Capital Consumption

Everything in our society is measured in nominal prices. Nominal prices are given prices, prices which are stated by all vendors.

Real prices are prices which take inflation into account. Austrians believe that inflation is a rise in the money stock. The rate at which the money stock rises would be a subjective measurement once the money starts being consumed within the free market.

Mainstream economists believe that inflation can be measured using a commonly accepted average which is a year over year measurement of the change in prices. Basic mathematics can be used to describe the change in the group of generally accepted goods from one year to the next.

The problem with using these types of averages to measure the abstract idea of a rise in prices from two different points in time, is that math theory's substrate assumptions leave the premise of subjective factors in the hands of those designing the formulas and cobbling the data.

Nobody has perfect information, and data is historical, thereupon the averages arrived to are best and most assuredly safest when used in the private sector. When in the hands of government, they become tools of artifice intended to seduce the voters to emphatically support the very coercive institutions which amplify and bring about poverty, crime and all other iniquities in our society.

Mainstream economists tend to use the consumer price index (CPI) or producer price index (PPI). Both of these averages are broad assumptions. The CPI measures prices at the final stage of production, the lower order goods, while the PPI combines all prices within a wide array of other stages aside from the consumer stage, higher ordered goods.

As the money stock rises, so will prices at a later point in time. This could either be gradually or more precipitously. In either case, inflation is in effect. Gauging this phenomenon is the daunting task of the market actors, particularly the captialist-entrepreneurs.

Consequently, we can conjecture that inflation is subjective at every stage of the structure of production.

As was previously described, the consumption-savings/investment ambit is gauged by all actors, individuals found in all sectors: families, corporations, et cetera. Humans are imperfect and make bad choices frequently, so as inflation is imparted on the market, the enshrouded effects of rising prices causes these human actors to delve into their consumption withheld.

This type of over consumption of savings can come as a surprise to people whom abruptly realize that due to a deceptive monopolized benchmark rendering cost wariness feeble, have also undertaken an unsustainable amount of debt.

Capital consumption is essentially a subjective over consumption of savings. As discussed in a prior post, a malinvestment is a poor decision endeavored. Generally, when describing the activities of the capitalist-entrepreneur, a malinvestment is a bad business investment. This poor decision can be realized in the form of a monetary loss, which is similar to capital consumption.

It is important to hearken the quite common Austrian pithy saying of "the seen and the unseen," as this will allow for enhanced chary decision-making. Theory gives us this elemental acumen, and indeed I am also referring to the so often misunderstood theory of mathematics.

Deflation

The economics profession is notorious for despising the idea of falling prices. Due to the quasi-paper-mache models erected from the coercive hands of government officials, those adulators of their concoctions entice them to render society asunder.

These amusing tools are the IS-LM curves and Cobb-Douglas function which aggregate quantities, assumptions respectively. The most virulent of the former two is the Cobb-Douglas function which agglomerates capital.

Previously, we discussed why this assumption of a large K (capital) cajoles the learner toward the seductive powers of numerical symbols. The superficial idea of agglomerating what the Austrians detail in a latticework of more realistic theory allows the reader to not be persuaded by the theory of math. In essence, the numerate is more wary of the tools which assist in making these assumptions. The innumerate does not understand that the weapon he wields is a plastic sword.

Rothbard goes on to describe the nature of falling prices as a moment in time by which capitalist-entrepreneurs withdraw their capital from the said stage of production and move it into a higher returning stage. Effectively, since price spreads are shrinking--as buying prices get closer to selling prices--the capitalist-entrepreneur is unsatisfied with a smaller rate of return, let alone real rate of return.

Money at all times is either consumed or saved-invested. Never is it the case that money is held outside of this ambit. Both concepts are subjective, as consumption takes place at the present moment. On the other hand, savings-investing is consumption withheld. Hoarding is subjective. Is it the cash held in pockets, or on green dot cards?

During the moment in time in which actors desire withholding consumption, they are contributing to the accumulation of capital elsewhere. For example, holding money in a demand deposit contributes to savings-investing, it is capital not being presently consumed.

Additionally, moving money from one class of securities to another, will make the price spreads of one sector expand, while the others being consumed shrink. For this reason, in being the first buyer, and conversely the last seller, one is able to garner the largest price spread or rate of return.

As prices fall in one market sector, one's purchasing power is enhanced in that same sector. Thus the old adage of buy low, sell high. Rothbard coined this "increasing effective cash balances."

