The View From 1776
Tuesday, May 25, 2010
Economic Booms And Subsequent Recessions
Ludwig von Mises explains, in Malinvestment, Not Overinvestment, Causes Booms.
Read the full extract from Mises’s book.
A key phrase is: “...an expansion in the production facilities and the production of the heavy industries, and in the production of durable producers’ goods, is the most conspicuous mark of the boom.”
The Fed’s over-expansion of the money supply leads to non-economic investment that has to be liquidated by the recession that inevitably follows.
During the stagflation of the 1970s, investment in commercial real estate was wildly distorted by the Fed’s inflationary over-supply of money. Short term interest rates at times exceeded 20% per annum, and institutional investors and mortgage lenders were demanding at least a 15% per annum return on investment. Most traditional commercial real estate - office buildings, shopping centers, and apartments - couldn’t produce such a high growth rate in net cash flow, because tenants wanted to sign leases with terms of five to twenty five years. The one investment that did qualify, theoretically, was hotels, which could raise their room rents every day, as inflation roared ahead. The result was a massive overbuilding of hotels.
In similar fashion, riding the wave of money the Fed poured into the economy after the stock market’s sharp break in 1986, high tech companies were able to obtain almost unlimited amounts of equity capital, producing the dot-com boom of the 1990s. So much money was seeking any plausible outlet that normal credit and investment standards disappeared. Dot-com startups, with zero sales, obtained hundreds of millions of dollars of venture capital on no more than an idea for a product. When the bubble burst near the end of President Clinton’s second term in the presidency, the nation’s mileage of installed fiber optic cable, for example, was said to be roughly ten times what the market could support.
We all know, of course, the recent repetition of that pattern.