How the Fed Killed the Rust Belt

[krazy kaju]

The "rust belt" is essentially an area in the Midwest made up of heavy capital industries - e.g. steal mills and the auto industry. And though punitive taxes, regulations, and labor unions have done much to ruin the rust belt, I believe that the main culprit is the Federal Reserve. Here's why:

The Fed has had a policy of continuing inflation and lowering interest rates. Lower real interest rates have done two things to the economy: first, it has promoted consumption over saving, and second, it makes US investors look overseas for higher return on capital (due to higher interest rates overseas). The result? Less capital investment in the United States. Lower interest rates mean that US and foreign investors who would invest in the US choose not to do so, instead seeking out to invest in foreign lands. At the same time, the fall in US saving has caused investment to fall even more.

Thus, less investment in the US has meant less capital accumulation, which makes US industries less profitable, since capital is the comparative advantage of the US over other countries (after all, other countries have lower labor costs). This has been the major reason why outsourcing has occurred. In order to increase capital investment/accumulation in the United States, the Fed needs to promote saving and investment by raising interest rates (or better yet: disbanding itself). Such a move would cause short-term pain, but the rust belt would boom again and good paying blue collar jobs would return to America.

[tmosley]

Good analysis, though I'm not sure you can really tell which of the factors that has lead to their decline is the most important.

[krazy kaju]

Well, I would say that even if we had low business taxes and a minimal regulatory structure, capital would still flee the United States due to abnormally low interest rates. Low interest rates mean a low return on investment, which reduces investment. Less investment means less capital accumulation, which puts the US at a competitive disadvantage with countries such as China.

[tmosley]

Well, I would say that even if we had low business taxes and a minimal regulatory structure, capital would still flee the United States due to abnormally low interest rates. Low interest rates mean a low return on investment, which reduces investment. Less investment means less capital accumulation, which puts the US at a competitive disadvantage with countries such as China.

That's true, but if we allowed those companies to keep more of what they earned, and allowed them to lower their costs, they wouldn't need loans for capital improvements, they could self finance such projects.

But I'm glad you pointed that out. That is another great reason to get rid of the Fed.

[fahayek]

To me, this is the most destructive aspect of the Fed.

Here's Robert Murphy's great article on "The Importance of Capital Theory"

Here's Robert Murphy's great audo lecture on "Capital and Interest"

And of course, here is Bohm-Bawerk's great book, "Capital and Interest".

[krazy kaju]

That's true, but if we allowed those companies to keep more of what they earned, and allowed them to lower their costs, they wouldn't need loans for capital improvements, they could self finance such projects.

This is true, however, if interest rates were at their market level, they'd be much higher, which would tremendously boost saving and investment in this country.