Most importantly, falling prices from a fall in the money stock is associated with the readjustment process. At any point in time that defaults occur, money in the system diminishes. Whether it be at the banking level--where loans can disappear due to inability to pay, bankruptcies at the corporate level--which would lead to a vanishing of demand deposits, or the Federal Reserve Bank intervening (selling off reserves) or raising the monopolized benchmark (which essentially affects the Repo rate).

This readjustment process will only result in what is a weeding out of bad business practices whereon the recrudescence period after that ultimate free market trough is affected. This trough is completely natural on the free market, with freely moving prices--all prices. Prices must fall to their appropriate market level, in accordance with the time preference of human actors.

Allow me to formulate an addendum: a revival in the form of a palliative will not remove the cancer, but only catch the Tower of Babel as it falls, fomenting it's continued growth in it's partially dilapidated state. Hence, bazooka joe reinflates.

Time

Time is of the essence when it comes to deciding the actual agio of a good. The agio, mark up, rate of return or interest rate are all decided by the difference between the buying and selling prices of goods.

In order to understand how an agio is formed, one must first grasp the concept of time. Everything exists within time. Time is scarce and man must economize his time accordingly. Man subjectively values the time in which his actions are rendered, or in which he will exist.

Moreover, man always values money now more than he values money in the future. Rothbard would point out that one tends to discount future goods at a higher rate than present goods. The inverse can be stated as one garners a higher premium for present goods as compared to future goods.

Everything is dependent upon time, and points in time are indeed subjective. Present time is manifested in one's action, when they make their choice on their value scale. The Future exists at any later point in time, it is the action not undertaken.

Thus, as mentioned in my previous blog post about the rate of interest manifesting itself in an individual's choices by using their income, one can also see this confection in the structure of production.

Let us recapitulate, present goods are tantamount to those entities being consumed, in example, the monetary unit of exchange. One sells money, and buys a television.

Future goods are tantamount to those entities being bought or wielded, wherefore, savings (consumption withheld) will be money used in the future. It is hoarded.

Transferring this basic Austrian theory to the structure of production, a Capitalist will advance factors to the various stages of the production process. The Capitalist will use savings, selling money to purchase future goods. These future goods are capital goods.

The Capitalist will hold these goods for a period of time, mixing them with land and labor until a final consumer's good is produced in the future. This consumer's good is then sold at a mark up or rate of return.

Recollecting the common theme of subjective value, we find that for one actor a consumer's good is a present good and for another actor, a capital good is a future good.

Accordingly, savings is also a subjective construct. Holding money in one's pockets is outside of the savings-investment process, whereas money held in demand deposits is still considered savings. Here we arrive at a new discussion of assets withheld earning an agio, and those which are consumed. I believe I have just gone full circle.

More on the Rate of Interest

Retroactively viewing my description of the rate of interest which derives from individual time preferences, we came across a point where I described the rate of return differently there than the way I described the rate of return with other prices.

Let us harken that moment. On the market, the difference between buying and selling prices equals the rate of return. This is tantamount to the price of Treasury Notes and Bonds in comparison to the yield rendered.

The 10-year Treasury Note sells at a price of $900 with a yield of 4% in present value terms. Par Value of the bond is $1000, hence when the debt instrument matures it will pay out par value. The coupon is 2%, this is the percent mark up at issue.

Each debt instrument has different contractual terms and different moments in time of paying out cash flows. The cash flows will be paid out over the duration of the contract. Those holding instruments look to make money on the spread.

Hence, the spread would be between the face value of the Note and the coupon. If one is holding the Note, the spread they seize would be between the price they bought the Note at, and the price they sell the note at plus the dollar quantity of cash flows they received for the period of time that they held the Note. The yield is a present value abstract contrivance.

Both Notes and Bonds can either be sold at a discount or a premium depending on which mathematical formula is used to calculate the present value of the debt instrument. If this abstract average, the yield, is above the coupon rate (rate of return) the debt instrument will be sold at lower prices. If this abstract average, the yield, is below the coupon rate (rate of return) the debt instrument will be sold at higher prices.

This brings me back to explaining the difference between the Pure Time Preference Theory of Interest and the Natural Rate of Interest. In my last post I described how within a total income of 10, consuming 1 would leave 9 of savings.

Thus, this ratio would be stated as 1/10 where there is a rate of return of 10%. This is tantamount to the pricing of short-term debt instruments. Treasury Bills are sold at a discount for example, where Par Value would be stated as an increment, 100. In consequence, a stated market value of 98, would mean that the yield is 2 or 2%.

