The Capital Structure As A Mirror Of The Bubble Era

Effects of Monetary Pumping on the Real World

As long time readers know, we are looking at the economy through the lens of Austrian capital and monetary theory (see here for a backgrounder on capital theory and the production structure). In a nutshell: Monetary pumping falsifies interest rate signals by pushing gross market rates below the rate that reflects society-wide time preferences; this distorts relative prices in the economy and sets a boom into motion – which is characterized by widespread malinvestment of scarce capital and over-consumption; eventually, the distorted capital structure proves unsustainable – interest rates begin to rise, and boom turns to bust. Many businessmen belatedly realize that the accounting profits of the boom were an illusion – in reality, capital was consumed. Many as yet unfinished investment projects have to be abandoned, as they either turn out to be unprofitable at higher rates and/or the resources needed to complete them are lacking.

When capital runs short: several of countless housing developments in Spain which had to be abandoned when the bust of 2007-2009 started. The image on the right-hand side shows a Spanish construction machinery graveyard in 2010. Money supply growth in the US and the euro area exploded after the turn of the millennium, as central banks pumped heavily to combat the demise of the tech boom. In the process they egged on an even more dangerous bubble in real estate. In their great wisdom they have now replaced the expired real estate boom with an even larger, more comprehensive bubble in everything.

Below we show updates of a chart that depicts the effect of money supply and interest rate manipulation on the capital structure. The caveat to this is that such statistical data have to be viewed with a critical eye: one must always to ask to what extent the economy is actually amenable to “measurement” – often such aggregated data obscure more than they reveal. Having said that, many data series at least convey information about general trends.

The chart shows the ratio between the production indexes for capital and consumer goods in the US. The trends in the ratio certainly seem consistent with theory: in booms driven by credit expansion, investment is increasingly drawn toward the higher stages of the production structure – capital goods production therefore increases relative to consumer goods production.