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NOTE Capital, Interest and the Structure of Production

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Today's lecture is on the topic of capital interest and the structure of production.

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Before I start with that material, though, I want to say a few words about the minimum wage law.

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Now, the analysis of the minimum wage law is very similar to the analysis of union effects on the labor market, which we dealt with yesterday.

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But in the case of minimum wages and in the case of unions, there's a good mental experiment that you can conduct, and that is to imagine a world in which the minimum wage was not five or six or seven dollars, or even ten dollars, but one in which it's a hundred dollars.

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Okay, so if the minimum wage really raises wages for the labor force as a whole, or at least for those low skilled people in the labor force, then, you know, there should be no objection to raising it to $100.

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But of course, if it was $100, most of us would not have jobs, okay, $100 an hour. So if it's good at $6 or $7, okay, why isn't it good at $50 or $100, okay?

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The third world or developing countries could simply cure their poverty by raising it to the minimum wage to astronomical heights.

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But of course what we know is that the demand for labor, like demand for any other good, slopes downward.

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So the higher the price of labor, that is the wage rate, the fewer jobs that are offered, that is the lower the demand for labor.

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So minimum wages destroy jobs, just as unions raising wages above equilibrium levels destroy jobs.

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There's a very interesting article which more or less manifests the fact that even politicians somehow know this, okay, when they raise the minimum wage.

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Now, this was back in 1989 when the first President Bush vetoed an increase in the minimum wage that was proposed by a Democratic Congress.

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And this was 1989. And the article says that President Bush vetoed a bill that would have raised the minimum wage to $4.55 an hour in three years, arguing that the increase is excessive and would cost young people jobs.

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Which sounds great, right?

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Mr. Bush, who had advocated a minimum wage increase to $4.25 an hour from the current $3.35, vetoed the bill within an hour of when the White House received it from Congress.

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It was the first veto that he had issued and he issued it from his airplane as he was flying between speeches.

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Now, what was his rationale? He wanted an increase in minimum wage of $4.25, but he was against one to $4.55.

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Apparently sensitive to democratic charges that he is dooming any minimum wage increase in a quibble over a few cents an hour, Mr. Bush also said,

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I'm quoting, my differences with Congress is not just about 30 cents an hour, it is about hundreds of thousands of jobs that will be preserved by my administration's approach as opposed to those that would be sacrificed under the excessive increase included in this legislation.

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So in other words, what he's not telling you is that raising it a dollar or 90 cents from $3.35 to $4.25 may cost 200,000 jobs.

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But raising it that extra 30 cents, that could cost a few more 100,000 jobs.

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So he's quibbling over the number of jobs being destroyed, which implicitly is saying that yes, the minimum wage destroys jobs.

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And his 90 cent increase is going to destroy jobs, maybe fewer jobs than the additional 30 cents that the Democrats wanted.

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So the minimum wage is a very efficient way of destroying jobs for the low skilled.

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And that's why unions are always very friendly, as we talked about, to the minimum wage, because low skilled workers compete with higher skilled workers.

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Okay, let me go to the material for today's lecture, beginning with that.

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And we're going to go back to the law of time preference, which I talked about earlier in this seminar.

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I'd like to restate it because it's really at the foundation of the determination of the interest rate.

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We can state it in a number of ways. We can say that the law, what Murray Rothbard calls the universal law of time preference,

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according to this law, individuals prefer to achieve their goals sooner rather than later.

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Again, all other things equal. We can restate that in a way that's more relevant to the determination of interest in a modern economy as follows.

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Everyone ranks a present good, including a present sum of money, more highly on his value scale than the same good or sum of money available in the future.

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All other things equal, meaning people's value scales equal in the future and their money incomes or assets equal in the future.

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Now, let's illustrate this little time preference with regard to the interest rate.

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We're just going to assume that the interest rate is there for a moment.

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We're not going to talk about its determination.

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Let's assume for the moment that you trust me implicitly, ignoring the fact that I come from New Jersey,

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you trust that if I give you an IOU to pay you a certain sum of money in the future,

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that there is no uncertainty about me making a payment.

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okay that I'm not dishonest but I'm not going to default okay so now let's assume

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that that level of certainty is there and I asked one of you for a ten thousand

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dollar loan and I promise that in one year I'll pay you back ten thousand

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dollars one year from today would anyone take me up on that most honest guy in

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the world of course not okay so you gotta be out of your mind even if there

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There's no risk involved, the reason being that time preference operates.

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That is to say that in giving that $10,000 up, $10,000 of present money to me and accepting

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an IOU from me for exactly $10,000 in the future, you would be postponing consumption.

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That is, you would be giving up present consumption for the same amount of future consumption

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and this would cause you to face the pain of giving consumption up in the present.

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Now, you may make that loan to me if I offered to pay you back $11,000 in the future.

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So let's say I do that and you accept the loan, okay?

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That's a voluntary exchange. You accept the deal. That's a voluntary exchange.

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So, the borrower is me and you're the lender.

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And so what happens is that I receive $10,000 in present money, and let's put subscript P for present, okay, in exchange for giving up to you $11,000 of future money, which I rank lower on my value scale and what I'm giving you in effect is an IOU.

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So that goes to you, whereas you value the perspective of $11,000 a year from now more than the $10,000 of present money.

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Which is the future, $11,000 of future money from IOU.

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So there is a mutually beneficial exchange that is made.

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We each get a good that we prefer more to a good that we prefer less.

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Now, why do I have to pay you a premium? Why do I have to pay you extra future dollars to get those present dollars from you?

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Are you exploiting me in some sense? Certainly not. I'm better off and you're certainly better off.

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There's no exploitation involved. It's a voluntary exchange like any other voluntary exchange.

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The key point here is that the two goods exchanged are different. One is money in the future, one is money today.

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The extra $11,000 that I must promise to pay you a year from now

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represents the difference in value between present dollars and future dollars.

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Present dollars are worth more than future dollars due to time preference,

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and therefore I have to pay you more future dollars for every present dollar.

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So I have to pay you $1.10 for every present dollar that you give up.

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In other words, it's the prospect of greater consumption in the future

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that gives you the incentive to postpone consumption in the present.

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So we can define the interest rate, even before we talk about how it's determined,

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as a difference in value between present money and future money, or present goods and future goods,

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because really it's reflected throughout the economy, as we'll see, not just in the loan market.

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It's also defined as the premium on present goods.

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Now, we can, if we wish, subtract the principal, okay, that you loan me from the money that I'm paying you back, okay,

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and that sum that's left over, the $1,000 that's left over after the subtraction,

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we can then divide that by the $1,000 present dollars and we get 10% as the interest rate, okay,

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And we can state it that way, that I'm paying you 10% interest for the $10,000 loan.

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But the key here is the sum of dollars that are exchanged on both sides.

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The interest rate is just a mental construct that we use to compare different loans.

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It's the difference in sums of money in the present and the future that constitute the essence of the transaction.

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Now let me just give you a few counter examples that have been brought up against sort of the law, the time preference theory of interest.

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For example, one example, a similar example was brought up in arguing against this theory was that, well, someone who picks fresh blueberries and has 20 pints of fresh blueberries

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and certainly couldn't consume them all before they go rotten may very well make a deal.

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I might make a deal with Alex to give him 10 pints of those 20 that I picked today.

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In exchange, he'll return to me five pints of fresh blueberries two weeks from now.

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Well, isn't that a negative interest rate?

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Aren't I giving up more consumption in the present, 10 pints of blueberries, for only five in the future?

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No, it's not a negative interest rate.

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So really the choice is between ten pints of rotten blueberries two months from now and five pints of fresh blueberries, because they would become rotten if they remained in my possession, because I wouldn't be able to consume them before that period of time.

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And then there's the famous ice in the winter, ice in the summer example.

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Why would someone who was given the choice of a delivery of ice now in January prefer to postpone that to July?

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Well, because ice in the winter has a different utility than ice in the summer.

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There are more satisfactions that people derive from having ice in the summer than they do in the winter.

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That is before the period of refrigeration, when this example was formulated.

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So let's go on for a moment and talk a little bit about low and high time preference.

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Again, high time preference is a great eagerness to achieve one's goals now, versus the future.

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A lower time preference still indicates that people prefer present satisfaction to future satisfaction.

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satisfaction, just not as strongly as a higher time preference.

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So let's take some examples. Children are notorious for wanting things right now.

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They want something right now. Children have very high time preferences as a rule.

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When my son was three years old, we would go to a diner, which of course would always put, you know, a few video games right up in the front as you entered.

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And as soon as he'd see the video games, he could play them back then, at three, he'd want to play.

