The most fundamental mistake in economic thinking is believing that all value can be set on the physical nature of the goods produced. We can very easily see the value in a computer or a house, but these physical goods are but a small part of the market process. The most undervalued considerations are that which we can’t see, yet are no less essential than food and infrastructure. Without appreciating the role of these unseen forces in the market economy, much of what we see in it appears mysterious or irrational.
Adam Smith’s idea of the “invisible hand” is much mocked among those with a superficial understanding of how the market economy works, probably because they’re taking it too literally. The operative word here is “invisible” — that which makes the market tick isn’t immediately apparent, and very often can’t be measured.
Catholic opposition to “usury” came from a misunderstanding of the role of time in the economy. From a superficial view, the guy who earns from the interest of a debtor seems like he’s merely making money out of money. He’s inventing money for himself that did not exist in the first place. It’s difficult to place exactly what value he is bringing to the economy.
It was only when the Austrian school of economics came along that we got a satisfactory explanation of interest. The Godfathers of the Austrians, Carl Menger, Eugen von Bohm Bawerk, and Ludwig von Mises together developed a theory of interest based on time preference.
This came from the general economic insight that we prefer present goods to later goods — we’d rather have what we want now instead of later. That said, individuals differ in their preference of how soon they would prefer to satisfy one particular end. Those who are abundant are in less need and therefore demand less urgently. Those that are a bit light would prefer what they want sooner than the first person.
Individuals form lending arrangements to reflect this difference in time preference. Those who borrow money have higher time preferences than those who lend money. The creditor sees it in her interest to lend the money for a chance of earning more in the future. Their assets mitigate the risk of doing so.
Economic fallacies would not proliferate if more thinking people had a more thorough appreciation of the importance of risk in society. It’s another invisible force. Take, for instance, the widespread distaste for the landlord, or the proverbial slumlord that uses her position of privilege to exploit desperate people in need of shelter. For what value is the landlord providing if she is altogether absent and non-interventionist as far as the leaky ceiling is concerned?
The economic purpose of a landlord is to take on the risk of an unknown future. In the absence of perfect knowledge, one cannot know with certainty whether a potential building will actually be of use to anyone. Or, more precisely, will the use gained be greater than the potential use of a building in a different location, or a bigger building, or a building designed for a different use, or the resources being used for something different altogether?
We can take an educated guess, but who’s actually going to stake their livelihoods on it? It’s one thing thinking you know about real estate, it’s entirely another thing to expose your innards to your theories about how the market works. The landlord is that person. The rent they gain from tenants is the premium for successfully anticipating future demand.
Every economic decision is necessarily another decision forgone — don’t forget it. You can see the coffee you bought this morning. You have direct evidence of your life being improved by that purchase. What you don’t see is the other product you could have bought with that money, say a 1st edition classic, that might have been available only at that time, but you were too enamored with caffeine lust to notice. This is what we call opportunity cost.
Humanity’s best effort at attempting to illuminate these hidden workings has emerged through the pricing system. When decision-makers have skin in the game and can respond to natural price signals, our lack of knowledge can be bridged — at least to the extent that risk can be quantified. When prices are allowed to function as a response to consumer demand, resources are allocated most efficiently. Don’t mess with it; lest large scale trade and cooperation become a grope in the dark.
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