Patterico's Pontifications

12/20/2014

The Austrian Theory of the Business Cycle: Part Two in An Occasional Series of Posts on the Fed

Filed under: General,The Fed — Patterico @ 3:17 pm

One of my commenters, Dana (but not the Dana who posts here), responded to my assertion that the Fed has contributed to booms in the stock market and housing sector with the following comment:

Caused by the Fed in what way? If you are saying that the Fed has done so by working to keep interest rates low, I’d agree, at least in part, but the Fed really had little choice in this: the Fed was attempting to help economic growth following the downturns in 1991 and 2001, and there would have been no support at all for raising interest rates at those times. Since economic growth wasn’t as strong as people would have liked, especially following the 2001 recession, all of the pressure was for keeping rates low.

I started to write a response and realized that, with the amount of energy it was going to require, I might as well make it into a post. In June I argued that ending the Fed is a free market solution, and promised future posts on the Austrian theory of the business cycle and related concepts. Now is as good a time as any to continue the project.

The implicit assumption underlying Dana’s comment is twofold, and is held by most mainstream economists: that 1) the proper response to an economic downturn is to lower interest rates, and 2) the Federal Reserve should be entrusted with manipulating interest rates to make macroeconomic corrections in the economy.

I believe both assumptions are misguided. To explain why, I need to explain the Austrian theory of the business cycle.

The Austrian theory of the business cycle, developed by Ludwig von Mises and refined by F. A. Hayek, addresses the following question: why is it that there are times when all entrepreneurs seem to be making bad decisions, all at the same time? The free market, of course, assumes that many entrepreneurs will make bad business decisions — and when they do, their businesses should fail, to make way for better ones. But in this process, entrepreneurs with better foresight should succeed — in other words, the market selects for the very best entrepreneurs. So it seems odd, then, when in a recession or depression, great numbers of these people all make bad decisions, all at the same time. What explains that? Why would all the very best entrepreneurs all make bad decisions at once?

The answer lies in banks, especially central banks, engaging in artificial credit expansion and (worst of all) manipulation of interest rates.

Imagine a world with no Federal Reserve setting interest rates. In this hypothetical Shangri-La, the market would set interest rates. So: what would cause interest rates to go up and down? The conclusion is simple if you think of credit as a good, like any other good, subject to the laws of supply and demand. The more credit is available, the cheaper it will be — and the less credit is available, the more expensive it will be. If banks have a lot of money to lend, they will have to compete with one another to get people to borrow from them — and that means lower interest rates. If banks have very little money to lend, then demand will increase relative to supply, and borrowers will have to compete for that limited credit by offering higher interest rates. Easy enough so far, right?

Now, when do banks have a lot of money to lend? If you take the Federal Reserve out of the picture, the answer is: banks have a lot of money to lend when a lot of people are putting money in the bank. Consumers are usually in one of two modes: either they are spending a lot, or they are saving a lot. When they are saving a lot, two things happen: 1) banks have more money to lend, and interest rates naturally should go down, and 2) there is less demand for consumer products, because consumers are spending less.

Businesses, like consumers, go through natural cycles. Sometimes they are focused on long-term expansion — things that are not going to pay off today, but which will increase production capacity years into the future. This includes activities like research and development, or building factories. Conversely, sometimes businesses are concerned with providing more consumer goods right now, and put long-term expansion on the back burner.

At this point we need to take a small step back and provide a couple of necessary definitions. (Don’t worry: it’s very simple stuff.) Even the simplest good has an entire production structure behind it. For example, Milton Friedman popularized Leonard Read’s example of the lengthy production process involved in manufacturing a pencil in his series “Free to Choose”:

Look at this lead pencil. There’s not a single person in the world who could make this pencil. Remarkable statement? Not at all. The wood from which it is made, for all I know, comes from a tree that was cut down in the state of Washington. To cut down that tree, it took a saw. To make the saw, it took steel. To make steel, it took iron ore. This black center—we call it lead but it’s really graphite, compressed graphite—I’m not sure where it comes from, but I think it comes from some mines in South America. This red top up here, this eraser, a bit of rubber, probably comes from Malaya, where the rubber tree isn’t even native! It was imported from South America by some businessmen with the help of the British government. This brass ferrule? [Self-effacing laughter.] I haven’t the slightest idea where it came from. Or the yellow paint! Or the paint that made the black lines. Or the glue that holds it together. Literally thousands of people co-operated to make this pencil.

The process to deliver that pencil involves multiple stages. Those stages of production that are closer in time to the point of sale — such as the transportation of the pencils in trucks to the store — are called “lower-order” stages of production. The parts of production that are further removed from the point of sale — such as planting the trees that will eventually be chopped down for the wood, or mining the iron ore to make the steel to make the saws that cut down the trees — are “higher-order” stages. Investment in the higher-order stages will have the eventual benefit of making the production process more efficient, and making the product cost less . . . but it may take years for that investment to pay off. Conversely, investment in lower-order stages (the store needs more pencils! Hire more trucks to deliver them!) is unlikely to lower the cost of the good, but it will ensure delivery of a sufficient supply in the immediate future.

The key here is time preference. If it is important to deliver more consumer goods right now, a business will tend to invest more in the lower-order stages of production (hire more trucks now!). So investment in lower-order stages is good when consumer demand is high right now. Conversely, if consumer demand is low, it may be a good time for a business to engage in things like research and development, or investment in other higher-order stages of production — things that won’t pay off today, but that will ensure efficient production in the future.

Here’s the thing: long-term investments in higher-order stages of production typically require a business to borrow money. The longer the period of time it will take for the investment to pay off, the longer the period of the loan. The longer the period of the loan, the more important it is for the interest rate to be low — because long-term loans are very sensitive to interest rate changes. Businesses (and individuals too, of course) are far more likely to take out long-term loans when the interest rate is low, because the longer the loan, the more money they save. That means that borrowing for investment in higher-order stages of production typically happens when interest rates are low.

When interest rates are allowed to fluctuate with the free market, all this works in harmony. When consumer demand is low, people save more. The interest rate is lower, causing businesses to invest in higher-order stages of production. Times of low interest rates are a good time for businesses to make such investments, because the need to provide great numbers of consumer goods is not great when people aren’t buying them in great quantities.

By contrast, when demand for consumer goods increases, people are saving less. Interest rates rise, and businesses divert their profits into investment in lower-order stages of production, the better to deliver greater amounts of consumer goods to the public in a short time span.

Now consider what happens when a central bank artificially lowers interest rates. Businesses are incentivized to invest in higher-order stages of production. However, this action is not balanced by a lowering of consumer demand, and there is no increase in savings. Consequently, there is unexpected competition for the same resources. For example, when consumer demand is low, the trucking business takes resources away from delivering consumer goods, and moves them into delivering materials for, say, factory building. But when consumer demand is still high, trucks are in demand for delivery of consumer goods and for delivery of raw materials to build factories. The competition for resources drives up prices of inputs into production, and the long-term projects end up being more expensive than the businesses anticipated. Businesses start to fail, and a recession or depression hits.

The central observation here is that central planning never works in a complicated market economy. To some extent, people have internalized this lesson when it comes to prices of goods. At least a significant segment of the public understands that when the government sets prices, through price controls or otherwise, this introduces distortions into the market economy and makes it less efficient. But for whatever reason, we seem to have a tolerance for central planning when it comes to setting price controls for credit. Interest rates, after all, are nothing more than the price of credit. Why do we think it’s a good idea to allow a central authority to set that price, any more than we should tolerate central planning for any price in a free market?

To come back to Dana’s question, then: lowering interest rates when the economy is not doing well is a bad idea. Recessions/depressions are caused by malinvestment by businesses responding to manipulation of the price of credit. The proper response is to let the economy readjust, and keep government out of the way. This is what the U.S. did in 1920-1921, and that recession disappeared right away. Conversely, Hoover and then FDR monkeyed with the economy after the onset of the Great Depression, and with their actions they extended the misery unnecessarily for years.

Let’s put a stop to central planning. It didn’t work when Josef Stalin did it, and it doesn’t work any better when Janet Yellin does it.

145 Responses to “The Austrian Theory of the Business Cycle: Part Two in An Occasional Series of Posts on the Fed”

  1. Raise your hand if you read the whole thing and it made sense to you.

    OK, raise your hand if you read the whole thing.

    I worry that I will see very few hands. But I hope some people do read this — especially people who never heard of the theory before. I think it’s very important to understand how the Fed causes these boom/cycles.

    Patterico (9c670f)

  2. Art Deco is going to be so mad that he is in moderation and can’t come make contentless, ad hominem attacks on this post.

    Dude, your instructions are clear. Follow them and you may comment. They involve nothing more than a requirement that 1) you engage in commentary of substance, and 2) you not run away from a discussion where you have challenged me to defend my point of view, and I have then expended time and energy to do so.

    It must be so frustrating for you!

