In my last article ‘Costs of Compliance’, I wrote about the Mengerian concept of ‘Marginalism’ particularly as it applies to the Marginal Productivity of Labor. Specifically, how this margin is defined; as the line between profit and loss as far as labor productivity vs costs is concerned. I also mentioned that a similar concept will hold for the marginal productivity of capital, that is the profitability or lack of it in regards to investments in productive capital.
Now in a world of honest money, the situation is simple. Savings are equivalent to hoarding; stuffing Gold and Silver coins and bars into the mattress, to hold for a rainy day… and to enjoy the natural appreciation, the natural increase of purchasing power of money as the world economy improves, and the cost of producing most goods slowly and inexorable declines.
Investing in an honest world is also simple; investment implies the purchase of Gold bonds; bonds that produce return in the form of Gold, bonds that mature into Gold… and bonds that are protected from loss or gain of market value through the benefit of sinking funds designed to do just that. Investment in bonds in such a scenario implies absolute security and steady income for widows and orphans; return of principle at full value plus increase in purchasing power, coupled with modest but dependable returns.
Speculation is also a part of the honest money world; this simple fact is stuffed down the memory hole, and speculation is equated with gambling, but this is not so; speculation is not gambling. In an honest money economy, speculation has positive and important roles. Speculators buy shares of companies; yes, buying stocks is speculative; after all, how does the share buyer know that the company will prosper, produce income (dividends) and in fact survive?
Thus, speculation provides funds needed for capital investment, a crucial component of economic development. Furthermore, speculation is essential to the viability of commodities markets; commodities such as grains and fuel are traded on these markets… which are in effect a regulated, well defined method of forward sales. For example, a grain farmer wishes to sell his crop for a reasonable price, well before the crop actually matures.
This relieves the farmer of the risk of a price drop due to bumper crops or lesser demand… by giving up the opportunity to make excess profits due to price increases that poor crops or unexpectedly high demand would produce. On the flip side, the grain mill operator also would like to buy grains at a known price, avoiding the risk of soaring prices while giving up potential gains due to prices dropping.
In other words, the producer and the buyer both wish to avoid risk. Commodity markets allow for this in a systematic manner. However, these markets cannot thrive without liquidity, that is plenty of money… and supplying liquidity is another role of the speculator; the speculator takes on the risk avoided by producers and consumers, in return for the opportunity to profit from price swings. Not only does this speculative buying/selling allow the producer and consumer to meet, but it tends to reduce wild destructive price swings; speculative buying when prices tank supports the farmer and speculative selling when prices soar supports the buyer.
Finally, we have an activity called gambling; a form of ‘entertainment’… and while gambling seems to provide titillation for the gambler, and serves to enrich the casino or ‘game house’, gambling does not in any way contribute to economic development. Human nature seems to get a kick out of gambling… but there is no place for gambling in a proper economic system, no important role like for investment, and for appropriate speculation.
Indeed, New Austrian Economists consider speculation to be bets placed against natural phenomena like poor weather that effect crop yields and gambling to be bets placed against man created risk. Weather is not controlled by any casino; but in today’s Fiat world, speculation has degenerated into gambling; interest rates and Forex, the biggest futures markets of all, are vehicles for gambling on casino created risk. Humans (casino owners) set Forex and interest rates, not nature.
This is how low we have sunk; whereas bonds used to be considered safe, secure sources of income for widows and orphans, today the bond market is the biggest casino of all. Zirp and Nirp policies ensure that there is no income available for bond holders, for savers; gamblers, falsely called speculators, however, are well served by rising or falling interest rates. Bond prices rise and fall in inverse proportion to interest rates.
Mainstream Austrian economists, if I may call them mainstream, do not recognize this fact; they are still stuck with the words of Mises, written many decades ago, before the importance of ‘speculation’ in interest rate and Forex futures was recognized.
