Symptoms of misallocation

There are several glaring signs of misallocation of resources in our economies.

I noticed one of these today in my economics studies. One of the other students had worked for a few years in a cardboard factory, making pizza and takeout fastfood boxes. He reported that despite being in one of the better run, more efficient factories, the price competition was wicked and they continuously lost money.

This is likely what has been happening on the coast of China in spades. There has been too much money available for capital investments, leading to excess, unprofitable manufacturing capacity. Along with this, major manufacturing firms were no longer making money in their mainline businesses, and depended on investments, loans, financial products or speculation to stay in business. [P.S. For a delightful report on the enormity of the misallocations in China, see Inside China: A Sculptor's View, a post on Mish's blog, dated Feb 20, 2009]

Other signs of misallocation were the housing bubble, McMansions for NINJA applicants, millions of sudden profits for young hotshot traders on Wall Street, the humongous increase in derivative, swap and other leveraged financial paper, the weakening book to price, earnings to price and dividends of public companies, and the mushrooming, opaque, and entangled debt markets.

A giant house of financial cards provided a massive influx of investment and credit money for both expanding production capacity and consumption. Then the house collapsed.

We need to learn how to develop more robust global financial and credit markets.

Production and consumption are signs of prosperity, and the rapid expansion of both led us to think we were robustly healthy. Like the athlete winning on high doses of steroids, we didn't notice that our liver was getting destroyed ... or in this case our global financial system.