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I want to play his video games. I said, no, we'll eat first, then you can play.

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And he would, you know, we'd get into an argument, and I'd say, look, instead of playing one game now, okay,

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then it was a quarter, I'll give you 50 cents and let you play two games later.

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You know, I even take out the money, you know, saying, you know, you sit down, and we eat first, and we can play two games later.

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So that's 100% interest return over one hour. That's millions of percent per year.

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But of course, he would still want to play the game now.

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So at that point, as a patriarch, I simply overruled his time preference and dragged him to the table.

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And then, because I was angry at him, then I wouldn't pay off at all. I wouldn't give him anything.

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Well, I let him play one game at the end. Okay. Now, let's look at older, as people age, okay, they begin to get older and we say that the maturing process involves people giving a lot of thought to the future.

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Okay, so as people age, most of us tend to have lower and lower time preferences, especially after we have children and we begin to think about our retirement.

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We begin postponing consumption. We begin having a greater incentive to postpone consumption, lowering our time preferences.

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But then we get to a very old age, someone who was a septuagenarian or an octogenarian in the 70s, 80s.

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They begin to spend money on things that we would consider, like my grandparents, things that we would consider frivolous.

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Okay, and the phrase that they're going to a second childhood,

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they're buying expensive automobiles they would never have purchased before and so on.

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Okay, well what's the point? Well, their time preferences are going up again,

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okay, because time is becoming more and more scarce, okay.

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Let me give you two other examples.

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Let's say scientists determine that there'll be a meteor that's going to strike the Atlantic Ocean in large meteor.

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In about a year's time, they're pretty certain of it, and that it will wipe out almost all human life on the planet as we know it.

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Well, you will see meteor to strike Earth the next day after it's discovered. What will you see on the business page regarding interest rates?

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Will anyone want to make loans anymore? No.

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Meteor to strike Earth, interest rates skyrocket. Why? Because people's time preferences have skyrocketed.

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On the other hand, what if you read, you know, on the technology page, that scientists develop some sort of elixir or some sort of a drug to prolong human life, to double the average human life, you know, from 70 years, up to 77 years now, from 70 years to 150 years old, okay?

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What would happen to interest rates? They would fall, okay, because people would have, time would be less scarce, okay, people would have more time to achieve their goals and they'd be more likely to postpone present consumption into the future.

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They take more thought about the future, not everyone, but enough people that you would see interest rates falling, okay?

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So, what reflects people's interest rate, what reflects people's time preferences, and is important to the determination of interest rates, is the consumption saving ratio.

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The proportion of their income that people spend on present consumption, versus the proportion that they'll put aside, not hold as money, not as cash, or not as in their checking accounts,

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but invest in mutual funds and certificates of deposit and directly invest in businesses, stocks and bonds and so on.

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Let's say someone earns $1,000 per week and they're young, they're out of college and they're earning a good salary

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and they may spend $900 a week on consumption goods and put aside $100.

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So their consumption saving ratio is 9 to 1.

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Then as they get older, they begin to think about a family and so on.

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Well, let's say they get engaged and they begin to plan to buy a house and so on.

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This may fall, okay, to, let's say, 800, 200.

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Then after they get married and so on, there may be reasons, a child on the way and so on, to have it fall even further, to 600, to 400.

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Okay, so notice it starts out at nine to one, then four to one, then it's one and a half to one, okay.

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As the consumption-saving ratio falls, it reflects a fall in people's time preferences.

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And as we'll see, this is going to have an effect on the determination of the interest rate.

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Okay, now the interest rate is determined on what we call sometimes the time market or the intertemporal market.

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In your textbooks in economics, it's called the loanable funds market.

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Now we can call it the loanable funds market if we remember that it's really not just loans that are involved in determining the interest rate.

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and the interest rate. In fact, Dr. Roger Garrison, using a term that Keynes actually coined, calls it the investable funds market.

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Murray Rothbard calls it the time market, and it's also been called the intertemporal market, implying that it's the market on which people trade present goods for future goods.

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Well, there are two components to this time market or inter-temporal market.

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One is the loan market, it's only part of it.

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And the second and more fundamental market is what we call the structure of production.

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So the two components of the market on which interest rates are determined is the loan market.

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And secondly, the structure of production, which is the more fundamental market.

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and which we'll deal with.

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Okay, so those are the two components.

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And once again, as long as you remember that it's not merely loans

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that are involved in determining the interest rate,

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you may call it the loanable funds market, investable funds market, okay?

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But keeping in mind that only one part is the loan market,

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the other is the investable, the structure of production.

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Okay, let's look at the capitalist function in the simpler market, the loan market.

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The capitalist is the person that supplies the present money. So in the loan market, the capitalist is the lender.

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What's the function of the capitalist? The function of the capitalist is to advance present money to the borrower, which allows the borrower to anticipate his income.

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So in other words, the capitalist must save prior to becoming a capitalist. He himself must postpone present consumption over a period of time in order to come up with the funds necessary to operate as a capitalist on the loan market.

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So the function that the capitalist performs is waiting for income.

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He assumes the burden of waiting for income from the borrower.

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So the loan allows the borrower to enjoy an automobile today rather than having to wait and save up for it.

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Let's say she has to save two years for it.

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Or to get a down payment on a house and have a house today rather than having to save themselves

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for 10 years or 15 years for the home.

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So interest in this sense, that the capitalist receives, is a return to waiting.

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Actually it's a return, or it's the incentive to postpone consumption.

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Well, that's pretty straightforward. Now let's look at the structure of production.

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And before we can do that, we have to just set out to present two important and fundamental truths about time and production.

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First is that production takes time, any act of production takes time, even the simplest act of making yourself a lemonade, and it proceeds in stages.

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And these stages of production are known as, or are referred to as the structure of production.

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I'll give you just a very simple example that illustrates both of these truths.

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Let's say someone wants to produce bread, or a group of people get together to produce bread.

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It's going to take them time. They're first going to have to produce wheat, actually even before that they'll have to produce tools.

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And even before that they'll have to mine the iron ore that's necessary to produce the tools.

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So it's actually going to take much more time than this illustrates. They're producing bread from scratch.

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So let's say it takes a year for the wheat, then the wheat must be ground into flour.

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So it's going to take them a while to produce the flour, say another year, if you include also the equipment and the mill that is necessary to produce the flour.

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and then they're going to turn the flour, transform the flour into bread at wholesale and then it's going to be packaged and shipped and it will finally wind up in the retail store.

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Bread at the retail store ready to be sold to consumers is known as the final good or the lowest stage good.

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The further away from the consumer you are, the higher the stages are.

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So wheat is the highest stage goodness in the structure of production and bread at retail is the lowest stage good.

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So goods are transformed over time through different stages from the original factors of production, the land and labor that originally gets together and produces the wheat,

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Through various intermediate goods, the flour, the breaded wholesale, and all the equipment that's necessary, those are all intermediate or capital goods.

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And eventually what emerges is the final good, which is bread.

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And just some other diagrams which illustrate this.

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Producing shoes takes a number of stages, takes time. You must have, actually you have to raise the cattle first, then you have to slaughter them, so you have to have a whole slaughterhouse industry.

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And then you have to have hides and you have to tan them, so it has to be a whole industry that processes the leather.

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Then you get your leather and then it's transformed into shoes and then finally shoes at retail.

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So production of even the simplest thing, and I think I put on the syllabus the reading eye pencil, even producing a pencil requires a tremendous number of stages and a tremendous amount of time going back to the mining of the material that actually is the lead in the pencil, it's not really lead.

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and growing the trees that are going to be turned into the wood and so on, making the paint, the yellow paint or whatever color the pencil is.

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It takes many, many stages and there are many industries that are involved.

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Okay, now let's take the case of, before we talk about capitalists, let's take the case of joint production.

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In the case of joint production, let's say you have a number of people, both land owners and laborers, these are the original factors of production,

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they want to produce an automobile from scratch. It's going to take an enormously long time, many stages to go through, beginning with trying to manufacture some tools for mining,

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then mining the iron ore, then processing it into steel, then shaping the steel into the various parts of the car and so on, then assembling the automobile.

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Let's say it takes seven years for all of this.

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If there's no capitalist, the people that are involved in producing that automobile have to wait seven years for their income.

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That is before they sell the automobile on the market.

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So there's an enormous burden of waiting.

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In order to do that, they would have to begin saving up years before to develop a subsistence fund, a fund of consumer goods

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and consumer goods that is going to allow them to exist for seven years before the course finally completed.

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So there's an enormous burden of saving on them.

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What does a capitalist do? And here's what Karl Marx criticized capitalism.