    Patterico (9c670f)

  3. i like Mr. Deco and plus it’s christmas

    and this “commentary of substance” stricture is very worrisome

    i’m a go to my quiet place now

    happyfeet (831175)

  4. Here is the quote that set me off:

    No, you haven’t ‘explained’ it. You recycled a bogus argument by one Thomas Woods who is in turn channeling others on the staff of the von Mises Institute. If you fancy the entire economics profession does not understand the contours of the economy, you are welcome to do so. You should not expect anyone to take what you say on these matters the least bit seriously.

    The thing he claimed I had not tried to explain, I had in fact explained, in detail. His response was, not to make an argument in response, but to attack some of the people who make similar arguments. That is an ad hominem fallacy. He concluded the comment with another fallacy: the Appeal to Authority. He tried to dismiss my arguments by claiming that, well, economists don’t agree with you. Then we got the personal insult: nobody should take anything I have to say on these matters seriously.

    There was not a scrap of actual logic, evidence, or valid argumentation in the whole comment. I don’t have to tolerate that on my blog, and I won’t.

    This is a form of thought fascism: discount all unallowable opinions, not by refuting them, but simply dismissing them with a wave of the hand. It is a pattern with your beloved Mr. Art Deco on a certain sort of thread, and I simply won’t stand for it. I make no apologies for my stance.

    Patterico (9c670f)

  5. ok

    but i love it that we still have people like you and Mr. Deco what engage in passionate discussion about economic theory

    we need a lot more

    but still

    it’s a nice counterpoint to the stupid lady what doesn’t know how to ride a train

    happyfeet (831175)

  6. I would love to have that actual discourse, and I am happy when he raises actual arguments (even bad ones) to discuss.

    But I can’t tolerate stuff like what I blockquoted above. Do you love that?

    Patterico (9c670f)

  7. i’m a chicagoan now!

    erudite people getting snippy about matters economic

    it don’t phase me

    happyfeet (831175)

  8. It’s a waste of time for me to discuss things with someone who just engages in insults rather than advancing substantive points.

    This bit where you say:

    and this “commentary of substance” stricture is very worrisome

    is as if you are accusing me of trying to suppress discussion.

    I didn’t ban the guy. I just said I won’t publish comments that are insulting. And I won’t.

    That is not trying to suppress discussion. It is trying to advance it.

    Patterico (9c670f)

  9. Does the post make sense to you, happy?

    Patterico (9c670f)

  10. I read it. And I understand some of it. This is really inside baseball for the merchant class. The government sin is that it forces the rest of the population to subsidize them, without controlling them. Yellen gives money to the moneylenders, the moneylenders give it to the pushcart peddlers, the pushcart peddlers fail and default to the moneylenders, the moneylenders fail and default to Yellen, my daughter is stuck with Yellen’s bad paper down the line. Am I close?

    nk (dbc370)

  11. the fed is the very epitome of market distortion i think

    happyfeet (831175)

  12. but nonono

    my worry is that

    my comments of late, they lack heft I feel

    it’s so hard to engage seriously in discussions about this most unserious of nations

    and it makes me sad

    and though yes I’m grateful that there are those like you and Mr. Deco that still make the brace attempt

    me, I think we all need to take a lil time every day to enjoy the twilight of that shining wonderful moment on erf that was called america

    happyfeet (831175)

  13. gack

    *brave* attempt i mean

    happyfeet (831175)

  14. if i were catholic there’d be a woeful candle shortage

    happyfeet (831175)

  15. I don’t mind market distortion. That’s how I got this great jacket for $5.00 at the thrift store that was $80.00 at Land’s End. I mind my daughter bailing out and continuing to prop up Land’s End’s banker.

    nk (dbc370)

  16. There are far too many ‘Masters of the Universe’ phyqueing up the world.
    Perhaps it is time to return to Au.

    askeptic (efcf22)

  17. i still think of land’s end as sears but the googles say i need to get with the program

    happyfeet (831175)

  18. *lands’ end* i mean

    happyfeet (831175)

  19. would it be gay if me and eric church got married

    happyfeet (831175)

  20. Our honored host wrote:

    The implicit assumption underlying Dana’s comment is twofold, and is held by most mainstream economists: that 1) the proper response to an economic downturn is to lower interest rates, and 2) the Federal Reserve should be entrusted with manipulating interest rates to make macroeconomic corrections in the economy.

    I just now saw this post, and want to make clear that while our host has made two accurate statements concerning the views of most mainstream economists, such are not my views, personally. I stated, back in 2011, as well as previously, that the proper response to the recession should be “to let the economy heal itself.”

    I still have to read the rest of our host’s article.

    The Dana honored to have been mentioned in a Patterico post! (1b79fa)

  21. I’m serious. The way I see it, the Fed is borrowing money to give to its capitalist cronies and signing our names and our children’s name on the notes. Am I wrong?

    nk (dbc370)

  22. P, feets was just being feets, he was trying to be lightheartedly funny without thinking too much about anything, it’s what he does usually, he wasn’t seriously reflecting on the post or you other comments

    I read most of it, sort of understood some of it, but could not recruit enough cells in my frontal cortex to fully grasp it

    If I managed to make an intelligent question, it would be about what appears to me some simplified thinking about cause and effect,
    like the idea that if people are not spending it is because they are saving. What if they are not spending or saving? What if companies put investments into things that didn’t work out, so the companies go out of business. The banks don’t get their money back, people have no jobs to make money to spend or save.
    I guess the assumption is that while some companies are having a bust, there are others that are working out.

    The pencil thing is pretty wild. In my very rudimentary thinking, I think critics of capitalism do not believe that the “invisible hand of the market” always works out for the best, so people have to manipulate it. I think some of those who espouse capitalism do NOT necessarily think the “invisible hand” is always doing such a good job, but rather a handful of people manipulating things aren’t going to make anything better.
    Like democratic republics are a terrible form of government, it’s just that there is nothing better. Decentralized economies aren’t perfect, they are just better than the alternative as well.
    probably fits somewhere with the constrained vs. unconstrained as well.

    MD in Philly (f9371b)

  23. *signing forging*

    nk (dbc370)

  24. Mr. Feets – It’s the holiday season. If you want heft, you know what to do.

    daleyrocks (bf33e9)

  25. If I managed to make an intelligent question, it would be about what appears to me some simplified thinking about cause and effect,
    like the idea that if people are not spending it is because they are saving. What if they are not spending or saving?

    I don’t understand. If you get a paycheck, don’t you pretty much have to spend it or save (invest) it? What is option 3?

    What if companies put investments into things that didn’t work out, so the companies go out of business. The banks don’t get their money back, people have no jobs to make money to spend or save.
    I guess the assumption is that while some companies are having a bust, there are others that are working out.

    Sure, that happens all the time; I address it in the post.

    The free market, of course, assumes that many entrepreneurs will make bad business decisions — and when they do, their businesses should fail, to make way for better ones. But in this process, entrepreneurs with better foresight should succeed — in other words, the market selects for the very best entrepreneurs. So it seems odd, then, when in a recession or depression, great numbers of these people all make bad decisions, all at the same time. What explains that? Why would all the very best entrepreneurs all make bad decisions at once?

    That some businesses fail is expected and, in fact, good. That is what redirects misdirected resources into lines of production that satisfy the consumer.

    But when many, many businesses are failing all at once, it’s generally because some distortion has entered the market. This is an effort to explain one major such distortion: manipulation of interest rates by the Fed.

    Can you specify where the explanation breaks down for you? Or was it just too much of an endurance test — too many words all at once? I can’t really cure the latter part easily, but if there is a particular part of the explanation that needs clarification I’d like to know.

    Patterico (9c670f)

  26. I’m serious. The way I see it, the Fed is borrowing money to give to its capitalist cronies and signing our names and our children’s name on the notes. Am I wrong?

    I think you are right.

    Patterico (9c670f)

  27. I just now saw this post, and want to make clear that while our host has made two accurate statements concerning the views of most mainstream economists, such are not my views, personally. I stated, back in 2011, as well as previously, that the proper response to the recession should be “to let the economy heal itself.”

    I apologize if I have misstated your views. It seemed from your comment that you were accepting the Fed’s role in manipulating interest rates as appropriate.

    Patterico (9c670f)

  28. “why is it that there are times when all entrepreneurs seem to be making bad decisions, all at the same time?”

    Patterico – I read the post, but don’t understand the bit about the bad decisions. Even with government interference, is not the assumption that people are making the best possible decisions with the information they have? Who is making the judgement that the decisions made are bad?

    Can you provide some examples of everyone making bad decisions in unison?

    daleyrocks (bf33e9)

  29. BTW, the best pencils are made from willow charcoal which you can pay a ton of money for at art supply stores or make yourself by baking willow sticks in your barbecue pit. If you don’t have your own willow tree, someone down the street does, ask him nice for some branches. https://www.youtube.com/watch?v=xKeHfO6Cegg

    tne one-time art student nk (dbc370)

  30. In his first comment, our extremely patient host wrote:

    Raise your hand if you read the whole thing and it made sense to you.

