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Economics

The hope of Osborne and the error of Osborne

The following quote is taken from page 155 of Capital and Production by Richard von Strigl, which you can download in PDF format from our downloads section, or in various formats from Mises.org. H/T to Sean Corrigan for drawing our attention to this note.

The Error

Financing consumption through consuming capital also occurs in what is generally recommended under the title of emergency measures in times of crises. Even though production is directly financed here, this is only done for the purpose of creating values which do not free up the invested capital. If a production integrated in the normal course of the economy is financed, then it creates a product — as we have already explained — from whose sale the further financing of this production becomes possible. If, in contrast, a street is built, then means are employed which produce a street that can naturally be valued in economic terms, too, but not a product whose sale will finance further production processes.

No more shall be said here on the question of when such an expenditure can be justified solely from an economic point of view. There is only one thing to be said: If the neighbours (and other interested parties) attain a greater return after the street is built and save this return; that is, use it for new investments, then in this case the capital invested in the street is set free via a detour. If, however, this increased return is consumed, then from an economic point of view this is a case of freezing free capital. In both cases there occurs, of course, an enrichment of such interested parties at the expense of those who have provided the means for the street (or respectively in the case of inflationary money creation: at the expense of all owners of money). A purely economic calculation of profitability of the street could take place via the formula of comparing the costs with the possible surplus return for the interested parties, whereby naturally in this formula an interest rate would have to be incorporated.

The book is one of the most accessible introductions to capital theory and the Austrian Theory of the Business Cycle in the style of Mises and Hayek. As we know, the ATBC is the only theory that can predict credit booms and busts, so if you get a chance, do read it.

Anyway, the hope of all politicians in a tough economic climate is that they can get some money from somewhere – tax, more debt, or QE – and spend it on something to hopefully create some demand and jobs where the private sector has “failed”.

The Hope

MoneyMarketing – Osborne plans state-backed bank for small businesses:

Chancellor George Osborne is planning to set up a Government-backed bank to lend to small businesses as part of wider measures to prop up the economy…

He said the small business bank would “bring together all the alphabet soup of existing schemes” which provide funding to small businesses.

Osborne said: “The weakness in our banking system is one of the biggest problems we have got. Small businesses are the innocent victims of the financial crash.”

The Financial Times reports the idea has been developed based on similar models from Germany, the US and Ireland.

The newspaper reports the bank would operate online initially, and in future could enter into partnerships with the private sector or access the securitisation market.

The Error Further Explained

Any layman with more than room temperature IQ can understand that he needs to do some useful work for somebody, either in an employed or self-employed capacity, to gain money that he can exchange for goods and services produced and provided by others. He first focuses on his most urgent survival needs, and later on the products and services that provide a “good” life.

When the government taxes, taking money productively earned by Person A and giving it to institution B to spend on person C, this is redistribution only and never new incremental wealth creation. So there is no increase in productivity or more products made for exchange than there would have been. All that has been achieved is that B and C have A’s money to spend.

When the government issues debt, and it is bought by people who have previously produced and earned (e.g. most pensioners and large numbers of savers), all we have is savings spent today on current consumption that would have been spent on tomorrow’s goods and services. So there’s nothing new to lift up the wealth of the nation on a permanent basis.

When the government buys its own debt through QE, there is no new production, just raw consumption (we may see it as stealthy confiscation of the purchasing power of all money-holders). The wealth of the nation is decreased whenever this is done.

In a well-reasoned article for the FT (“Sorting fact from fiction on Bank’s QE” – 3 Sept), Jonathan Davis writes:

You do not have to be a fully paid up member of the Austrian school to believe the long term costs of distorting price signals in the bond market may turn out to be very high, and by inducing the misallocation of capital ultimately potentially every bit as damaging as the short term benefits are positive. QE is a path that leads eventually to zombie banks, zombie property companies and zombie businesses

The corrective process of the market has been stopped. It seems we are destined for a prolonged Japan-style zombie recession that will go on for decades. If we let the corrective process start, then billions of pounds held on corporate balance sheets and in investment funds will be freed up to exercise real demand and sort out these companies – to make them produce things people want at prices they’re willing to pay.

When bank credit is granted unbacked by the real savings of others, the credit it is created “out of thin air”.  As Frank Shostak has repeatedly argued, such transactions do not enrich the nation.  They enrich some at the expense of others, and destroy wealth overall.

Savings, investment, and production are the answer, not credit and consumption.  Osborne’s scheme is especially suspect because credit and consumption will be directed according to the whims of government.

Even with the best intentions, they cannot possibly guess which projects are worthy and which are not.  Only the market can determine this.  Osborne’s project will not achieve what it has set out to achieve.

6 comments to The hope of Osborne and the error of Osborne

  • “When the government issues debt, and it is bought by people who have previously produced and earned (e.g. most pensioners and large numbers of savers), all we have is savings spent today on current consumption that would have been spent on tomorrow’s goods and services. So there’s nothing new to lift up the wealth of the nation on a permanent basis.”

    Au contraire. When government borrows £X, gives the private sector bonds worth £X and spends the £X back into the economy, the private sector’s paper assets rise by £X. That raises private sector spending. That’s not too clever if the economy is at capacity, but if there are excess unemployed resources (labour and capital) the effect is to bring those unemployed resources into use.

    As to the idea in the above quote that the exercise somehow prevents those who have bought bonds from spending and consuming in the future, that’s not true. Only an idiot stocks up with so many bonds that they run out of cash. That is, the people buying the above bonds will tend to be those with cash to spare. Or to be more realistic the bonds are more likely to be institutions like pension funds which are being supplied with cash by those saving for their pension. When in due course those people actually claim their pension, the fund can always sell the bonds, though it may not need to on account of fresh supplies of cash coming in from younger pension fund contributors.

  • john in cheshire

    Mr Osborne, don’t do it. It’s none of Government’s business and I certainly don’t want my tax money to be spent on such ridiculous notions. If you want to ensure a healthy and prosperous nation, then stop taxing, stop spending and raise interest rates.

    • mrg

      If you want to ensure a healthy and prosperous nation, then stop taxing, stop spending and raise interest rates.

      We don’t so much need them to raise interest rates, as to allow them to rise — i.e. give up trying to manage them.

  • Paul Marks

    If even the Financial Times is running away from this credit bubble policy – then truly the end (the breakdown) must be close.

  • Samuel Eglington

    Dear Mrs Musgrave Can you explain the difference between the pension fund you have just discribed and a ponzi scheme?

  • Samuel Eglington

    Sorry there is no edit link I mean Mr and describe.