Why capital accumulation is important and how it effects the price structure

 

The title of this blog post is directly related to a key tenant in Austrian economics, which says that the joy of consuming wealth is derived from the self evident supply of given good or rendered service X,Y,Z.  We shall skip the semantics regarding resource transformation to fulfill this desire.

The primary goal of creating any supply of capital is to sustain the individual for a lengthy period of time in order for him to complete other tasks he deems satisfactory or necessary to bring him in a state that he strives to. Capital accumulation in a free market is a wonderful process because it is based on voluntary compliance of a mass of individuals, each seeking its own end.

This process is disturbed when a self appointed entity with a monopoly on the judiciary system can appoint how and what resource may be effectively employed in a certain endeavor. This entity compounds the problem when it, through the banking system, legalizes the counterfeiting of the currency through fractional reserve banking, creating an artificial boom in the capital goods industry and subsequent inflation.

According to business.hr, the inventory of the manufacturing industries fell 12,3% YOY. While this may be a bullish sentiment for commodity broker dealers, who may just take a long position in a certain commodity and with the same demand dynamics that prevail YOY expect to profit from a spike in inventory products, this is bad for the average consumer, because it will eat away a part of his income when purchasing the final product.

Unfortunately, this is what happens when the economy is shaking of the addiction of cheap credit from the banking system. When the boom faze is over, the manufacturers are forced to dump their inventory onto the market at deep discounts in an attempt to salvage themselves from insolvency. Sometimes, they go under. The subsequent step in this process, is the curtailing of expansion, brought by lower inventory levels.

Some of this inventory had to be sold at a deep discount, as some inventory, due to the artificial boom, have been used in an accelerated manner as the boom faze continued, as more often in industries where day were wasted in suboptimal projects. So, now, it will take time for these stocks to be replenished.

If the government stays out of this process, the recovery will happen sooner than later. If the government interferes in this process through subsidizes of purchases or outright price controls, there will be even less inventory numbers YOY.

The market has to clear. The malinvestments must be liquidated and capital must be freed in optimal projects. If the government inflates it will only lead to more resource consumption and with that lesser inventory numbers.

To reiterate what was said at the beginning, capital formation makes economies tick. A greater unused level of inventory that is known to satisfy future demand in certain industries boosts the economy. Artificial credit gives a artificial boost and excess inventory consumption.

The government better let the market clear and make it easier for producers to sell their products in lines of production which are most profitable for them. Until that happens, expect more inventory volatility…

Cracking Krugman on Croatia

 

Princeton Professor of Economics Dr. Krugman was interviewed by Jutarnji list newspaper a couple days ago regarding the way Croatia should get itself out of an economics rut it has been it for the past couple of years.

The headline reads: “Spend, spend, spend!”

Now, I am sure that Krugman doesn’t spend all of his salary on consumer goods and therefore surely “deepening” the depression in The US, lets just briefly skim across the interview and make some short assessments of what he said.

The following unbiased short excerpts are:

“In a recent manifesto, which tries to primarily to summon economic reason in TheUS - hence the title "Manifesto for Economic Sense" - Krugman and his collaborator on the project is Richard Layard of the London School of economics,  put forward the thesis that the assertion of the majority of today's politicians and economic policymakers that the main cause of the present crisis is irresponsible borrowing countries is completely wrong. Krugman and Layard exception is Greece, which broke all reasonable limits long before the catastrophe that has happened to her.”

So according to Krugman, it is the “level” of “excess” spending that is to blame for Greece’s mess, but not for Spain’s nor Italy’s mess. Too bad he couldn’t specify what “level” of spending this is.

Next, no mention of a credit expansion in these countries, that manifested itself in the capital goods market that brought on a subsequent boom. But, before we dive into that, the following line is also intriguing:

- If you save your income so you do not buy from me, you destroy my income and my sinking jointly deepen the crisis.

Again, what magical level of personal consumption is sufficient to satisfy Krugman? Which level won’t worsen the crisis? 20%? 60? 130?

I ask the question, why do I have to save then? Lets look at the 100% option. I spend all my resources on consumer goods. I cannot purchase durable consumer goods, which qualify as capital goods, because an automobile (a durable consumer good) is purchased with a lot of resources. So, with my salary, I am priced out of this market. To buy a car I will have to lever up. I will have to go into debt. OK. Cool. So, someone will have to give me funds, WHICH ARE SAVED SO I CAN PURCHASE THIS VECHILE. Nope, can’t do that, everyone else is also spending all of their funds on consumer goods as well.

Hmm, I really hope that factories that produce consumer goods will able to keep up with all this demand. I wonder, how will factories that produce machinery which, sell them to other consumer producing factories be able to obtain funds, if all the funds that directly hit the consumer goods industries bid for factors of productions for their immediate disposal (selling clerks, janitors, new corporate automobiles, computers etc.)? They have a choice (the consumer producing industries), to bid for resources (even outbid) to satisfy the demand for their products, or save the funds and investment them in PP&E. THEY CAN’T HAVE BOTH AT THE SAME TIME.