    OK, raise your hand if you read the whole thing.

    My hand is raised, and I certainly understood the arguments made, but that does not mean that I agree with all of them. Toward the end of the main article, you wrote:

    Now consider what happens when a central bank artificially lowers interest rates. Businesses are incentivized to invest in higher-order stages of production. However, this action is not balanced by a lowering of consumer demand, and there is no increase in savings. Consequently, there is unexpected competition for the same resources. For example, when consumer demand is low, the trucking business takes resources away from delivering consumer goods, and moves them into delivering materials for, say, factory building. But when consumer demand is still high, trucks are in demand for delivery of consumer goods and for delivery of raw materials to build factories. The competition for resources drives up prices of inputs into production, and the long-term projects end up being more expensive than the businesses anticipated. Businesses start to fail, and a recession or depression hits.

    You had previously noted:

    Greenspan’s interest rate slashes had an effect on lowering interest rates, but the two rates (federal funds and mortgage rates) did not go in lockstep. When Greenspan slashed the federal funds rate to 1% mortgage lenders did not follow them with a commensurate drop.

    The Fed tried in that instance to artificially lower interest rates, by lowering the two rates it directly controls (the feral funds and discount rates), but the commercial lenders did not follow them that far down because they didn’t believe it was a wise move. The Fed can influence interest rates, and can (almost) directly push them higher, but can’t force them lower. At best, the fed can set conditions which allows commercial banks to lower interest rates, and those things are frequently followed, but not all the time.

    The problem for the policy makers at the Fed — and the Obama Administration — is that they don’t control the economy, but they think that they should, and the voters hold them responsible when they don’t. Interest rates are very low now, which you said provides business with an incentive to take out he loans for longer-term development, but the government has been worried that businesses have not been responding to this incentive with the vigor needed to create enough jobs. The reason is simple: even though the ability to borrow at low interest rates is there, businesses don’t forecast sufficient returns on investments to borrow as much as the Administration would like them to borrow.

    Now, when do banks have a lot of money to lend? If you take the Federal Reserve out of the picture, the answer is: banks have a lot of money to lend when a lot of people are putting money in the bank. Consumers are usually in one of two modes: either they are spending a lot, or they are saving a lot. When they are saving a lot, two things happen: 1) banks have more money to lend, and interest rates naturally should go down, and 2) there is less demand for consumer products, because consumers are spending less.

    The Wall Street Journal noted just he other day that Americans have reduced their total individual debt again, though after three straight quarters of slight increases. It was also noted that consumers have been consistently more cautious into what kinds of things they buy on credit; big ticket items like cars have seen increased borrowing, but other things showed declines (housing being one item.) However, savings are not all of the same type: due to the very low interest rates being provided by savings accounts, certificates of deposit and bonds, some of the increases in savings are going into the stock markets, in the form of increased 401(k) contributions into mutual funds.

    One of the greatest problems with economics as a science is that too few professional economists realize just how much of a behavioral science it is. Karl Marx, of all people, came sort of close, but he got it bass ackwards: he thought that economics would control people’s behavior, when the reality is that people’s behavior is what controls economics. The incentives being offered, by the Fed, by the banks, by the government, have not led to the results projected for them, because the people have not responded to the incentives the way they expected.

    I absolutely agree with your statement, “The central observation here is that central planning never works in a complicated market economy.” It never worked in the command economies of the Communist nations, and it certainly hasn’t worked here, because the economy is, in essence, literally billions of economic decisions taken, every single day, by a couple hundred million economic actors.

    The argumentative Dana (1b79fa)

  31. … why is it that there are times when all entrepreneurs seem to be making bad decisions, all at the same time? …

    I don’t think there is any big mystery about this, it reflects certain human traits. People tend to follow the crowd, people tend to assume the future will be like the recent past and people tend to imitate successful people.

    So if for example oil prices are high and a few people are making a lot of money from new technology oil wells there is a natural tendency for lots of people to rush to get in on a good thing and drill their own wells. Because of time lags between the decision to invest and the resulting increased production this can cause a glut crashing prices and making the new wells unprofitable.

    You see this sort of boom bust cycle all over the place. I think it is inherent in market systems and not invariably caused by government interference as you seem to believe.

    James B. Shearer (00eea2)

  32. Patterico – I read the post, but don’t understand the bit about the bad decisions. Even with government interference, is not the assumption that people are making the best possible decisions with the information they have? Who is making the judgement that the decisions made are bad?

    The argument is that entrepreneurs who make good decisions will have businesses that succeed, and entrepreneurs who make bad decisions will have businesses that fail.

    When an unusually high number of businesses fail, you could decide that a bunch of businessmen suddenly made bad decisions, or that (as you say) they are making the best possible decisions with the information they have . . . but those decisions are bad because the information is bad. Namely, the price mechanism — the most critical information for businessmen, because it helps them calculate profit and loss — has been distorted for the credit market.

    Patterico (9c670f)

  33. I agree with our host that the Federal Reserve ought not to be trying to control (which it can’t) or manipulate (which it sort-of can, but not often successfully) the economy. The question becomes: is there any role for the Fed or some other form of central bank?

    I believe that there is. At a minimum, the Fed sets the reserve requirement ratio for commercial banks, and someone has to do that, and the Fed is there to provide overnight loans to banks which edge too close to the minimum reserve requirement; those things are necessary, in my view, to keep banks solvent, and though it doesn’t work in every individual case, we aren’t seeing massive bank failures.

    It could be argued that a federal agency could perform that function without taking the form of a central bank, but I’d see that as worse: such would be under far more direct control of the President.

    I would argue that our greatest President ever was Andrew Jackson, because he made the elimination of the national debt one of his goals, and he achieved it in 1836; President Jackson was an implacable foe of the Bank of the United States, and got it eliminated. It wasn’t that long after he was gone that the need for some form of central banking or banking regulation was seen. We didn’t really like central banks, but eventually saw them as necessary. We went through a period of forcing state-chartered banks to become national banks, subject to federal regulations, and finally wound up with the Federal Reserve Act, signed into law by President Wilson. Unfortunately, the Federal Reserve Act was amended in 1977 to state that:

    The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.

    I’m not sure that they’ve done a very good job of that one!

    The not very contrarian Dana (1b79fa)

  34. You had previously noted:

    Greenspan’s interest rate slashes had an effect on lowering interest rates, but the two rates (federal funds and mortgage rates) did not go in lockstep. When Greenspan slashed the federal funds rate to 1% mortgage lenders did not follow them with a commensurate drop.

    Yes, and the next thing I said was:

    That being said, 30-year rates went from 8.5% in the middle of 2000 to under 5.5% three years later. That was enough to fuel a boom. The fact that they didn’t go all the way to, say, 3% in 2003-2004 doesn’t mean the historically low rates didn’t fuel a boom — they did.

    It’s pretty difficult to deny that a) the Fed lowered interest rates dramatically in the early 2000s, b) mortgage rates followed suit, and c) a housing boom was the result.

    Patterico (9c670f)

  35. Our host wrote:

    When an unusually high number of businesses fail, you could decide that a bunch of businessmen suddenly made bad decisions, or that (as you say) they are making the best possible decisions with the information they have . . . but those decisions are bad because the information is bad. Namely, the price mechanism — the most critical information for businessmen, because it helps them calculate profit and loss — has been distorted for the credit market.

    Or, you could argue that the entire business climate became too bad for many businesses to succeed. Businesses which had done well before 2008 suddenly found themselves in real trouble following the crash, not because they had bad information, but because a previously sound business model was being negatively impacted by a lot of factors wholly outside their control, which caused consumers to stop spending so much.

    The somewhat contrarian Dana (1b79fa)

  36. Our host noted:

    It’s pretty difficult to deny that a) the Fed lowered interest rates dramatically in the early 2000s, b) mortgage rates followed suit, and c) a housing boom was the result.

    Actually, there was a housing boom all along: once we recovered from the 1991-1992 recession, housing took off again, and continued, seemingly unaffected by the 2001 recession. I kept wondering how, with unemployment rising to 10%, builders kept on building houses, and people kept on buying them. The lowering of interest rates certainly helped — and we bought our current home in 2002 — but the interest rate actions didn’t start the boom; it simply helped it along.

    The Dana who sells concrete for a living (1b79fa)

  37. Well, I have already said there were many factors, but the Fed was a big part of the problem. And they WANTED a housing boom.

    Patterico (9c670f)

  38. The appeal to me of the theory is its logic. The market should set interest rates. When the Fed manipulates them, it interferes with the market, and people respond in predictable ways.

    Patterico (9c670f)

  39. Defending corporations, I worried about maintaining the corporate veil and avoiding personal liability on the part of the shareholders. Capitalization is a factor. That’s when I learned that debt is not capital. Borrowing to start a business is not investing in a business. I think that when we say “businesses borrow money to invest in expansion and capital improvement” it’s a lie. They’re not investing. They’re betting on credit, pulling chips out of the pot to mark their bet instead of throwing their own chips into the pot, hoping they’ll win the hand.

    nk (dbc370)

  40. Our most gracious host wrote:

    The appeal to me of the theory is its logic. The market should set interest rates. When the Fed manipulates them, it interferes with the market, and people respond in predictable ways.

