Wednesday, March 2, 2016

Greenspan Wrong Again

As far as the US economy is concerned, Greenspan isn’t optimistic. “We’re in trouble basically because productivity is dead in the water…Real capital investment is way below average. Why? Because business people are very uncertain about the future.”

Business people are always “very uncertain about the future.”  “uncertainty” is an inherent characteristic of the thing known as “future.”  It is inherently unknown, left to entrepreneurs (businessmen) to judge, estimate and even guess as to the best course of action.

Increasing productivity requires increasing real capital investment – machinery, equipment, technology, education, etc.  Increasing productivity requires allowing failing businesses to fail – there is nothing productive about allowing unproductive companies (those unable to satisfy customer demands profitably) to limp along.

Both mechanisms have been deformed and even halted, directly due to the actions of the Federal Reserve and the US Treasury.  Let’s take them one at a time.

As Greenspan notes, “real capital investment is way below average.”  Why is capital investment way below average?  We see the reasons why in public markets: low interest rates have greatly reduced the universe of potentially profitable capital investments.

Every investment will look for return commensurate to risk.  When returns of a major asset class – in this case, Treasuries – are driven to near zero, investors will look elsewhere, bidding up prices and driving down returns.  Investments are not compartmentalized – the returns in one arena help determine the prices of assets in another arena.  Prices of assets have been driven up in search of return.

Uncertainty about the future is constant.  If I am uncertain about the future but my analysis suggests a potential 20% return, I might be willing to invest.  If I am equally uncertain about the future but my analysis suggests a potential 2% return, I might keep my money in my pocket.

The uncertainty is constant; the potential return for dealing with uncertainty has been reduced to near zero.  This is why “real capital investment is way below average.” 

And the solution being proposed is to drive interest down even further.  Go figure.

Now, allowing failing businesses to fail.  By definition, failing businesses are employing assets in unproductive ways.  Allowing for the removal of those assets from the hands of the failing entrepreneurs and allowing the assets to be purchased by the highest bidder is the only way to increase the productivity of these assets.  It does not guarantee success, but it guarantees the end of continued failure.

We have seen the combination of the Fed and the US Treasury stop the process in both arenas.  Interest rates were not allowed to find their own level; the bankruptcy of every major bank and several industrial firms was circumvented.  Many businesses today continue to limp along solely due to the availability of cheap credit.

As an aside…what is curious to me is that the interest rate mechanism may have suffered long-term damage.  There is so much credit available today – sitting in excess reserves and due to the several episodes of quantitative easing – the supply of available credit is so far exceeding demand that prices for assets can only be bid up with the result that returns will remain lower.

Until this excess is drained or otherwise consumed, we may never escape from the issues that underlie Greenspan’s concerns.  Of course, the draining of liquidity required to move the federal funds rate up even 0.25% has sent shivers through markets, but this is a story for another day.

Instead of focusing on these underlying issues, Greenspan blames the situation on uncertainty about the future, as if this is something new.


  1. "When returns of a major asset class – in this case, Treasuries – are driven to near zero, investors will look elsewhere, bidding up prices and driving down returns."

    What is the relation between buying Treasuries - or stocks for that matter - and "capital investment"? I don't see any. Buying Treasuries is lending to the government, and does not build capital. Buying stocks is done on the secondary market and the firms you're "investing" in don't see a penny of that money. It goes to the current owner, not the company. Again, no capital investment. People who buy and sell bonds and stocks on the market are speculators, not investors.

    To me, capital investment would be starting a business, or at least providing funds directly to the business to be spent on capital improvements. Low interest rates - harmful though they certainly are - don't really factor much into this process.

    Igor Karbinovskiy

    1. Igor

      The choices available to me regarding decision I make toward what to do with the dollar in my pocket are almost infinite. Spend? Spend on what? Save? In what form? Invest? In what enterprise. My dollar can be used in any way I choose.

      The "returns" (financial or otherwise) to me of each possible option are always weighed against each other: do I want a candy bar today, or should I use the money to buy a machine tool?

