One of the most critical concepts in Austrian Economics is that of capital malinvestment.  This occurs whenever a firm makes an investment in future business that fails to pay off as originally expected.  Obviously this happens all the time, people and firms are not perfect and naturally make mistakes.  Also obvious is that these same firms are putting as much effort as they can into NOT making such mistakes since the penalty could ultimately be bankruptcy.  Therefore in an economy free of outside manipulation such failures would tend to be infrequent and sporadic enough as not to cause serious disruptions.  A business may take a heavy loss but regroup and recover with a new investment.  Or it may continue to fail, liquidate its assets, and have them put back to use by more productive firms.

This is NOT what is happening in America today.  Since the inception of the vile Federal Reserve in 1913 the Federal Government and the Fed Reserve have pursued an openly stated policy of nonstop monetary inflation and artificially low interest rates.  This is a very bad thing and one of the key factors in the major economic bust we are currently experiencing.  I’m sure you may be asking yourself “What’s so bad about low interest rates?  I hate paying interest!”

The problem with manipulated interest rates is that they increase the level of malinvestment in the economy.  Instead of sporadic and generally inconsequential malinvestments, you get huge clusters of malinvestment, entire industries blowing up at once.  Interest rates are THE key factor that a business uses when evaluating where to invest its money.  If virtually unlimited credit is available to every firm in the country for virtually zero interest, suddenly every investment starts to look like a winner.  Applied to consumer credit, this causes people to borrow too much feeding right into the malinvestments of the firms that serve consumers.  Eventually the bubble bursts.  Someone stops spending when they realize what a mistake they’ve made, this cascades through the entire system popping all the bubbles in sight.

The concept of malinvestment is completely foreign to the economists who write economics textbooks, work in industry, and run the federal government.  To them, all demand is good demand.  All investment, all spending on anything and everything is good.  They pursued the low interest rates on purpose, because they believe that if you drive the rates low enough that you can create a bubble that expands forever without consequence.  This belief is utterly false.  Malinvestment is everywhere you look today: housing, automobiles, restaurants, the list goes on and on.

Still need proof?  Here’s an example near and dear to my heart and the well being of quite a few people here in Michigan and the midwest: automobiles.  Do you have any idea how many economists and financial analysts and marketing experts are employed by the auto industry?  Thousands!  Every single one of them in some capacity is given the job of forecasting the future, and evaluating investments to satisfy consumer demand.  Smart people, with all kinds of experience and training and fancy degrees and complex computer models.  And yet look at what is going on right now, they were all wrong, VERY wrong, and at the same time!  What a coincidence!

Automobile demand has essentially collapsed in virtually every market around the globe, at the same time.  Virtually every automobile company on the planet overinvested in capacity, and in the wrong kinds of products.  Currently worldwide automobile capacity is probably being utilized at about 40%, that means 60% sits idle and unused.  That means the entire industry guessed wrong on demand by more than 100%  Amazing!  Not exactly a near miss.  People expect such stupidity from the Detroit 3, but even the untouchable Toyota has made some huge blunders, maybe fewer than the domestics but huge nonetheless.  Their new $1.2 billion Austin, TX truck plant sits completely idle less than a year after opening.  They’re the smartest guys in the business, how did they screw up so bad?

Whoops, didn’t see that coming…

Everything was looking pretty good for a while there.  Demand just keeps going up and up.  Then thwack!  In less than a year demand falls back to where it was 20 years prior.

Still think artifiically low interest rates are so great?  Suddenly you have twice as many auto companies as you really need, half of them could just disappear tomorrow and we would still have plenty of production capacity to serve consumer demand.  That’s one heck of a coincidence!

But back to the point I originally started in on: the malinvestments are not being purged.  The failed companies are not allowed to fail.  The capital is not being diverted to productive activities.  The federal government steps back in with bags of free money to keep the failed companies going.  Billions upon billions of free money to GM and Chrysler, to keep building cars that no one wants.  Oh wait, the government has a plan for that too.  Plenty of free cash to the financing companies so dealers can buy inventory and keep the 0% loans flowing to consumers.  Still not enough though probably.  The Cash For Clunkers bill is virtually guaranteed at this point – the government will literally pay consumers to scrap perfectly good cars and buy new ones.  The government is already planning to buy the hybrid and electric cars to be built by the “new” GM and Chrysler, gee I wonder why…maybe because they will be ungodly expensive and no one will willingly buy one with their own money except a few celebrities.  And if that’s still not enough they’ll find any number of ways to move that metal (or plastic).

Right now, a lot of people are rightfully freaked out about the economy.  Mainly, they are confused because they don’t really understand why things are happening or what to do about it.  If you are the type given to believing in conspiracy theories, you think this ignorance is intentional.  Intentional or not, it is the case that almost no one you know, and no one you see on the news has any idea what they are talking about.  In particular this includes anyone holding a Phd in economics from any American university.

