Monday, August 27, 2012

"Dead Money" & The Circular-Flow Fallacy

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"This is dead money," said Mark Carney during a press conference after his speech last Wednesday to the Canadian Auto Workers union. He was referring to the $600 billion in unused cash being held by non-financial Canadian companies. Since the financial crisis of '08, Canadian corporations have increased their cash reserves as a hedge against the uncertain global economy. "The level of caution could be viewed as excessive," he continued, "if companies can't figure out what to do with it, then they should give it to shareholders and they'll figure it out."

Unfortunately entrepreneurs are accustomed to obeying the whims of bureaucrats, but it's quite extraordinary for a bureaucrat to be seen as the expert and for the entrepreneurs to be viewed as anything but. Clearly, Mark Carney knows what's best for corporate Canada. After all, he spent his fair share of time in the corporate sector working at Goldman Sachs. But of course, his views on "dead money" are dead wrong.

Other things being equal, if the price of something falls the demand of it will go up. Despite official inflation statistics, the purchasing power of the Canadian dollar is falling. Therefore, demand is up and thus the hoarding going on by corporations. So if Mark Carney wants to point the finger at someone he should be looking in the mirror.

But things are not so simple. Large cash balances are nothing new and it shouldn't be viewed as a negative thing. Typical among Keynesians like Carney, "hoarding" or savings are seen as a private virtue but a public vice. What's good for an individual or business may not be best for everyone in society.

This is utter nonsense.

The problem with the Keynesian analysis is that it views the economy as static. That is, Mark Carney, if he abides by the theory, won't account for the passage of time and thus can't grasp the capital structure of a modern complex economy. This is due to the "circular-flow" model of the economy the Keynesian theory adheres to.

Apparently, since the financial crisis businesses have been "excessively cautious" and therefore are investing less and hoarding more. This means they are spending less on various factors of production, like buying/replacing capital equipment and hiring labour. Less employment means fewer people are out buying goods and services and then that means less money for businesses, so that circles back to fewer investments by businesses which then leads to fewer goods and services which means less consumer spending which means less business investments, so fewer goods and services and etc. ad infinitum until the economy collapses and we're all impoverished beyond belief.

The Keynesian rationale for government intervention rests on the fallacy that individuals will increase their cash reserves when the going gets tough, but in doing so ensure that the tough will never get going. Therefore it is the job of governments and central banks to entice businesses and consumers to start spending. Right now Carney is just giving verbal warnings for corporate Canada to step up, but this friendly advice can be replaced by force. Governments can force business to liquidate their cash reserves via increased taxes or any other kind of means. The sky is the limit when you are the ultimate decision-maker.

The problems of the circular-flow model are many, as previously stated, it doesn't take into account the capital structure. As Gene Callahan points out, "The Austrian concept of capital envisions not a great blob, but complex orders of goods interlocked in complementary structures." And as Ludwig von Mises brilliantly sums up,

Capital goods come into existence by saving. A part of the goods produced is withheld from immediate consumption and employed for processes the fruits of which will only mature at a later date. All material civilization is based upon this "capitalistic" approach to the problems of production. "Roundabout methods of production," as Böhm-Bawerk called them, are chosen because they generate a higher output per unit of input. Early man lived from hand to mouth. Civilized man produces tools and intermediary products in the pursuit of long-range designs that finally bring forth results which direct, less time-consuming methods could never have attained, or could have attained only with an incomparably higher expenditure of labor and material factors. Those saving, that is consuming less than their share of the goods produced, inaugurate progress toward general prosperity. The seed they have sown enriches not only themselves but also all other strata of society. It benefits the consumers.

The capital goods are for the owner a dead fund, a liability rather than an asset, if not used in production for the best possible and cheapest provision of the people with the goods and services they are asking for most urgently. In the market economy the owners of capital goods are forced to employ their property as if it were entrusted to them by the consumers under the stipulation to invest it in those lines in which it best serves those consumers. The capitalists are virtually mandataries of the consumers, bound to comply with their wishes.

If the men and women of corporate Canada really are sitting on "dead money," and refusing to accommodate to the wishes of consumers, then the issue is state intervention in the market economy that has created this trend. If consumer sovereignty is taking a backseat to 'corporate greed' then the problem may be a central bank that is keeping interest rates lower than the natural rate for an extended period of time.

One of the many fallacies of the Keynesian theory comes from an emphasis on demand. Keynesians believe demand is the driving force of the economy. I demand a ham sandwich, therefore the economy submits to that demand.

But that's only half the equation. Supply is equally important; the ham sandwich must first be produced. Savings allow for greater production by increasing the capital stock. Consumption must be delayed otherwise there'd be no way of investing into tools, machinery or labour to achieve higher outputs. The only people who can determine "how much" savings are required and how long one should save for are the individuals doing the saving. In the case of Mark Carney versus the entrepreneurs of corporate Canada, the Bank of Canada bureaucracy is no position to accurately determine what's best for each private firm.

Roger Garrison sums up the Keynesian problem, and the subsequent political opportunism, nicely in his essay, "The Austrian Theory of the Trade Cycle,"

Keynes offered the profession relief from all this by articulating--though cryptically--a capital-free macroeconomics. As Rothbard's discussion implies, all the thorny issues of capital theory were simply swept aside. An alternative theory that featured the playoff between incomes and expenditures left little or no room for a capital structure. Investment was given special treatment not because of its link to future consumption but because spending on investment goods is particularly unstable. Uncertainties, which are perceived to be a deep-seated feature of market economies, dominate decision making in the business community and give play to psychological explanations of prosperity and depression. And the notion that depression may be attributable to pessimism on the part of the business community suggests a need for central direction and policy activism. Prosperity seems to depend upon strong and optimistic leadership in the political arena. Relief from the complexities of capital theory together with policy implications that were exceedingly attractive to elected officials gave Keynesianism an advantage over Austrianism. An easy-to-follow recipe for managing the macroeconomy won out over a difficult-to-follow theory that explains why such management is counterproductive.

The reason we're richer now than we were in centuries past isn't just a matter of technological advancement. The formation of capital goods (tools, machinery, equipment) that have been imparted to subsequent generations are responsible for this wealth accumulation. And as common sense dictates, there can be no wealth accumulation without saving a portion of your wealth.

Despite following the Keynesian prescriptions, to my knowledge Mark Carney hasn't explained his reasoning for his "dead money" statement by quoting John Maynard Keynes. But even if Carney subscribes to the Austrian theory of capital-based macroeconomics, he is no position to tell individuals what to do with their own money.

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