Market Forces and Own Rates

A modest wordpress through its linkback facility can sometimes trigger vigorous internet discussions.  As my post yesterday on multiple own rates did which triggered discussion by David Grasner and then Nick Rowe, with follow up in the comments by Richard Murphy and JP Koning.

David said

Laiton (sic) apparently thinks that there could be multiple real own rates, but seems to me to overlook the market forces that tend to equalize own rates, market forces wonderfully described by Keynes in chapter 17.

No it is not market forces that ‘equalise’ own rates it is market forces which create own rates.  The point I was making that it is the money market not product markets which equalises interest rates was missed.

In the supermarket yesterday, the same physical product but two commodities.  Unripe mangos half the price of ripe ones.  It says on the packet keep them in your fridge for a few days to ripen.  Here we have a commodity with a very high own rate.

Market forces do not lead to the convergence of own rates between ripe and unripe mangos, rather it is the product market which always and everywhere leads to the divergence of own rates.

Market forces will erode differences in cost between a single  commodities but here we are talking about two different commodities with the same cost structure to the producer.

My post was triggered by the comment to the debate from Daniel Kuehn

So what accounts for the different observable own-rates on Chicago and Minneapolis wheat? First, you have to take into account storage. Sure, you may earn more holding Chicago wheat, but storage costs may be far higher in Chicago so that final returns are equalized. You also have to think about risk.

JP Konings comments

The above is really just a restatement of John Maynard Keynes’s Chapter 17 of the General Theory.

Chapter 17 of course was concerned with the equalization of the investment returns.  The quote from the chapter which sums it up is

the total return expected from the ownership of an asset over a period is equal to its yield minus its carrying cost plus its liquidity-premium, i.e. to q – c + l. That is to say, q – c + l is the own-rate of interest of any commodity, where q, c and l are measured in terms of itself as the standard.

Then he set out an investment schedule

As output increases, own-rates of interest decline to levels at which one asset after another falls below the standard of profitable production; — until, finally, one or more own-rates of interest remain at a level which is above that of the marginal efficiency of any asset whatever.

But there is an error here, either of clarity of exposition or theory, because at the profitability frontier what is being equalised is the rate of profit on investments not those aspects of return which are time variant.  Costs of carry and liquidity premiums (which are likely to be relatively time inelastic) may more than outweigh differential yields, the primary cause of differential own rates, as in our example above.  Keynes example is of an investor investing directly in one of many possible production processes and receiving all profits, not of an investor investing in one of many possible firms each with different rates of profit.

And let us underline we are talking about own rates in a monetary economy not in some hypothetical barter economy (where costs of carry and liquidity premiums would be way different).

Minky’s concept of dual markets is useful here.  In output prices differential yields create differential own rates however the asset price market through the money & equity market equalises rates of profit on those products.