Posted tagged ‘Scarce Resources’

Interest Rates Set By The Market vs. Interest Rates Set By The Fed

September 29, 2015

The Fed has kept interest rates at near zero since the 08 economic crash. For the last year the Fed has floated the trial balloon that they would raise interest rates this September by a mere quarter of a point. The Fed huffed and puffed and failed to follow through with this increase. To understand if the original lowering of the interest rate and the failure to raise the interest rate is good or bad, a few questions have to be answered.

What is an interest rate? How is an interest rate determined? What is its purpose? What happens if the interest rate is set artificially?

We will attempt to answer these questions with some excerpts from these articles, Central Banks Don’t Dictate Interest Rates, Frank Shostak, and Low Interest Rates Cant Save A House Of Cards, by Richard Ebeling. These articles give great explanations about interest rates, central banks, and the Austrian business cycle theory. Take time to read them.

WHAT IS AN INTEREST RATE

Individuals place a higher value on a good possessed in the present than a good possessed at some point in the future. The interest rate is the difference in time preference made by each individual between possessing a good in the present as opposed to the future. Put differently, the premium we place on present goods compared to future goods, or the discount we place on future goods compared to present goods is the interest rate.

Shostak –“…… a lender or an investor gives up some benefits at present. Hence the essence of the phenomenon of interest is the cost that a lender or an investor endures.”

“……For instance, an individual who has just enough resources to keep himself alive is unlikely to lend or invest his paltry means. The cost of lending, or investing, to him is likely to be very high — it might even cost him his life if he were to consider lending part of his means. So under this condition he is unlikely to lend, or invest even if offered a very high interest rate.”

“Once his wealth starts to expand, the cost of lending — or investing — starts to diminish. Allocating some of his wealth toward lending or investment is going to undermine, to a lesser extent, our individual’s life and well being at present. From this we can infer that anything that leads to an expansion in the real wealth of individuals gives rise to a decline in the interest rate (i.e., the lowering of the premium of present goods versus future goods). Conversely, factors that undermine real wealth expansion lead to a higher rate of interest.

HOW INTEREST RATES ARE DETERMINED

The time preference of all individuals determines the interest rate. As savings by individuals accumulate the interest rate decreases. As savings by individuals diminish the interest rate increases. The amount of savings determines the interest rate, the interest rate doesn’t determine the amount of savings. When the interest rate is falling we are saving more and consuming less, which means resources are being saved for future consumption. When the interest rate is rising we are consuming more and saving less, which means resources are being used for present consumption.

Shostak – “In the money economy, individuals’ time preferences are realized through the supply and the demand for money. The lowering of time preferences (i.e., lowering the premium of present goods versus future goods) on account of real wealth expansion, will become manifest in a greater eagerness to lend and invest money and thus lowering of the demand for money.”

“This means that for a given stock of money, there will be now a monetary surplus.”

“To get rid of this monetary surplus people start buying various assets and in the process raise asset prices and lower their yields. Hence, the increase in the pool of real wealth will be associated with a lowering in the interest rate structure.”

“The converse will take place with a fall in real wealth. People will be less eager to lend and invest, thus raising their demand for money relative to the previous situation. This, for a given money supply, reduces monetary liquidity — a decline in monetary surplus. Consequently, this lowers the demand for assets and thus lowers their prices and raises their yields.”

PURPOSE OF INTEREST RATES

Resources are scarce and have alternative uses. Low interest rates send a signal to producers that resources are being freed up for use in future lines of production. But all they need to know is the lower interest rate makes expanding for future production affordable. Higher interest rates send a signal to producers that resources are being used for present consumption. The higher interest rate makes their plans to expand unaffordable and that is all they need to know.

Each individuals unlimited desire for specific goods, their time preference for specific goods, all of which are constrained by the scarcity of resources, their different uses, and the desire of individuals to produce specific goods based on whether they think it’s profitable is coordinated by interest rates. Interest rates coordinate production across time as long as they are determined by the market i.e. individuals time preferences. If set arbitrarily, interest rates distort the production process.

Ebeling – “Investment requires the availability and application of real resources and the distribution of raw materials and the use of a portion of the existing workforce to manufacture and at least maintain the capital goods – tools, machines, equipment, machinery and factory structures – finished and final goods and services produced and made available on the market that consumers want.”

“But all this takes time, repeated periods of production, through which goods are not to be done only once or even twice, but ever-so-every day, every week, every month, every year, there is a constant flow of them…..”

