Statism, Rinse, Repeat…Collapse, by Robert Gore
Pick a perceived problem to which a government has intervened. There’s a stupidity cycle: the intervention makes the problem worse, which leads to more intervention, which makes the problem even worse, and so on. Statism, rinse, repeat. You may wonder: how long can a stupidity cycle persist before the problem that government has exacerbated gets so bad that there is a reckoning, or just plain collapse? Pull up a chair and make yourself comfortable—2015 is offering the opportunity to view cyclical stupidity exhaustion on multiple screens. There’s also a feature you won’t see in conventional AV rooms: the screens are interrelated; what happens on one screen affects what’s happening on the others.
This is an excerpt. For the rest of the article, please click the link above.
This is an excerpt. For the rest of the article, please click the link above.
The problem is not just the peculiar policies of central banks, it is the herd instinct of the public, the market, which thinks asset price have gone up and so will continue to go up. True, until they don't.
Rents depend on the demand for and availability of housing.
Earning similar. That is, the real economy.
So the theory goes like this: Suppose I set up a business. After the cost of the pick-and-place machines, reflow ovens, test fixtures, benches, and all the people, I earn $100k. I could sell this for $500k, meaning someone else gets that stream of income if they keep and eye on it and keep it earning $100k.
When business slows down, I'm afraid to hire people. People are afraid to buy new smartphones unless they see jobs are plentiful. I'm afraid to hire until I see a steady stream of orders from smartphone companies. The smartphone companies won't order more boards while people are afraid to buy new phones. So the central bank comes in and says "We'll prime the pump. We'll hand money to you and consumers so you can go ahead and hire them and they can go ahead and start buying. They want phones and they want jobs running production lines, and you've got this production line sitting there collecting dust and going to waste. We'll prime the pump to get those people and your equipment back to utilization." That sounds great, I say, but all the free money elevates the cost of my business. Soon I find people are offering me one million for my business, even though it's still doing the same revenue and has the same costs and profits. That sounds great until I got to diversify my wealth by investing in other businesses, e.g. S&P 500, and I find it's trading at 23 times earnings. I stop and wonder if my business is worth $2.3 million, 23 times earnings. I ask my broker, and she says it's because the market has priced in projected 20% growth in earnings over the next few years. Really? I figure I'll just go buy bonds, and I find they're expensive too, resulting in yields in the 3% range. I guess I could just go spend my wealth on all those products. But that's bad for me building wealth and it's bad for long-term growth of the economy. In this scenario, the gov't has created a great system to ensure constant demand and employment, but it's discouraging investment or storing wealth.
The thing I don't get about this scenario is why it makes means of production more expensive without affecting the cost of the things produced.
Suppose there is an investment possibility available, you reckon the free cash flow will be $100 pa and it will go on for 10 years.
What would you be willing to pay for it? The quick answer is that depends on the discount rate - your cost of capital.
If you use a discount rate of 5% pa then it works out that you can pay $772.
But if the rate drops to 2% pa then you can pay $898.
The seller of the business is wealthier by about $126, nothing has changed, no extra sales. Beauty! Buyers are not put off as they can borrow more. All that has happened is the central bank has dropped the interest rate.
The economy has been stimulated, there is more money for investment, more plants and factories are built, employment increases, wealth has been created at least for those with money,
another victory for central planning, or is it?
The drop in interest rates causes a drop in incomes of those who have money market investments. And /or, the extra liquidity from printing money reduces its purchasing power. The usual result is a short upward blip in the economy, then another decline, then calls for another drop in interest rates, more pump priming, all smoke and mirrors.
After a few cycles, private investors do not respond to pump priming which has no net benefit. If lucky we get stagflation, inflation with no increase in production, if not then recession.
You rightly point out that someone who purchased the business when rates were at 5% and sold when rates were at 2% made a $126 profit, not for any value they created, just due to fluctuations in cost of capital. Then you say these lower rates hurt long-term investors in short-term bonds and cash instruments. This is true, but what are the long-term investors doing in deposit accounts and short-term bonds? If they simply owned a diversified portfolio of businesses and real estate, along the lines of the hypothetical $100/yr investment, they will keep earning the same amount without regard to short-term rates.
So why not put all your money in (riskier) assets? Unfortunately it is never an evenly spread rise across all assets, and there is increasing likelihood of financial collapse (straighlinelogic's point), then cash etc hold value better.
These topics are dealt with on other threads here by MM, dbh, and others.
See also- robbery.
Returning to the topic of economic intervention by central banks and why asset values go up irrespective of earning power, take a look at:
https://mises.org/library/college-tow...
Because of my background living in a place where the currency is designed to lose 3-5% per year, I naturally think of money as a medium of exchange. I accept the small loss in value as I take it from one thing I sell to another thing I buy as a cost of using it, like the cost of maintaining currency, the cost of armored cars, etc. (BTW, I don't accept the cost of circulating pennies and nickels or using paper notes for $1 and $5. I find this absurd. The smallest coin I need is about $0.15.)
"Returning to the topic of economic intervention by central banks and why asset values go up irrespective of earning power"
I have certainly heard the argument that loose monetary policy leads to malinvestment. I'm not knowledgeable enough to compare a fractional reserve system to the alternatives, but the argument does not ring true to me. There have been speculative mania for hundreds of years. They crop up in odd things: tulips, emerging markets, railroads, high tech, real estate. It seems like the Texas sharpshooter fallacy, drawing the bullseye on whatever speculative mania most recently occurred and saying "loose monetary policy and fractional reserve banking create this type of malinvestment. I do not feel qualified to assert our banking system does not cause mania. I'm just saying mania predate our banking/monetary system.
I just posted on GG "Real Money." Let me know what you think.