All short-term debt instruments, typically less than one year, are sold at a discount. Due to the contract maturing much quicker than Notes and Bonds, this will always be the case. The latter two, longer-term debt instruments, will tend to fluctuate in price, above or below Par, as mentioned above.

In essence, the micro or individual preference of time derived from subjective value scales can theoretically be summed up as previously mentioned. Human actors endue their investment-consumption ratios where the rate of return is subjectively the consumption portion, leaving the consumption withheld as savings.

This is commensurate to the aforementioned example of Treasury Bills, the market price reflecting a reduced price (discount) of Par. Not only is there profit in accordance with a measured price, but there is also mental profit.

The Natural Rate of Interest on the other hand reflects the price spreads of the various factors of the production process. In general, it is the spread between the buying and selling prices of capital goods within the structure of production. Let us not forget, it is theoretical.

Most importantly, the Natural Rate of Interest can basically be described as the average of all price spreads within the the free market. Factors are made up of savings. Therefore, when observing the stock market, the spreads seized in the speculative process, are also price spreads that contribute to the Natural Rate of Interest.

At any one time, the Natural Rate can be conceptualized within various markets, or more broadly in a city or country's economy as a whole. It pervades all markets.

In a truly free market, without the intervention of government, spreads open and close as the speculative process is undertaken, as well as when the nascence of entrepreneurial creations are introduced in the market.

Save Yourself from College Debt

I hardly delve into describing strategies where one can earn a positive rate of return over time. Today I shall elaborate a bit on one that may be helpful to those who believe going to the university is an investment.

Firstly, I will describe the basics of savings. The most rudimentary mechanism is keeping one's money in a savings account which is cash within a demand deposit. At this point in time one can only earn is very small rate of return. It is one offered by a banking institution.

The rate of return offered through a banking institution tends to move in tandem with the fluctuation in yields which is affected by the monopolized benchmark. Of course private contracts can be influenced by any point of reference, whether it be a rate of interest on the free market, or a simple mark up that is decided bilaterally.

Higher rates of return can be effectuated through riskier savings vehicles. Some are packaged, and some stand alone. Some are debt instruments, and some are more liquid, such as equities. Debt instruments are less liquid and less risky. Equities are more liquid and more risky.

There are also other types of contractual bets that attempt to predict the future value of some other underlying instrument. These are called derivatives. They are called hedges or insurance. It is a bet in the fluctuation of the value of the reference instrument. One wins, the other loses. Blackjack.

Insurance is of the most safe savings mechanisms one can find. It is a pooling of liquidity, with the promise to return the same amount paid in, plus a percentage more at a certain point in the future. This would be called the settlement period.

Americans today have taken for granted these basic savings vehicles due to the heavy reliance placed upon entitlements. All entitlements are government programs which are funded by government debt. Government has also exacerbated the welfare consumption of Americans by creating moral hazards. Their monopoly of banking insurance has proliferated speculative bubbles.

Here is one simple way a college student looking to make themselves debt free can do so without looking to the pampering of government when they graduate. This pampering burdens all other Americans in the form of inflation. And unfortunately, the majority of college grads are not necessarily a boon to the economy. Their debt renders them a net burden while in college. America is overleveraged.

A Universal Life Policy with flexible premiums is the best way to accumulate a pool of capital to use in the future, as the asset will cancel out the obligation after college, or at least decrease it's size. With Option A, that is, the option that allows for greater cash value to be accumulated until the age of 100, would be the best choice. The insurance portion levels off at a certain age.

By depositing much more than the minimum every month, one could generate enough cash value so that by at least age 40 or so one could take out a policy loan or surrender the policy and take the cash value, using that to pay off their school loan obligation.

Indeed the surrender would discount the final value, but at least it would help to decrease the student loan obligation. With the Policy Loan, you simply keep paying the premium until death which would also include a smaller mark up, keeping in mind the accumulated interest needs to be paid off for the Policy Loan throughout the remainder of the contract.

The greatest benediction is that the Policy Loan need not be paid back. It will simply be deducted from the death benefit at settlement. This will simply leave for a smaller estate.

Best bet, stop going to college altogether.

Where is the Inflation Found?

Although much of the data fed through various channels where mathematicians are encountered alchemizing integers can be deceiving, we do sometimes find inklings or traces of correlative relevance towards Austrian Economics.

Austrians understand that data only serves to reify, nothing more. Thus nobody should take a model as an absolute or even as a prescient measurement of truth.

In this case I will attempt to use some of the legerdemain of the statisticians that work for the monopoly of data collection, the US Federal Government.

Here in this chart we see the PPI (Producer Price Index) compared against the CPI (Consumer Price Index).