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They said, look, all capitalists, and he wasn't talking about managers, he was talking about capitalists.

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So what the capitalists do is sit back and collect either, let's say, bond interest or dividends on stocks, they make an investment, they invest some money, the workers do all the work, the product is sold, and it's sold at a price that is above the total wage payment to the workers.

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The difference between the total revenue from the good, whatever it is, and the total wage payments to the workers is expropriated by the capitalists.

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It's surplus value. It's in effect stolen by the capitalists. They've done nothing to deserve it.

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They have not worked in the process of production. They have not managed. They haven't expended any labor whatsoever.

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Now, the Austrian economist Eugen von Boehm-Bawerk answered this and developed the theory of time preference.

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and on the basis of the theory of time preference refuted the Marxian claim that the capitalist does nothing.

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What does the capitalist do? Now the capitalist comes in to the automaking process.

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What he does is he pays the workers every two weeks or every week or whatever it is during that seven year period.

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He is the one who assumes the burden of waiting for his income.

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He's the one who must have saved in advance of initiating the process of production.

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He's the one who postpones consumption for seven years.

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The return is based on the fact, the return that he gets, even if he doesn't perform any

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other function in that production process, reflects the fact of time preference.

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That is that he would not have advanced this money to the workers if total revenue was

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was just equal to the total advances, because the sacrifice he made in postponing consumption is not compensated at all.

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So what is the capitalist function in the structure of production?

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The capitalist function is to pay the resource owners, the laborers and landowners,

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And from here on in, for simplicity, I'll refer to them as the laborers, in advance of the sale of the product on the market, okay?

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Now, what does he get in exchange? Unlike in the loan market, he doesn't get an IOU, which is a claim to a future sum of money, okay?

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What he gets is the product of their services. In other words, he gets ownership of the various stages of production, okay?

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He gets the hides, the leather, the shoes, those are all his.

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The workers work on them and produce them in conjunction with all the complementary machinery and so on.

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But he's the one who gets the ownership in exchange for the money that he's advancing to the workers.

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So the capitalist owns the various stages of production.

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Now, typically, in a modern economy,

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capitalists do not own the entire structure of production for anyone good.

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In fact, they own a very small part or one stage of production, if that.

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Integrated firms can own more than one stage of production.

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So, let's look at the exchange in this case.

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You have to bring everything back to voluntary exchange, okay?

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In this case, you have the capitalist investor as opposed to the capitalist lender,

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and on the one hand, you have the laborer on the other hand, okay?

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The capitalist provides the present good, let me just pull this down a little bit.

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The capitalist, let's say, provides wages, okay?

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And that's the present good, PG for present good.

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That goes to the laborer. What does the labor provide? The labor provides factor services, his or her labor services.

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What the capitalist actually gets, however, are the capital goods and then finally the consumer goods.

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So the factor services are combined with other capital goods and so on, and they yield a capital good.

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But really, the capitalist himself doesn't want the hides or the leather.

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It doesn't directly satisfy any of his wants.

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What he's getting, what he sees himself as getting in the structure of production,

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is the expectation of future income.

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It's not an IOU, it's not a legal claim,

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but the ownership of these goods, which will eventually be transformed into consumer goods and sold on the market,

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or if he's a higher stage capitalist, let's say someone who produces oil, he's able to sell that to the next lowest stage capitalist in exchange for money.

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So what he sees is expectation of future income at some point when the product that is produced by the laborers is sold on the market.

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and the expectation of, let's say, future goods.

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So it's a voluntary exchange, just like the exchange in the loan part of the time market.

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To be a capitalist in either part of the inter-temporal market, you must have saved in advance.

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You must advance income to someone else and postpone it yourself, and postpone consumption yourself.

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Now, the capitalist investor receives the difference, as I'll show you in a moment,

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the difference between the total revenue that he sells the product at, in whatever stage he's at, and the total factor payments.

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The difference, it might be called the rate of price spreads, you can turn into a rate as we'll see, it's also called the natural rate of interest, it's not a loan rate but it's a natural rate of interest, it occurs naturally in production.

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So that difference is known as the natural rate of interest, and that is a return to the capitalist function, not to the entrepreneurial function, it's not profit.

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This function or this return is always positive. It's not, as in the case of the entrepreneur, it can be positive or negative depending on whether the decisions are successful or unsuccessful.

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are successful. In this case, it's a return to overcoming time preference, postponing consumption.

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So let me go through an example with you.

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and this will illustrate the nature of the interest payments we still haven't

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Let's say there's a four-stage process and this production process takes all together four years, so each stage takes one year.

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Don't get overwhelmed by the numbers, let me just show you what's occurring here.

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Okay, in the highest stage, the fourth stage, you only have the original factors of production.

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So we're going to assume that there's only labor as the original factor of production.

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We'll forget about land for simplicity.

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So the capitalist comes in, the capitalist that owns this stage or owns the firm which embodies this stage pays $10 in wages to the laborers.

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So that's the upward arrow, pays $10. When he sells a product of the stage, one year later, he sells it for $11. Now what happens? Of that $11, his payments have been $10 and his revenue is $11, so he gets $1 of interest off the left there.

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That's 10%. He receives 10% return on his investment.

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So he postpones consumption, he advances the labor, let's assume he pays everybody right at the beginning of the year,

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like a consultant or something, he just pays them right at the beginning of the year, they get to $10.

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At the end of the year he gets $11, so he has $1 left over above his original savings, and that's his interest return.

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Now in the second stage, the third stage capitalists have purchased this capital good that was created in the fourth stage for $11.

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They also have paid $9, see the arrow going up here, $9 to the original factor, which is wages.

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So altogether, they've paid out in factor payments for the capital good, they've paid $11, and for the labor, they paid $9.

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So, they combine labor and capital goods. It's $20 worth of labor and capital goods.

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The process continues for a year. At the end of the year, they sell the good to the second stage, the capital good, for $22.

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So, they've originally advanced $20 and receive a return, the capitalists that own the stage, $22.

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Their interest return is $2. Again, a 10% return on their investment.

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And we're assuming no uncertainty here. Everyone knows exactly what the future prices will be of all capital goods and of all consumer goods.

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Why are we doing that? Why are we assuming what we call the evenly rotating economy in which nothing changes?

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Only to show you, or to isolate, interest. We want to isolate interest from profit. So there is no profit or loss in this economy.

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Okay, and then in the second stage, these capitalists, okay, have purchased the capital good from the third stage for $22, okay,

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but they need labor, so they have to go and buy labor, and they spend $28 on labor, so the combined amount is $50, okay,

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they've advanced $50 at the beginning, they sell to the final stage of production the capital good at the end of the year for $55,

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So there's a premium of $5, which is a 10% return on the $50 investment.

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And finally, in the last stage, the $55 is spent on the capital good, but they need labor too.

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They spend $45 on labor, they bring labor and capital together.

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According to the production function, they transform it into the final consumer's good.

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And then they sell to consumers at $110.

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So they've laid out $100 at the beginning of the year, they've received $110,

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and the natural return or the natural rate of interest or the rate of price spreads,

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the spread between what they've purchased and what they sell for, is 10 percent, okay?

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So in an evenly rotating economy, all production is adjusted, everyone earns the same interest return, okay?

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And that is a natural rate of interest.

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Now let me just make some other comments about this.

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What's the total return to labor?

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Well, the total wages, $92, okay?

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Total consumption is $110, okay?

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The $92 that the workers receive, spent on consumption, okay?

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But also, the $18 received by the capitalists, the interest, is spent on consumption.

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So together, that gives you $110 of consumption.

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Now, how much has been saved?

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Because the saving isn't all spent.

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What happens is that all the capitalist spends, for this process to go on year after year after year,

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the capitalist can only spend what we call his net income.

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And his net income is his total interest. He's living on his interest.

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He saves all of the money that's been invested.

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This person invested 10, this person here invested 20 in total, so the 10 is saved, the 20 is saved by the third stage capitalist, by the fourth stage capitalist, the 50 is saved, okay, and they only, remember, they're selling their good for $55, they're only spending 5 on consumption, the other 50 is saved to be reinvested in continuing the process, and finally, in the final stage, they're saving 100 out of the 110 they're receiving, okay?

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So, the total saving investment is 180 and total consumption in this economy is 100, okay?

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Now, let's conduct this mental experiment.

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What if everyone said, you know what, let's say the capitalist in the second stage said,

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you know what, I don't want to just spend $5 on consumption, my time preferences have gone up, I'm going to spend all $55.

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What would happen then? What would happen to the structure of production?

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It would collapse. There would be much less money saved and invested.