So, how does all this tie to the marginal productivity of capital? In the days of honest money, the answer was clear; bonds produced steady, secure income… and only gains higher than the prevailing rate of interest would encourage speculation, the purchase of equities. For example, if the long term interest rate is 5%, consider the choices facing someone with funds to invest.
If a business venture promises a 10% net return, this is a powerful inducement; buy the business (shares) and double your investment income. Likely the increased income is worth the increased risk. On the other hand, if interest rates are 7.5%, and the equity can produce 10%, the difference may not be worth the extra risk; fewer speculators will show up. And at the limit, if the business gains 7.5%, no one would take the risk; much easier and safer to buy the 7.5% bond, and simply clip coupons.
Thus interest rates are limited by equities; if interest rates rise, there will be more buying of bonds and selling of equities; this pushes up bond prices, which is the same as pushing down interest rates… and pushes down equity prices, which is the same as increasing dividend yields. On the other hand, if interest rates are too low, hoarding takes over; no one will buy or hold bonds for a pittance… but will choose to hold their Gold money out of the markets. A scarcity of money due to hoarding leads directly to higher interest rates; those who need capital must pay the price requested by the holders of Gold.
Now this natural feedback mechanism falls apart under Fiat; the interest rates floor is no longer set by holders of Gold coin, but by banksters; so rates continue to fall… rates approach zero, debtors (like the G’man) benefit, savers are robbed, speculators (gamblers, mostly the banksters themselves) make a killing, and the economy tanks due to the impoverishment of the saver (middle) class.
But wait; if interest rates are so low, should not equities soar? Should not entrepreneurs gleefully invest… after all, with 0% interest, even an enterprise that produces only 2-1/2% net return seems lucrative, no? Furthermore, unnaturally low interest rates reduce the cost of capital; it is possible to borrow at near zero rates, and invest in business that would normally be marginal, or even sub-marginal; unprofitable.
Indeed, this is one of the tenets of Austrian economics; malinvestment. That is, investment in business ventures only viable under artificially low interest rates, ventures that will collapse when rates return to the norm.
But what if interest rates never rise, are not allowed to return to the norm? What if rates keep going down, asymptotically approaching zero… in fact, and incredibly, even going under zero? Should not there be a mad scramble for ever more ‘malinvestment’? For ever more enterprises… leading to more and more employment, more and more economic growth? With negative rates, an enterprise that simply breaks even sounds so good!
Why is this not happening? Why instead of a boom is there severe structural unemployment, debt explosion, looming economic collapse? Is it possible that the theories under which the CB’s control interest rates are wrong? Is it possible that artificially lowering interest rates is destructive to the economy?
Thus we come to the crunch; even though the marginal productivity of capital has been forced down by ‘policy’, there is no improvement to the economy, only destruction. The reason should be obvious; newly minted ‘money’ has not flown into productive enterprise, but into speculation (gambling). Why should anyone invest in a business that is marginal, that is risky, and that produces meager returns… when there are enormous profits to be made in gambling?
Especially risk free gambling; the big banks not only gamble in interest rates futures, to the tune of a quadrillion dollars’ worth of interest rate and forex derivatives, but the big banks also set the rates! If this is not a giant casino, then I don’t know what is. This is like arsonists running the fire insurance business.
Not only is wealth being burned in this gambling frenzy, not only is wealth being transferred from savers and producers to gamblers and gangsters, but endless human talent is tragically wasted in working to devise ever more effective means of profiting from gambling… instead of turning to solving all the problems that plague our world; war, hunger, poverty, pollution, the ongoing destruction of civilization.
William Jennings Bryan, American presidential hopeful, advocate of honest money, battling against the demonetization of Silver, famously said “You shall not crucify mankind upon a cross of gold”. Unfortunately, while he was right in his battle for Silver money, he was wrong about the ‘Cross of Gold’. Mankind is being crucified on a cross of paper.
By Rudy J. Fritsch