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What makes us invest more?
The Godfather of Government Stimulus, J.M. Keynes, (General Theory, Chapter 7) defined Investment as “the increment of capital equipment, whether it consists of fixed capital, working capital or liquid capital” and noted that “exchanges of old investments necessarily cancel out”. We should point out that although “liquid capital” is included in Keynes’ definition, this is not cash which can be withdrawn from the business without a reduction in investment. It is cash committed to enabling future production.
Some will argue with how we apply this definition, but let’s give it a whirl: If I buy already-committed capital assets, that is, “old investments”, I have not made an investment (added to the capital stock). So, to the extent that a share of stock (or a bond) represents ownership of previously committed capital, when I refrain from consuming some of my income to buy it, I have saved, but I have not invested. Sure, it is true that the companies whose shares I own are retaining earnings and thus making new investments, which, by the way, I could use to manufacture my own dividend income, but let’s keep this simple. I have truly “invested” only when I buy an asset that is newly issued to fund creation of new capital.
So, we have two choices for what to do with our savings: 1) we can “park it” in existing assets (stocks, bonds, mattresses), or 2) we can invest it in new capital formation. What makes us choose one over the other? Answer: a sufficiently higher expected rate of return of the one over the other. When we park it, we hope to get a financial return, but part of the “return” from investing in new capital formation is real: new jobs. Thus, for example, IF we can put my and your savings to work AND put our out-of-work sons and daughters to work too, that may represent a more attractive opportunity than the financial return of existing assets. Actually, IF we can put enough of our out-of-work buddies to work, we may actually grow the number of customers for the product which our investment produces and “everybody wins”.
The keyword above is “IF”. There is more than the usual uncertainty “out there” right now and the IF’s are scary-big ones. Should we make an investment or buy the relatively sure thing available in parking our savings in existing savings accounts, bonds, stocks, or even credit default swaps? Which offers the best “risk adjusted return”? No one, except perhaps, communists like the Chinese, wants to build new production capacity without a reasonable dependable market. Brad Setzer has been saying for a while that there is a lot of savings floating around, but no investments. Where is the savings being parked? Hmm…. The FED has made sure its owners, the banks, have plenty of reserves and, while they aren’t being lent, many are “somehow” being used to inflate existing financial asset prices.
When will existing asset returns become sufficiently less attractive so that new investments will be made and people will be put back to work? It looks like another existing asset bubble (or two) needs to pop first and the FED just needs to refrain from financing any more of them…
View the original article at:
http://www.swampreport.com/economy/what-makes-us-invest-more/
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Great analyses here!
As Ludwig von Mises said of Hazlitt’s The Failure of the “New Economics” : Hazlitt has entirely demolished the Keynesian misconceptions.
Keynesianism – as set forth by John Maynard Keynes 73 years ago in his General Theory of Employment, Interest and Money– holds that the twin answers to unemployment and economic downturns are massive government deficit spending and “cheap money” – the artificial driving down of interest rates to “free up more credit.”
Vin Suprynowicz writes in And They Call It ‘Change’ (Las Vegas Review-Journal) in March: Hazlitt, way back in 1959, demonstrated not only that these Keynesian remedies did not work, but that they often had precisely the OPPOSITE effect of that intended!” on high unemployment, business failures, and other symptoms of economic maladjustment.
Suprynowicz cites some succinct conclusions and charts correlating deficit spending to unemployment, year-by-year from Hazlitt’s book:
“In Keynesian policy, unemployment is never to be corrected by any reduction of money-wage-rates,” Mr. Hazlitt summarizes. “Keynes recommends two main remedies. One is deficit spending (sometimes euphemistically called government ‘investment’). How good is this remedy? It was tried in the United States (partly because of Keynes’ recommendations) for a full decade. What were the results? Here are the deficit in the Federal budget, the numbers of unemployed, and the percentage of unemployed to the total labor force, year by year in that decade. All the figures are from official sources:” (Chart follows.) …
“The central and decisive fact is that heavy deficits were accompanied by mass unemployment. …
“The other main Keynesian remedy for unemployment is low interest rates, artificially produced by ‘the Monetary Authority.’ Keynes incidentally admits … that such artificially low interest rates can only be produced by printing more money, i.e. by deliberate inflation. But we may let this pass for a moment. The question immediately before us is: Did low interest rates prevent mass unemployment? …” (Another chart, measuring the commercial paper rate against the unemployment rate for the years 1920 through 1940, follows.)
