Malinvestment: Creating Bubbles, Thanks to the Federal Reserve

Nick Sorrentino
Posted: May 17, 2014 12:01 AM
Malinvestment: Creating Bubbles, Thanks to the Federal Reserve

Malinvestment is a very important concept to understand. It simply means the allocation of capital in ways which appear to be (and may be) rational in a period of artificially cheap credit, but in ways which in the end prove to be inefficient once the market corrects for artificially low rates. (Created by a central bank.) Malinvestment is a symptom and a driver of economic bubbles.

In periods of broad economic malinvestment, when the economy is skewed and the price mechanism is not allowed to work as it should – as is the case now – other parts of the economy where capital is not flowing (but should be with free prices) languish and further compound the damage caused by the easy money. Not only is capital going into stocks (for instance) where perhaps it shouldn’t be, that capital isn’t going to places in the economy where it likely would do more good. So it’s a double loss.

And then there’s a crash.

(From Of Two Minds)
There are 80 acres directly east of me that were subdivided into 12 lots. That happened about 6 year ago at the peak of the housing boom. Three of the lots sold. One additional lot was in process when the bottom fell out and never went to closing.
My neighbor to the south and west raises cattle. He has more head of cattle than he has land to feed them.
He approached the speculators and asked if he could fence and graze the unsold 60 acres of land until it sold.
They told him to pound sand. If he wanted the property he could spend the $10,000 an acre: the full asking price.
A full grown calf (1200 lbs) might go for $2000 at auction….but that is still not enough to support that kind of price. Further, there is no guarantee those prices will continue into the future. My neighbor said, “No thank-you.”
The owners of the property can afford to play hardball because it costs them so little to service the debt. There is little incentive for them to activate the frozen resources in productive ways. Consequently resources that could be growing beef (or potatoes or corn or green onions) are being withheld from production.

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