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You'd have many fewer goods being produced and many fewer capital goods being produced.

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The economy would become much less productive.

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Or let's take an extreme assumption.

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Instead of simply spending their interest, let's say every single capitalist,

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once he sold all the goods to the next stage, spent the whole amount.

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Okay? Would there be any saving in the economy? There will be no more saving in the economy.

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What kind of production could be run after that? Very, very short, short processes.

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People would basically be trying to make goods with their hands.

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Now think about the American economy. There's a tremendous amount of saving.

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The saving in the American economy far exceeds the spending on consumption.

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If people in the auto industry and all of these other industries suddenly decided to liquidate all their stocks and no one was there to buy those stocks,

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all they did was they just simply liquidated the whole firm. The money was just sent back to everyone.

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And everyone spent it on consumption goods. Well, for a while, we'd have a lot of consumption for a year or two.

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But what would happen to the factories after a while that weren't being maintained, that would collapse?

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So, in contrast to the Keynesians, saving is necessary to a modern economy.

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The more saved, as we'll see in a moment, the greater the structure of production can be.

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That is, the more capital goods you can produce, the further away from the consumers you can begin producing capital goods,

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and the more productive that laborers will be, and the higher people's consumption will eventually be.

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So you have consumption, you have saving, we have total spending, okay, this is total spending, 110 by consumers,

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but then you have to add in 180 by the capitalists who are investing in the higher stage goods, okay.

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So total spending in the economy is 290, wages are 92, interest is 18.

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The rents to the capital goods, the capital goods that are purchased at each of these stages,

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they add up to 55 plus 22 plus 11, which gives us $88, okay.

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And then, so the net income is always wages plus interest, that's the total amount of money that's going to be spent on consumption, right, the net income, unless time preferences change.

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Gross income includes whatever's spent on consumption, okay, plus the total spending on capital goods.

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And we see that more spent on capital goods than on consumers' goods.

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To conduct, to run a modern economy, you need a tremendous amount of capital spending.

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And in order to have that capital spending, there first has to be saving, okay?

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Now, let me show you how time preferences are determined.

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I'm sorry, the interest rate is determined.

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And then I'll come back and show you what happens when people's time preferences change.

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So let's take the interest rate.

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The interest rate is determined like any other price.

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It's actually a ratio of prices.

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It's determined by supply and demand. On this axis, we have savings, which is the present good that capitalists are advancing toward to laborers.

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And I'll make that more realistic in a moment. And the supply is the supply of savings or the supply of present goods.

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Now, why is it that the demand curve slopes downward for present goods? Or actually, let's look at the supply curve.

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Why does the supply curve slope upward with respect to the interest rate?

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Well, the higher the interest rate, the greater the return that you get for every dollar that you invest.

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So at low interest rates, if it's 5% or let's say 3%, you're getting $1.03 per year for every dollar that you invest for a year or that you loan out for a year.

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So you're going to have fewer people supplying savings.

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savings. However, as the interest rate rises, it indicates that you're getting more future

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consumption for a dollar that you're giving up a present consumption. So more and more

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people will be inclined to save. So it slopes upward in a positive way. The interest rate

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slopes downward. One of the reasons why it slopes downward has to do with part of the

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The loan market consumers are willing to borrow more the lower the interest rate.

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The less future money they have to give up to get that automobile today or that house today,

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the more willing they will be to borrow.

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So as the interest rate goes up, quantity demanded of savings goes down on the part of the consumers in the loan market.

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So you have supply and demand, the intersection gives you the interest rate, let's say that's 5%.

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Now that interest rate tends to be the interest rate, okay, now we're abstracting from risk,

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this is a risk component on every interest rate and it's also inflation.

373
00:44:53.100 --> 00:44:59.100
Since we're in the evenly rotating economy, there's no inflation and we're assuming there's no risk.

374
00:44:59.100 --> 00:45:03.100
Everybody knows exactly what prices are in the future, okay.

375
00:45:03.100 --> 00:45:08.100
So what we call the pure interest rate is the return to time preference.

376
00:45:08.100 --> 00:45:20.100
and that, let's say, is five percent. What that indicates is that, on an average, people in this society value present goods five percent more than future goods, or present money five percent more than future money.

377
00:45:20.100 --> 00:45:50.100
Money. Now, let's make this more realistic in the following way. Who actually supplies savings? Are there really just two classes that they wear sweatshirts, one says capitalist, one says worker? No, of course not. You and I combine many functions. If we work, we're a laborer. We're part of the demand for present goods. We're the people that are receiving it in the structural

378
00:45:50.100 --> 00:46:00.100
If we have any kinds of savings in banks, or if we own stocks and bonds, or if we run our own business, we are at the same time on the supply side of the market.

379
00:46:00.100 --> 00:46:10.100
That is, when we receive our income as workers, as we're demanding present goods, we put aside some. So we're functioning then as capitalists.

380
00:46:10.100 --> 00:46:19.100
So in a recurrent process, we are capitalists and workers, or many of us are.

381
00:46:19.100 --> 00:46:22.100
Some people might have no savings whatsoever, they're only demanders of present goods.

382
00:46:22.100 --> 00:46:26.100
Most people are both demanders and suppliers of present goods.

383
00:46:26.100 --> 00:46:33.100
To the extent that you supply any savings, even if it's through a financial intermediary like a bank or a mutual fund, you are a capitalist.

384
00:46:33.100 --> 00:46:37.100
You are supporting the structure of production.

385
00:46:37.100 --> 00:46:45.100
Same thing with people who own land. They demand money when they rent their land out to someone who's going to use it to produce.

386
00:46:45.100 --> 00:46:51.100
But at the same time, to the extent they save some of the rents that they're getting, they are also capitalists.

387
00:46:51.100 --> 00:46:56.100
Or if they invest in that land themselves, they're capitalists and landowners at the same time.

388
00:46:56.100 --> 00:47:05.100
For example, a farmer that owns a farm and invests in it himself, then he is a capitalist and he's a landowner.

389
00:47:05.100 --> 00:47:10.100
Capitalist Landowners, the Capitalist Landowners.

390
00:47:10.100 --> 00:47:15.100
Now what happens when people's time preferences change?

391
00:47:15.100 --> 00:47:19.100
Well what happens when time preferences change is that the interest rate will change.

392
00:47:19.100 --> 00:47:26.100
Let's look at the following.

393
00:47:26.100 --> 00:47:29.100
So we're starting at 10% here.

394
00:47:29.100 --> 00:47:33.100
If at 10% people suddenly want to increase the supply of savings,

395
00:47:33.100 --> 00:47:38.600
If the consumption-saving ratio goes down, and I'll give you a symbolic presentation of this,

396
00:47:38.600 --> 00:47:42.600
then if they spend less on consumption and more on saving, they put aside more for savings,

397
00:47:42.600 --> 00:47:45.600
that means they're going to want to save more than they did before 10%.

398
00:47:45.600 --> 00:47:47.600
There's going to be a surplus of savings.

399
00:47:47.600 --> 00:47:54.600
In order to loan the savings out to businesses and to consumers, what's going to have to happen?

400
00:47:54.600 --> 00:47:59.600
The interest rate is going to have to drop and the quantity demanded of savings will then increase

401
00:47:59.600 --> 00:48:02.600
and there will be a new lower interest rate of 5%.

402
00:48:02.600 --> 00:48:08.200
In a moment, I'll show you what that means for growth in the modern economy.

403
00:48:08.200 --> 00:48:12.200
Without changes in time preferences, we cannot have growth.

404
00:48:12.200 --> 00:48:16.200
Growth occurs as people's time preferences fall.

405
00:48:16.200 --> 00:48:17.200
That's not completely true.

406
00:48:17.200 --> 00:48:23.400
It also can occur as a result of a change in certain types of changes in technology

407
00:48:23.400 --> 00:48:29.400
and changes in the amount of labor and other natural resources.

408
00:48:29.400 --> 00:48:46.400
Let me give you first an example. Here's a question that people raise. They say, wait a minute. If people save more and spend less on consumption, why should businesses increase the amount of capital goods they're buying?

409
00:48:46.400 --> 00:48:58.400
People want less consumption. They're spending less on hamburgers, they're spending less on automobiles, they're spending less on clothing, and they're saving more of that money.

410
00:48:58.400 --> 00:49:05.400
And that money is being put into making more machinery and better machinery for producing clothing,

411
00:49:05.400 --> 00:49:11.400
making better equipment and building more factories and plants for automobiles,

412
00:49:11.400 --> 00:49:16.400
making more ovens for hamburgers, but yet people are buying fewer hamburgers. How can that be?