“In sum, over this period of a dozen years low interest rates did NOT eliminate unemployment. On the contrary, unemployment actually INCREASED as interest rates went down. In the seven-year period from 1934 to 1940, when the cheap money policy was pushed to an average infra-low rate below 1 percent (.77 of 1 per cent) an average of more than 17 in every 100 persons in the labor force were unemployed.” (end Hazlitt)
Continues Suprynowicz:
Hazlitt proceeds to demonstrate that from 1949 to 1958, when the same policy of artificially pushing down interest rates was tried, “the relationship of unemployment to interest rates is almost the exact opposite of that suggested by Keynesian theory.”
How could Keynes have gotten it so wrong?
Easy. Hazlitt shows again and again that Keynes pronounced his theories “ex cathedra,” without substantial statistics to back them up. Then, if actual statistics were produced that seemed to show results opposite to what his theories had predicted, he simply challenged the statistics! (emphasis mine)
If I purchase an existing share of AAPL, I'm saving.
If Apple Corp issues a new share of AAPL, and I happen to buy that share directly from Apple, I'm investing.
If somebody else bought that share directly from Apple then immediately sold that share to me, that person made an investment, but I'm just saving.
Is that correct?
Monetarist - Say mid-70s not early 80s. Madness started in 1982 alongwith 401k programs and people went berserk!!
good starting point....michael hudson is a good source to consult in considering our current plight with respect to capital formation...
he argues that the aversion to productive investment is largely driven by tax policy which has supported the fire economy disproportionately since c. 1980....
in this world non-earned income is favored over earned income in terms of tax treatment thus driving economic activity in that direction. under such a structure our economy has become the rentier economy which the classical economists sought to avoid....in my horror as a low tax advocate i see great merit in raising capital gains taxes and lowering taxes on labor....
fekete argues that the presence of the fed and open market operations creates risk free trading in bonds and thus in a falling interest rate economy these transactions trump capital creating ones....i disagree with a lot of the thesis but there is a good deal of logic and truth to it...he further points out that continuously falling interest rates raise the liquidation value of debt as falling rates require greater effort to retire the debt....as such companies find themselves in a horrible capital deficit because the accountants have not accounted for this state of affairs...
i advance the general argument that artificially low interest rates misdirect capital and evaporates it....the point is that interest is the mediator between wealth and income....one's preference changes over time but without adequate interest to cover the risk of loaning, money will stay under the matress or in non-productive t-bonds....interest must find a level where wealth holders and income producer both benefit but the government has created enormous uncertainties with their juvenile consumer driven economic biases which thrive on insanity.....
and so to the point made above central banks = central planning = failed investment = failed economy, i heartily concur as did our founders who saw the people as sovereign over the money....the wisdom is simple, timeless, and beyond the ken of most americans....and thus we flush merrily down the toilet....
these are the kinds of topics i love.
Great posts Swampfox. The distinction between saving and invetment is lost upon the landscape of modern economics IMO.
I agree that until we see the asset bubbles pop we will not rid ourselves of the risk and uncertainty these looming bubbles carry. However, given the gargantuan size of the Fed's balance sheet, and the actions of the government of backstopping virtually all losses, it does not look like this is an option. To me, it seems like like the Fed and Treasury have already hedged their existence on the reflation of the bubble. That would imply that investment will not exist for a very long time, because if these asset bubbles burst, and assuming I am right and they take the institutions that have backstopped them with them, then there will be a lot more uncertainty and risk out there and for a long period of time.
I see very few solutions for reducing risk.
