Opinion
- Editorial- Commentary
Mary King
:
As Rome burns
Our Government fiddles while our economy burns. Petrotrin is striving to avoid collapse after making a 2008 loss of TT$200 million, down from a profit of TT$2 billion in 2007. The rest of our one-horse economy-the energy sector is in similar straits-petrochemical plants are shut in for maintenance because of low prices and demand. LNG prices are low as inventories are high in our major markets. Like Caesar our leaders are economically impotent in the short term and are willing to sit on their assumptions and watch the flames.
In the present leadership stasis let us chat a bit about the phenomenon that has engulfed the world. Theories abound that describe the boom-bust economic and business cycles, characteristic of our capitalist economy. Two of them, though somewhat discredited at present, appear to explain some of what is taking place now in our economic-financial turbulence. These concepts are the Austrian theory, due to Hayek and von Bohm-Bawerk and the work of Karl Marx, the father of communism.
The Austrian theory recognises that there is a time delay between investment in the production process and the consumption of these products. Further, that those who invest, i.e. postpone their consumption, are rewarded by interest (dividends) since this added value is obtained by the postponement of consumption.
For the system to work it is important that investment at the present time provides products to be bought in the future. Hence, input investment and output products have to be coordinated. The Austrians claim that this coordination between the future spending of consumers and the present investment plans of entrepreneurs depends on the availability of "loanable" funds-i.e. consumers who are willing to forego consumption, offer their savings to entrepreneurs to make this future output. The price of these funds for this dynamic allocation is termed the natural rate of interest. At this rate the saver's reward for her patience is equal to the expansion of the future output made by the time-consuming production process.
If the society decided to save more there would be more money for investment, lowering its price, which would expand the entrepreneurial capital base, allow longer production processes, more added value and a larger flow of production goods for the future. Hence the correct interest rate is key to keeping the investment, production and consumption process in synch.
The Austrian model sees the influence of central banks on monetary supply and interest rates as a disturbance of the natural interest rate and hence the availability of loanable funds, interfering with the dynamic relationship between the future plans of consumers and entrepreneurs.
For example, if the central bank/state injects liquidity into the market, dropping the interest rate below the natural rate, this affects the balance of savings and investment demand-i.e. consumers will reduce savings and entrepreneurs with cheaper funds will favour longer production processes. There will be more output available in the future but consumers would have shifted consumption nearer to the present, consuming more now and less in the future. Austrians call this an example of mal-investment since the entrepreneur will not be using consumer savings but credit from the banks. Then there will be a shortage of consumer goods in the present with the corresponding price increases, demanding more consumer credit, so pushing up the market interest rate.
Since firms did not plan on this new interest rate they will make less profit in the future, labour demand shrinks and household income declines; a recession ensues as the firms restructure their capital resources.
Were the Central Bank to inject more liquidity into the market, the pressure on the interest rates would be renewed as before. At some time the central bank has to stop injecting liquidity into the system and previous investments become unprofitable and a crisis ensues. Once mal-investment takes place any effort by the authorities to avoid the necessary capital restructuring through monetary expansion can only postpone the recession and prolong the required adjustment.
The Austrian model fell out of favour not least of all because economists and policy makers found it difficult to accept that something as fundamental as the central bank control over money supply was the cause of business cycle fluctuations. But listen to the US Treasury Secretary in 2001:
"The current economic cycle in the US is different from previous post-war cycles. Typically excess demand causes inflation to take off, which forces the Fed to raise interest rates which pushes the economy into recession. This expansion is driven by credit. The absence of rising inflation has allowed the expansion to go on for longer, but at the cost of greater accumulation of debt."
Mary King is a columnist of the Trinidad Express (maryking@tstt.net.tt). Petroleumworld does not necessarily share these views.
This
commentary was originally published by Trinidad Express, Monday, January 5, 2009. Petroleumworld
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