This article has been named the 2012 winner of the Beth A. Hoffman Memorial Prize for Economic Writing.
On November 3 the Federal Open Market Committee announced plans to purchase, by printing money, $600 billion of long-term government bonds over the next six months. This “Quantitative Easing,” Chairman Bernanke assures us, is necessary to aid an economy that is suffering from “a very high level of under utilization of resources.” In other words, there’s a whole lot of unemployment out there, of both labor and capital, and it will take a huge jolt of monetary stimulus to get these “idle resources” back to work.
This massive money injection is supposed to work as follows: buying up Treasury bonds will make their prices rise, and their yields — hence long term interest rates in general — fall. (Recall that previous monetary stimulus has already pushed short-term rates close to zero.) Lower interest rates mean investment capital will be even cheaper than it already is, pushing idle investment money “off the sidelines” and into productive, labor-demanding business activity. And because all the fresh money starts its life as bank reserves, banks will be in a position to extend new loans six ways from Sunday.
Keynesians insist that this kind of massive stimulus is the only weapon the monetary authorities have left in their struggle to cure unemployment. This is a short-term fix, mind you; all economists realize that printing money does not call new goods or services into existence, and not even Keynes himself would tell you that straight-up money printing is a recipe for long-term prosperity. But can printing money induce entrepreneurs to expand output? Can it make unemployed resources suddenly employable? The answer depends on why those resources became unemployed — “underutilized” in fedspeak — in the first place. This is precisely the question that Austrian economists are asking: What exactly went wrong in the economy such that so many resources are now not being utilized? By addressing this crucial question, only the Austrian perspective can adequately dissect the very concept of “underutilization” and offer a coherent critique of this mad-hatter monetary stimulus.
Underutilized, or Simply Useless?
Let’s deconstruct this notion of resource “underutilization.” Resources are only resources to the extent that they have value, or usefulness, to somebody. Resources, properly speaking, are components of a broader plan of entrepreneurial action that brings more and better goods into existence, which people can use to improve their lives. Not all things are resources — things that can’t be used to enhance life aren’t resources, but just objects; things that used to be resources but are now worn out, obsolete, or otherwise have lost their usefulness aren’t resources but just junk.
Context matters when we’re talking about resources. The mere fact that a good was produced at some point and sold for some price does not mean it is still as valuable as originally anticipated. For example, if I took the trouble to fatten 100 steers in hopes of selling 50 tons of beef, only to later discover that everyone has become a vegetarian in the meantime, the beef I produced, economically speaking, would not be a resource! Nor would the beef-producing equipment, tools, and knowledge I invested in have the same value to me once I found out the true state of people’s dietary preferences. While some cattle-raising equipment could be converted to other uses, much of it — like the squeeze chute used for medicating and branding cattle — was highly specific to beef production and would be worth no more than its scrap-metal value in a world where nobody wanted to consume beef. My plan to be a cattleman turned out a big mistake entailing a loss on investment. Losing investments mean economic waste has occurred — to some degree, resources have been turned into junk.
This example may be ridiculous, but is it really that far-fetched? It is highly unlikely that people’s preferences would change so drastically, or that entrepreneurs would be so clueless at forecasting market trends. But a strong enough outside influence might induce enough entrepreneurs into misreading the true state of the market such that they become overoptimistic and invest too much. If, for instance, politicians were dedicated to stimulating the beef industry and promoting beef consumption, and built policy on policy over the decades — a labyrinthine mixture of subsidies, tax breaks, and cheap credit — they just might generate an investment boom in beef production. The boom, however, would be destined to end as soon as the policy changed or, more likely, the oversaturation of the market became evident.
At this point, with declining beef prices and (now-apparent) excess capacity in beef production, market forces will oust marginal producers from the industry and induce even the large, established operators to scale back production. As for the now “underutilized” resources, it will take some time and a lot of extra work to melt down those excess squeeze chutes, to convert cattle pasture into other crops, and for the reluctant surplus cowboys to eventually accept city jobs mopping floors, answering phones, ringing up sales, and so on.
The value of capital — both capital equipment, or physical capital, and people’s knowledge, experience, and training, or human capital — is critically dependent on how well it can fit into the structure of actual consumer demands and the structure of existing complementary capital (both physical and human). It is precisely this kind of interconnectedness among different kinds of resources that mainstream economists tend to disregard. Yet the extent of economic losses revealed by the recent financial crisis and recession is making the malinvestment (waste) of resources hard to ignore. Even at the Fed, some people show signs of understanding the relevance of the structure of capital resources, as opposed to sheer quantities or supposed dollar values. As Naranya Kocherlakota, president of the Minneapolis Fed, recently stated: “the Fed does not have a means to transform construction workers into manufacturing workers.… Most of the existing unemployment represents mismatch that is not readily amenable to monetary policy.”