    Alas! The bigger problem is that they have responded in what the government found to be unpredictable ways! But I have somewhat less appreciation than you do in the Fed’s ability to manipulate interest rates: they can force them higher, but only try to influence them lower.

    (The Fed) WANTED a housing boom.

    As did President Bush and as did the Republican Party, and as did (some of) the Democratic Party. Our government’s policy since the 1920s has been to encourage home ownership through the mortgage interest deduction. It was part of conservative belief that people who owned their homes would take better care of them than would renters.

    The shade tree economist Dana (1b79fa)

  41. As did President Bush and as did the Republican Party, and as did (some of) the Democratic Party. Our government’s policy since the 1920s has been to encourage home ownership through the mortgage interest deduction. It was part of conservative belief that people who owned their homes would take better care of them than would renters.

    Yes, I have already said a) tax incentives are part of the problem, and b) Republicans and Democrats are both part of the problem.

    Patterico (9c670f)

  42. But, more importantly, the University of Kentucky Wildcats destroyed the UCLA Bruins 83-42 in Chicago today. The halftime score was UK 41, UCLA 7, and no, that isn’t a football score and it isn’t a typo.

    The University of Kentucky alumnus Dana (1b79fa)

  43. “The argument is that entrepreneurs who make good decisions will have businesses that succeed, and entrepreneurs who make bad decisions will have businesses that fail.”

    Patterico – Okay, I understand that argument. I was focused on the words you used; “why is it that there are times when all entrepreneurs seem to be making bad decisions, all at the same time” and looking for examples of this abnormally high rate of business failures/bad decision making/business cycle in real life as opposed to theory. Your words say it happens, so that was why I asking for examples of what you meant, to better understand your description of the theory. I meant it as a serious question.

    daleyrocks (bf33e9)

  44. Does that mean you would end the home mortgage interest deduction?

    The inquisitive Dana (1b79fa)

  45. I would end the income tax.

    Patterico (9c670f)

  46. Patterico – Okay, I understand that argument. I was focused on the words you used; “why is it that there are times when all entrepreneurs seem to be making bad decisions, all at the same time” and looking for examples of this abnormally high rate of business failures/bad decision making/business cycle in real life as opposed to theory. Your words say it happens, so that was why I asking for examples of what you meant, to better understand your description of the theory. I meant it as a serious question.

    I know you did, and I took it as a serious question. It was sort of rhetorical: Q: why are all these people making such bad decisions? A: because they are getting bad information.

    Patterico (9c670f)

  47. I was focused on the words you used; “why is it that there are times when all entrepreneurs seem to be making bad decisions, all at the same time” and looking for examples of this abnormally high rate of business failures/bad decision making/business cycle in real life as opposed to theory.

    Recessions/depressions — with the clarifications above about what I meant.

    Patterico (9c670f)

  48. And, to answer my question to our host, I would, if I could, end all of the deductions. We ought to have a flat tax, a single percentage rate tax on income, with no deductions for anybody, or anything, other than expenses incurred to earn that income.

    Of course, my real preference would be to eliminate the 16th Amendment, and have everybody taxed identically in dollar amounts, meaning that Bill Gates, Patterico, nk, daleyrocks and I would al owe the same dollar amount in taxes.

    The flat-taxer Dana (1b79fa)

  49. “As did President Bush and as did the Republican Party, and as did (some of) the Democratic Party.”

    The University of Kentucky alumnus Dana (1b79fa) – I believe it was Barney Frank and Chris Dodd leading the stout Democrat resistance to reigning in the excesses of Fannie and Freddie pushed by Republicans last decade in spite of multibillion dollar accounting frauds at those GSEs. The lobbying machines put together by both could exert enormous pressure on politicians and I believe contributions generated by them flowed largely to Democrats who protected them and generated favorable legislation.

    daleyrocks (bf33e9)

  50. “Memba when we used to say, “Safe as houses?” Good times.

    Gazzer (ae5179)

  51. When you let them play on credit, they’re more likely to play a bad hand, go broke, and also stiff you for what they owe.

    the former card player nk (dbc370)

  52. I believe it was Barney Frank and Chris Dodd leading the stout Democrat resistance to reigning in the excesses of Fannie and Freddie pushed by Republicans last decade in spite of multibillion dollar accounting frauds at those GSEs. The lobbying machines put together by both could exert enormous pressure on politicians and I believe contributions generated by them flowed largely to Democrats who protected them and generated favorable legislation.

    There is blame to go around, but yes, it was the Barney Franks and Chris Dodds of the world who were pushing for affirmative action in lending to the poor and minorities who did not qualify for loans, and who were collecting big from Fannie and Freddie as they pushed these destructive policies.

    Patterico (9c670f)

  53. Of course, my real preference would be to eliminate the 16th Amendment, and have everybody taxed identically in dollar amounts, meaning that Bill Gates, Patterico, nk, daleyrocks and I would al owe the same dollar amount in taxes.

    Yeah, but that is totally unrealistic, because hoboes would owe the same amount and cannot afford it.

    Patterico (9c670f)

  54. safe as houses is from depeche mode i thought

    happyfeet (831175)

  55. Alas, maybe so, but then we could throw them in debtor’s prisons.

    I concede that we can never get to a time where everybody is taxed the same; I just wish it could be so.

    The unrealistic Dana (1b79fa)

  56. “Recessions/depressions — with the clarifications above about what I meant.”

    Patterico – We’re still crossing signals. Businesses fail all the time outside recessions/depressions. Sometimes businesses can’t cut costs/overhead/staff, etc. fast enough in a downturn and wind up going belly up. Sometimes competitors within an industry can react faster and not all industries are affected simultaneously, although in a general downturn, if it lasts long enough, most are.

    Did we have an abnormal number of business failures in 2008-2009? I don’t know.

    How about 2001 in the technology area?

    Before that? The oil patch or rust belt in the 1980s?

    daleyrocks (bf33e9)

  57. I see Patterico is going full Austrian. That is not surprising. I’m waiting for him to declare that the attorney’s office should be privatized.

    Half of the posts on Patterico are interesting. The other half are sky-is-falling radical libertarian stuff that sounds like it’s from the Voice of the Revolution bunker complex.

    OmegaPaladin (3504d9)

  58. Crikey, feets they’re still touring!

    Gazzer (ae5179)

  59. I concede that we can never get to a time where everybody is taxed the same; I just wish it could be so.

    Yes, we can if everybody has the exact same amount of money.

    nk (dbc370)

  60. I s’pose that if I had to work all day with the scumbags the Compton Police dragged in, I’d go full libertarian as well.

    There was a first season episode of Star Trek: The Next Generation in which the crew found themselves on a planet in which any infraction of the law, regardless of how small, was punished by death, almost immediately administered. I’m not certain that that would be a bad idea.

    The somewhat libertarian (but not Libertarian) Dana (1b79fa)

  61. everything counts in large amounts Mr. Gazzer

    happyfeet (831175)

  62. nk wrote:

    I concede that we can never get to a time where everybody is taxed the same; I just wish it could be so.

    Yes, we can if everybody has the exact same amount of money.

    While he didn’t really propose it, President Nixon is given the credit for proposing a “guaranteed annual income.” I s’pose that we could put something like that into place, and then tax that, and everything else above that would be tax free, but it sure seems overly complicated.

    The Dana who remembers President Nixon (1b79fa)

  63. I see Patterico is going full Austrian. That is not surprising. I’m waiting for him to declare that the attorney’s office should be privatized.

    Nope, I don’t buy the idea that the military or law enforcement functions can be privatized. I have listened to the arguments but they seem pie-in-the-sky.

    Half of the posts on Patterico are interesting. The other half are sky-is-falling radical libertarian stuff that sounds like it’s from the Voice of the Revolution bunker complex.

    Heh. Well, hardly half of my posts deal with Austrian economics or other “radical libertarian” arguments, but you are welcome to debate these issues with me. Maybe you can teach me something! I truly do have an open mind. But I find the Austrians’ defense of the free market highly persuasive.

    Patterico (9c670f)

  64. I s’pose that if I had to work all day with the scumbags the Compton Police dragged in, I’d go full libertarian as well.

    There was a first season episode of Star Trek: The Next Generation in which the crew found themselves on a planet in which any infraction of the law, regardless of how small, was punished by death, almost immediately administered. I’m not certain that that would be a bad idea.

    I am.

    Patterico (9c670f)

  65. While he didn’t really propose it, President Nixon is given the credit for proposing a “guaranteed annual income.” I s’pose that we could put something like that into place, and then tax that, and everything else above that would be tax free, but it sure seems overly complicated.

    It also seems like a horrible idea that would create horrible incentives.

    Patterico (9c670f)

  66. Mr Paladin wrote:

    I’m waiting for him to declare that the attorney’s office should be privatized.