413
00:49:16.400 --> 00:49:22.400
Well, this is the point. When people save, does that mean they want fewer consumption goods for all time?

414
00:49:22.400 --> 00:49:25.400
This is a mistake Keynesians make.

415
00:49:25.400 --> 00:49:29.400
No, they want fewer consumption goods today and more when?

416
00:49:29.400 --> 00:49:31.400
In the future, exactly.

417
00:49:31.400 --> 00:49:34.400
So what happens is, and I'll show you this flagrammatically,

418
00:49:34.400 --> 00:49:39.400
labor is moved away from producing hamburgers today and automobiles today and so on.

419
00:49:39.400 --> 00:49:45.400
Those shrink temporarily and they're moved into making machinery and ovens and so on.

420
00:49:45.400 --> 00:49:51.400
And then later on, when someone's ready to spend that money on tuition for his kid

421
00:49:51.400 --> 00:50:16.400
Did the Austrian take into account that this time preference is going to be all right like the parents were saying huge amounts so that they can dequeue it when they pass on to their kids in the next few years?

422
00:50:21.400 --> 00:50:30.400
time horizon or sometimes called a period of provision in Austrian economics that people provide only for their own lifetimes or part of their own lifetimes.

423
00:50:30.400 --> 00:50:35.400
People's period of provision may extend to their grandkids and even further.

424
00:50:35.400 --> 00:50:42.400
If someone's a big businessman and wants to leave a legacy, keep his business, he's going to keep building the business up.

425
00:50:42.400 --> 00:50:49.400
Some people may, as they approach retirement, may liquidate the business and spend all the money on consumption.

426
00:50:49.400 --> 00:51:03.400
But others will keep building it up. I don't think Bill Gates is going to just liquidate Microsoft or sell it and splurge and spend all the money on consumption.

427
00:51:03.400 --> 00:51:18.400
But that's a good point, the point being that many people have an intergenerational view and that they save not just for their own futures but for those of their children and grandchildren.

428
00:51:18.400 --> 00:51:32.400
Let's answer this Keynesian point that it doesn't make sense to increase production of capital goods if people are spending less on consumers' goods.

429
00:51:32.400 --> 00:51:44.400
And that the increased savings are going to cause a recession because there's no reason to produce more consumer goods because demand has fallen.

430
00:51:44.400 --> 00:51:56.400
And there's no reason to produce more capital goods, because if people want fewer consumer goods, well, you need fewer capital goods, so the economy is going to be tending towards a perpetual depression.

431
00:51:56.400 --> 00:52:01.400
I'm going to give you a Crusoe economy first, then I'll talk about the real economy.

432
00:52:01.400 --> 00:52:21.400
Let's take Robinson Crusoe alone on an island, okay, and let's say initially, we're only going to worry about the first three columns, forget about the second two columns, this is from an article, a little bit more technical.

433
00:52:21.400 --> 00:52:29.400
In period T0, he arrives on the island, he has absolutely no capital goods, all he has is human energy and the natural resources on the island.

434
00:52:29.400 --> 00:52:35.400
So, what is the standard of living? The standard of living is based on his output.

435
00:52:35.400 --> 00:52:41.400
He spends 12 hours of leisure and he catches four fish for 12 hours with his hands.

436
00:52:41.400 --> 00:52:46.400
Very primitive method, he has no capital goods, low productivity method of catching fish.

437
00:52:46.400 --> 00:52:49.400
So his output then is four fish and 12 hours of leisure.

438
00:52:49.400 --> 00:52:55.400
Leisure is an immediately producible consumer good. It's one of my favorites.

439
00:52:55.400 --> 00:53:01.400
Now, let's assume that he wants to increase his productivity in the future.

440
00:53:01.400 --> 00:53:04.400
He wants to catch more fish and he wants more leisure.

441
00:53:04.400 --> 00:53:10.400
The only way he can do that is by creating more capital goods so that he can become more efficient in the future.

442
00:53:10.400 --> 00:53:15.400
But that means that in the interim, in period T1, he's going to have to cut back on what?

443
00:53:15.400 --> 00:53:18.400
He's going to have time to produce capital goods.

444
00:53:18.400 --> 00:53:23.400
He has to cut back on his consumer goods and his leisure, which is a consumer good.

445
00:53:23.400 --> 00:53:29.400
So here's what he does. Let's say it's going to take him 500 days to produce a fishing net.

446
00:53:29.400 --> 00:53:39.400
Well, in that time then, what he's going to do is cut back on his leisure to 11 hours and cut back on fishing to 9 hours from 12 hours.

447
00:53:39.400 --> 00:53:43.400
So he's going to have a lower standard of living for a while, fewer consumer goods.

448
00:53:43.400 --> 00:53:46.400
But he's going to allocate those four hours that he has saved.

449
00:53:46.400 --> 00:53:52.400
Those four hours are saved because he postpones consumption by not using them in the consumer's goods industry.

450
00:53:52.400 --> 00:53:58.400
and he builds a fishing net, okay? Now what happens? Later, he becomes more efficient.

451
00:53:58.400 --> 00:54:04.400
There is now an increase in output. That represents the payoff to his time preference.

452
00:54:04.400 --> 00:54:12.400
To the fact that for 500 days, he reduced his consumption.

453
00:54:12.400 --> 00:54:16.400
So now look what happens. With the net, he can catch nine fish in nine hours.

454
00:54:16.400 --> 00:54:20.400
Instead of catching one fish every three hours, with the net he can catch one fish per hour.

455
00:54:20.400 --> 00:54:22.800
One fish per hour. He's much more productive.

456
00:54:22.800 --> 00:54:27.360
Not only that, since he only has to work nine hours instead of twelve, he has more hours of leisure.

457
00:54:27.360 --> 00:54:28.920
He's better off.

458
00:54:28.920 --> 00:54:30.920
Now, he could stop there.

459
00:54:30.920 --> 00:54:33.560
If his time preference doesn't fall any further,

460
00:54:33.560 --> 00:54:35.480
he can say, well, you know what?

461
00:54:35.480 --> 00:54:36.760
I'm better off

462
00:54:36.760 --> 00:54:38.640
and I'm happy here.

463
00:54:38.640 --> 00:54:39.600
But, of course,

464
00:54:39.600 --> 00:54:40.880
now he's richer.

465
00:54:40.880 --> 00:54:42.880
The richer you are,

466
00:54:42.880 --> 00:54:44.560
the more wealth you have,

467
00:54:44.560 --> 00:54:49.160
the more income you have, the easier it is to save even more.

468
00:54:49.160 --> 00:54:53.560
The effect is going to be that his time preference is going to become even lower.

469
00:54:53.560 --> 00:54:58.600
So what does he do? He cuts back on his new higher standard of living,

470
00:54:58.600 --> 00:55:02.320
cuts back to 13 hours of leisure, forgoes two fish

471
00:55:02.320 --> 00:55:06.960
for 1,200 days. He engages.

472
00:55:06.960 --> 00:55:11.480
One hour, of course, he has to replace the net. He has to keep the net in good shape.

473
00:55:11.480 --> 00:55:13.360
He has to maintain it.

474
00:55:13.360 --> 00:55:17.840
So one hour's replacement investment to maintain this standard of living.

475
00:55:17.840 --> 00:55:26.600
But another three hours is new investment into producing a ladder and again, what's the payoff?

476
00:55:26.600 --> 00:55:36.400
The payoff is that at the end of this, he doesn't just want the ladder, he wants the coconuts that he can get high up in the trees when he has the ladder to aid him.

477
00:55:36.400 --> 00:55:57.240
So, to finish this off, at the end of T3, okay, he now has a higher standard of living yet again, okay, actually higher than he had in T1, okay, or T2.

478
00:55:57.240 --> 00:56:05.140
So, he was at 14 hours of leisure, 9 fish, he saved 3 hours, okay, so that he could build a ladder, right?

479
00:56:05.140 --> 00:56:18.640
But then, once the ladder is built, he now has 13 hours of leisure, he has 8 fish, so he has one less hour of leisure, one less fish, but he has 6 coconuts, okay?

480
00:56:18.640 --> 00:56:25.940
And so he has a new good, and so his standard of living, as he judges it, has gone up, right?

481
00:56:25.940 --> 00:56:35.940
And he still has to maintain both the ladder, every time he uses it, he has to spend about a half hour maintaining it and the net.

482
00:56:35.940 --> 00:56:44.540
So now here, the point I'm trying to make is this, in order for him to grow, he has to cut back during periods of time on consumption goods.

483
00:56:44.540 --> 00:56:48.140
And that is what has to happen to a modern economy.

