This is a silly criticism of the ABC. The chronically underappreciated insight of Austrian capital theory is that *time* is a factor of production; the value added by savers is that one can invest other factors (labor, natural resources) into lines of production that require more time but also offer greater quantities of outputs as compensation for having to wait longer for the returns. Interest rates need to be understood as a price of time, a crucial point that seems to be lost on non-Austrian economists who always think in terms of time-independent production possibilities frontiers. Interest rates are pervasive throughout almost all planning of production.
If one tries to counterfeit such savings by funding credit expansions via the creation of money and/or money substitutes out of thin air, one isn't in fact furnishing additional time but is nonetheless systematically mispricing time-discounted inputs and capital goods as if additional time were available. When Mises formulated the ABC (and the Swedish economist Knut Wicksell formulated similar theories around the same time), the inescapable deduction is that if such mispricing occurred, too many inputs would be diverted towards the more interest-rate-sensitive sectors at the expense of the less interest-rate-sensitive sectors; which is unsustainable over the long run as physical shortages appear in the less interest-sensitive sectors and input prices forced upwards relative to output prices, selectively squeezing operating margins and generating widespread losses concentrated in the more interest-sensitive sectors.
The notion that entrepreneurs can magically foresee and correct every instance of mispricing to prevent investment errors (in the ABC scenario, preventing the diversion of labor and natural resources towards earlier stages of production than is warranted by the time preferences of savers) is an unrealistic assumption of omniscience. Obviously *some* mitigation of cyclical errors happens; I think one can build on the ABC theory by noting how this imperfect entrepreneurial mitigation of errors is often focused on sectors that proved to be problematic in previous cycles while failing to anticipate newly-emerging vulnerabilities of other sectors to cyclical problems (often associated with the emergence of new technologies, new methods of financing, new government regulations of banking, etc.).
Btw, a roof collapse due to the excessive weight of bananas stored on it represents an engineering error, not an error in the pricing of bananas. The entrepreneurial risk of banana mispricing associated with subsidies is that an entrepreneur stores too many of them in anticipation of being able to resell or consume them in a timely fashion. Once this surplus of bananas becomes manifest (i.e. one discovers can't make profitable use of the stored bananas in spite of how cheap they were), an entrepreneur fooled by the artificially low prices has to accept their spoilage or absorb the excessive costs of storing them longer. This inability of the banana entrepreneur to make profitable use of the surplus after the error is committed is analogous to having to write off an excess of capital goods in the interest-sensitive boom sectors in the bust phase of the ABC scenario.
I am no economist, let alone an Austrian. But businesses don't march in lockstep. Some businesses will have been planning investments before the interest rate cuts and accelerate their plans by a few months or a year, others will see that and not want to be left behind. Some investments can bear fruit almost immediately, others take longer. Tax laws provide all sorts of deductions, and that can make it a reasonable bet to invest now. When a competitor expands or invests in newer equipment to be more efficient and productive, some competitors will react by bringing forward their own improvements, and better to do it while rates are low than later. Knowing that the rates are controlled by a capricious government and not likely to last can actually be an inducement to getting on the investment bandwagon while the getting is good.
Yes, some will be. That's how people are -- different. Some jump the gun, some wait to see how things shake out. Some make better decisions than others.
But blaming it all on all businesses and implying they all do the same thing is wrong.
"His implicit assumption is that [all] businessmen believe that short-term interest rates cuts will last forever. That’s a really stupid thing for [all] businessmen to believe. And if [all] businessmen are really that stupid, it’s pretty unfair to blame government for the whole business cycle."
"Average" is for statistics. I provided a good plausible explanation for why *some* businesses invest when interest rates are low even with the knowledge that they are temporary, sometimes even because they know they are temporary, and why other businesses follow suit. It has nothing to do with averages. It's no different from stocking up on some food item when the grocery store has a sale.
