During yesterday's Yellen testimony, a Senator asked a profound economics question that we should all be considering:

In essence, he probed Yellen whether the sole effect of monetary easing is to shift forward consumption and investment–that's it's all about timing–and that after nearly a decade of ultra-low interest rates, whether all of the forward consumption and investment had been exhausted.Yellen somewhat demurred–acknowledging that economists agree that there is a shift, but that there are other lasting effects–notably in the housing market.

I was surprised by Yellen's response, especially with respect to investment (not consumption).

Do businessmen lower their hurdle rate on investment based on the market cost of capital? When companies issue new debt and buy back their stock is that an illustration of this effect? And if a company is planning to make a capital investment, does it look at the valuation of its stock as one element of the Capx decision. For example, if a company is considering building a new plant, surely the ability to finance at 3% versus 9% affects the decision…as does the implied cost of capital in its stock price??

Perhaps the counter argument is that this ignores the final demand for goods that come out of the new plant. And it ignores the potential overinvestment and malinvestment that will eventually occur when interest rates are "too low".

But if the Senator is right — then it's not going to be pretty…

Stefan Martinek writes:

Ludwig von Mises ("Human Action") would agree with the Senator:

Resource misallocations => liquidation.

Alan Millhone writes: 

whether the sole effect of monetary easing is to shift forward consumption and investment — that's it's all about timing — and that after nearly a decade of ultra-low interest rates, whether all of the forward consumption and investment had been exhausted.

From the cheat seats, this has been the theory of choice for a while. Of course cheap financing moves future consumption into the present. The problem is that every form of consumption has absolute limits unrelated to cost: We only really need one house, and moving is a pain no matter how cheap the financing is; we bought two new vehicles in the last two years, and my prediction is that we will not be in the market for another one for a long time, no matter how cheap the financing is; if Macy's puts shirts on sale for 50%, I might go buy some, but it won't fundamentally change the rate at which I consume shirts.

Add in the profound effects of China+globalization (and India and other countries as well) as an inflation sink, a strong downward vector on global wages, and a powerful upward vector on productive capacity, and it doesn't seem surprising at all that we are kind of muddling along. The real action globally is the chance for poor people to get less poor. The next big phase will be China and India developing and expanding new patterns of consumption.

Eyeballing the data, M2 fell by about 30% from 1929 to 1932. The Bernank's pledge was that no matter how bad things got in the Great Recession, a contraction in money supply was not going to make things worse, and the Fed kept that promise, as far as I can tell, though some argue they acted too slowly.

So here we are with negative interest rates, sub-replacement birth rates, seemingly endless productive capacity, the interweb allowing the cheap utilization of all sorts of physical and human capital…what's not to like?

Question: When a company buys back the last share of its stock, who then owns the company?

Stefan Jovanovich writes: 

A corporation does not legally exist without shareholders. The last share of its own stock a company can buy is #2. I have often wondered why Buffett did not follow Henry Singleton's model and use B-H's cash to buy in shares when the stock price was down and keep doing it until he is the last shareholder standing. The snarky explanations I have ever come come up with are (1) buy-backs would screw up his successful tax evasion use of the state insurance laws regulating accounting for reserves, and (2) he has calculated that saving the cash for large acquisitions is a better use of his talents, since he is not a particularly gifted trader.

Gregory Van Kipnis writes: 

Had I been Yellen and asked the question and felt free from political retribution I would have answered:

It's not so much a question of bringing forward as it is increasing the set of investment and consumption opportunities which would exceed the hurdle rate (cost of capital in the case of investment) and consumer time preferences (the marginal rate of substitution of present and future consumption). However, nothing occurs in a static environment where only one variable (interest rates) change. If pessimism, risk, and the profit margins associated with investments are worsening at the same pace as interest rates are declining, there will be little positive response from lower interest rates. Take note, however, that economic activity would be a lot more depressed were interest rates not lower. As for the outlook for confidence and profit margins much of that is being adversely impacted by fiscal, administrative and political policies.


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