    Considering that the Attorney General’s office seems to have been a favored job for the worst people a President could ever nominate — something true of both Republicans and Democrats — it might not be such a bad idea.

    As for state Attorneys General, Pennsylvania has the worst in the country!

    The bipartisan Dana (1b79fa)

  67. Did we have an abnormal number of business failures in 2008-2009? I don’t know.

    Not as many as we would have had if the feds had not stepped in with countless bailouts, delaying the inevitable and making the certain coming carnage worse.

    Patterico (9c670f)

  68. The other half are sky-is-falling radical libertarian stuff that sounds like it’s from the Voice of the Revolution bunker complex.

    Can I safely assume that you see no impending financial collapse? We can just borrow and inflate forever without consequence? Is that the “sensible” and “non-radical” position?

    Patterico (9c670f)

  69. I would note that during this era of ZIRP, or free money, businesses have borrowed and issued bonds largely to repurchase their stock rather than invest in a tepid market for their products.

    This has been a major goose to the equity markets that now capitalize firms at 20X earnings where for years now the path to profitability has been cutting costs.

    “Congress established the statutory objectives for monetary policy–maximum employment, stable prices, and moderate long-term interest rates” has evidently been given short shrift.

    DNF (d52fb5)

  70. I still like OmegaPaladin. And he still likes half of my posts! I remember he agreed with me on Rand Paul and Ebola, and had some experience to back it up.

    Patterico (9c670f)

  71. We can also do what the Spartans did by repealing the 24th (poll tax) Amendment. The people who wish the franchise can pay their sisytion “mess fee”, a set amount regardless of wealth and income, and be Equals (“Peers” if you wish). Those who could not would be “Neighbors”, free residents, who would pay only any applicable excise tax on transactions (there weren’t many, the Spartans avoided commerce), but would not participate in government.

    nk (dbc370)

  72. DNF: the Fed’s mission is nominally (in part) to control inflation . . . and they now consider it their duty to create inflation. You can’t make this stuff up.

    Patterico (9c670f)

  73. nk, I don’t think I consider the very scary and totalitarian Spartan society to be my ideal.

    Patterico (9c670f)

  74. Our host wrote:

    While he didn’t really propose it, President Nixon is given the credit for proposing a “guaranteed annual income.” I s’pose that we could put something like that into place, and then tax that, and everything else above that would be tax free, but it sure seems overly complicated.

    It also seems like a horrible idea that would create horrible incentives.

    And that was why it didn’t go anywhere during the Nixon Administration, but the obvious question is: would it be any worse than the hodge-podge welfare system we have now? One system, restricted to citizens, that said, “OK you get $1,500 every month, and you can either live on that, very poorly, with no other assistance available, or you can get a job, and live better,” would eliminate fraud and duplication of services.

    My preferred welfare system was described by St Paul in 2 Thessalonians 3:10, but we won’t ever do that.

    The argumentative Dana (1b79fa)

  75. In England, the felony prosecutors who try the cases in the higher courts are private attorneys retained by the Crown on a case by case basis. A lawyer can be defending one case and prosecuting another on the same court call.

    nk who watched BBC (dbc370)

  76. And that was why it didn’t go anywhere during the Nixon Administration

    Really? Because Richard “price controls” Nixon would not sanction a policy that would create horrible incentives?

    [T]he obvious question is: would it be any worse than the hodge-podge welfare system we have now? One system, restricted to citizens, that said, “OK you get $1,500 every month, and you can either live on that, very poorly, with no other assistance available, or you can get a job, and live better,” would eliminate fraud and duplication of services.

    My preferred welfare system was described by St Paul in 2 Thessalonians 3:10, but we won’t ever do that.

    I don’t feel qualified to compare different forms of solutions advocated by experts. All I can say is that they are all inferior to free markets.

    Patterico (9c670f)

  77. In England, the felony prosecutors who try the cases in the higher courts are private attorneys retained by the Crown on a case by case basis. A lawyer can be defending one case and prosecuting another on the same court call.

    This is true. That being said, did you mean to post that comment in this thread?

    Patterico (9c670f)

  78. In response to the privatizing the DA’s office discussion.

    nk (dbc370)

  79. Oh.

    Patterico (9c670f)

  80. One thing that is fun about being a blogger is that you post your post, and then the discussion goes wherever it goes.

    I mostly consider that a plus. It’s not like I am smarter than my readers on a collective basis. You put up my readership vs. me on just about any issue, and the readership knows more.

    Patterico (9c670f)

  81. That being said, STAY ON TOPIC, DAMMIT!

    (I am obviously kidding.)

    Patterico (9c670f)

  82. Our perceptive prosecutor wrote:

    I don’t feel qualified to compare different forms of solutions advocated by experts. All I can say is that they are all inferior to free markets.

    The free market solution to welfare is starvation; if you don’t work, you don’t eat. As previously noted, I am perfectly fine with that, but I doubt that the majority of people would be.

    The Dana eating buffalo wings at the computer (1b79fa)

  83. That’s perfectly compatible with totalitarian socialism, too, Dana.

    nk (dbc370)

  84. 69. ” impending financial collapse”

    The chart below shows energy companies going under as their bond purchasers unsuccessfully unload their holdings.

    http://www.zerohedge.com/sites/default/files/images/user3303/imageroot/2014/12-overflow/20141219_HY.jpg

    Bad bets are coming in all over, e.g., hundreds of billions in China owed to developers’ bond holders whose collateral is non-existent.

    The same is true of European banks where collateral may be used and reused as bankrupt Portugal, Spain and Greece will default once the next payment from Germany and the Netherlands is late.

    Japan and Italy are swinging with their eyes bugging out.

    We are already ‘in collapse’ its just not fast enough for most of our ostriches.

    DNF (d52fb5)

  85. #28:Daley, Hayek addressed this issue in many ways. The basic idea is that an individual immersed in the realities of his local circumstances will find ways to make a living by satisfying the needs of his local customers using the unique mix of resources at hand. Thankfully, this is even true in authoritarian regimes as long as they are inept, as was the Ottoman Empire. My take on it is that black markets always serve a useful purpose, if only to suggest the cost of maintaining the current regime. This happy result of regime neglect does not apply in modern police states like Cuba, North Korea, or what was the Soviet Union. There are no local solutions to anything in these places. With the EPA, Army Corps of Engineers, Bureau of Land Management, Forest Service, OSHA, EEOC, and so on we have arrived at a very interesting point in our history where a lot of economic activity is in this black market realm, and the governement is beginning to respond as all despotic regimes do, with brute force. If you doubt this, drive by your local Home Depot or Lowes store. If this is the first time you’ve been there in the last ten years, you might wonder what all those men are doing standing by the exit. They are one manifestation of your local black market. And as for the despotic response, consider Harry Reid’s attempt to seize the ranch out side Las Vegas so one of his buddies could build a solar power facility.

    It is also the case that this local entrepaneur’s solutions are local. You cannot take a poll and by some consensus find a single way of doing anything that will make sense in every locale. In fact, this consensus is likely to work almost nowhere.

    And I raised both hands in resonce to Patterico’s questions.

    Now to read the next 40 replies …

    bobathome (348c8a)

  86. The free market solution to welfare is starvation; if you don’t work, you don’t eat.

    When did charity disappear from the planet?

    Patterico (9c670f)

  87. I don’t understand. If you get a paycheck, don’t you pretty much have to spend it or save (invest) it? What is option 3?

    I was thinking of economists looking at the overall numbers. If enough businesses are folding there are decreasing jobs and decreasing paychecks, there would be decreased spending and decreased savings.
    I could see situations where companies do not so much make “bad” decisions, as there is some wide-ranging event outside of control. What about a several year drought in the US Midwest that devastates the grain crops, the farmers themselves, food distribution companies, banks that loan to farmers, people that sell farm equipment, makers of farm equipment, a zillion things that depend on agricultural raw materials.
    Maybe the economy is diverse and global enough that there is no single insult that would cause enough massive company failure like I’m suggesting. At this point I don’t know what widespread war in the ME and a great reduction in oil production from that part of the world would do, for example. Or if the source of certain rare earth metals that much of the computer age is dependent on were cut off.
    Yes, I am grasping.

    MD in Philly (f9371b)

  88. sorry for the mistake in italics there.

    MD in Philly (f9371b)

  89. The real solution to starvation is find employment. It works whenever it is tried, and it continues to work irrespective of the whims of the elite. Provided, or course, that you support private property and the rule of law as it was practiced in communities that honored their Anglo-Saxon heritage between 1776 and 2008.

    The trick is to ensure your government creates and maintains circumstances under which it is reasonable to expect that employers will invest in your community. This is a remarkably high standard.

    bobathome (348c8a)

  90. @The Dana If you offered the $1,500 unconditionally, you wouldn’t have any disincentives.