Great chapter. I have always struggled to reconcile the reasonableness of, and seemingly historically correct, Austrian perspective that Keynes’ system fails to account for stagflation and a few other empirical facts, with the fact that it has persuaded nearly every working economist. I am not persuaded that Mises wasn’t translated early enough, and then Keynes took over and no one ever looked back and we got paradigm lock-in. The Austrians have had moments of fame and appreciation by big figures. It seems unlikely that nobody ever read Mises and that’s the problem. I guess though I just don’t understand why the field as a whole has always been Keynesian and kind of just sweeps under the rug the inability to square its theories with what the world actually shows us. Even the frontier models of heterogeneous agents still cling to a fair bit of Keynesian baggage. So what’s the real explanation for the Keynesian ascendancy and its ability to withstand falsification? What do the mainstream keynesians know that I don’t?
The other thing I wondered about reading this chapter is whether or not we don’t have enough data nowadays to test wether capital goods actually rise/fall in proportion to consumer goods in the way the Austrian theory predicts. Rothbard makes it seem like this would be a very easy and palpable way to prove or disprove the theory. He states repeatedly that capital goods rising during the boom and then collapsing during the bust (and vice versa for consumption goods), and this is a plain as day fact. Seems like something we could actually look at the data for nowadays.
The only time I have wondered about the paradigm lock-in perspective is when Greg Mankiw wrote on his blog that he has never read any Austrian and never will bc he holds a whigg view that someone else already has, so everything good is in the textbooks already and everything bad has been set aside. But he writes the textbooks, so shouldn’t he be one reading the Austrians?
Don’t we literally just go through a cycle during Covid were we got zero interest rates, businesses and individuals way over invested in ZIRP models, and then when inflation spiked and rates went back up it caused a huge dislocation? Like this was really dramatic in recent memory.
Wasn’t the housing crisis in the 2000s kind of similar.
Like, people and business really are that stupid that they get hoodwinked by easy money.
We got 10% inflation and now firms are trying to layoff people via RTO and we've got a record low new hiring rate. Our labor market has ossified. Our housing market is a Frankenstein of people in 3% mortgages sitting on their houses because of the seesaw even if they are two people living in a five bedroom or a big family that would like to move out of their starter home. VCs are basically stuck with the fact that they can't up value from the last round.
What exactly did we gain from having the fed print to bail the government out of its COVID and other policies? Why not blame the fed for having made a bad choice?
If I take a gambling addict to a casino it's folly for him to gamble, but it's also folly for me to bring him to the casino. I know what the hell is going to happen, so why do it?
It's not being hoodwinked, it's reacting to low rates by accelerating existing plans and competitors' investments. When it seems like everyone really is that stupid, that's a sure-fire indication that they have some real reason which the experts are ignoring. I trust the people with skin in the game far more than I trust armchair experts.
But all those companies that engaged in massive hiring are now laying those people off.
And all those VCs can't sell at the valuations people paid for them.
And all those MBS weren't worth what people paid for them.
Like we constantly see people in business, who have skin in the game, overact to signals and make bad predictions, and these misfires tend to correlate with loose money and rapid asset appreciation.
The alternative is that the fed didn't lower rates to bail out the governments COVID policy and/or it raised them harder and faster instead of being behind the curve.
That's no alternative. May as well wish for wise government bureaucrats. Clap for Tinkerbell while you're at it.
I remind you that this thread started from your complaint about stupid people and businesses, and I responded that the people in question are not stupid. You can't suddenly pivot to wishful thinking about Tinkerbell bureaucrats.
"Like, people and business really are that stupid that they get hoodwinked by easy money."
Dude you can literally look at say Arthur Burns vs Paul Volcker and realize that governance matters and can turn out different.
The simple repeatable fact is that periods of negative real rates tend to produce bubbles and misallocations over and over and over again. Business people do in fact find it difficult to make accurate economic decisions when the rates whipsaw.
One other distortion of free markets worth mentioning is government cronies with insider information. While this may not be large much of the time, once you add in effects of regulatory capture, things will get more messed up.
This is a silly criticism of the ABC. The chronically underappreciated insight of Austrian capital theory is that *time* is a factor of production; the value added by savers is that one can invest other factors (labor, natural resources) into lines of production that require more time but also offer greater quantities of outputs as compensation for having to wait longer for the returns. Interest rates need to be understood as a price of time, a crucial point that seems to be lost on non-Austrian economists who always think in terms of time-independent production possibilities frontiers. Interest rates are pervasive throughout almost all planning of production.
