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Why Capitalists Are Repeatedly "Fooled" By Business Cycles
Submitted by Frank Shostak via The Mises Institute,
According to the Austrian business cycle theory (ABCT) the artificial lowering of interest rates by the central bank leads to a misallocation of resources because businesses undertake various capital projects that — prior to the lowering of interest rates —weren’t considered as viable. This misallocation of resources is commonly described as an economic boom.
As a rule, businessmen discover their error once the central bank — which was instrumental in the artificial lowering of interest rates — reverses its stance, which in turn brings to a halt capital expansion and an ensuing economic bust.
From the ABCT one can infer that the artificial lowering of interest rates sets a trap for businessmen by luring them into unsustainable business activities that are only exposed once the central bank tightens its interest rate stance.
Critics of the ABCT maintain that there is no reason why businessmen should fall prey again and again to an artificial lowering of interest rates.
Businessmen are likely to learn from experience, the critics argue, and not fall into the trap produced by an artificial lowering of interest rates.
Correct expectations will undo or neutralize the whole process of the boom-bust cycle that is set in motion by the artificial lowering of interest rates.
Hence, it is held, the ABCT is not a serious contender in the explanation of modern business cycle phenomena. According to a prominent critic of the ABCT, Gordon Tullock,
One would think that business people might be misled in the first couple of runs of the Rothbard cycle and not anticipate that the low interest rate will later be raised. That they would continue to be unable to figure this out, however, seems unlikely. Normally, Rothbard and other Austrians argue that entrepreneurs are well informed and make correct judgments. At the very least, one would assume that a well-informed businessperson interested in important matters concerned with the business would read Mises and Rothbard and, hence, anticipate the government action.
Even Mises himself had conceded that it is possible that some time in the future businessmen will stop responding to loose monetary policy thereby preventing the setting in motion of the boom-bust cycle. In his reply to Lachmann (Economica, August 1943) Mises wrote,
It may be that businessmen will in the future react to credit expansion in another manner than they did in the past. It may be that they will avoid using for an expansion of their operations the easy money available, because they will keep in mind the inevitable end of the boom. Some signs forebode such a change. But it is too early to make a positive statement.
Do Expectations Matter?
According to the critics then, if businessmen were to anticipate that the artificial lowering of interest rates is likely to be followed some time in the future by a tighter interest rate stance, their conduct in response to this anticipation will neutralize the occurrence of the boom-bust cycle phenomenon. But is it true that businessmen are likely to act on correct expectations as critics are suggesting?
Furthermore, the key to business cycles is not just businessmen’s conduct but also the conduct of consumers in response to the artificial lowering of interest rates — after all, businessmen adjust their activities in accordance with expected consumer demand. So on this ground one could generalize and suggest that correct expectations by people in an economy should prevent the boom-bust cycle phenomenon. But would it?
For instance, if an individual John, as a result of a loose central bank stance, could lower his interest rate payment on his mortgage why would he refuse to do that even if he knows that a lower interest rate leads to boom-bust cycles?
As an individual the only concern John has is his own well being. By paying less interest on his existent debt John’s means have now expanded. He can now afford various ends that previously he couldn’t undertake.
As a result of the central bank’s easy stance the demand for John’s goods and services and other mortgage holders has risen. (Again it must be realized that all this couldn’t have taken place without the support from the central bank, which accommodates the lower interest rate stance.)
Now, the job of a businessman is to cater to consumers’ future requirements. So whenever he observes a lowering in interest rates he knows that this most likely will provide a boost to the demand for various goods and services in the months ahead.
Hence if he wants to make a profit he would have to make the necessary arrangements to meet the future demand.
For instance, if a builder refuses to act on the likely increase in the demand for houses because he believes that this is on account of the loose monetary policy of the central bank and cannot be sustainable, then he will be out of business very quickly.
To be in the building business means that he must be in tune with the demand for housing. Likewise any other businessman in a given field will have to respond to the likely changes in demand in the area of his involvement if he wants to stay in business.
A businessman has only two options — either to be in a particular business or not to be there at all. Once he has decided to be in a given business this means that the businessman is likely to cater for changes in the demand for goods and services in this particular business irrespective of the underlying causes behind changes in demand.