“If the resources, capital, equipment, and the work is not allocated and maintained, over and over again, to begin the process for the assembly of the next device, the output would shortly come to an end….”

“It must be the necessary savings in the economy to buy, implement and use the necessary raw materials, capital, equipment and workers so that each of the goods that are going on in the partially completed sequence can be brought to its final, usable form that is ready to be sold to consumers on the market.”

“Goods and services of all kinds are bought and sold with the help of money. But pieces of paper money, or even minted coins of gold or silver, can’t make the lack of real raw materials, capital, equipment, work or services disappear or less limited. Print out pieces of paper currency does not create out of thin air more coal, iron, or platinum. such paper money does not lead to a capital equipment miraculously falling from the sky. Nor do they materialize more working – age workers ready to be assigned to the desired job.”

THE ARTIFICIAL BOOM AND THE REALITY OF THE BUST

What happens when the Federal Reserve intervenes into this complex process? Fed policies usually result in artificially low-interest rates, and the injecting of electronically printed money into the system. The policy sends mixed signals through the market. The artificially low interest rate is a false signal that says there are more resources for expansion. Unfortunately people are still consuming at their present rate and haven’t started saving more for future production. The economy is being pulled in two different directions. The counterfeit money is demanding scarce resources for future production, but the structure of production is set up to meet people’s desires for present consumption. This is what happened with the housing bubble. The prices for scarce resources, labor, capital, and time were being bid up because they were being demanded for the expansion of new processes of production for future consumption. And at the same time these resources were being demanded for present consumption patterns that hadn’t changed. At some point there weren’t enough resources to go around and they were wasted when the bubble became unsustainable and collapsed.

Ebeling – “This balancing and coordinating function of the interest rates on the financial markets is undermined and distorted by central banking “activist” monetary policy that pushes for more money in the banking system. Since money is the medium through which the savings and investments carried out further amounts of money being made available for lending purposes creates a false impression that there are more savings to support longer and more time-consuming projects for investment than is actually the case. And artificially lower interest rates makes it seem as if these new or expanded investments in projects that are more profitable than they seem as if the higher market interest rates that prevailed in the financial markets.”

“….the investment boom stage of the business cycle will come to an end, and investment projects that can not be implemented or can not be profitably maintained if they are brought online. The downturn in the economy sets in. The imbalance between savings options and investment decision-making and the allocation and use of resources, capital and labor between the shorter and longer production processes become visible.”

“There  must be a balance between supply and demand, prices, and wages, resources, capital and labor use between different sectors of the economy in order to more accurately reflect the post-boom realistic conditions on the market and profitabilities.”

“Jobs are temporarily lost, unsustainable and unprofitable investment projects must be written down or written out, and the illusory wealth positions will prove to be not as good or as high as they appeared in the previous boom phase of the business cycle.”

“What has happened over the last decade is the home, the stock market and the investment boom that was driven by the Federal Reserve easy money policies beginning in the year 2003 finally came crashing down in 2008-2009. Then, in the name of preventing the decline it mutates into a fearsome new deflation-driven “great depression”, the Federal Reserve has opened the monetary spigots for the last six years, setting up and running the same type of rise in the stock market, capital malinvestments, and the work of the misallocations that its monetary intervention had caused earlier in our century.”

“Now the Fed authorities want to rein in monetary expansion and “push” the interest rates up……. But if they do, this threatens to shake out the imbalance market relationships their own monetary policies have created.”

“This is how and why the roller coaster of the economic cycle continues to repeat itself, but each phase of the cycle varies in duration, and many special properties, depending on specific historical circumstances. The Federal Reserve’s own expansionary monetary policy, wets out for the boom that finally turns into a recession from which it is Fed authorities consider themselves as responsible to prevent or mitigate, that just sets in motion the next unsustainable boom of a new offset the monetary expansion.”

“So while the Federal Reserve has decided to keep its key interest rate near zero, it is only delaying the inevitable result of its own monetary policy, another needed economic correction that its actions will have generated but it will no doubt blame on the supposed  “failures” of the market economy.”

CONSLUSION

The Federal Reserve and all Government bureaucrats don’t have a fraction of the knowledge that the market can bring to bear on any decision, but they have enough arrogance to think they do. As Hayek says their “pretense of knowledge” makes them think they can bring about results that aren’t possible because they fly in the face of the most basic economic principles.

Related ArticleThomas Woods Explains The Austrian Business Cycle Theory, at austrianaddict.com.