If one tries to counterfeit such savings by funding credit expansions via the creation of money and/or money substitutes out of thin air, one isn't in fact furnishing additional time but is nonetheless systematically mispricing time-discounted inputs and capital goods as if additional time were available. When Mises formulated the ABC (and the Swedish economist Knut Wicksell formulated similar theories around the same time), the inescapable deduction is that if such mispricing occurred, too many inputs would be diverted towards the more interest-rate-sensitive sectors at the expense of the less interest-rate-sensitive sectors; which is unsustainable over the long run as physical shortages appear in the less interest-sensitive sectors and input prices forced upwards relative to output prices, selectively squeezing operating margins and generating widespread losses concentrated in the more interest-sensitive sectors.
The notion that entrepreneurs can magically foresee and correct every instance of mispricing to prevent investment errors (in the ABC scenario, preventing the diversion of labor and natural resources towards earlier stages of production than is warranted by the time preferences of savers) is an unrealistic assumption of omniscience. Obviously *some* mitigation of cyclical errors happens; I think one can build on the ABC theory by noting how this imperfect entrepreneurial mitigation of errors is often focused on sectors that proved to be problematic in previous cycles while failing to anticipate newly-emerging vulnerabilities of other sectors to cyclical problems (often associated with the emergence of new technologies, new methods of financing, new government regulations of banking, etc.).
Btw, a roof collapse due to the excessive weight of bananas stored on it represents an engineering error, not an error in the pricing of bananas. The entrepreneurial risk of banana mispricing associated with subsidies is that an entrepreneur stores too many of them in anticipation of being able to resell or consume them in a timely fashion. Once this surplus of bananas becomes manifest (i.e. one discovers can't make profitable use of the stored bananas in spite of how cheap they were), an entrepreneur fooled by the artificially low prices has to accept their spoilage or absorb the excessive costs of storing them longer. This inability of the banana entrepreneur to make profitable use of the surplus after the error is committed is analogous to having to write off an excess of capital goods in the interest-sensitive boom sectors in the bust phase of the ABC scenario.
I am no economist, let alone an Austrian. But businesses don't march in lockstep. Some businesses will have been planning investments before the interest rate cuts and accelerate their plans by a few months or a year, others will see that and not want to be left behind. Some investments can bear fruit almost immediately, others take longer. Tax laws provide all sorts of deductions, and that can make it a reasonable bet to invest now. When a competitor expands or invests in newer equipment to be more efficient and productive, some competitors will react by bringing forward their own improvements, and better to do it while rates are low than later. Knowing that the rates are controlled by a capricious government and not likely to last can actually be an inducement to getting on the investment bandwagon while the getting is good.
Or to be extremely hesitant!
Yes, some will be. That's how people are -- different. Some jump the gun, some wait to see how things shake out. Some make better decisions than others.
But blaming it all on all businesses and implying they all do the same thing is wrong.
"His implicit assumption is that [all] businessmen believe that short-term interest rates cuts will last forever. That’s a really stupid thing for [all] businessmen to believe. And if [all] businessmen are really that stupid, it’s pretty unfair to blame government for the whole business cycle."
You don't need [all]. Just "average."
"Average" is for statistics. I provided a good plausible explanation for why *some* businesses invest when interest rates are low even with the knowledge that they are temporary, sometimes even because they know they are temporary, and why other businesses follow suit. It has nothing to do with averages. It's no different from stocking up on some food item when the grocery store has a sale.
Great chapter. I have always struggled to reconcile the reasonableness of, and seemingly historically correct, Austrian perspective that Keynes’ system fails to account for stagflation and a few other empirical facts, with the fact that it has persuaded nearly every working economist. I am not persuaded that Mises wasn’t translated early enough, and then Keynes took over and no one ever looked back and we got paradigm lock-in. The Austrians have had moments of fame and appreciation by big figures. It seems unlikely that nobody ever read Mises and that’s the problem. I guess though I just don’t understand why the field as a whole has always been Keynesian and kind of just sweeps under the rug the inability to square its theories with what the world actually shows us. Even the frontier models of heterogeneous agents still cling to a fair bit of Keynesian baggage. So what’s the real explanation for the Keynesian ascendancy and its ability to withstand falsification? What do the mainstream keynesians know that I don’t?