484
00:56:48.140 --> 00:56:54.640
People have to cut back on their spending on hamburgers and movie tickets and automobiles and so on.

485
00:56:54.640 --> 00:57:02.640
in order for resources, as Crusoe's resources were used, to be shifted to the capital goods industries to produce more capital goods.

486
00:57:02.640 --> 00:57:12.080
So let me now show you what the new structure of production might look like once people's consumption savings ratios have fallen.

487
00:57:12.080 --> 00:57:18.920
Remember before, this economy had four stages, we combined all the stages of the economy into four.

488
00:57:18.920 --> 00:57:23.920
Now you have six stages, now why do we have six? For the following reason.

489
00:57:27.920 --> 00:57:32.920
Consumers have cut back, remember consumption was 110, consumer spending.

490
00:57:32.920 --> 00:57:36.920
They've now cut back from 110 to 90.

491
00:57:38.920 --> 00:57:44.920
What has happened to that extra $20 worth of consumption that they have sacrificed?

492
00:57:44.920 --> 00:57:50.920
They're only spending $20, $90 on consumption goods. That all goes to the higher stages of production.

493
00:57:50.920 --> 00:58:00.920
In other words, they are now able to produce other capital goods and to rearrange the capital goods into more effective and more productive combinations.

494
00:58:00.920 --> 00:58:07.920
So now you have a bigger structure of production, which basically reflects the fact that you have more capital goods.

495
00:58:07.920 --> 00:58:13.920
There's the same amount of labor in this economy, same number of laborers, yet they're more productive and they'll produce more consumer goods.

496
00:58:13.920 --> 00:58:17.920
So, what happens here is something similar. Now the interest rate has fallen.

497
00:58:17.920 --> 00:58:23.920
The interest rate has to fall as you add more stages of production.

498
00:58:23.920 --> 00:58:33.920
Let's look at it this way. Why does it have to fall? It has to fall because the stages in the lower sections are becoming smaller,

499
00:58:33.920 --> 00:58:39.920
less is being spent on them, and more is being spent, more of that 20 ounces is being spent here, so they're expanding.

500
00:58:39.920 --> 00:58:54.920
Expanding. So the difference between them becomes smaller. So now the interest rate is, falls to, let's see what it's, 28 over 4. I calculated it here, let's see.

501
00:58:54.920 --> 00:59:23.920
Yeah, the natural rate of interest is about seven percent, it's approximately seven percent, I'll just show you that here, right there, okay, if you divide this by the four ounces and the, what else we have here, 0.28 over 4.0 dollars, 0.5 dollars over 7.5 dollars,

502
00:59:24.920 --> 00:59:44.920
and so on. That will come out to about 7%. So the interest rate has fallen from 10% to 7%. Structure of production has lengthened or increased in a number of stages and I won't go through all of the various payments and so on.

503
00:59:44.920 --> 00:59:53.920
It's the same as the first diagram that I showed you. But what I do want to show you is that you now get more consumer goods and I'll show you that in a moment.

504
00:59:53.920 --> 01:00:07.920
I'll show you that in a moment, but certain things happen. Consumption falls, savings rises, savings investment rises to 200 whereas before it was $20 less than that, it was $180.

505
01:00:07.920 --> 01:00:22.920
Total spending stays the same at $290, but now $90 goes to consumption and $200 to investment, whereas before it was $110 went to consumption and $190 went to investment, or $180 went to investment, excuse me.

506
01:00:22.920 --> 01:00:31.920
The interest rates lower. Now, notice that wage payments are lower and interest payments are lower in dollar terms, okay?

507
01:00:31.920 --> 01:00:41.920
However, and here's where I'll show you the productivity increase that we've seen.

508
01:00:41.920 --> 01:00:49.920
If we go through these.

509
01:00:49.920 --> 01:00:59.920
The number of stages have increased, so this is production structure one, before the economy experienced a fall in time preferences, and this is production structure two.

510
01:00:59.920 --> 01:01:14.920
So there are more stages of production. Consumption has fallen to $90 from $110, saving investment has risen by $20, total spending stays the same, it's just reallocated, more spent on capital goods, so more capital goods are produced, less on consumer goods.

511
01:01:14.920 --> 01:01:22.920
The consumption saving ratio falls from 110 over 180 to 90 over 200.

512
01:01:22.920 --> 01:01:26.920
Interest falls, wages in money terms fall.

513
01:01:26.920 --> 01:01:31.920
Now, what I'm interested in showing you is what happens to output.

514
01:01:31.920 --> 01:01:37.920
Output is going to go up and now I'm assuming this is bread that we're using as our output.

515
01:01:37.920 --> 01:02:02.920
as our output. Let's say that the price of bread was $2 a pound, and now there's so much more bread produced, supplies increased to the right because there's more capital goods, bread's produced more efficiently, it's now 90 cents, and the output of bread has gone from 55 pounds to 110 pounds.

516
01:02:02.920 --> 01:02:23.920
Now, notice that nominal wages were $92, okay, and there were 10 laborers, and there's still 10 laborers, so each laborer is getting $9.20 in the first structure of production, and now they're getting less, they're only getting $7.57 per year in the second structure of production, or second economy, okay.

517
01:02:23.920 --> 01:02:28.160
However, what the key is, what is happening to real wages?

518
01:02:28.160 --> 01:02:32.000
Bread was $2 when the workers were getting $9.20 apiece,

519
01:02:32.000 --> 01:02:36.320
which meant that they were only getting 4.6 pounds of bread apiece.

520
01:02:36.320 --> 01:02:42.160
Now bread's 90 cents because of the tremendous increase in output from these new capital goods.

521
01:02:42.160 --> 01:02:48.280
And the workers, they're getting less in money wages, but they're getting much more in real wages.

522
01:02:48.280 --> 01:02:52.200
The amount of bread they're consuming has almost doubled, okay?

523
01:02:52.200 --> 01:02:57.200
Also, the people who get the interest are getting more bread.

524
01:02:57.200 --> 01:03:02.200
Instead of nine, they're now getting 15.86 pounds of bread.

525
01:03:02.200 --> 01:03:07.200
Even though interest has fallen, total interest payments from $18 and $14.28.

526
01:03:07.200 --> 01:03:15.200
So basically what you have then, and I can show you this with symbols,

527
01:03:15.200 --> 01:03:20.200
you have a situation in which you have more capital goods, the same amount of laborers,

528
01:03:20.200 --> 01:03:29.200
But you have a new and better technology that is embodying these capital goods and allows an increase in output.

529
01:03:29.200 --> 01:03:35.200
And that output then raises the real wages of both the capitalists and the workers.

530
01:03:35.200 --> 01:03:39.200
Now this is what has happened to the American economy in the last 200 years.

531
01:03:39.200 --> 01:03:48.200
From using its saving and investment that allowed us to advance from using, let's say, wooden plows and horses to farm

532
01:03:48.200 --> 01:03:55.200
to computer-controlled tractors and whatever else is used on forms, combines and so on.

533
01:03:55.200 --> 01:04:03.200
So a given worker earns much more productive, a given farm worker,

534
01:04:03.200 --> 01:04:07.200
and therefore his or her real wage is much higher than it was 200 years ago.

535
01:04:07.200 --> 01:04:09.200
It's because of the capital goods.

536
01:04:09.200 --> 01:04:15.200
Now, if people stop saving, if they stop saving, what would occur is that

537
01:04:15.200 --> 01:04:25.200
that much less money would be available for maintaining and building new capital goods, more money would be spent on consumption, we'd have a big splurge of consumption for a few years,

538
01:04:25.200 --> 01:04:36.200
but then our factories and our machinery and so on would simply deteriorate and become useless and we would go back to the structure of production we had 200 years ago, or even further back.

539
01:04:36.200 --> 01:04:44.200
One other point I wanted to make regarding savings.

540
01:04:44.200 --> 01:04:51.200
Now, we really depend on the capital structure that was built up by our ancestors.

541
01:04:51.200 --> 01:04:55.200
The fact that they did not consume all their capital before they died.

542
01:04:55.200 --> 01:05:05.200
They left capital goods rather than allowing them to deteriorate by spending a lot of consumption before they passed away.

543
01:05:05.200 --> 01:05:15.200
That has made it much easier for each succeeding generation to save and invest and further build up the structure of production.

544
01:05:15.200 --> 01:05:24.200
So the structure of production that we have in the United States, or actually in the world economy, really goes back to the Industrial Revolution of the late 1700s.

545
01:05:24.200 --> 01:05:33.200
Before that, people's standard of living was the same, let's say, in 1600 as it was four or five hundred years BC.