WIKI :The paradox of thrift is a paradox of economics popularized by John Maynard Keynes , though it had been stated as early as 1892 by John M. Robertson and similar sentiments date to antiquity. The paradox states that if everyone tries to save more money during times of recession, then aggregate demand will fall and will in turn lower total savings in the population because of the decrease in consumption and economic growth. The paradox is, narrowly speaking, that total savings may fall even when individual savings attempt to rise, and, broadly speaking, that increases in savings may be harmful to an economy. While individual thrift is generally averred to be good for the economy, the paradox of thrift holds that collective thrift may be bad for the economy
An AlixPartners study was referenced in today's WSJ in an Orwellian article entitled 'More shoppers hitting the malls' which included nuggets like : 'consumers remained thrifty ...but a growing number of shoppers turned up' -geez was it the weather? did they charge for loitering?; and a description of a lady who went over her $150 budget - yea beer - but 'bought a larger size so that her children can wear it throughout the year'
Alix Partners:
While American industry is struggling to get through what could become the worst recession since the Great Depression, Americans say that even after the recession ends, their spending will return to just 86% of pre-recession levels, which would take a trillion dollars per year out of the U.S. economy for years to come. According to this in-depth survey of more than 5,000 people,Americans plan to save (and therefore not spend) an astounding 14% of their total earnings post-recession, with the replenishment of their 401(k) and other retirement savings leading the way among their biggest long-term concerns.
(On the bright side, I guess, a lot of that money will go into Treasuries. -AM)
Survey participants estimated that their retirement savings have dropped an average of 25% from pre-recession levels, the same percentage they feel their total net worth has declined as well. And almost a quarter of those polled (22%) said they now plan to retire later than previously expected, driving the expected retirement age up over 3.5 years compared with 2007 levels.
Also of note, 82% of those polled said they would use upcoming U.S. government tax rebates, not to stimulate the economy via immediate spending, but instead will save that money or use it to pay down personal debt.
And those planning to save the stimulus money reported they would be sitting on that cash for three years on average.
(Your money has no velocity here sir. -AM)
Even if these findings are colored somewhat by the emotions of the day, Americans are definitely speaking loud and clear: They believe the “new normal” for the American economy going forward will be more like the early 1980s than the mid-2000s.
I thought Henry Hazlitt disabused people of this ridiculous notion when he wrote "The Failure of New Economics" in 1959. Keynes got a lot of cause and effect exactly backwards, but he just totally missed the point on the market for loanable funds.
First, let's clear up the problem of saving versus investment. If I put my money into an equity security, I am saving the money. If I purchase capital equipment, I am making an investment.
As Hazlitt writes about Keynes' misconception, "Saving" equals merely the negative act of not buying consumption goods; "investment" equals merely the positive act of buying or making capital goods. Yet these two acts are both parts of the same act! The first is necessary for the second.
If I buy a security (save), then that frees up capital to eventually go into investment. Eventually, someone somewhere will have that capital to invest in capital equipment. If they don't borrow my savings to invest at the current interest rate, then the interest rate will fall until we have market clearing at an equilibrium of saving and investment at some lower rate.
Hazlitt goes on to say, "When we are talking in monetary terms, however, the problem is more complicated. In monetary terms today's saving is not necessarily tomorrow's investment, and today's investment is not necessarily yesterday's saving; but this is because the money supply may have contracted or expanded in the meanwhile."
What we do have is uncertainty (a lot of which has been government manufactured). We have a ton of saving with nowhere to go. However, since it has been sent to Treasury securities to pay off bad banks, only the bad banks have capital to lend. They do so only at extraordinary interest rates because ... the risk is so high! Banks are hoarding their capital to make sure they are properly capitalized for the next round of mark-to-model.
So the market worked to lower interest rates (at least on a Treasury security), but government intervention sent the funds to the wrong places in the wrong way.
Keynes is dead.
I too wish the idea that the government knows better what to do with our savings than individuals had died at the same time that Keynes found his "long run".