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Friday’s malinvestments sink Crusoe’s retirement

Investors spend a lot of time trying to make the right investment moves; however, there are “mixed signals” that cause making the right decisions difficult if not impossible. Many of the mixed signals come from the Fed’s intervention in the financial markets, which are populated with malinvestments kept alive by the Fed’s manipulations of interest rates, quantity of money in circulation and bailouts.

The economic concept of malinvestments is not difficult to understand, but it is a concept never taught in basic Keynesian economic college classes. Readers wanting a better understanding of malinvestments and how they come about will want to read Today’s Wealth Destruction Is Hidden by Government Debt by Philipp Bagus. The two paragraphs below illustrates the clarity with which Bagus writes and adds to one’s knowledge of malinvestments.

Another source of malinvestment has been the business cycle triggered by the credit expansion of the semi-public fractional reserve banking system. After the financial crisis of 2008, malinvestments were only partially liquidated. The investors that had financed the malinvestments such as overextended car producers and mortgage lenders were bailed out by governments; be it directly through capital infusions or indirectly through subsidies and public works. The bursting of the housing bubble caused losses for the banking system, but the banking system did not assume these losses in full because it was bailed out by governments worldwide. Consequently, bad debts were shifted from the private to the public sector, but they did not disappear. In time, new bad debts were created through an increase in public welfare spending such as unemployment benefits and a myriad of “stimulus” programs. Government debt exploded.

In other words, the losses resulting from the malinvestments of the past cycle have been shifted to an important degree onto the balance sheets of governments and their central banks. Neither the original investors, nor bank shareholders, nor bank creditors, nor holders of public debt have assumed these losses. Shifting bad debts around cannot recreate the lost wealth, however, and the debt remains.

In this short essay, Bagus uses the famed Daniel Defoe characters Robinson Crusoe and Friday to illustrate the flawed thinking that the government bailouts are beneficial to anyone except those being bailed out.

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