Related ArticleReal Savings = True Credit, Printed Savings = False Credit, at austrianaddict.com.

Related ArticleFederal Reserve Policies Cause Booms And Busts, at austrianaddict.com.

Related ArticleCounterfeiting By The Federal Reserve, Although Legal, Still Results In Theft, at austrianaddict.com.

 

Why Stop At Community College? Let’s Make Everything Free!

January 20, 2015

President Obama wants to make tuition free at 2 year community colleges. Here is an excerpt from the White House Fact Sheet: Free Community College For Responsible Students, at whitehouse.gov: “Today the President is unveiling the America’s College Promise proposal to make two years of community college free for responsible students, letting students earn the first half of a bachelor’s degree and earn skills needed in the workforce at no cost.

WHAT IS AN ECONOMIC GOOD

College education can’t have “no cost”, because it is an economic good. No matter how much the Presidents utopian vision of the world tries to tell us it isn’t an economic good, it is. What is an economic good? It is a good that is scarce and/or has to be brought to the market by the use of labor and capital. In other words it has to be produced. Air and sunlight are examples of non economic goods because they exist in abundance without having to be produced by anyone. There are very few non economic goods.

Someone has to pay for an economic good. The producer pays the original cost for the production of an economic good. If the good can’t be exchanged at a price that covers the cost, plus a profit, it tells the producer that there is no market for the good and the producer will cease production and absorb the loss.

I love the phrase “AT NO COST“. There is no such thing as, at no cost, in a world ruled by scarce resources that have alternative uses. Economic goods always have a cost and no amount of rhetoric can escape this reality. Political rhetoric is an attempt to shift the cost to someone else. I suspect we, the tax payers, are going to be forced to pay the cost for this new “free” good. Let’s take a look at this from another angle. Instead of shifting the cost of community college to the tax payers, lets see if we can shift the cost to some other individuals.

LET’S MAKE EVERYTHING FREE!

If educating our children is so important that we need to make it free, let’s make the professors volunteer to teach at no cost. Let’s make the workers at the colleges provide their services at no cost. Let’s make text-book companies provide their books at no cost. Let’s make businesses who support the infrastructure of the college provide their good of service at no cost. This would lower the cost of college significantly or possibly make it free if we went far enough down the chain of production.

What would happen if Government bureaucrats mandated that every good and service was free? Would you continue to work as many hours at your job, or would you spend some of your time doing other things that are now free? Anybody with a degree of common sense knows that this wouldn’t work. No one would provide their good or service for free. People trade their good or service for money, and then exchange this money for other goods (food, clothing, shelter, etc.) that allow them to survive every day. If everything was free they wouldn’t need to work.

When you went to the grocery would you choose the ground beef you’ve always purchased, or would you upgrade to ground sirloin or a T-Bone steak? When it was time to get a new car would you choose a used car like you’ve always chosen or would you get a new car?

Do you see the problem? People will choose to consume more things and different things than they would have when there was a price on goods. People will also produce less because they know they can get what they want for free without any corresponding production. We can’t escape the reality of the world we live in. We live in a world of scarce means that have to be used to satisfy the unlimited ends desired by all individuals. Scarce resources, time, labor, and capital have to be rationed in some way. There are three ways to ration scarce resources: 1) through prices in a free market economy, 2) by bureaucrats in a centrally planned economy, 3) or by fighting over them. Voluntary cooperation in a price coordinated free market economy uses scarce resources in the most efficient way possible. It also satisfies a higher amount of ends out of the unlimited number of ends that exist among all individuals. There is no other way of rationing scarce resources, that currently exists, that can come close to what the free market has produced.

Free college isn’t free, the cost is just shifted. Obamacare is an attempt by Government to shift the cost of healthcare to the taxpayer. Welfare, food stamps, and subsidies to big businesses are other examples of shifting costs to the tax payer. As more is made free by Government officials, less will be produced in the free market. Central planning ultimately leads to a lower standard of living, or as F.A. Hayek has said, it’s “The Road to Serfdom“.

OTHER OBSERVATIONS ABOUT THE FACT SHEET

Here is another excerpt from the fact sheet; “Responsible.. students who attend at least half-time, maintain a 2.5 GPA while in college, and make steady progress toward completing their program will have their tuition eliminated.

