too stupid to voluntarily know what and what does not increase their subjective wealth , by definition of trade? It’s a miracle Austrians haven’t called for a benevolent government police agency to keep people from making trades which leave them worse off.)
rtr, The newly printed money has the same value as nonprinted money. How are people supposed to tell the difference? (All paper money is replaced by new bills every so often with no inflation) Also, they may benefit from the printing of the money, but they are getting less than the people that bought the capital from them and less than the person he recived it from. The trade is not what would leave them worse off, it is the printing of the money.
Because I am to lazy to refute your entire (huge) entry I’ll state the following two facts.
Legal tender laws do not allow for an entirely free market.
Most people equate production with economic activity. (I make the same distiction you do however.)
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