Understanding the Concept of Malinvestment and its Consequences

Malinvestment refers to the error of investing in unproductive projects that only become apparent when stressed by external events. This quote emphasizes that panics do not destroy capital; instead, they reveal capital previously wasted on unproductive ventures. Malinvestment occurs due to bad decisions being made at the time of investment, which become evident only when circumstances test the investment. When interest rates are low, people tend to invest in speculative assets with long payback periods, such as real estate, leading to bubbles. The bust phase of malinvestment occurs when there are insufficient funds to complete investments made during the boom. Examples of malinvestments include venture capital businesses failing as interest rates rise and alternative energy businesses facing difficulties as interest rates increase. Therefore, the concept of malinvestment highlights the crucial link between investment decisions, interest rates, and the eventual viability of projects.