(effectively) Every single college and university in this country teaches an incorrect theory of economics that asserts that the only solution to recession/depression is increased government regulation and market interference, inflation in the money supply, and manipulation of interest rates.  There is no diversity of thought (excepting Ron Paul) within the government, no matter how much “diversity” is celebrated.  Obama himself has stated he doesn’t know much about economics, and he will not get the correct answers from the people who advise him.  These are the people running the economy now, you are right to be worried.

There is one, and only one, school of economic thought which correctly predicted and explains the current economic recession.  None of the people in the government follow this theory, and no one is teaching it in an economics class anywhere in this country.  I will let you wonder to yourself why this is.  This alternative economic theory is known as Austrian Economics, or The Austrian School.  You can learn all about it for free at the Ludwig von Mises Institute website.

A good starting point is the Bailout Reader page.  The essential component of the Austrian School is the alternative explanation of the business cycle, nicely summarized here by Lew Rockwell.

Some other good sites, most of which are on my daily must read list:

• Safe Haven – an aggregation of investing articles
• The 5 Minute Forecast – a daily summary of the investing world
• Lew Rockwell – essays on economics, investing, and random conspiracy theories
• The Mogambo Guru – the most hilarious economic commentator out there

There you go, ignorance is no longer an excuse.

Rand was right.  A refreshing glimmer of hope.

I read today that Ayn Rand’s magnum opus Atlas Shrugged is once again climbing the sales charts as people rediscover the novel’s prophetic description of a world brought to the brink of destruction by government control.  The affordable paperback currently sits at #44 on the Amazon sales ranking, and the Ayn Rand institute reports that sales have tripled thus far in 2009 over their 2008 pace, noting that 2008 was the best sales year ever at 200,000 copies.  Not too freakin’ bad for a novel first published in 1957!!!

“Americans are flocking to buy and read ‘Atlas Shrugged’ because there are uncanny similarities between the plot-line of the book and the events of our day” said Yaron Brook, Executive Director at the Ayn Rand Center for Individual Rights. “Americans are rightfully concerned about the economic crisis and government’s increasing intervention and attempts to control the economy. Ayn Rand understood and identified the deeper causes of the crisis we’re facing, and she offered, in ‘Atlas Shrugged,’ a principled and practical solution consistent with American values.”

I’ve spent a lot of time thinking about what to say about this whole mess.  I just didn’t know where to begin.  Should I tell people what idiots they are for repeatedly voting all these treacherous Democrats and Republicans into office again and again?  Or maybe try to explain the massive inflation that has been and will continue to happen as a result of the insane policy of eternal deficits, ever growing federal debt, and ever expanding money supply?  But that would be a lot of work, and today I found the perfect little snippet that just sums it all up perfectly.  A reader writes in to the 5 Minute Forecast:

“I worked hard,” says a reader, adding to the housing bailout debate, “and had to start over from scratch 23 years ago when I lost all but my shirt, pants and children in a divorce. I always searched for bargains and wore clothing found at garage sales. I paid my credit card bill on time every month to avoid interest charges. I finally bought a home and was able to pay it off in approximately 12 years by loading up my payments by denying myself the new cars, vacations and other luxuries that I saw others around me enjoying. I changed my own oil under my leaky, drippy old car and put off making my home more comfortable with improvements. I finally obtained the prize last year when I paid off the mortgage and felt so good being responsible and doing the right thing.

“The joke was on me, because now my government has signed my name onto a contract to help pay for the mortgages of all of those people that I saw driving around in the new cars and enjoying their hot tub every night in their great big beautiful homes. I am glad that I bought gold along the way so at least I can eat in my broken-down paid-off shack.”

Bloomberg covering the automotive bailout hearings today:

Lynn LoPucki, who teaches bankruptcy law at Harvard University and the University of California at Los Angeles, said Democrats’ goal of preserving a U.S. auto industry is not doable without a bankruptcy.

“A workout requires everybody’s agreement,” LoPucki said. “If I own bonds, GM can’t force me to take less than 100 cents on the dollar outside of bankruptcy court. Bankruptcy is the only thing that can work because GM and the government need the ability to force people to go along with the plan. Paying everyone in full is prohibitively expensive.” (my emphasis)

This little snipped struck me by its sheer straightforwardness.  It is so rare to see such a thing stated so directly in a political hearing!  You get so used to the double-talk and evasiveness, when the naked truth is laid out there you almost miss it out of pure shock.  This is what they’re really talking about after all: power, the power to force people to do what they want.  Not what is in their own best interest, but in the auto maker’s (and ultimately the government’s) interests.

The auto industry has been in downsizing mode for about 30 years now, with only brief blips of prosperity.  Almost all of the recent staff reductions have come in the form of voluntary early retirements and separations.  Although each reduction is usually billed as the last one before the big turnaround, in reality they form a steady chain of layoffs.  Now think about the eventual outcome of such a practice.  Put yourself in the place of someone facing such decision.