Why is the President going to discriminate against students who, through no fault of their own, are irresponsible. Why should they be made to pay? Why should there be a cut off at a 2.5 GPA? Why not 2.2 or 2.0? What heartless bureaucrat arbitrarily chose 2.5? Shouldn’t it be more like our graduated income tax? Wouldn’t it be “fair” to gradually increase the amount a student would pay at each incremental point they receive below a 2.5 GPA? The President is being mean and unfair, which are the very qualities he paints his political opposition with.

Read the fact sheet. It is a piece of political propaganda that would make Joseph Goebbels blush.

 

Producing Capital Goods, Requires Restricting Present Consumption

August 29, 2014

Understanding the role capital goods play in an economy is important, but understanding the process of producing capital goods is more important. Using capital goods allows individuals to become more productive over time. Capital goods are scarce, they don’t magically appear. Present consumption has to be foregone to save the resources and time needed to produce capital goods. The foundation of the advance in the worlds material standard of living is due to the capital structure that has evolved over time.  The two articles below explain Capital Theory using analogies that are simple to understand. The first by Mark Tovey is from this week, and the second is by Robert P. Murphy and is from Oct. 2008, which was in the middle of the economic crisis.

Austrian Capital Theory And The Dawn Of The Planet Of The Apes, by Mark Tovey, at mises.org. Here are a few highlights from this article.

“The adoption of ever-more roundabout and convoluted production processes is, paradoxically, the hallmark of economic development. This is not, of course, because time-consuming methods are inherently more productive. If that were the case, we could increase output by simply working more slowly!…..roundabout methods are immensely more productive than their labor-intensive counterparts, hence it is why the more complex methods have come to replace the labor-intensive ones in the developed human economies of the world.”

“In the process of economic growth, saving is crucial. No matter how ingenious the individuals comprising a society, if the means to forgo present consumption are unavailable, capital goods simply cannot be created. Crude, labor-intensive methods of production will then necessarily be employed,”

The Importance Of Capital Theory, by Robert P. Murphy, at mises.org. Here are a few highlights from this article.

“The basic Austrian story is that during the artificial boom, workers’ labor and other resources get channeled into investment projects that aren’t compatible with the overall level of real savings. Sooner or later, reality rears its ugly head, and the unsustainable projects have to be abandoned before completion. Entrepreneurs realize they were horribly mistaken during the boom, everybody feels poorer and slashes consumption, and many workers get thrown out of jobs until the production structure can be reconfigured in light of the revelation.”

“As our simple story illustrates, in modern economies workers use capital goods to augment their labor as they transform nature’s gifts into consumption goods. Because of the time structure of production, it is possible to temporarily boost everyone’s consumption (with Government or Fed stimulus), but only at the expense of maintaining the capital goods, which are thus “consumed.” At some point, engineering reality sets in, and no “stimulus” policies can prevent a sharp drop in consumption.”

Related ArticleCapital Consumption, aka, Eating Our Seed Corn, at austrianaddict.com.

Charles Hugh Smith – After 6 Years Of Unprecedented Central Planning, The Economy Is More Fragile Than Ever

June 23, 2014

File:Organiztion of the Federal Reserve System.jpg

Charles Hugh Smith does another brilliant analysis of how central planning, by the Federal Reserve, has markets completely distorted to the point that nobody knows what is real or fake, in this article, After 6 Years Of Central Planning, The Economy Is More Fragile Than Ever.

Artificially holding interest rates lower than they would be in an unhampered market, distorts the production process. It brings about economic activities that wouldn’t have existed if the market was left to decide what the interest rate should be. Interest rates “coordinate production across time”.  Any interference with the knowledge that passes through the production process, because the interest rate is distorted by the Fed, consumes scarce resources, scarce capital, and scarce labor. As we talked about in this article Capital Consumption, aka, Eating Our Seed Corn, and this article, A Look Over The Horizon At What Lies Ahead If We Continue Down The Central Planning Road.

Here are some excerpts from CHS’s article.

“Here are the key characteristics of Central Planning:”

1. “The central bank/state intervene in the economy in a dominant fashion, controlling functions such as interest rates…”

2. “The central bank/state pick winners and losers: ….. The central bank/state bailed out the too big to fail banks private losses with public-taxpayer money. In effect, the central state/bank enrich cronies at the expense of everyone else.”

3. “The central bank/state manipulate the nominally “free” market to boost asset valuations as a way of enriching cronies who own most of the financial assets and as a public-relations charade to mask the failure of their picking winners and losers.”

