AUSTRIAN ECONOMICS ADDICT

Corn Seeds (Photo credit: Stevie Rocco)

This article on ZeroHedge.com, R.I.P. Retirement: 28% Of Americans Are Raiding Their 401k Plans, talks about how people are withdrawing a portion of their retirement savings and spending it on present consumption. A large part of these savings will be used  to produce capital goods (tools, buildings, vehicles, machines, etc.), which will be used to produce future goods more efficiently. When we start to use money saved for capital formation and use it for present consumption, we are eating our seed corn. If we start to eat a portion of the corn we’ve set aside for use as seed, we won’t produce as much corn for next years consumption. This has been happening for the last four years. Individuals have been using savings earmarked for the future, in order survive in the present.

CAPITAL FORMATION

The money an individual gets paid for the good or service he produces will be used to purchase a consumers good. The only question is whether it will be spent on present consumption, or whether it will be saved for future consumption. Retirement accounts are savings for an individuals future consumption. The portion of the saved money that is invested in capital markets represents real resources that are not being purchased and used for present consumption. Those resources, not purchased for present consumption, will be used to produce capital which is then used in processes of production that are more efficient and productive than the previous processes. The concept of saving resources to produce capital is how economies expand and produce a higher standard of living for society. This is an ongoing process in a free market. New and better ways of production are always driving out less productive methods of production. New jobs are being created as less productive jobs are becoming obsolete. Politicians and Government bureaucrats pay lip service to the benefits of free market capitalism, but in reality they don’t like the results of the free market process, or they would never intervene after the fact. These Government intervention’s in the free market are another factor, and not an insignificant one, that market forces have to take into account, as they allocate scarce resources, labor, and capital toward their most productive uses according to consumer demand. Government interventions don’t produce the results the planners envisioned, which means more interventions are needed to correct the previous interventions, thus creating a dog chasing its tail scenario.

CAPITAL ALLOCATION

Saving is the most important element for a growing economy, which seems counter intuitive at first glance. If you save doesn’t  that mean consumer demand is drying up? No, it just means that consumption will happen at some point in the future. Remember you can’t consume something that has not been produced. Production comes before consumption as I’ve written about in a previous post. When people start to save more of what they produce, this means scarce resources are being saved in order to be used in more productive processes. As the amount of savings increases, interest rates decrease, according to the law of supply and demand. The lowering of the interest rates are signals the market sends to entrepreneurs and businesses that it is now economical to expand for future production, because the cost of interest is a significant factor when calculating for expansion. Businesses and entrepreneurs  don’t need to understand that scarce resources are being saved in order to be used for their expansion. The lower interest rate passes this information along without them knowing the significance of the information. All they need to know is that now it is economical to expand. The interest rate reveals the time preference of all individuals cooperating in the market. The economy runs smoothly when consumption and production are coordinated by interest rates set through the market process.

CAPITAL MISALLOCATION

When the Fed gets involved in producing counterfeit money and lowering the interest rate, it starts us down a very different road. The counterfeit money produced by the Fed, and injected into the banks as loanable funds, looks like real savings. The interest rate is artificially lowered and false signals are sent out to businesses and entrepreneurs that it is now cost-effective to start their expansion projects. Unfortunately individuals are still consuming at the rate they were before the interest rates were artificially lowered. Resources that are needed for the new expansion, haven’t been freed up because they are being used for present consumption. As the counterfeit money works its way through the market it pushes up the prices of these scarce resources. The economy is being pulled in two different directions because production for present consumption, and expansion for future production are both demanding these scarce resources. At a certain point these projects will have to be stopped because there are not enough scarce resources to supply the artificial demand created by the counterfeit money. A liquidation of the assets and resources will have to take place in order to reallocate them to their most productive uses. Their will be a great waste of land, labor, capital, resources, and time, but the liquidation process (recession) has to take place. It is the cure for the artificial boom which was created by artificially low-interest rates, and the counterfeiting of money. Capital has been consumed by the artificial boom. If the Fed decides that they don’t want the liquidation (recession) to occur, and they keep counterfeiting and lowering interest rates, the misallocation of scarce resources will continue and grow bigger. This is where we are today. The Fed has injected 3 trillion counterfeit dollars into the economy since 2008, look at chart here. The misallocation of scarce resources is worse now then it was during the collapse in 08. The liquidation will have to happen, at some point we have to find the bottom in order to start back up. The Fed is doing everything in its power to make the decline to the bottom as slow as possible. One reason is that when something happens incrementally we don’t notice the changes as much, another reason is they are hoping for a miracle to happen to jump-start the economy, and still another reason is they don’t want the collapse to happen on their watch.

CAPITAL CONSUMPTION

The Fed’s artificial lowering of interest rates, and it’s injection of counterfeit money, has the economy in a bind. Economic forces are trying to liquidate the misallocations  produced by the Fed, the very entity which is trying to keep economic forces from performing the cleansing liquidation. We are eating our seed corn in a variety of ways. 1) The eventual liquidation will destroy capital that can’t be scraped or used for another purpose. 2) The shrinking economy will force people to consume their savings, and because capital can only be produced from real savings, future capital is being destroyed. 3) When Government tries to pick winners in the market, (green energy), capital is wasted, and Government’s need to fund it’s debt by borrowing 1.3 trillion dollars a year by selling bonds, takes much-needed investment dollars away from capital markets. 4) The expanding amount of Government workers, and the expanding number of people who are subsidized to not work, takes potential human capital out of the economy.

The intervention of Government into the economy whether through taxation, regulation, spending, borrowing, and especially counterfeiting, is the problem. The Government isn’t the economy, the free market economy funds the Government. Government can only exist because of what it appropriates from the production of the free market. Since we are consuming capital, our future production will shrink. It’s time to get rid of the parasite before it kills the host and itself.

Read this article, “Why Expansionist Central States Inevitably Implode” , by Charles Hugh Smith, at oftwominds.com.

Here are a few quotes from the article.

“The key dynamic in State spending is this: the allocation of public capital is intrinsically a political process, not a market or communal process. Thus politically powerful cartels and guilds will secure State funding for their vested interests, and potentially higher-value investments will go begging.”

“As the State expands its share and control of the economy, this political allocation of capital and national income also expands. As the State grabs an ever-larger share of the economy and extends its Central Planning to every layer of the economy, the “best game in town” inevitably becomes lobbying the State for funds and perquisites.”

“Private investment decisions start being made on the basis of State subsidies and tax loopholes rather than market-based metrics. This dynamic is especially pernicious: not only does the State increasing choose to fund projects with diminishing returns as a result of political allocation, the State’s expansion of command and control distorts private investment as well.”

This entry was posted on January 30, 2013 at 9:48 pm and is filed under Econ. 201, Government and Politics, Hall of Fame. You can subscribe via RSS 2.0 feed to this post's comments.

Tags: Capital Consumption, Capital Goods, Counterfeit money, Free market, Public sector, Saving, Seed Corn, The Fed