You have the option of giving up future salary and benefits for an immediate lump sum payout, or staying on and keeping your salary and benefits and hoping you are not laid off involuntarily.  If you ask me, it’s pretty easy to predict who will leave and who will stay: Good employees will take the money and run, to find another job.  They don’t want to risk an unplanned layoff and the prospect of interviewing amidst a mass layoff.  Bad employees will remain, collecting their paychecks, marking their time to retirement, and generally not producing anything of value.  They’re willing to take the chance of an involuntary layoff, heck odds are by the time that happens they will have collected more in salary than the buyout anyway.

There is no way that the potential cost of litigation outweighs the huge buyout packages being offered to employees.  So the buyouts which are intended to lower costs and thus lead the company back to profitability end up sabotaging any possible hope of recovery by giving the best and brightest a strong incentive to leave and saddling the company with a remaining workforce that is less productive.

The leaders of these companies are so far removed from reality and the day-to-day operations that they have no idea who the important and useful employees are.  Or maybe they are just so incapable of making the hard decisions that they would rather just take the easy way out.  I guess it seems like the nice thing to do.  Unfortunately the nice thing spells doom for the rest.

Never mind that even in its current government subsidized state, E85 is still not price competitive with regular gasoline.  I find E85 fascinating mainly because it is such a classic example of government interference gone predictably and horribly wrong.  I can’t convceive of a single objective anyone might have had for E85 which it has achieved.  Even better, the complete opposite of the stated goals has occurred in many instances.  At the very least the failures have lead to significant unintended consequences.

Several such negative consequences are outlined in this excellent but lengthy and sometimes wandering Washington Post article.

• 92% of the 112,000 government owned Flex Fuel vehicles are run exclusively on regular gas, mainly becuase there are no E85 filling stations anywhere near where they are used.
• Perverse government incentives on auto manufacturers resulted in them producing Flex Fuel capable vehicles but only amongst their most fuel inefficient V6 and V8 powered large sedans and SUVs.  Consequently:
• The Post Office’s legally mandated 37,000 delivery van fleet consumed 1.5 million gallons more gasoline than if they had simply purchased more fuel efficient non-Flex Fuel capable models.

So let’s see, 16 years and billions of taxpayer dollars later, what has Flex Fuel accomplished?  It has resulted in more, not less fossil fuel being consumed – with the related increase in greenhouse gas emissions.  By consuming massive amounts of corn for fuel instead of food, it has raised the price of all sorts of corn based foods.  And people wonder why the auto companies continued to build inefficient vehicles for so long, well look no further than the incentives pushed on them by the Fed.

The Fed falls back on its last possible spinnable benefit: that they have created an alternative, all other problems aside.  What an accomplishment!  An overpriced alternative that no one wants to use even when faced with a government mandate!  Congratulations!  And if we were in fact faced with a real disruption in the supply of oil, E85 wouldn’t make a dent in replacing that supply, not even if every last kernel of corn grown in the country were diverted to fuel.

Read the whole thing – its hilarious!  Now multiply the ill effects of this one government program thousands of times over.  This is the government people vote for, time and time again.  And the really hilarious thing is that they want even more, not less!  Thank you sir may I have another!  The government intervenes and completely screws up.  And yet people seem to think the answer is more intervention by the same idiots who screwed up in the first place.

“There’s the feeling that next to financial services, automotive execs are the dumbest people in the world,” said Thomas Stallkamp, a former Chrysler president

Some conspiracy theorists have put forth the idea that there is no difference whatsoever between the two major political parties in this country, it goes something like this:  The continued existence of the two party system is artificial, maintained by those in power to create the illusion of choice.  This illusions quells the outbreak of open rebellion by the population in the face of an aparant dictatorship, or at least a loose oligarchy.  Academia and the media are willing participants in the deception, and consciously work to both indoctrinate the population through the education process, and maintain an ongoing sense of hysteria through media coverage of trivial differences between the two parties.

Seems vaguely familiar doesn’t it?  As if maybe someone wrote a novel along these same lines.  Oh wait, that novel you’re think of had three ruling parties, not two – that can’t be it…

Maybe it was a movie, yeah, no one reads anymore anyway!  Well except for Harry Potter books.  I’m pretty sure they never discuss economics in those, although I could have skipped that chapter…  What was I talking about, oh right, a movie.  Mabye something with Keannu Reeves?  Nah, that movie was full of killer robots – those don’t really exist! Well ok so they sorta do, but they definitely aren’t thinking for themselves…yet.

So I guess I was way off base with that whole conspiracy theory idea.  That couldn’t really happen, I mean between the two major candidates they have collectively raised over a billion dollars in order to convince people of just how different they are.  And think of all the ways they spend that money: buttons, t-shirts, hair stylists, non-stop mass media advertising.  Hmm, I sense it’s time for a new topic.