Failing to do so will put him out of business very quickly. Now, regardless of expectations once the central bank tightens its stance most businessmen will “get caught.” A tighter stance will undermine demand for goods and services and this will put pressure on various business activities that sprang up while the interest rate stance was loose. An economic bust emerges.
We can conclude that correct expectations cannot prevent boom-bust cycles once the central bank has eased its interest rate stance. The only way to stop the menace of boom-bust cycles is for the central bank to stop the tampering with financial markets. As a rule however, central banks respond to the bust by again loosening their stance and thereby starting the new boom-bust cycle phase.
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Overlooked is .... with zero interest rates....CEO's of public companies buy back shares for personal $$$ gain.
This guarantees the "Bust" cycle.
A prog will tell you the US corporate tax rate of 39.1% evens all that out, of course they don't say YOU end up paying for it via higher retail prices.
(sigh)
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Wut...a prog thinks I'm lying?
I'm not your downvote, but a focus on retail prices misses the point. Retail prices are as low as they are for many goods because they are made by slave labor overseas. The US consumer would be better off paying more, but having an even higher wage. Low retail prices mean jack if there is no middle class to buy the goods at any price. As for taxation on corporations, it also misses the point. Corporations also pass along the cost of paying the executives outrageous compensation packages, and no one seems to give a fuck about that. I will grant you that taxation of corporations is not the answer. The other two issues need to be addressed, however.
The focus on retail DOES NOT miss the point, corporations MAINTAIN their profit by the end user.
Meaning YOU.
No profit, no stuff.
And...why does society need a middle class if .gov is just going to pass out ObamaFones, EBT etc. ad nauseum?
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I guess it took having the HIGHEST CORPORATE TAX RATE ON THE PLANET to wake "somebody" up? ;-)
Do you know that corporate tax revenue as a percentage of federal revenue was much higher in the early 1960s than today? It's been a downward spiral of 50+ years. Why is that if the rate is so onerous now?
http://www.cbpp.org/blog/what-should-corporate-tax-reform-look-like
Did you stop and think about why that could be? Perhaps it's because there are more people? Could it be because the rate was lower then in real terms? That maybe it's because there were actually more corporations then than now?
I love how leftists word their questions to imply something very specific without acknowledging that it could be because your looking at the situation inaccurately.
Oh thats very coy, are you saying THE COMBINED 39% RATE is not onerous?
http://taxfoundation.org/blog/us-has-highest-corporate-income-tax-rate-oecd
So by your impeccable centrally planned logic, corporations, facing a downward spiral of "federal taxation" are packing up their shit and moving overseas, for what reason?
The corporations of the 1960s had a higher effective tax rate but put millions of Americans to work. Today, not so much.
Not that the red arrows will look at it, but corporate tax revenue is a less significant source of federal revenue than in the 1960s.
http://www.taxpolicycenter.org/taxfacts/displayafact.cfm?Docid=205
Focus your "we pay too many taxes" on individuals.
Nobody works unless they need to or want to, I don't know what "put millions of Americans to work" even means, that derives from some Wilsonian philosophy I can't relate to. Having jobs available so THEY and I can profit from it is what I would have said.
If there are millions clawing, begging, screaming for handouts (instead of working for themselves) just what do you think a politician is going to do?
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You're doing the same thing Rand does, amending a comment before anyone can respond.
YES...WE AS INDIVIDUALS PAY TOO MANY TAXES.
And fuck the federal government and their fucking taxes!
Define higher EFFECTIVE tax rate.
Your terms here are nebulous just as your argument is.
Gawdammit it's un-friggin believable, what I'm getting out of this convoluted conversation is, corporations are fleeing the US corporate tax structure (and parking billions of profits offshore) because of a trajectory of lower US corporate taxation and the only way for corporations to provide Jobs Jobs Jobs! for millions of Americans is...to increase corporate taxation!
Makes perfect sense! I need a shot of booze.
It's not meant to make sense, it's meant to stop the conversation from occurring in the first place. You know how to win from there, I am sure of it.
Corporations are fleeing the US corporate tax structure because they can pay even less elsewhere. US corporate taxes have in fact gone down, but any money loving corporation is going to go wherever it can pay the least. Can't blame them, either. If anyone really cared to solve the problem it would require not allowing US companies to engage in wage arbitrage and tax avoidance in this manner if they want to sell their shit in the US. But of course no one among the two Teams wants to solve the problem. They just want the sheeple arguing about higher taxes or lower taxes or some other bullshit non-answer.
