QEinfinity: Revisiting Rothbard’s Words, by Trevor Polk

01-boom-bustI know, I know. I’m preaching to the choir – and it’s the same sermon taught every Sunday – but let’s talk about the recent announcement by the Federal Reserve. A lot of pieces of advice are given, but I think none are as perceptive as the master himself, Murray Rothbard. Before we revisit his words, let’s take a look at some of the other buzz out there. This comes from a weekly market wrap provided by a financial firm of fine repute:

“The Fed is not the gasoline for the engine [the stock market]. The sustainable source of fuel for market returns comes from economic growth and corporate profitability. But Fed policy has delivered a boost to confidence and continues to provide underlying support for the economy.”

Now, I won’t outright disagree that Fed policy does not provide support – in fact, it does provide support to certain sectors, markets, and firms. However, this “support” is not so much a foundation for growth but is more akin to a diverting of resources from productive sectors to unproductive sectors. Typically, these bubbles are created within markets of what Carl Menger termed higher order goods. Rothbard explains,

“The new money pours forth on the loan market and lowers the loan rate of interest. It looks as if the supply of saved funds for investment has increased, for the effect is the same: the supply of funds for investment apparently increases, and the interest rate is lowered. Businessmen, in short, are misled by the bank inflation into believing that the supply of saved funds is greater than it really is. Now, when saved funds increase, businessmen invest in ‘longer processes of production’ i.e., the capital structure is lengthened, especially in the ‘higher orders’ most remote from the consumer. Businessmen take their newly acquired funds and bid up the prices of capital and other producers’ goods, and this stimulates a shift of investment from the ‘lower’ (near the consumer) to the ‘higher’ orders of production (furthest from the consumer) – from consumer-goods to capital-goods industries.”

On the face of it, shifting investment focus to higher order goods seems like a boon to the economy! I mean, c’mon, wouldn’t we rather have investors and entrepreneurs concentrate on cranking out highly efficient machines that produce advanced medicines more cheaply rather than better providing some lower order consumer good like… like… a Twinkie? Rothbard tells us that not only do we prefer – by our actions in the market – businesses to focus on catering Twinkies, but that this preference means bad news bears (and future bear markets) for businesses that are misled into investing too much in higher-order capital goods.

“If this were the effect of a genuine fall in time preferences and an increase in saving, all would be well and good, and the new lengthened structure of production could be indefinitely sustained. But this shift is the product of bank credit expansion. Soon the new money percolates downward from the business borrowers to the factors of production: in wages, rents, interest. Now, unless time preferences have changed, and there is no reason to think that they have, people will rush to spend the higher incomes in the old consumption-investment proportions. In short, people will rush to reestablish the old proportions, and demand will shift back from the higher to the lower orders. Capital goods industries will find that their investments have been in error: that they thought profitable really fails for lack of demand by their entrepreneurial customers. Higher orders of production have turned out to be wasteful, and the malinvestment must be liquidated.”

“Liquidated” sounds like a light, fluffy word. Feel-good pictures of ice melting or summer days at a splash pad may color your thoughts. Possibly less vivid, doubtlessly darker, the mental images formed by the phrase “malinvestments must be liquidated” are more alike to these wonderfully happy phrases: the Great Depression, dot-com bubble, 1980s recession, or the Financial Crisis of 2008. The purported “boost to confidence” is undisguised by economic reasoning as nothing more or less than a period of wasteful malinvestment based on miscalculation of businesses misled by bank credit inflation.

Remarkably, the same weekly market wrap shows that the firm is, to a degree, aware of this bust:

“Looking back at the performance of stocks in the mid-1990s, we saw a balanced contribution to market gains from earnings growth and rising valuations, until valuations ultimately began to rise to excessive levels. At some point in the future, valuations will again overshoot.”

Unfortunately, the weekly market wrap makes no direct connection between the bust and the Fed’s bond purchases, but instead heralds Bernanke’s efforts as “an octane boost.” Of course, as long as explanations of economic policy rely on obscure, inappropriate car analgoies like “running out of gas,” “firing on all cylinders,” “fuel,” “octane,” and “engine,” we should expect that the understanding of the repercussions of credit expansion will be lost on financial firms of even the finest repute. These comparisons only bring to mind ideas of controllable machination in lieu of the dynamic change that is the real essence of a market society. As the character representing Hayek retorts to the character depicting Keynes in the YouTube rap video hit “Fight of the Century” (do watch, if you haven’t):

“The economy’s not a car/there’s no engine to stall/no expert can fix it/there’s no “it at all/the economy’s us/we don’t need a mechanic/put away the wrenches/the economy’s organic.”

So please, even if it means plugging your ears during your meeting with your financial advisor, listen to Rothbard, not the car talk.  Trevor Polk

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