    Sammy Finkelman (6a57b5)

  91. “The basic idea is that an individual immersed in the realities of his local circumstances will find ways to make a living by satisfying the needs of his local customers using the unique mix of resources at hand.”

    bobathome – I completely understand this point and it has no conflict with the questions I am asking Patterico. Perhaps after reading the later comments you will see that. Yes, I have see black market labor outside stores, but again, that presents no conflict with businesses making good or bad decisions.

    I guess part of what I find facile about the explanation is that a business failure in a recession is automatically a result of bad decisions. I guess if a business fails you can find bad decisions somewhere, but in a recessionary environment how much is really under the entrepreneur’s control? That is why I was asking for specific examples. Are the entrepreneur’s at fault for not making their cost structures variable enough to withstand downturns and also serve existing volume levels? Are those the type of bad decisions Austrian economics faults entrepreneurs for after the fact because they went belly up?

    daleyrocks (bf33e9)

  92. 57. “sky-is-falling”

    Laying out a grid and tagging individually every item of debris is beyond the scope of this forum.

    Let it suffice to note that the Federal Reserve is no longer able to repeat QE 1 thru 3, the bond market for issued US Treasuries cannot bear, for an unknown duration, even a moderated continuance.

    They can buy equities thru a broker or give the Treasury a stipend directly but they are already clear that the war is lost.

    DNF (d52fb5)

  93. What market would set interest rates? Where is this market? When did it ever exist?

    Sammy Finkelman (6a57b5)

  94. I guess part of what I find facile about the explanation is that a business failure in a recession is automatically a result of bad decisions.

    But you understand at this point that the bad decision can be the result of bad information, right?

    Look: even in a recession, if you’re selling the right product at the right price, you can make money. There is no recession or depression I have heard of yet in which every business loses money.

    But it’s harder when you have bad information. I’m not blaming the businessman for the bad price information resulting from the distorted signals resulting from government intervention. You get that, right?

    Patterico (9c670f)

  95. What market would set interest rates? Where is this market? When did it ever exist?

    Any market resulting from something other than bank control of interest rates and credit expansion due to fractional reserve banking?

    Patterico (9c670f)

  96. My problem with 19th century an earlier libertarian theories (besides their being apologetics for the merchant class in their rivalry with the landowning nobility), is that back then a man and a woman could go up the Mississippi, the man with his rifle and his axe and the woman with her kettle and her spinning wheel, clear out a piece of land for a cabin and a cotton patch, and float bales of cotton on top of a raft of lumber down the river to the cotton mills and sawmills the next year, dressed in their finest buckskins and linsey-woolsy. Take this as a metaphor, please, even though it was an actuality then. Who can do that now? Figuratively?

    nk (dbc370)

  97. Nobody, thanks to government regulation.

    Patterico (9c670f)

  98. I would argue banks foregoing foreclosure, keeping bad debts on the books, unmarked to market, is a bad business decision. Japan’s twenty years of deflation ought to convince them of that conclusion.

    Instead one can drive around the Mpls/StP beltline and give up counting ‘For Lease’ signs as frequent as an interminable Burma Shave advert.

    These properties, as the homes in Las Vegas, will rot and decay just as Detroit has.

    Citi, BofA, Chase, etc., are making hundreds of millions every year on the reserves the Fed holds in their stead paying 0.25%. They don’t need your deposits, let alone loan you money.

    DNF (d52fb5)

  99. Look for more islands to spring up in the South China Sea:

    http://www.zerohedge.com/news/2014-12-20/china-tests-nuclear-icbms-us-analyst-warns-arms-control-failing-increase-american-se

    Please don’t beat me Uncle.

    DNF (d52fb5)

  100. 95. Patterico (9c670f) — 12/20/2014 @ 7:49 pm

    Any market resulting from something other than bank control of interest rates and credit expansion due to fractional reserve banking?

    Are we going to do away with fractional reserves and central banks?

    The strongest, or most interventionist central bank wins. There can only be one world price for short term money. Short term (especially “overnight”) lending of money also only makes sense within the confines of government regulation of banks.

    Sammy Finkelman (6a57b5)

  101. I am just a “watchman on the wall” sounding the alarm the best that I can. And there are lots of others that are doing the same thing. We are deeply concerned about where this nation is heading, and we have been pleading with our leaders to do something about it for a long time but they have not listened to us.

    http://www.zerohedge.com/news/2014-12-20/there-hope-understanding-great-economic-collapse-coming

    When the unhinged outnumber those at peace, it might just be time to check one’s assumptions.

    DNF (d52fb5)

  102. 102. Sorry the indentions and their lack are exactly wrong.

    DNF (d52fb5)

  103. 101. “The strongest, or most interventionist central bank wins.”

    Normally I would ask for an expatiation of this ellipsis.

    In this case, nevermind.

    DNF (d52fb5)

  104. Mr Finkelman wrote:

    @The Dana If you offered the $1,500 unconditionally, you wouldn’t have any disincentives.

    The disincentive is that enough basic needs can be met to allow the lazy not to work at all. That’s already happening with our current welfare system, so there’s no use pretending that supporting people without requiring work would be different under a different form.

    I picked $1,500 a month as a number on which people could survive, but not live well . . . and many people take that same decision today, just under a different set of programs. I regard all welfare as socially destructive, and were I Tsar and Autocrat of All the Americas, I’d cancel every last welfare program out there, and require people to work, or starve. Of course, I am an [insert slang term for the rectum here], and most people don’t want to be [insert slang plural term for the rectum here], so I’m in the minority on this one.

    The Dana who has seen too many lazy people (1b79fa)

  105. Would you hire everyone you “required” to work?

    Sammy Finkelman (6a57b5)

  106. We don’t have any programs, I think, that don’t punish people for working, except Social Security after normal retirement age or many government pensions.

    Many military retirees, although receiving pensions, work, don’t they?

    Sammy Finkelman (6a57b5)

  107. “But you understand at this point that the bad decision can be the result of bad information, right?

    Look: even in a recession, if you’re selling the right product at the right price, you can make money. There is no recession or depression I have heard of yet in which every business loses money.”

    Patterico – The above three sentences represent a conflict to me.

    The first, a business person can make a decision based on information that turns out badly. You can choose to call it a bad decision based on bad information because the government distorted the signalling content in the information. Alternatively, for the same situation I can say the business person made the best decision they could with the best information they had available and it turned to crap. The result is the same either way. I guess by saying he made a bad decision you are not trying to judge the business person, but to me that is the implication. To me, he relied on the information he had to make the decision. Your point is the information was tainted.

    With respect to the second and third sentences, I am not claiming money cannot be made in a recession, which is exactly why I struggle with:

    So it seems odd, then, when in a recession or depression, great numbers of these people all make bad decisions, all at the same time. What explains that? Why would all the very best entrepreneurs all make bad decisions at once?

    I don’t think they do all make bad decisions all at the same time. Examples would be nice.

    daleyrocks (bf33e9)

  108. Dana, St. Paul was talking about his Christian communes, practically monastics. Those rules were for them. They’d go out and tend the sick and feed the needy without judgment. I imagine communes and monastic orders these days have much the same rules. It’s not really work or starve, it’s work or get out. Where would “we” expect “them” to go? Gulags, for parasitism?

    nk (dbc370)

  109. 94. “But you understand at this point that the bad decision can be the result of bad information.”

    How many times during this Recovery(sic) has the ISM beaten expectations on increases in inventory by business hanging on the BLS and BEA forecasts for the next quarter?

    Let’s reckon: 7 X 12 equals 84. Not quite that many perhaps.

    DNF (d52fb5)

  110. The daughter is studying early American history right now (and it’s been about 45 years for me). The early pilgrims faced the same problem. They organized themselves communally and found that not everyone was pulling his weight. Their solution, let everybody have his own patch of land to work and keep everything from it.

    nk (dbc370)

  111. yes, somebody ought to tell the President that socialism has already been tried in America, long Marx, and it didn’t work.

    If he only read Rush Revere, he would know that.

    MD in Philly (f9371b)

  112. long before Marx

    MD in Philly (f9371b)

  113. nk, St Paul was writing to a Christian community, but his words are applicable today, for all of us.

    I respect anyone who works for a living, and have none at all for anyone who isn’t retired or disabled who will not. I respect the man who drives the tuck to clean out porta-johns on construction sites; I have none for the Occupods who whine about their Mistress of Arts degrees in Women’s Studies who combitch that they can’t get a job in their field, so they won’t work at all.

    There’s a rather famous picture of a rather homely woman holding a sign complaining that she has her Mistress of Arts degree in Women’s Studies and $60,000 in student loan debt, but that the only job she can get is tending bar. A lot of people have laughed at the picture — myself included — but the fact that she is at least working at something means I have to have some respect for her.

    I’ve had the guys come up to me, at work, claiming that they were looking for a job but clearly were not — you don’t go looking for work at a concrete plant in jams and flip flops — and all that they wanted was a name to turn into welfare to show that they had looked for work, so that they could keep getting a check.

    When I say that I am an [insert slang term for the rectum here], you may rest assured that I have had that quality burned into me through long work experience.