546
01:05:33.200 --> 01:05:49.200
The structure of production only began to be built up when we began, after the industrial revolution, and we really stand on the shoulders of our predecessors, those people that saved in the past.

547
01:05:49.200 --> 01:05:57.200
Now the other point I want to make, or actually I want to show you something symbolically here, that is the following.

548
01:05:57.200 --> 01:06:08.200
is the following. When time preferences fall, you have two chains of effects, which I tried to show you.

549
01:06:13.200 --> 01:06:16.200
Actually, I should have something in the middle here.

550
01:06:16.200 --> 01:06:22.200
It implies that consumption-saving ratio falls, and then the two chains take place.

551
01:06:22.200 --> 01:06:28.200
On the one hand, the top chain, the consumer goods industry.

552
01:06:28.200 --> 01:06:38.200
The Austrians are unique in emphasizing that there are two different sets of industries in the economy that are affected differently by saving and investment.

553
01:06:38.200 --> 01:06:45.200
You have a fall in the demand for consumer goods, which results in a fall in the price of consumer goods.

554
01:06:45.200 --> 01:06:58.200
The subscript C represents consumer goods, which results in a fall in profits in consumer goods, which results in a fall in the amount of laborers hired,

555
01:06:58.200 --> 01:07:07.200
so you get a fall in labor in the consumer goods industry and in wages, wages fall, so fewer laborers.

556
01:07:07.200 --> 01:07:15.200
And for a while you have less consumer goods, so consumer goods themselves go down, okay.

557
01:07:15.200 --> 01:07:17.200
Let's stop the chain there, okay.

558
01:07:17.200 --> 01:07:21.200
And let me just zoom out a little bit here.

559
01:07:21.200 --> 01:07:22.200
Okay, let's stop the chain.

560
01:07:22.200 --> 01:07:27.200
Now, on the other hand, you have less money spent on consumption, but more saved.

561
01:07:27.200 --> 01:07:30.200
So your interest rate falls, okay.

562
01:07:30.200 --> 01:07:32.200
So the pure interest rate falls.

563
01:07:32.200 --> 01:07:35.200
At lower interest rates, businesses buy more.

564
01:07:35.200 --> 01:07:41.200
And they don't want to just borrow the money and just keep it lying around. They want to invest it.

565
01:07:41.200 --> 01:07:52.200
They increase the demand for capital goods. We use K to represent capital goods, which in turn increases the prices of capital goods, which in turn increases profit.

566
01:07:52.200 --> 01:08:00.200
We use the symbol pi in the capital goods industries, which in turn increases wages in the capital goods industry.

567
01:08:00.200 --> 01:08:05.200
Now, where do the laborers come from to build the extra capital goods?

568
01:08:05.200 --> 01:08:08.200
They come from consumer goods industries where the wages are falling.

569
01:08:08.200 --> 01:08:15.200
So you get a transfer of labor here.

570
01:08:15.200 --> 01:08:22.200
Now eventually, when these processes are completed, when the capital goods are in place

571
01:08:22.200 --> 01:08:28.200
and the new greater structure of production is ready,

572
01:08:28.200 --> 01:08:34.200
You get an increase in consumer goods in the future.

573
01:08:34.200 --> 01:08:38.200
All that leads to a future increase in consumer goods.

574
01:08:38.200 --> 01:08:45.200
Let me just zoom out a little bit here.

575
01:08:45.200 --> 01:08:54.200
And we know that as economic growth.

576
01:08:54.200 --> 01:08:56.200
With the same labor force, you have more consumer goods.

577
01:08:56.200 --> 01:09:11.200
More consumer goods, the reason you have more capital, actually I should have inserted, I forgot to insert, you get more capital goods, more K, and all capital goods are, are unfinished what? Consumer goods, okay?

578
01:09:11.200 --> 01:09:15.200
So when those capital goods are put in place, you will then get more future consumer goods.

579
01:09:15.200 --> 01:09:26.200
So people's real incomes will go up, and as their real incomes go up, there'll be a tendency for them to lower their time preferences again, and again, and again, okay?

580
01:09:27.200 --> 01:09:31.200
And as time preferences drop, you continue to get economic growth.

581
01:09:31.200 --> 01:09:36.200
So economic growth seems as if it's smooth, okay? But it's not smooth.

582
01:09:36.200 --> 01:09:44.200
At any point in time, people can make the discrete decision to save less and consume more.

583
01:09:44.200 --> 01:09:48.600
more and if they do that this process will be reversed that is there'll be an

584
01:09:48.600 --> 01:09:51.820
increase in consumption and all those hours will point up and there'll be more

585
01:09:51.820 --> 01:09:56.240
consumers goods produced for a while okay as laborers are drawn away from the

586
01:09:56.240 --> 01:10:00.400
capital goods industries but interest rates will rise and the demands for

587
01:10:00.400 --> 01:10:04.320
capital goods will fall and less capital goods eventually be produced to the

588
01:10:04.320 --> 01:10:07.760
point where maybe even the capital goods that are wearing out aren't even

589
01:10:07.760 --> 01:10:13.000
replaced in which case the economy is no longer growing it's retrogressing okay

590
01:10:13.000 --> 01:10:18.000
called a retrogressing economy as opposed to a growing economy.

591
01:10:18.000 --> 01:10:28.000
A stationary economy could occur if there is no further fall in time preferences and no new resources or technology developed.

592
01:10:28.000 --> 01:10:34.000
We could then have a stationary economy.

593
01:10:34.000 --> 01:10:42.000
One last point I want to make here and that is that this has an effect on factor pricing.

594
01:10:42.000 --> 01:10:52.000
Remember, the capitalists did not pay the workers their full marginal revenue product as we assumed yesterday.

595
01:10:52.000 --> 01:11:03.000
In fact, they pay them marginal revenue product minus a discount that's determined by the interest rate.

596
01:11:03.000 --> 01:11:31.000
So let's say that someone's hiring a worker who is going to work on a process that takes one year. So he pays the worker at the beginning of the year, pays the worker at the beginning of the year, and let's say that worker makes up a steel section for a car, and that car is going to come onto the market in a year.

597
01:11:31.000 --> 01:11:38.000
So that worker is performing an operation that will not return any revenue for a full year.

598
01:11:38.000 --> 01:11:46.000
If that worker is making, if the marginal revenue product, that piece adds, if the marginal revenue product is $10,

599
01:11:46.000 --> 01:11:54.000
the worker is not going to get the full $10. He's going to get 10% less than that. He's going to get $9.

600
01:11:54.000 --> 01:11:57.000
There's going to be a discount on his marginal revenue product.

601
01:11:57.000 --> 01:12:05.000
So, at the end of the year, who's going to get the extra dollar? The capitalist, which will be his interest return.

602
01:12:05.000 --> 01:12:16.000
Or if there are workers that are earning $20, or have a marginal revenue product of $20 per hour, and they're operating in a process,

603
01:12:16.000 --> 01:12:33.000
In the process, or in the part of the process that is not going to yield a product for a full year, well then, because there has to be interest return, the demand will drop so that it's the discounted marginal revenue product that that worker will be paid.

604
01:12:33.000 --> 01:12:52.000
$20, they'll be paid $18. At the end of the year, the entrepreneur will receive $20 for that contribution that he paid $18 for, which represents, well, in this case, it would represent about an 11% rate of interest. Let's assume the rate of interest is 11%, okay?

605
01:12:52.000 --> 01:13:00.000
The further away you are from the final sale of the product to the consumer, the greater the discount on wages.

606
01:13:00.000 --> 01:13:10.000
So the actual demand for labor is not given by the marginal revenue product schedule but by the discounted marginal revenue product schedule.

607
01:13:10.000 --> 01:13:22.000
There's a marginal revenue product discounted by the interest rate over the time during which the worker's contribution will add revenue to the firm.

608
01:13:22.000 --> 01:13:32.000
And lastly, what about goods that are durable?

609
01:13:32.000 --> 01:13:36.000
Obviously, in a market economy, you cannot own a laborer.

610
01:13:36.000 --> 01:13:39.000
Under slavery, you could own a laborer.

611
01:13:39.000 --> 01:13:42.000
I'll show you, laborers were priced like machines under slavery.

612
01:13:42.000 --> 01:13:47.000
But what about something like a machine that you can own, or a piece of land?

613
01:13:47.000 --> 01:13:50.000
How are they priced, given time preference?

614
01:13:50.000 --> 01:13:56.000
This is called capitalization, okay, determining the capital value of durable factors of production.