In other words, no amount of money-printing will change the real relationship of any particular object to its economic context. But the term “mismatch” implies mistakes have been made — entrepreneurial error — and raises the question: What went wrong to cause such massive mistakes in the first place? Again, Austrian capital theory provides the answer: The Fed itself, with its cheap money, along with a host of government “affordable housing” policies, severely overstimulated the housing construction market in the years of the boom.
The Housing Boom and Idle Resources
Entrepreneurs always have many options in which to employ their time, labor, and capital. During the housing boom the amazing increase in home prices relative to construction costs made projects like new home construction and even flipping condos seem an obvious profit opportunity. Following the price signals, people expanded their investments appropriately: Young entrepreneurs learned about real estate and construction management, and new workers learned construction trades; building companies were started and existing companies expanded, purchasing more new equipment like nail guns, Skilsaws, and pickup trucks; upstream suppliers similarly expanded investment in things like cement plants, timber plantations, sawmills, and the like.
Regardless of whether these workers and entrepreneurs were cognizant of the temporary, cheap credit- and subsidy-induced nature of the boom, the lure of high prices and high profits proved irresistible. In retrospect it is easy to see how the Fed’s cheap money policy, along with a host of government subsidies to homebuyers and lenders, set the stage for an unsustainable boom — a boom that did not match well the actual, long-term consumer demand and for which the credit that financed it was not fully funded by actual savings. (For an excellent explanation of the government’s role in the housing boom and bust, see Peter Boettke and Steven Horwitz’s “The House That Uncle Sam Built” [pdf].) Nonetheless, the slew of political interventions into the housing market led these entrepreneurs on for years before the inevitable market correction occurred. The net result was that too much investment capital went into home building, and not enough into other economic activities — a mistake of grand proportions.
The housing bust revealed that many of the capital investments of the boom period — from concrete trucks on up to skilled construction tradesmen — were actually malinvestments whose value turned out to be less (in some cases much less) than anticipated. The capital resources created to build houses are, to varying degrees, ill-suited to other tasks. They will necessarily be underutilized relative to the boom era, precisely because they have lost value (usefulness) in light of the new economic reality. Indeed, economic reality in the bust indicates that many of these resources will have to find other ways to be productive, as attested by the overbuilt housing market. (According to National Association of Realtors figures, there were between 1.02 and 1.77 million “excess” homes as of September. Supply was converted into excess units on the basis of six-to-eight months’ supply representing “normal” conditions.)
But this adjustment takes time, and the more specialized the resource, the longer the wait. Some excess concrete trucks can be sent overseas or converted to other industrial uses, but many will simply sit, awaiting the next boom or the scrap heap. Indeed, in some cases, when a particular resource loses its usefulness, leaving it idle can be its optimal “use.” Likewise, the surplus low-skilled construction laborers can perhaps get jobs washing dishes, but skilled tradesmen, engineers, and jobsite managers must retrain to find different jobs that match their boom-era earnings. Not surprisingly, some choose to wait (and take unemployment benefits) rather than risk retraining. For those who have thrown in the towel on a construction career, retraining and reemployment can take years. No amount of money-printing can change this reality.
Implications for Monetary Policy
Political efforts to “stimulate” economic activity will necessarily alter the capital structure of the economy. Government-based stimulus for industry Z necessarily detracts from what the market would have provided industries A through Y. Even a nonspecific stimulus, if such is possible, will only stimulate the investment fad du jour; there is no such thing as neutral government policy. The key policy implication of Austrian capital theory is that any attempt to stimulate the economy will, by spurring malinvestment, doom some resources to superfluousness. From a statistical standpoint this may look like underutilization; from an economic standpoint, however, it’s simply the waste that results from too many investment plans gone bad. Attempting to undo the waste by further stimulus will only exacerbate the problem: more stimulus, more malinvestment, more wasted resources.
So what should the wise and munificent monetary central planners do? Ironically, the optimal monetary policy is not to have one, but to let the competitive market process function for money and credit the way it does for countless other goods. If we must have central banking, the ideal policy is simply this: First do no harm by abstaining from continually tinkering with interest rates and the money supply in an attempt at perpetual stimulus. Despite the seductive logic of the Keynesian physicians, printing money is patent-medicine quackery that stands to do the patient more harm than good.