    The Dana who has seen these lazy scumbags in person, and doesn't care at all about them (1b79fa)

  114. I guess by saying he made a bad decision you are not trying to judge the business person, but to me that is the implication. To me, he relied on the information he had to make the decision. Your point is the information was tainted.

    Right. It’s only a “bad” decision in that the information was bad.

    If I report something on this blog that turns out to be wrong, but I relied on reliable sources (what those are these days, I don’t know, but make something up), it’s a “bad” post — but it’s not really my fault. If the sources are really reliable.

    Prices are usually reliable. When the Fed monkeys with interest rates, not so much.

    I am not blaming the businessmen. I am blaming the Fed.

    Patterico (9c670f)

  115. Are we going to do away with fractional reserves and central banks?

    No. In my ideal world we would though.

    Patterico (9c670f)

  116. A short course on the current regime:

    (Raoul Pal): Debt dynamics, deflation, positioning and technicals all suggest that a dollar bull market of some considerable velocity and length is underway.

    When dollar bull markets occur, emerging markets get hit.

    When dollar bull markets occur, carry trades get unwound.

    When dollar bull markets occur, they tend to usher in disinflationary forces as commodities and goods get re-priced.

    The preceding three factors lead to a self-reinforcing of the dollar bull market, creating more of the same in a cycle of liquidation and bad debts, creating more demand for US dollars.

    Raoul Pal is a former Goldman-Sachs thirtysomething trader owning a palatial estate on Majorca.

    DNF (d52fb5)

  117. 115

    Prices are usually reliable …

    Today’s prices are often not a reliable guide to prices in a year. Which can cause businesses get into trouble by building unneeded capacity. Independent of government policy or interest rates.

    James B. Shearer (00eea2)

  118. Our Windy City barrister wrote:

    They organized themselves communally and found that not everyone was pulling his weight. Their solution, let everybody have his own patch of land to work and keep everything from it.

    The Soviets found out the same thing following the collectivization of agriculture, and had to allow the restoration of the private family plots along with the collective farms.

    The Russian Dana (1b79fa)

  119. Today’s prices are often not a reliable guide to prices in a year. Which can cause businesses get into trouble by building unneeded capacity. Independent of government policy or interest rates.

    Yes. For the thirteenth time: businessmen can make mistakes.

    But it doesn’t help for the government to deliberately monkey with the price of credit.

    Which is something you studiously avoid, in your typical desire to be contrarian without grappling with the actual arguments made in the post.

    Patterico (9c670f)

  120. 120

    Yes. For the thirteenth time: businessmen can make mistakes.

    And lots of them can make the same mistake at the same time for the same reason.

    Which is something you studiously avoid, in your typical desire to be contrarian without grappling with the actual arguments made in the post.

    The post argues that interest rates naturally rise when times are good and businessmen are optimistic about the future and naturally fall when times are bad and businessmen are pessimistic about the future. This provides a negative feedback which helps stabilize the system.

    The post then gives an example of a central bank artificially lowering interest rates in a boom leading to excessive investment and inflation. But this is not what central banks do (at least in theory). They raise interest rates when the economy is doing well (boom conditions) and cut them when the economy is doing poorly (bust conditions) thereby making the negative feedback mentioned above stronger and the system more stable (at least in theory). Without such intervention the natural negative feedback is not strong enough to prevent all destructive boom and bust cycles. Bubbles and crashes are a natural feature of market systems.

    Now you can argue the cure (central bank intervention) is worse than the disease (natural boom and bust cycles) but I don’t think it makes much sense to argue the disease is imaginary. There is no reason to expect a market economy to be inherently stable and observation shows that it isn’t. You get small scale bubbles and crashes all over the place and sometimes they become large enough to affect the economy as a whole.

    James B. Shearer (00eea2)

  121. “How many times during this Recovery(sic) has the ISM beaten expectations on increases in inventory by business hanging on the BLS and BEA forecasts for the next quarter?”

    DNF – No clue. Never pay attention to any of that crap. The only expectations that matter to me are my own.

    daleyrocks (bf33e9)

  122. 122. The point is business routinely relies on the government for data.

    Enuf said.

    DNF (d52fb5)

  123. It’s not that businesses make mistakes – except for the mistake that trends will continue – it’s that things are not predictable.

    And recessions are caused by a reduction in the real money supply – when the real money supply goes down, the total volume of business has </b? to come down. (some people maybe moight not think there could not be such a thing as the "real money supply" but that is what explains stagflation, which we are not having now.

    Right now the Federal Reserve Board is trying to get the rate of inflation up to 2% and not succeeding. (that may not make sense as a goal, but who says that what government does has to make sense?)

    Sammy Finkelman (6a57b5)

  124. @Patterico: While interest rates set by the Fed may or may not be a good idea–as I said in earlier thread the chain of causation is so long that all you can point to are correlations–I do object to the term “central planning”, because words means things and the hyperbole detracts from your argument.

    The interest rate set by the Fed is no more “central planning” than the income tax rate set by Congress, or the minimum wages set by states, or the speed limit. “Central planning” is when the government dictates methods, investments, production, etc.

    Speed limit is a good analogy. Central planning would be that the government dictates not only the speed you can travel at, but your origin, your destination, and your route as well as what conveyance you use to get there. Central planning is light rail or a bus route, it’s not a speed limit.

    In the UVa threads didn’t a lot of us decry the defining-down of rape to suit a progressive agenda? Let’s not do the same thing here for a more worthy agenda.

    Gabriel Hanna (dcffe4)

  125. Look, English lit may be dead and buried but a rhetorical equivalence of the Federal Funds Rate to ‘central planning’ is a legitimate device, a stand in for policy.

    The Federal Reserve has manifestly exceeded its statutory authority, has ushered in global economic collapse, has pursued for the benefit of the few policies that are destroying millions of lives the world over and is a signal, unmitigated failure.

    Some of you are clearly out of your depth.

    Anklebiters.

    DNF (d52fb5)

  126. Does Not Function wrote:

    The point is business routinely relies on the government for data.

    Enuf said.

    The private sector is full of economists who try to forecast what the government data will be when it is released, and those learned economists are frequently wrong. Then, a month after the government data are released, the data will be updated, and changed.

    There is a real problem involve with businessmen basing their decisions on economic forecasts: economists have so much trouble measuring accurately what has already happened that it starts to get silly to base your decisions on what they tell you is going to happen.

    The economist Dana (1b79fa)

  127. Read all of it. I am not sure if I understood it, or it just resonates too strongly with my college econ and general systems classes in the 1960s. Nit: supply-demand-price. It’s a mechanism with TWO joints, not one. The Fed seems to think it has no joints at all, like a teeter-totter.

    The Fed is attempting to be a feed-forward mechanism, it seems to me, and those — without huge feedback mechanisms — always both overcorrect and undercorrect. They do not work with perfect knowledge, they do not work with perfect forecasting, they cannot do one thing. They think they do one thing, but both the immediate and the long term consequences frequently demonstrate that they did not; they then attempt again to do one thing ….

    We’re doomed.

    htom (9b625a)

  128. 127. Ha, ha. Was that because you are being ignored?

    DNF (d52fb5)

  129. 128. A useful study in itself.

    DNF (d52fb5)

  130. @Patterico: While interest rates set by the Fed may or may not be a good idea–as I said in earlier thread the chain of causation is so long that all you can point to are correlations–I do object to the term “central planning”, because words means things and the hyperbole detracts from your argument.

    The interest rate set by the Fed is no more “central planning” than the income tax rate set by Congress, or the minimum wages set by states, or the speed limit. “Central planning” is when the government dictates methods, investments, production, etc.

    Speed limit is a good analogy. Central planning would be that the government dictates not only the speed you can travel at, but your origin, your destination, and your route as well as what conveyance you use to get there. Central planning is light rail or a bus route, it’s not a speed limit.

    In the UVa threads didn’t a lot of us decry the defining-down of rape to suit a progressive agenda? Let’s not do the same thing here for a more worthy agenda.

    The Fed, through its open market operations, attempts to set the price of credit. Setting prices, in my view, is central planning.

    Patterico (9c670f)

  131. The post then gives an example of a central bank artificially lowering interest rates in a boom leading to excessive investment and inflation.

    It does? Could you point me to the language in the post where I say that? I thought I was saying that the Fed artifically lowers interest rates thus causing a boom. I didn’t say they do it in a boom. Also, I didn’t say that this lowering of interest rates leads to “excessive” investment, but rather malinvestment — investment in higher-order stages of production, when the economy needs investment in lower-order stages.

    Typically, by the way (as you say), the Fed does this in a downturn — preventing the recession’s work of redistributing resources, and creating artificial bubbles that then burst, causing even more pain.

    But this is not what central banks do (at least in theory). They raise interest rates when the economy is doing well (boom conditions) and cut them when the economy is doing poorly (bust conditions) thereby making the negative feedback mentioned above stronger and the system more stable (at least in theory). Without such intervention the natural negative feedback is not strong enough to prevent all destructive boom and bust cycles. Bubbles and crashes are a natural feature of market systems.

