For those fed up with five years of Keynesian pump-priming, the recent attention given to business investment in Canada is a welcome change. Anybody familiar with Say’s Law knows that “sustaining aggregate demand” through increased consumer and government spending is not what brings about economic growth. More investment in productive capacity does.
Thus, in remarks following a recent speech in London, Ontario, Bank of Canada governor Mark Carney assured us that dependence on the housing market and consumer debt is giving way to “solid business investment.” Although Statistics Canada noted a slowing down of business investment intentions for 2013 in a February report, Financial Post editorialist Terence Corcoran had earlier found indications of strong growth in business loans in the Bank of Canada’s aggregated data, as households seem to be pulling back.
“This is where real economic growth comes from,” he wrote. “The credit indicators suggest what the economy needs is what it is about to get.” (FP, January 13, 2013)
There is no question that more business credit and investment is better than more household debt, and especially more government debt, which is generally pure consumption and brings little long-term benefit, despite all the government propaganda to the contrary. But is more business investment always a good thing?
What aggregated data don’t show is if the money is being invested in profitable processes that will answer a real and sustainable demand. With hindsight, someone praising the growth of investments in the high-tech sector in 1998 on the grounds that it will improve the economy’s productive capacity appears hopelessly naive to us. We know that the bubble popped three years later and that billions of dollars worth of misdirected investments were then lost.
Thanks to Mr. Carney and his central bank colleagues, there is growing evidence that the same phenomenon is happening, with the US once again leading the way.
CNBC ran a very enlightening report last month on how the Federal Reserve’s cheap money policies are allowing poorly rated companies to get low-cost financing (“Fed Throws Junk Bond Lifeline to Weak Companies,” March 15).
You might think that after all the risky investments that went wrong in recent years with subprime, asset-backed securities and the like, a boom in junk bonds would be the last thing we’d be entertaining as the economy recovers. But junk bond volume is more than double what it was in the pre-financial crisis days of 2007, and spreads between junk bond yields and their benchmark measuring sticks are at their lowest since then. (Due to the risk they entail, junk bonds usually offer a much higher yield – or interest rate – than other, safer types of investments. But because they are becoming so popular, their prices are going up and their yields are consequently going down, closer to that of other assets with which they are being compared.)
According to the report, junk bond issuance stands at a historic mark of $108.5 billion globally, buoyed by central banks pursuing the same policies of low interest rates and money creation as the Fed.
This is only one small indication among many others that scarce resources may not be going to their optimal uses, just as was the case during the high-tech boom of the 1990s and the real estate boom of the 2000s.
More fundamentally, it should be clear that a larger flow of credit by itself doesn’t mean much in this era of wild and unprecedented monetary inflation. Easy credit is available for everybody, with household indebtedness reaching records levels in Canada and governments drowning in debt everywhere. Meanwhile, record low interest rates discourage people from saving. Where does all this credit come from?
In his London speech, Carney praised the high level of trust in Canada’s banking system since the crisis, which led commercial banks to create even more credit through the agency of fractional reserve. This trust, he said, “multiplies base money created by the central bank many times, creating an aggregate credit supply that finances our modern economy.”
Like almost everyone nowadays apart from Austrian School economists, Carney believes that multiplying the volume of credit will benefit the economy, whether or not this credit derives from real savings on the part of consumers.
But adding digital zeros to numbers on bank computers doesn’t make more real resources available for investments. Creating a billion dollars out of thin air doesn’t make new trucks, steel beams or computer programmers suddenly appear. It only creates more claims on existing resources.
This is precisely how the cycle of booms and busts is being fed. As Ludwig von Mises and Friedrich Hayek taught long ago, artificially low interest rates and abundant phony credit gives the impression that lots of resources have been set aside to fund new productive processes, when this is actually not the case. This leads to all kinds of questionable investment projects, which need to be liquidated when they are revealed to be unprofitable as the boom peters out. The effects of the cycle are only worsened and prolonged when governments try to prevent the liquidation of unsustainable projects through bailouts and massive fiscal stimulus.
This is the third time we go through this wrenching cycle of economic dislocation in under two decades. Although the Austrian analysis is much more widely understood today than in the early 2000s, governments and most economists still count on the same inflationist and Keynesian magic tricks to kick-start the economy. How many times will we need to repeat them before it becomes obvious that these remedies don’t work?
* Martin Masse is publisher of QL.