There is so much confusion about economic statistics and basic definition of terms such as ‘savings.’ I wrote a lengthy reply to a commentator on my latest article at Russia Insider that I thought should help clarify some of the terminology I use and why I hate GDP as a statistic.
To clarify the final bolded point, Mises described the business cycle in terms of his “Master Builder” parable. Wherein the builder sets out to build a house based on the number of bricks available to build the house. The price of those bricks, however, was altered due to an artificially lower cost of capital (interest rate on borrowing).
This sent the signal that the ‘pool of real savings’ in the economy for bricks was larger than it actually was. But, since the builder got the pricing signal that more bricks were available than actually were, he laid out plans to build a bigger house than he could finish.
This would be all well and good if he found this out before he started building. But, the problem is he finds out when he runs out of bricks. If there was no opportunity cost to the process of starting to build a house one couldn’t finish it wouldn’t be so bad. But, there is. And that opportunity cost is enormous.
Not only is the builder out his time he’s put into an project he can’t finish, he’s also out the time to tear it all down and rebuild it based on the bricks he has.
By the Bank of Russia and the Russian government embarking on a ‘savings rich’ economic recovery they are minimizing the potential damage from mispricing risk and the cost of capital during the boom. The possibility exists that the ‘pool of real savings’ will, at a minimum, be larger than the expended capital within the economy, so that if malinvestment does take place, it’s not catastrophic when the bills come due.
A free market in debt is obviously the best solution, but as I said in my reply above, that’s not the world we live in. High interest rates divert capital to where it is most needed right now, flowing to where the rate of return is higher than the cost.
This is why Quantitative Easing and negative interest rates are so damaging to an economy in both the long and short run. They stifle the liquidation of old capital (tearing down the unfinished house) AND encourage the same malinvestment that precipitated the problem in the first place.
This is why we are approaching the end of ‘borrow from ourselves until we drop’ economics. We’ve borrowed so far ahead of our future selves that no interest rate correction will clear these markets without a complete reset of the financial and monetary system.
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