615
01:14:01.000 --> 01:14:04.000
Let's take a machine, it has a life of three years, it's going to wear out in three years.

616
01:14:05.000 --> 01:14:14.000
The marginal revenue product is $1,000 per year, that is, the machine yields $1,000 of revenue per year, of additional revenue to the firm, and the interest rate is 10%.

617
01:14:14.000 --> 01:14:23.000
What is 10%? Well, there's a formula for, it's the present value formula, figuring out the present value of a stream of payments.

618
01:14:23.000 --> 01:14:30.000
The stream of payments that the machine is going to yield you is, let's say, $1,000 at the end of each of the three years going forward.

619
01:14:30.000 --> 01:14:43.000
And the formula is to divide the revenue by one plus the interest rate raised to the power of the year, the number of years away from you in time it is.

620
01:14:43.000 --> 01:14:54.800
So in this case, we take the $1000 and plug it into this formula, we find that the entrepreneur doesn't pay $3000 for the machine, even though it's going to yield to him a total of $3000 over three years.

621
01:14:54.800 --> 01:14:58.100
How much does the entrepreneur pay?

622
01:14:58.100 --> 01:15:05.100
The discounted marginal revenue product, which is lower and lower the further away in time the marginal revenue product gets.

623
01:15:05.100 --> 01:15:14.100
So it's $2,487. If he pays that much for the machine, then he will get a return on that investment of about 10% per year for the three years.

624
01:15:14.100 --> 01:15:25.100
And that's how durable factors are all priced in the market. If you want to rent the machine, then he would rent it at each year.

625
01:15:25.100 --> 01:15:30.100
He'd pay a yearly rent each year. It would be 10% less than the marginal revenue product.

626
01:15:30.100 --> 01:15:38.100
But if you want to purchase it outright, it would be the stream of those expected future products, marginal revenue products.

627
01:15:38.100 --> 01:15:42.100
And by the way, we call that rent. I just want to make that point.

628
01:15:42.100 --> 01:15:49.100
That the return per unit service on any factor of production, including labor, is called the rent.

629
01:15:49.100 --> 01:15:55.100
So if a laborer has a marginal revenue product of $10 per hour, that's the laborer's rent.

630
01:15:55.100 --> 01:16:02.100
If a machine has a marginal revenue product of $1,000 per year, we call that the rent of the machine, and the same thing with land.

631
01:16:02.100 --> 01:16:09.100
Land, certain types of land are permanent, the land like urban land, land in the city, okay?

632
01:16:09.100 --> 01:16:16.100
That never wears out, okay? It's not used for cultivation, so it's not a capital good, it's a pure original factor.

633
01:16:16.100 --> 01:16:21.100
How do you price land? Land has an infinite life, it's permanent, okay?

634
01:16:21.100 --> 01:16:36.100
But we see that land doesn't have an infinite price. If time preference didn't exist, land would have to have an infinite price because it would go on forever and you'd have to add up all of the income from that land and it would be infinite.

635
01:16:36.100 --> 01:17:03.100
Well, in fact, land has a price that is a finite price, and the present value formula for a permanent stream of income, and let's say this is 50,000 per year is the marginal revenue product or the rent of the land, at an interest rate of 10%, the formula is the stream of income, okay, per year, whatever, divided by the interest rate, okay?

636
01:17:03.100 --> 01:17:10.100
And in this case then, someone would pay $500,000 for this piece of land.

637
01:17:10.100 --> 01:17:22.100
Each year that land would yield that person, either if they rented it out to someone else or if they used it in their own production, it would yield $50,000, which is 10%.

638
01:17:22.100 --> 01:17:27.100
So that's how time preference figures into the pricing of the durable factors of production.

639
01:17:27.100 --> 01:17:31.100
Now, what about labor?

640
01:17:31.100 --> 01:17:37.100
A labor is priced if there were slavery. First of all, in a free market, labor can't be owned.

641
01:17:37.100 --> 01:17:46.100
I disagree with Walter Block on this. He or she cannot sell themselves into slavery.

642
01:17:46.100 --> 01:17:59.100
But in a slave economy, for example, in the South prior to the Civil War and going back in many societies where slaves were bought and sold,

643
01:17:59.100 --> 01:18:09.100
They would be priced just like machines. People would estimate the marginal revenue product of the slave, and then they would be priced accordingly.

644
01:18:09.100 --> 01:18:17.100
In a free economy, people can only be rented, in a sense. Their services can only be rented. You can only get rents.

645
01:18:17.100 --> 01:18:26.100
There is no capital value of a human being in a free economy, whereas there is in an economy where you have slavery.

646
01:18:26.100 --> 01:18:41.100
So every other durable good has both two prices, a rental price per unit service and a price for the entire embodiment of all the services, that is the physical good itself.

647
01:18:41.100 --> 01:18:46.100
Only human beings have one price, that is a rental price.

648
01:18:46.100 --> 01:18:52.100
We'll stop there and I'll take any questions.

649
01:18:52.100 --> 01:18:54.100
Yes.

650
01:19:22.100 --> 01:19:29.860
Say, in this country, the brain of that thing is over all.

651
01:19:52.100 --> 01:19:59.900
First of all, globalization means that other countries are being integrated into a global structure of production.

652
01:19:59.900 --> 01:20:15.700
In fact, the structure of production was always international, international in the sense that there were parts of the structure of production that we were involved in, we in the US, that existed in Canada, in Latin America, in Europe and so on.

653
01:20:15.700 --> 01:20:22.700
No country encompasses an entire structure of production within its borders.

654
01:20:22.700 --> 01:20:24.700
In fact, borders are irrelevant.

655
01:20:24.700 --> 01:20:28.700
What's happening is that now, since property rights are being assured,

656
01:20:28.700 --> 01:20:33.700
and since there's a movement towards a freer economy in China,

657
01:20:33.700 --> 01:20:36.700
they are now being integrated.

658
01:20:36.700 --> 01:20:40.700
Pieces of the structure of production are being developed there

659
01:20:40.700 --> 01:20:44.700
that fit in and make the overall structure of production more productive.

660
01:20:44.700 --> 01:20:56.700
So, they're getting investment from us and from the US. Well, actually the US is a net debtor and we have capital inflow, okay.

661
01:20:56.700 --> 01:21:07.700
But they're getting investment from Japan and other parts of the world and what they're giving in return are cheaper products, both capital goods that can be used in lower stages or direct consumer goods.

662
01:21:07.700 --> 01:21:17.200
And by the way, even though there's no net investment from the U.S. in China because we have capital inflows in our economy,

663
01:21:17.200 --> 01:21:28.700
we are benefiting from the low-priced goods from China and from other parts of the world that are being integrated into the global structure of production.

664
01:21:28.700 --> 01:21:36.700
Because the U.S. has a current account deficit, because we spend more on foreign goods and services than we sell to them,

665
01:21:36.700 --> 01:21:44.700
They are financing that debt by sending capital to us.

666
01:21:44.700 --> 01:21:47.700
So we are a net importer of capital.

667
01:21:47.700 --> 01:21:50.700
We don't export capital.

668
01:21:50.700 --> 01:21:58.700
Only if you earn more money by selling abroad than you do by spending on goods abroad,

669
01:21:58.700 --> 01:22:03.700
can you export capital to another country or be a net exporter of capital,

670
01:22:03.700 --> 01:22:33.700
capital, which we used to be in the 60s and 70s. We're no longer a net exporter of capital. We're an importer of capital. If the Japanese and the Chinese and a few other countries, the Chinese holding our dollars and so on, and U.S. securities, if they were to sell these securities, our interest rates would rise in the U.S. We'd be worse off. We'd have less capital. And our workers' real wages would suffer as a result. So the reason for all this, by the way, is not the way our

671
01:22:33.700 --> 01:22:40.100
free economies operating here in the US, actually what's occurring is that there's a budget deficit.

672
01:22:40.100 --> 01:22:45.700
The US government is draining savings not only from its citizens, but from the rest of the world.

673
01:22:45.700 --> 01:22:51.500
And this budget deficit has ballooned, you know, with the beginning of the Iraq War.

674
01:22:51.500 --> 01:22:56.700
It's getting worse, okay. So that's what we are, sucking savings out of the rest of the world

675
01:22:56.700 --> 01:23:03.500
and we're using it in unproductive ways to destroy, you know, assets in other countries.

676
01:23:03.500 --> 01:23:09.500
and rather than using those savings to build up our own country

677
01:23:09.500 --> 01:23:13.500
or at least the economy within our borders.

678
01:23:13.500 --> 01:23:15.500
Any other questions?

679
01:23:15.500 --> 01:23:17.500
Okay, thank you.