Many times the actual year over year percentage change can be clandestine depending on the basket or averages one uses.

The basic chart I have chosen is nice because it does somewhat give light to the bidding up of higher order goods during the point in time of the next bubble. That being, as we all know, first TARP and later it's three follow up palliatives, QE1, 2 & 3 with Operation Twist in between.

Retrogressively summarizing, as the new money enters the market the higher order stages grow longer, while the consumption base grows narrower. As the theory goes, this should occur based upon genuine savings.

With a suppression of the benchmark as well as Federal Reserve Bank intervention, more money effuses into the market. This expansion of credit is simultaneous. This is due to the monopolized benchmark that the Fed has wielded through government dictum.

Overall, it is quite evident that although companies expand together when rates are suppressed, companies still invest in long term projects that result in the business cycle tending to commence at the higher ordered goods stage. This would be the abstract average concocted by using commodities prices found in the PPI.

Finally, since inflation exists at all times illusively, we must understand that the business cycle occurs within every market and within every business throughout the market process.

The Free Market Rate of Interest

In reference to my first blog, where I describe how the rate of interest derives directly from the subjective value scales of individuals, I will now describe where the market rate of interest arises from.

Within the structure of production we find various stages of the production process, starting with land and labor, and resulting in the final consumer product. During the free market process, the price spreads shrink and expand according to an array of market signals.

Buying prices can rise faster than selling prices, which will result in shrinking price spreads. This process is unknown, it is subjective and only perceived by the entrepreneur. In nominal terms it may be clear, but in real terms it is opaque.

When price spreads are high, capitalist-entrepreneurs apportion savings to this higher earning sector. On the other hand, when price spreads are low, capitalist-entrepreneurs pull their money out of this sector and advance savings to the other higher earning sectors. Rothbard calls this advancing factors to the various stages of the production process.

Be aware that within this theory, a capitalist-entrepreneur can invest in stage 5, higher order goods, mix land and labor to create a new capital good, which can then be sold in stage 3, a lower order goods sector. This process occurs over time, so stage 3 will happen at a later point in time than stage 5.

These price spreads, the difference between buying and selling prices of factors of production, are the going rate of interest in the market. The mainstream scholars would subscribe their idea of the market rate of interest as manifested in the Federal Funds Rate.

Mainstream scholars believe that the rate of interest derives from the producers loan market. It does not. Their models desire convincing us that it does by seducing us with hypostatization. Since, to them, their idea of a market rate of interest is ultimately so abstract and unknown, they feel there must be a monopolized rate of interest to dictate the amount of debt issuance.

They miscalculate and misunderstand how the private capital markets work in a competitive free society. They are ultimately forcing spreads toward the equilibrium they attempt to design. As an outcome, all expansion occurs simultaneously.

The central bank purchases assets at a certain contractual price, this in essence results in a change in yields. As a process new money enters the market. Unlike the rest of us who have to build savings, they can enter a debit and credit out of nowhere. Some coin this, money out of thin air. It causes a rise in the money stock.

For Austrians, we understand how the free market works, so there is no need for us to attempt to design a society. Our method is a priori. It is a value free science.

Referencing the description above about the price spreads of the various factors of the production process, if one were to average these spreads, one would arrive at what is termed the natural rate of interest. This is the market rate of interest.

What is most important to understand is that this theory of the natural rate of interest is simply theory. It is abstract, conceptual and unknown. Albeit subjectively we know it exists at all times. Even with numerical calculation, arriving at the exact price precludes making a mere assumption within the confines of what happened in the past; historical data.

Figuring out a method of actually averaging them out can only be done intuitively. Nobody has complete information. This is essentially a theoretical concept.

As a result of having limited information, capitalist-entrepreneurs on the free-market may only attempt to gauge this rate of interest within their proprietary framework. There would effectively be many competing benchmarks. Contractual rates of interest would be decided contractually.

The results of attempting to gauge the rate of interest with a monopolized benchmark are always disastrous. The monopolized benchmark will always be wrong, and in most cases tend to be below the natural rate constantly causing chaos. Credit expansion will ensue, and excessive malinvestments will amount.

As mentioned before, there will always be bad choices, which implies that there will always be malinvestments. Not even the capitalist-entrepreneur knows if his choices will result in monetary losses until after the choice has been made. Only free-market signals can quell excessive malinvestments, and ultimately vast amounts of monetary losses.

Conclusively, we arrive at where interest rates are born, or where they evolve from. The rate of interest is a subjective value that derives from individual human action.