Ahhh, booze is better.
"Corporations are fleeing the US corporate tax structure because they can pay even less elsewhere."
Meaning, wut? They're too high!
And look how you phrased it..."because they can pay even less elsewhere." as if-you-still-don't-understand WHERE THE MONEY COMES FROM TO PAY THEM.
It comes from us, the consumer, at retail, just like I said.
And I know you do know where it comes from because you've already said many times you're a small business owner, now you're asking me to believe YOUR HIGHER COSTS of doing business are not being passed on to your customers.
You and I both know the costs are or you would close your doors tomorrow.
No profit, no stuff.
Done.
Any correlation between domestic effective corporate tax rates and share of GDP is second order bullshit. On par with PE ratios of publicly traded firms trading as multiple of non-GAAP accounting measures.
In the 1960's a much smaller percentage of corporations had the option of jurisdiction shopping. Since then GATT, WTO, NAFTA et al have increased to options for large multinationals to reduce both their domestic and overall tax obligations, putting them at a competitive advantage to their smaller competitors, thereby driving their domestic competition out of business and reducing US corporate tax receipts.
I should have read your post before I posted mine above. Much better analysis. As you imply, what we are seeing is by design. US corporations do what their bottom line tells them, and so they buy politicians to write laws and treaties that allow them to avoid US taxes and US wage laws. Once you step slightly outside the box of the debate foisted upon us by the MSM, it is really pretty simple what is going on.
A) Correlation is NOT causation.
B) Corporations DO NOT PAY FUCKING TAXES. Shareholders, employees, and customers do. PERIOD.
There are no answers with the current group of jackasses in charge in every possible position. Thus pray we sink asap instead of the slo-mo to tent city approach like Japan. I'm thinking that since the rest of the world is getting fkd good we won't be able to prolong the agony for nearly as long as they think. Of course collapse sucks ass as well, oh well. Get this show on the fkn road already i'm tired of waiting.
Short term memory - they can't remember the last quarter results, much less the last time they got fucked in the market.
Sheeple muppet investors.
Why does a monkey stick his hand in the jar for a banana?
businessmen fall prey. omg that is some sick funnt shit right there.
Like the vampire that got AIDS. Fell prey to something. Totally a victim. Everyone make a quilt for the blood sucker.
You havn't considered that many of them probably took all they could get, paid themselves huge salaries and are now laughing all the way to bankruptcy court.
they got tricked into doing levered stock buybacks so they could get the biggest bonus possible. tricked i tell you.
I fall for it everytime they lower rates. Hate it when the happens. I guess I'm just a rube that way, making money without any work, I feel so stupid right now.
the only sector that could legitimately claim that they got fucked over by the fed is the energy sector because they did spend a bunch on capex and got hosed by a false market signal induced by zirp fueled speculators. however, even they can't blame the fed for rising rates. low oil prices and thin margins raised the default risk leading to a junk bond rout. that and some funky geopolitical price war. that, and the fed induced generalized depression we're in. so yeah, except for the 1% the fed sucks ass.
In 1985 Sheik Yamani cut a deal with Reagan and took the price down eventually to $9.60 in June 86'. This was by design a Washington DC objective to take out the Soviet Union. While to day the same objective is in place it is mitigated by China downturn creating a bigger world wide problem. than 86'
In both cases the guys in the oil patch were screwed, who didnt know what these people in DC were doing when they made the Capex decisions and have spent bond money and equity money and bet their leveraged companies on lease expirys along with the service industry supporting them
They are ALL going to lose their companies to Wall Street - KKR / Blackstone / Apollo et al - same thing - after thirty years happened again!
Because greed.
The artificial anything of rates causes distortion - that's simply precluding a free market.
But naturally there's more going and I haven't really read much mises {road to serfdom is on the list via recommends from ZHedgers} but I suspect he would marvel at the extent to which the state fucks with the free market, and for you die hard "i hate socialism" types - so does an unfetterered free market. Call it "crony capitalism" all you like, but it is a feature, not a bug, or any purely unregulated free market.
Please spare me that cute theory you have about how things "could" work. A theoretical is not a theory. Until it works, it has not been shown to work. Hence some regulation of corporate activity is vital, while much state regulation is merely political, i.e. extraneous.