We haven’t even discussed the effects that new money entering the economy has on the capital structure. Again, lets postpone this question for a little later. Lets assume that there is no new money in the economy. The money supply is highly inelastic.

Nobody can consume above the level he earns, unless there are individuals that refrain from immediate consumption. So, how does a factory get built? Can people chill on the beach and drink a pina colada from the pina colada factory if there is no factory? Well, I don’t think so. So, what do they have to do?

They will have to sacrifice a confortable time at the beach and drinking the colada for working on the factory. But since that they haven’t got a product (colada) to drink, their consumption level is zero. (Their consumption level is also zero if they stay on the beach, the colada doesn’t magically appear out of nowhere. I am sure that there is a demand for the colada, but without supply, good luck drinking one!). So these people will have to SAVE (refrain from consumption that doesn’t exist due to a lack of supply) whatever resource they can to sustain themselves while building the factory! This may be, for simplicity’s sake, dirt that grows on trees. They will have to use their own labor and time to accumulate dirt that grows on trees, to be able to sustain themselves while building the pina colada factory. What if they eat all their accumulated dirt that grows on trees before they finish the factory? They will have to USE THEIR TIME TO COLLECT MORE, WHICH COULD HAVE BEEN USED TO COMPLETE THE FACTORY! Again, they cannot make the cake and eat it too.

Enter credit expansion. According to ABCT, credit expansion creates the Cantillon effect and the subsequent reverse Ricardo effect that impoverishes the capital structure which is A MUST to maintain a certain level of consumption. If new money enters the economy in the capital goods industries, a boom will occur, if it enters the consumer goods industry, it will impoverish the capital structure, setting inflation, high nominal wages, and no capital structure to produce these goods.

Krugman gives no mention of what these effects have on the economy. He of course doesn’t even consider what occurs when you run out of loanable funds (present supply of resources that sustains you through the investment process). He acknowledges a need for a minimum level of inflation, of around 3%. Why not 5%? It is only marginally higher. Why not 30%? Things would really take off then.

Professor Krugman is confused of how economies function. He adheres to John Law and other monetary cranks and fiscal charlatans, such as John Maynard Keynes.

The art of spending money must not be confused with the art of creating wealth. Because, according to Krugman, people who are stupid enough to save  during the boom years, are at fault at causing the present crisis. Which means, under consumption is to blame for a depression, and not consuming more what you don’t have. That is, consuming capital to create false GDP growth.

The logical argument of Krugman’s assertions fall on the first pillar of growth. How does he get around the notion that if you wake up on a desert island, or if you are dropped of in the jungle, HOW ON EARTH, CAN YOU CONSUME SOMETHING IF THE RESOURCES HAVEN’T BEEN ACCUMULATED (SAVED)  TO SUSTAIN YOURSELVE THOUGH THE PRODUCTION PROCESS?

Professor, I encourage you to go to a location where there isn’t a trace of modern civilization (you can bring your co-author as well) and try to build up the skyscrapers as in New York, by spending your way to prosperity. 

Until then, go brake a window, since you will be helping the economy by creating demand for a window manufacturer…

Supply in a market will always find demand

 

Ina free market economy, in which the rule of private property is sacrosanct, and individuals are free to engage in any and all forms of competitive entrepreneurialism, any product that finds its way in the market will be sold in the market. Unlike the classical economists and todays neomercantilists  who suggest that cost determines price, the demand for a good will pinpoint its price through the aggregate subjective wishes of market participants in the form of an objective market price.

Due to recessionary trends across Europe, young people have decided to travel light and spend as little as possible on accommodation. This is best seen through cheap accommodations that have sprung across Zagreb, Croatia this past year.

According to business.hr:

“Opening of cheap accommodation for backpackers has become the most lucrative tourist industry in the metropolis, […]just this year opened seven hostels. Fierce competition from some 19 hostels in Zagreb will not survive even in the first six months of this year, 41 854 nights, nearly 4,000 more than the same period last year.

Instant business has become a popular tourist branch in the capital, according to latest data of Zagreb Tourist Board, according to which only the first half of the 2012th Open seven hostels, mostly in attractive locations in the city center.”

I have seen these “resorts” pop up and it is a brilliant way for youth who are on their way to the Adriatic coast to stop in Zagreb and get a feel of Zagreb during the summer as well. Since the unemployment rate of youth is morbidly high across Europe as well as escalating living costs, the market economy has adjusted in such a manner to bring about the best possible solution in such troubled times.

I believe cheaper prices will be expected in the future from these hostels, as more demand brings about greater competition and more square meters per guest with more attractive venues and business activity between the hostels and tourism outlets.

Unless the government decides to bump in and set hostel prices, as well as mandatory insurance coverage (government insurance coverage), young people should have no problem coming here and being afraid that they might be priced out due to higher prices. If anything, this sort of business activity should be encouraged, as well as quick capital mobility in case of shifting demand for hostel services in different locations.