“In other words, in centrally planned economies, markets are not allowed to discover price–they exist only to reflect positively on Central Planners.”

4. “The central bank/state use the power of the printing press to create as much money as they need to reward cronies and cram their decisions down the throat of the economy.”

5. “The central bank/state use the power of their public policy announcements to manipulate behavior and the financial markets while keeping programs that might attract scrutiny secret.”

“Central planning fails for intrinsic reasons unrelated to the specific policies. The decentralized, self-organizing market is like the immune system for the economy; it keeps the system healthy by burning off the deadwood of failed bets and failed investments and distributing credit and risk on performance rather than cronyism.”

“By eliminating the economy’s immune system, Central Planning dramatically increases vulnerability and guarantees systemic crises down the road…”

“The economy becomes dependent on the The central bank/state intervention and loses the ability to function in the real world. When the real world finally intrudes, the weakened, strung-out addict, no longer capable of responding to reality in a positive fashion, expires.”

The damage done by Central Planning has yet to come home to roost. Six years into the Grand Experiment–that Central Planners can pick winners who just happen to be their cronies–the chickens of consequence are still making their way home.”

CHS  has some great charts that show the results of the Feds interventions, which are hard to see let alone understand. As J.M. Keynes wrote, “There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”

In order to understand what Keynes was talking about concerning counterfeiting by central banks, you first have to understand this quote by his rival F. A. Hayek, “The coordination of mens activities through central planning or through voluntary cooperation are roads going in very different directions, the first to serfdom and poverty the second to freedom and plenty.”

Voluntary cooperation through free markets brings about individual freedom and a higher standard of living, while its opposite, central planning, brings about coercion by the state and a lower standard of living.

Related Article/VideoKeynesianism vs. The Austrian School, by austrianaddict.com.

Related Article/VideoKeynes vs. Hayek Round II, The Fight Of The Century, by austrianaddict.com.

 

 

 

Myths About Capitalism

April 4, 2014

Many people think big businesses like free market capitalism. The truth is when big businesses were small they liked free market capitalism, because it allowed them to compete with bigger businesses for a share of the market. Once these businesses get big, they don’t like competition. They want to protect their position in the market, and the only way to do that is to try to get Government to pass regulations that makes it difficult for their competitors to compete. This is crony capitalism.

Free market capitalism rewards people who are good at production. They are rewarded by consumers who vote with their dollars on who provides the best product or service. Crony capitalism rewards people who are good at political games.

Free market capitalism uses scarce resources more efficiently than the waste that occurs in a crony capitalist system. {Solyndra}

Top Three Common Myths Of Capitalism, Video by learnliberty.org.

Here is a quote by Murray Rothbard,

“The market promotes and rewards the skills of production and voluntary cooperation. The Government enterprise promotes the skills of mass coercion and bureaucratic submission…and those who get to the top will be those with the most skill in that particular task.”

Related ArticleWalter E. Williams: Free Market Capitalism Creates A Higher Standard Of Living For Everyone, by austrianaddict.com.

Related ArticleWhy Is Capitalism So Unpopular? by Art Carden at mises.org. Excerpt from the article.

“Under capitalism, the common man does not need an intellectual vanguard or a group of virtuous surrogates to make his decisions for him or to defend him against the rapacity of his fellows. He can do just fine without our help, thank you very much, and would be much obliged if we would go back to our ivory towers and leave him alone.”

Related ArticleDo Capitalists Produce Nothing, by D. W. MacKenzie, at mises.org. Excerpt from the article.

“Capitalists who improve production plans serve the needs of consumers and produce economic progress. This is how the system that we accurately call “free enterprise” actually works. Capitalists who participate in the redistribution of wealth through government policy produce disruptive production plans and economic waste. That is how the system that we accurately call “crony capitalism” works.”

 

Real Savings vs. Counterfeit Savings

July 19, 2013
Savings

Savings (Photo credit: 401(K) 2013)

RESULTS OF COUNTERFEITING

In a previous post titled, Financial Markets Move When The Puppet Master Speaks, we talked about some of the consequences the Fed creates, when it electronically counterfeits money and injects it into the economy. Some of these are 1) the misallocation of scarce resources into activities that can’t be sustained when the counterfeit money injections are halted, and 2) people’s real production is being redistributed to the first receivers of the counterfeit money (which is known in my world as theft). What’s the difference when real savings enter the market as opposed to counterfeit savings? Lets see what happens, but first let’s talk about money.

WHAT IS MONEY? (more…)