A lot of people are unclear on the concept of "malinvestment."
I'd like to start with an expanded version of a response I posted earlier in order to try and clarify the concept. Intelligent comments and constructive criticism appreciated.
Begin by considering two concepts:
The value of a prices, no pun intended, is that they provide signals to market participants: when, where, in what quantity, and towards what ends should investments be directed. These signals are valuable information that market participants use in directing the resources at their disposal, whether they be cash, credit, finished products, works-in-progress, etc. Any interference with prices, therefore sends inaccurate signals to investors, entrepreneurs, consumers, borrowers, and lenders.
When money is injected into the system, it causes prices to change without a corresponding change in time preference which would be necessary to meet the "demand" contrived by the inflation. The takeaway here is that if time preferences haven't changed, fiat injections cause a disconnect between prices and time preference.
New money, especially fiat money, typically manifests itself as demand for consumption goods. Keeping in mind that "consumption" is just a polite and roundabout way of saying that you're destroying something valuable, since this consumption wasn't matched with a previous investment in productivity, it's likely to be a net value destroyer.
What happens when new money is introduced, is that demand appears to have increased, manifested by higher prices. These prices tell people "make more stuff", this is how it works: People see a higher price being paid for certain goods, and this appears to indicate that there is perhaps profit to be made in that market. Responding to the apparent signal, they begin now to overwork their assets, or perhaps to invest in assets that will enable them to be more productive tomorrow.
What has not changed is the present productive capacity.
Prices rose, however, because of the money; the higher prices being merely reflections of the increased money supply, and not of any fundamental change in consumer preferences. This money eventually works its way through the system, and people discover that they over-utilized their productive assets yesterday (and therefore can't produce as much today) or that they invested in assets in an attempt to match increase capacity to accommodate a phantom increase in demand. When this fact is eventually revealed, many investments are revealed as unprofitable and must be liquidated, and in either case we are worse off.
It requires previously accumulated capital (higher order goods) to facilitate the production of more consumer products (lower order goods) without depleting the existing capital stock. In order to have more today, it is imperative to have invested in productivity, made some sacrifice towards that end, yesterday.
This process does not work in reverse.
Without that previously accumulated capital, a boom/bust phase is inevitable.
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David Z
"The issue is always the same, the government or the market. There is no third solution."
Prashanth Perumal: What about this actually makes it an unsustainable boom? Or am I failing to find something obvious here?
What about this actually makes it an unsustainable boom? Or am I failing to find something obvious here?
Prices need to convey meaningful information about the relative availability of goods & services. By increasing the money supply (whether in the hands of a single individual or many), the resultant prices convey less-accurate information.
How do others in the economy respond?
etc.
Snowflake:You're saying that investment = saving.
Yes, loan markets clear. Leave aside cases where banks get nervous and are more interested in holding reserves.
Snowflake:Also, its not investment/saving by the people who earned the money, its by you who didnt produce anything.
I am tired of this. I am not justifying credit expansion in any means. I am just seeing through the effects of credit expansion.
Prashanth Perumal:It doesn't matter. Consumers have lesser purchasing power now. So they really can't bid against businessmen who now have more purchasing power.
They're not necessarily bidding for the same resources at once. He needs fuel and finds that the fuel market has cleared, so he pays a little "extra" to get fuel. He needs machinery, but there is none not already in use, so he pays "extra" to buy it from someone else. He needs to hire employees he finds that the labor market has already cleared, he must offer someone "extra" to lure them away from their current employ.
All this "extra" is fraudulent. It seems we agree on this. (In fact, I'm not sure that we disagree on any of this...) These individuals or companies benefit in the short run at everyone else's expense.
Everything begins to cost more. But most people in most lines of work don't get a raise or a bonus. The "extra" is cannibalized mostly. The rest of the non-institutional individuals have less purchasing power; a standard indifference curve being phase-shifted leftwards. They now buy less, even though their bank balances haven't changed. Their consumption patterns change; where they previously bought a 34" television, maybe now only 27". Previously they bought meat from a deli, now from a grocery store, etc.
Now think of the businessman who bought the machinery from another, by paying a little "extra" with this new money. The other guy only sold it to him based on the then prevailing rates; he says, "I can do without a drill press for a few weeks if this guy will pay me an extra 10% over my cost, I'll just order a new one and ramp up production when it arrives..." But by the time it arrives, prices for the rest of his inputs have risen enough (or more) that the "extra 10%" is now revealed as illusory: there is no "extra"!. So we see capital decumulation/destruction and resource misallocation, or, malinvestment in the Austrian vernacular.
Prashanth Perumal:I am tired of this. I am not justifying credit expansion in any means. I am just seeing through the effects of credit expansion.
"It has always been the prerogative of children and half-wits to point out that the emperor has no clothes. But the half-wit remains a half-wit and the emperor remains an emperor." ~Dream
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