One of the ideas we drill into students very early on is that economists use the term “investment” in a very different way from how it is used in everyday speech. Thus average people may talk about “investing” in stocks or bonds, but economists consider that sort of activity to be saving (if the alternative is consumption–not if money is just moved from a bank account into stocks.) Economists consider “investment” to be the construction of new capital goods. That activity is financed through saving, and indeed it’s a tautology that aggregate saving equals aggregate investment, because saving is defined as the resources that go into investment.
Thus it makes absolutely no sense to talk about financial and physical investment as alternatives, as two types of “investment”. Unless you are Kevin Warsh:
We believe that QE has redirected capital from the real domestic economy to financial assets at home and abroad. In this environment, it is hard to criticize companies that choose “shareholder friendly” share buybacks over investment in a new factory. But public policy shouldn’t bias investments to paper assets over investments in the real economy.
How has monetary policy created such a divergence between real and financial assets?
This is from a 2015 WSJ article where Warsh claims that expansionary monetary policy has reduced real business investment by encouraging business to buy financial assets rather than build physical assets. If a business buys a financial asset, then someone else sells that asset. There’s no first order net effect on saving or investment. In contrast, if a business creates a new financial asset like a stock or bond and uses it to fund new investment, then aggregate saving and investment may rise (assuming no crowding out.) At the individual level, the decision to “invest” in financial assets is simply unrelated to the question of aggregate physical investment. It’s a non-sequitor. And at the aggregate level, to the extent that financial investment is a form of saving then more financial investment implies more physical investment.
Warsh realizes that his ideas are at variance with basic textbook economics, but doesn’t seem to care:
On his recent book tour, former Federal Reserve Chairman Ben Bernanke stated that low long-term interest rates are not the Fed’s doing. Low rates result from a shortage of good capital projects. If there were good investment projects, he explained, capital would flow and interest rates would rise. Mr. Bernanke insists that the absence of compelling investment opportunities in the real economy justifies continued, highly accommodative monetary policy.
That may well be true according to economic textbooks. But textbooks presume the normal conduct of policy and that the prices of financial assets like stocks and bonds are broadly consistent with expectations for the real economy. Nothing could be further from the truth in the current recovery.
His disdain for EC101 economics makes him a perfect choice for Trump.
PS. Actually, textbooks do not “presume the normal conduct of policy.” That’s simply false.
PPS. Warsh offers zero evidence that easy money reduced business investment, and zero evidence that asset prices are out of line with fundamentals. Even if he is correct on both points, it’s “broken clock twice a day” correct; he doesn’t seem to understand basic macroeconomic concepts.
HT: Karl Smith