Our Daily Bread

Tue, Jan 7, 2014 - 8:57am

There can be little doubt is that Adam Smith’s chief concern was not so much with what man might occasionally achieve when he was at his best but that he should have as little opportunity as possible to do harm when he was at his worst. It would scarcely be too much to claim that the main merit of the individualism which he and his contemporaries advocated is that it is a system under which bad men can do the least harm.

- Frederich Hayek, “Individualism and the Economic Order”, 1948 University of Chicago Press, pg 11.

As readers of this blog know, one of my strongest objections to Keynesian economics is that it facilitates, and indeed almost compels, massive malinvestment over time. Austrian economists usually explain the concept of malinvestment by noting that during times of monetary and credit expansion, the “easy money” available as part of a central bank-fueled spending binge encourages firms to make unwise investments, reduces the discipline with which they might normally allocate funds to various projects, and essentially takes a scarce resource (capital) and facilitates poor spending decisions by making it appear to be less scarce than it actually is.

As Ludwig von Mises wrote:

The popularity of inflation and credit expansion, the ultimate source of the repeated attempts to render people prosperous by credit expansion, and thus the cause of the cyclical fluctuations of business, manifests itself clearly in the customary terminology. The boom is called good business, prosperity, and upswing. Its unavoidable aftermath, the readjustment of conditions to the real data of the market, is called crisis, slump, bad business, depression. People rebel against the insight that the disturbing element is to be seen in the malinvestment and the overconsumption of the boom period and that such an artificially induced boom is doomed. (Ludwig von Mises, Human Action: A Treatise on Economics, 1966)

In short, I tend to think of malinvestment as spending capital unwisely on the (false) assumption that capital is plentiful and easily obtained, when in reality that capital represents a finite amount of stored value that is (contrary to the market signals given by easy money) hard-earned and not easily replaced. In the private sector, we might point as an example to the imprudent buyout of a competitor at higher prices than can reasonably be recouped from the acquisition over the long term. In the public sector, virtually any government boondoggle would suffice as an example, from “community development” projects to taxpayer-funded bailouts which always seem to go over budget and yet manage to underperform prior claims of economic benefit.

OK, all of this is a bit dry and esoteric, but it is necessary background for the two points I want to make in this essay. The first point is that I don’t think people truly understand the scope of the problem that modern central banks and politicians have created for us. We are now in a cycle of malinvestment that has lasted literally for generations, and hence has created worldwide malinvestment on a scale never before seen in human history. The second point is that the depth of this malinvestment goes well beyond government spending and the odd “bridge to nowhere” or the thinly-stretched balance sheets of multinational corporations. The scope of malinvestment has profoundly shaped generations of people – human capital being the most precious capital of all – and has left enormous swaths of society ill-equipped and ill-trained to actually produce anything of value, once the easy money spigot is turned off.

The scope of malinvestment

The examples I am going to use are tailored to US readers, but I suspect that anyone living in an “advanced” western country will recognize exactly what I am talking about here. Look around at the state of the economy in your city, county, or neighborhood. Chances are that you see “For Rent” signs on many empty buildings that used to house businesses. You see EBT cards being swiped at the grocery counter, and a general economic lethargy that is impossible to deny despite the incessant attempts to convince you otherwise on the evening news. Chances are you know somebody who has lost their job, and they will be very quick to tell you that those jobs are NOT being replaced. Many of the people you meet on a daily basis are quietly working two jobs at low wages and still are barely managing to survive. In short, nobody in their right mind would confuse our current situation with healthy economic prosperity.

Now think about this: the situation you see around you is what 17 trillion in debt, borrowed from the future to “stimulate” the economy of the present, has managed to buy. Six trillion of that debt has been run-up in just the last five years. We have borrowed from futurity such an enormous amount that it will not, in all likelihood, ever be paid back. And this is what we have bought- this grueling existence with 45 million on food stamps, jobs disappearing or being replaced with temporary or part-time menial labor, this walking dead economy. These are the GOOD times, purchased by borrowing from future prosperity. Think about that long and hard, and if you ever truly wrap your mind around this it will keep you up at night.

I have never read a reasonable estimate for the scale of malinvestment we currently have, perhaps because the scope of the problem makes it all but impossible to quantify. Or perhaps it is simply that the implications of such a study would be nearly too frightening to contemplate. What I do know is that it represents an enormous opportunity cost that will not be easily recouped, and that the transition to efficient capital/resource allocation suggests a substantially lower standard of living for a very long time.

Give us this day our daily bread

One aspect of this malinvestment that often gets overlooked is the human component. As mentioned earlier, the most precious capital any society has is its human capital - the aggregate of all the education, capabilities, skills, and ability to produce- contained within the population. Just like financial capital, human capital can be misallocated as well, and I would propose that we have seen a massive malinvestment in human capital thanks to 70 years of Keynesian policies. This goes far beyond simply “We have too many people doing X job and not enough doing Y”. To a degree perhaps never before seen, tens of millions of people over multiple generations have been trained and educated to perform jobs that literally would not exist sans easy money. Many others have been insulated from the immediate repercussions of their behaviors or choices to the degree that they now possess such paltry skillsets as to be virtually unemployable. To put it bluntly, we probably have a larger proportion of our population that is unable to produce anything of value than any civilization in history. This malinvestment in the citizenry (and resultant lack of productive or profitable skills) extends from the college educated Wymyns Studies major to the high-school dropout dependent on welfare benefits whose skills may not even merit minimum wage employment . At the same time, large swaths of hard-working, well educated people may have spent their entire lives training for professions that literally would not exist outside the rarified milieu of an easy money economy.

This is not just a temporary case of “monetary solutions failing to solve structural problems” as many Austrian economists would assert. Such a formulation downplays the true generational nature of the structural problems- decades of malinvestment has left us with a large numbers of people either unable or untrained to produce much of anything of genuine value. Not to put too fine a point on it, but what exactly are these folks going to do to earn their daily bread? To say that we may have a difficult transition to a different monetary regime if/when the current Keynsian debt-based system runs its course, is in my opinion a gross understatement. Such a financial transition may well suggest a lost generation, or even generations, in terms of human capital. It may suggest social or political implications that are rather bracing to contemplate.

. . .

The phrase “The End Of The Great Keynesian Experiment” implies a great deal more than just a financial reset. Bad decisions have consequences, and 70 years of bad decisions have compounded into a rather monstrous situation. How this situation will ultimately be resolved is anyone’s guess, but I suspect that the actual costs – including the human costs - of Keynesian economics will be something that we will be paying for, for a very long time. Prepare accordingly.

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