      Investment decisions are not made in a vacuum - as if the only choice I have is to either invest in a machine tool or burn my currency.

      This is the relationship. It is not more complicated than this. Do you think the returns on a machine tool will remain at 25% in a world where Treasuries trade at 0%? Why on earth wouldn't the market bid up the price of machine tools such that the return over treasuries respects a reasonable premium?

      Now, I am oversimplifying things, but there you have it.

      Money is fungible. My choices of what to do with my money are almost infinite, and always compete with ever other alternative.

    2. "The "returns" (financial or otherwise) to me of each possible option are always weighed against each other: do I want a candy bar today, or should I use the money to buy a machine tool?"

      Having been been both a sales manager in the machine tool industry and now an owner of a "job shop", utilizing said equipment- I have often thought at length about the state of manufacturing in the US and how it has possibly been impacted by the "easy money" policies from the Fed, not just since QE and the financial crisis, but back to 71' with the disconnection with the gold standard.

      It's accepted from an Austrian perspective that money printing causes distortion in capital markets, so why would it be so absurd to suggest that money creation has possibly cause an overabundance of capital investment OUTSIDE the US?

      Why is it not possible that money creation has distorted capital reinvestment/investment here to the degree of inordinate manufacturing loss to overseas markets where they have their own currency manipulation issues(ie. China)?

      There are times I read people claiming "good riddance"(in essence) to manufacturing(Gary North for example) and how the US economy is moving towards service based jobs for the "better"(for a variety of reasons) and how comparative advantage drives most of this....but what is ignored in most of these discussions(by Austrians none the less) is: What impact is money creation in the role of distorted capital markets globally?

      How do we know if it's money creation or comparative advantage that's driving capital investment movement?

      Ok...I'm all done for now, here's your soapbox

    3. " why would it be so absurd to suggest that money creation has possibly cause an overabundance of capital investment OUTSIDE the US?"

      I think this is a very safe bet that this contributes to manufacturing loss in higher labor cost countries.

      Artificially cheap credit makes borrowing easier, making capital investment easier. Making it easier to walk away from existing capital into new capital. And if I am going to invest in new capital, why do it in a high cost environment?

      Take it one step further: labor always competes with capital. As you know, investment decisions for productivity are analyzed relative to the potential labor savings (among other things). If capital is artificially lowered in price, it has an advantage over the labor it is competing with. Cheap credit drives out expensive labor.

      Now, these apply at the margin, and are not 100% explanatory of the shift - But these certainly are a contributing factor.

  2. " By definition, failing businesses are employing assets in unproductive ways."
    I don't think this is 100% accurate, at least not in the US today.
    Non stop changing of regulation and taxation is the business killer. In my industry, you can be going along just fine, then a government regulation comes along and can destroy you. It has nothing to do with using your assets unproductively. A new tax can come along and can kill you off just as easily. It doesn't mean you are all of a sudden producing something the market doesn't want, it may be as simple as the cost of business(tax/regulation) gets ahead of what you can absorb or pass on to your customer soon enough. A new regulation may cost you several hundred thousand dollars, implemented in a few weeks or pay heavy fines or get shut down. You can't just call on your customers to eat that in a short time, you can never have a large enough "just in case the government changes its mind" fund. The State makes sure you can't by stealing (taxing) any money you try to save for the unforeseen. Make a $million profit one year. Do you get to put that in savings or even under your pillow for hard times your company might face? Nope. The State will take $550,000 right off the top. So much for saving.
    The uncertainty of the future has everything to do with the State. What will my taxes be tomorrow, much less next year. How do I save for that? What regulation will they hit me with tomorrow? How much will it cost? What if my customers get hit with a new tax or regulation and they can no longer afford my services? The market I think is pretty easy to navigate, compared to the uncertainty of the State.
    I understand what you are saying in your post, and I understand Austrian Economics. But when dealing with small business especially, there are more to it than using assets properly, or not producing something the market wants. Start a business that the State regulates heavily, or didn't but is starting to more, and you soon find out. And I understand there is a lot written on this too, just wanted to bring this up here.
    The problem, is always the State.