But where the state, corporations and banks really come together to misallocate resources, by orders of magnitude, is wars of election.
There is literally nothing, not baby mommas with black skin, not rich florida jews using their social security on prime tee times, that is more of a misallocation and swindle.
The money squandered, or wastefully created then wasted on counter-productive mic boondoggles {well the goal of the zios was to destroy Syraq as military and economic rivals, but I've covered that} was certainly in the trillions by most estimates.
That's moon base money. That's super high speed internet. It's, dare I say it amongst the far right wingers and Randians, a massive jobs retraining program so we can shift the economy forward and invest in ourselves. It's money to public schools, x, y, z - some of these are picked to trigger your buttons, not to annoy you but to force the issue - even shit you dont "like" spent domestically would have been better than a few trillion on the wars in iraq, syria, libya, ukraine, af/pak.
The point is just that 3 trillion spent means a very few people got super wealthy off death and chaos and if you think roads and schools is just as bad you are a fucking idiot. Not all distortions are the same, not all government coercion is the same.
Sure, ideally there are no laws and everyone behaves fairly and honestly. Good luck with modifying human nature. In the meanwhile, so long as war is the health of the state, the state grows more and more hostile to its own people.
Curious that the same people who cry socialism at the suggestion Vermont, say, ought to fix some of its fucking bridges, in the real world, soon, are strangely absent with the hundreds of billions given to the MIC or tens of billions handed over to Israel, Egypt, and others.
the vast majority of businesses have nothing to do with the stock market, but with the real economy. These businesses are getting damaged as the article correctly describes. If your competitor is getting cheap loans, well, you have no other way to catch up with him. This is the trap that easy money policy sets up for businessmen. And after that, comes the bailout, where sustainable businesses come to the rescue of competitors and bankers all together.
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We have lost our good base of manufacturing jobs.
We will never get that employment back. Certainly not with 3D printing coming and the rest.
We are good and truly screwed.
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V-V
The business man who owns his own business is different than the hired manager running someone else's business. The hired manager doesn't care about the inevitable busts so long as he can enrich himself during the booms. In fact, the hired managers—the CEOs, CFOs, COOs, etc.—prefer the boom and bust cycles because they can enrich themselves by self-dealing. If in doubt, look at what Carly Fiorina did to Lucent and Hewlett-Packard; look at what the management of IBM has done to IBM. Today's hired management slaver at the opportunities that their pet Central Bankers lay at their feet to enrich themselves while destroying their companies. It's only legal because the Rich make the Law to allow the Rich to screw everyone else.
By the way, Capitalists no longer exist. Hired managers run businesses and they are entirely focused on stripping assets to enrich themselves. They need the booms and busts created by their captive Central Banking criminals to facilitate their self-enrichment objectives. That's how Mitt Romney made his millions. That's how Carly Fiorina made her hundreds of millions. But, don't call them Capitalists. Because they are definitely not Capitalists. They are criminal fascists, for want of better terminology.
Imagine a gang takes over a small country. The gangsters are not too sophisticated. They simply print money and force everyone to take it.
Whatever the gangsters like will be in demand. the booze, crack, and whore industries will prosper.
This can go on for quite a while
Eventually , the economy will have nothing left, Just just rich gangsters, and those who service them.
This is the case in most of the world, and over most of time.
It ABCT is all well and good, as far as it goes. The problem is that it ignores the basic problem. A gang of counterfeiters and thieves controls this and every other country.
It is not rational business people who screws things up. It is the gangsters who force counterfeit onto an unsuspecting population.
Honest producers are not so much fooled , as robbed.
Robbery and counterfeiting. Are much easier to understand than missal location of time preference.
Lets keep it simple. Stealing is bad. Counterfeiting is stealing.
We get it wrong because you people won't do what is best for you. Do as you are told. Question nothing.
The easy money allows malinvestment that is removed during rate hikes.
But did you think...
A century ago when we formally started to apply Keynes and easy money creation so elites could maintain their position malinvestment really kicks off. If we did not have cyclical boom-bust the malinvestment would have stagnated the economy a long time ago.
Oops ... we did just that in 2009 and wonder why we are struggling for real growth and not the price increase growth.
So are we by central banker intervention and no bust being held in stagnation now. If so then the only way out is through the bust because no matter how much you throw at the problem the major share becomes malinvestment or supports malinvestment.