The other thing I wondered about reading this chapter is whether or not we don’t have enough data nowadays to test wether capital goods actually rise/fall in proportion to consumer goods in the way the Austrian theory predicts. Rothbard makes it seem like this would be a very easy and palpable way to prove or disprove the theory. He states repeatedly that capital goods rising during the boom and then collapsing during the bust (and vice versa for consumption goods), and this is a plain as day fact. Seems like something we could actually look at the data for nowadays.
The only time I have wondered about the paradigm lock-in perspective is when Greg Mankiw wrote on his blog that he has never read any Austrian and never will bc he holds a whigg view that someone else already has, so everything good is in the textbooks already and everything bad has been set aside. But he writes the textbooks, so shouldn’t he be one reading the Austrians?
My best story on Keynes' appeal: https://www.betonit.ai/p/the_keynesian_ahtml
Don’t we literally just go through a cycle during Covid were we got zero interest rates, businesses and individuals way over invested in ZIRP models, and then when inflation spiked and rates went back up it caused a huge dislocation? Like this was really dramatic in recent memory.
Wasn’t the housing crisis in the 2000s kind of similar.
Like, people and business really are that stupid that they get hoodwinked by easy money.
What was the "huge dislocation"? Unemployment rapidly fell for years, and plateaued at a low level.
Why blame "easy money" rather than just folly? Like I said, if easy money can lead you to disaster, why not a thousand other factors, too?
We got 10% inflation and now firms are trying to layoff people via RTO and we've got a record low new hiring rate. Our labor market has ossified. Our housing market is a Frankenstein of people in 3% mortgages sitting on their houses because of the seesaw even if they are two people living in a five bedroom or a big family that would like to move out of their starter home. VCs are basically stuck with the fact that they can't up value from the last round.
What exactly did we gain from having the fed print to bail the government out of its COVID and other policies? Why not blame the fed for having made a bad choice?
If I take a gambling addict to a casino it's folly for him to gamble, but it's also folly for me to bring him to the casino. I know what the hell is going to happen, so why do it?
It's not being hoodwinked, it's reacting to low rates by accelerating existing plans and competitors' investments. When it seems like everyone really is that stupid, that's a sure-fire indication that they have some real reason which the experts are ignoring. I trust the people with skin in the game far more than I trust armchair experts.
But all those companies that engaged in massive hiring are now laying those people off.
And all those VCs can't sell at the valuations people paid for them.
And all those MBS weren't worth what people paid for them.
Like we constantly see people in business, who have skin in the game, overact to signals and make bad predictions, and these misfires tend to correlate with loose money and rapid asset appreciation.
What's the alternative?
* Do nothing? Businesses don't get better by doing nothing.
* Let the government decide? Nothing gets better that way.
Freedom includes the freedom to make mistakes, and as long as they do it with their own money, it's nobody else's business.
Are you seriously proposing that government make those decisions? If not, what is your alternative to freedom?
The alternative is that the fed didn't lower rates to bail out the governments COVID policy and/or it raised them harder and faster instead of being behind the curve.
That's no alternative. May as well wish for wise government bureaucrats. Clap for Tinkerbell while you're at it.
I remind you that this thread started from your complaint about stupid people and businesses, and I responded that the people in question are not stupid. You can't suddenly pivot to wishful thinking about Tinkerbell bureaucrats.
"Like, people and business really are that stupid that they get hoodwinked by easy money."
Dude you can literally look at say Arthur Burns vs Paul Volcker and realize that governance matters and can turn out different.
The simple repeatable fact is that periods of negative real rates tend to produce bubbles and misallocations over and over and over again. Business people do in fact find it difficult to make accurate economic decisions when the rates whipsaw.
One other distortion of free markets worth mentioning is government cronies with insider information. While this may not be large much of the time, once you add in effects of regulatory capture, things will get more messed up.