    So says you. But the whole point of the post is that, under Austrian theory, they aren’t. They are a feature of artificial credit expansion and lowering of interest rates. (This actually holds for American history, but that’s a separate post. You usually find people arguing that we had no central bank for much of the 1800s, but we had many panics, ergo this theory is incorrect. But Austrian economists have done a pretty thorough historical debunking of this argument. For example, Chapter 31 of Tom Woods’s latest book “Real Dissent,” which I offered to people for free here on the site, has such an analysis, and shows how artificial credit expansion by state and federal governments led to every panic and recession in U.S history.)

    Now you can argue the cure (central bank intervention) is worse than the disease (natural boom and bust cycles) but I don’t think it makes much sense to argue the disease is imaginary. There is no reason to expect a market economy to be inherently stable and observation shows that it isn’t. You get small scale bubbles and crashes all over the place and sometimes they become large enough to affect the economy as a whole.

    Again, I am not saying the disease is imaginary; I am diagnosing the cause differently from the way you are.

    Patterico (9c670f)

  132. the Caldwell bio of Hayek, which also covers Von Mises, illustrates that both were a reaction, to the dirigiste scientistism of Wagner and Moller, who dominated Austrian economics till the fall of the CreditAnstalt,

    narciso (ee1f88)

  133. 132

    It does? Could you point me to the language in the post where I say that? I thought I was saying that the Fed artifically lowers interest rates thus causing a boom. I didn’t say they do it in a boom. Also, I didn’t say that this lowering of interest rates leads to “excessive” investment, but rather malinvestment — investment in higher-order stages of production, when the economy needs investment in lower-order stages.

    The Fed isn’t trying to cause a boom, they are trying to speed up recovery from a bust. In theory they will raise interest rates back to natural levels as the economy recovers (and before a boom begins). And they will push rates above natural levels if the economy “overheats” (a boom begins). The Fed has kept interest rates low for some time without the inflation your post predicts. In your post you said:

    … But when consumer demand is still high, trucks are in demand for delivery of consumer goods and for delivery of raw materials to build factories. The competition for resources drives up prices …

    This sounds like the direct cause of problems is too much investment not investment in the wrong things.

    Again, I am not saying the disease is imaginary; …

    You seem to be saying that there are no such things as natural boom bust cycles, that boom bust cycles are always created (not just made worse) by central banks.

    … I am diagnosing the cause differently from the way you are. …

    What do you think causes small scale bubbles and crashes like for baseball cards or beanie babies? Or medium scale bubbles and crashes like investment in shale oil wells?

    James B. Shearer (00eea2)

  134. Some of you are clearly out of your depth.

    To quote Father Hamster, “Guilty as charged”.

    MD in Philly (f9371b)

  135. James B. Shearer,

    You need to re-read much of what I wrote. You’re busy refuting arguments I did not make.

    Patterico (9c670f)

  136. The Fed isn’t trying to cause a boom, they are trying to speed up recovery from a bust.

    I know very well what they’re trying to do. They are poor at predicting, though. Here’s Alan Greenspan in 2002:

    In housing markets, low mortgage interest rates and favorable weather have provided considerable support to homebuilding in recent months. Moreover, attractive mortgage rates have bolstered the sales of existing homes and the extraction of capital gains embedded in home equity that those sales engender. Low rates have also encouraged households to take on larger mortgages when refinancing their homes. Drawing on home equity in this manner is a significant source of funding for consumption and home modernization. The pace of such extractions likely dropped along with the decline in refinancing activity that followed the backup in mortgage rates that began in early November. Mortgage rates have gone back down again in recent weeks and are at low levels. This should continue to underpin activity in housing, but with perhaps less spillover to consumption more generally.

    The ongoing strength in the housing market has raised concerns about the possible emergence of a bubble in home prices. However, the analogy often made to the building and bursting of a stock price bubble is imperfect. First, unlike in the stock market, sales in the real estate market incur substantial transactions costs and, when most homes are sold, the seller must physically move out. Doing so often entails significant financial and emotional costs and is an obvious impediment to stimulating a bubble through speculative trading in homes. Thus, while stock market turnover is more than 100 percent annually, the turnover of home ownership is less than 10 percent annually–scarcely tinder for speculative conflagration. Second, arbitrage opportunities are much more limited in housing markets than in securities markets. A home in Portland, Oregon is not a close substitute for a home in Portland, Maine, and the “national” housing market is better understood as a collection of small, local housing markets. Even if a bubble were to develop in a local market, it would not necessarily have implications for the nation as a whole.

    Brilliant!

    In theory they will raise interest rates back to natural levels as the economy recovers (and before a boom begins). And they will push rates above natural levels if the economy “overheats” (a boom begins). The Fed has kept interest rates low for some time without the inflation your post predicts. In your post you said:

    … But when consumer demand is still high, trucks are in demand for delivery of consumer goods and for delivery of raw materials to build factories. The competition for resources drives up prices …

    This sounds like the direct cause of problems is too much investment not investment in the wrong things.

    Nope. It is investment in the wrong things: higher-order stages of production. The problem is that it is taking place at the wrong time, when consumer demand has not lessened and saving has not increased. In housing, the combination of various factors that I listed elsewhere, low interest rates spurred overinvestment in housing at a time when it was not needed.

    What do you think causes small scale bubbles and crashes like for baseball cards or beanie babies? Or medium scale bubbles and crashes like investment in shale oil wells?

    Bad decisions by businessmen? Like I have said many many times on this thread and in the post?

    Patterico (9c670f)

  137. 136

    You need to re-read much of what I wrote. You’re busy refuting arguments I did not make.

    I am not sure what you are arguing. Are you saying you would never have destructive bubbles like the recent housing bubble if the government didn’t influence interest rates?

    137

    Bad decisions by businessmen? Like I have said many many times on this thread and in the post?

    Sure bad decisions. But bad decisions prompted by governmental policy errors or bad decisions resulting from human nature interacting with markets?

    James B. Shearer (00eea2)

  138. 138. “I am not sure what you are arguing.”

    Interesting. Tell us more.

    DNF (1f3f17)

  139. I see a fault in your argument: generally the same companies are involved in either higher order production or lower order production, but not both. The only major exception I can think of off the top of my head is the oil industry. The pencil maker orders rubber based on how many pencils he expects to sell in the near future. The rubber tree plantation owner plans his inventory based upon on how much rubber he expects to sell over the useable life of a rubber tree (however long that is…I have no idea), and his customers include not only pencil makers but tire and engine belt manufacturers, rubber ducky makers, etc. The only higher order investment the pencil manufacturer will ever make is likely building a factory. The rubber planter makes some lower order investments, such as personnel, insecticides, transport of his rubber to the next stage if the process, but they are less central to his business.

    kishnevi (294553)

  140. 138
    19th century busts were the result of easy money suddenly tightening; usually some bank distortion was involved. Banks misjudged the credit market. But that merely forces the question up another notch. Why did the bankers all misjudge at once.

    kishnevi (294553)

  141. 141. Because people ignore black swans, and the longer something doesn’t happen, the more people reduce its estimatyed probability.

    They didn’t misjudge cureent conditions. Conditions, or what people might do, changed. Debts were called in.

    Sammy Finkelman (1b38fa)

  142. 142

    Yes, long periods of stability encourage greater and greater risk taking until it all comes crashing down. See Minsky moment.

    James B. Shearer (00eea2)

  143. I apologize – I hate being late to a thread, and I don’t have time to read every comment to see if this has been previously stated.

    There are two factors you are neglecting to consider 1) Since we are no longer on the gold standard, but instead suffer with a fiat currency, the goverment is directly responsible for the money supply. Ergo, crimping that supply should increase interest rates (and lower inflation), while printing money should decrease it (and increase inflation). Since the goverment is the sole arbitor of the number of dollars in circulation, it has ultimate control of interest rates. I can so no viable alternative to this scenario except to make the growth of the money supply automatic, that is linked to the growth rate of the economy.

    Also the goverment debt and deficit have a significant influence on interest rates. When the goverment is running a large deficit it is actively hoovering up dollars that would otherwise be invested in upstream corporate expansion. This is particularly true when interest rates on goverment debt are high, and when other investments are poor. Therefore the theoretical company that might seek to invest in upstream prodcuction during a slow down finds its supply of investment dollars crimped, because during the slowdown the goverment itself is running a major deficit borrowing money to pay for expanded benefits.

    Finally, when a goverment carries a large amount of debt, it seeks to keep interest rates low, because if interest rates rise, the goverment is stuck paying for even more debt, and sucking up more potential investment dollars, slowing the economy. We become trapped much like we seem to be now.The economy grows, interst rates rise, but the debt grows as well, requiring more goverment borrowing, which stranggles the recovery.

    So, ideally, the goverment would run no debt and have no annual deficit, or at least very small ones. The money supply should be linked to the rate of growth by some sort of transparent formula.

    Tennhauser (8c487b)


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