Greenwald on the Cyclical and Structural Recession (Nov 26, 2012)
Contrast the above with ABCT. Is there Empirical Evidence for the Austrian Business Cycle Theory
What Does the Fed Do?
James Grant on the Fed
Greenwald on the Cyclical and Structural Recession (Nov 26, 2012)
Contrast the above with ABCT. Is there Empirical Evidence for the Austrian Business Cycle Theory
What Does the Fed Do?
James Grant on the Fed
A friend informs me that the mainstream and prestigious CFA Institute now features Austrian economics in the study materials for the Level 1 CFA Exam. The section “Theories of the Business Cycle” includes several pages on Mises and Hayek (as well as Schumpeter), and they’re pretty good. “As a result of manipulating interest rates, the economy exhibits fluctuations that would not have happened otherwise. Therefore, Austrian economists advocate limited government intervention in the economy, lest the government cause a boom-and-bust cycle. The best thing to do in the recession phase is to allow the necessary market adjustment to take place as quickly as possible.” About 100,000 people take this exam each year, and now they are all being exposed to Austrian teaching.
Just remember that Wall Street will be in a shrinkage mode for many years. The low interest rates, miniscule spreads on bonds, the tiny commissions on stocks all bode ill for employment.
…… As marvelous as the market economy is at problem solving, in a sense the real genius of the market process is in how it brings problems to people’s attention in the first place. Before you can solve a problem, you have to be aware that there is a problem. This, I believe, is the great insight that Israel M. Kirzner, beginning in the 1970s, contributed to our understanding of the market—in particular, that it is a process of entrepreneurial discovery of error.
One implication of this insight is that government policies that undermine the (admittedly imperfect) reliability of money prices also make the discovery of inefficiencies profoundly problematic: Undermining prices casts doubt on the very meaning of inefficiency.
Strictly speaking, an inefficiency exists when, for a given person at a given time and place, the cost of an action outweighs the benefit. We’ve seen that to rationally calculate costs and benefits you need money prices of inputs and outputs, of steel and bridges. So when government erodes private property rights, interferes with trade, distorts prices, and manipulates money, it doesn’t just make it harder to be efficient; it also pulls the rug out from under anyone trying to spot inefficiencies at all.
Using the rules of arithmetic, for example, it’s easy to see that the statement 1 + 2 = 4 is wrong, but what about _ + _ = _ ? What’s the solution to this “problem”? Is there even a problem here? Money prices fill in the blanks; they “create errors”—i.e., reveal mistakes that no one could see without them—that alert entrepreneurs might then perceive and correct. If mistakes and inefficiencies remain invisible, the search for better ways of doing things could never get off the ground.
An economy without inefficiencies is either one where knowledge is so perfect that no one ever makes a mistake, or it’s one in which government policy has effectively foreclosed the very possibility of inefficiency. In a world of surprise and discovery, of experiment and innovation, the former is impossible; the latter sort of economy, as Mises showed almost 100 years ago, is impossible as well as intolerable.
So a living economy needs to “create” inefficiencies, and lots of them, to set the stage for greater efficiency and ongoing innovation. And that’s just what the market process does all the time—thank goodness!
“If a man has a talent and cannot use it, he has failed. If he has a talent and uses only half of it, he has partly failed. If he has a talent and learns somehow to use the whole of it, he has gloriously succeeded, and won a satisfaction and a triumph few men ever know.” — Thomas Wolfe
“Work is love made visible. And if you cannot work with love but only with distaste, it is better that you should leave your work and sit at the gate of the temple and take alms of those who work with joy.” –Kahlil Gibran
See’s Candies last discussed here: http://wp.me/p1PgpH-1bZ.
Readers did a fine job of analyzing why Buffett paid 3xs tangible book value. While cleaning out old files I came across a discussion of See’s that perhaps not many have seen, so I will post tomorrow.
Before you can know what is “wrong” with Austrian Business Cycle Theory (“ABCT”), you need to know about the theory.
A ten lecture series on Austrian Economic Analysis: http://mises.org/media/categories/89/Introduction-to-Austrian-Economic-Analysis
The Austrian School: http://en.wikipedia.org/wiki/Austrian_School
As a history fanatic, I am enjoying A Nation of Deadbeats: An Uncommon History of America’s Financial Disasters by Scott Reynolds Nelson.
More on the author here:http://www.wm.edu/research/ideation/social-sciences/economic-deja-vu6543.php
The book’s author has studied the Austrian approach but finds fault with it. He weaves an interesting account of the Panics of 1792, 1819, 1837, 1857, 1873, 1907, 1920 and 1929. He says government can’t be entirely to blame for some of the overleveraging, fraud and mal-investment of the booms that lead to busts. I lack historical knowledge to completely grasp his arguments, but after finishing this book I will take another crack. I do believe that understanding where leverage has built up is crucial to understanding the effects of the bust. For example, the Internet boom occurred mostly in equities while the 2008 credit crisis developed in the banking system. Banking panics will most likely be much more severe due to the high (at least 10 to 1) leverage in our banking system. The credit contraction is quick to spread throughout the economy. The Internet bust primarily caused a bust in Internet and Telcom companies’ stock prices.
The best model to understand the 2008 Crisis was the 1873 panic NOT 1929.
The author: “Everyone was talking about 1929, but I said in this article that the depression following the Panic of 1873 was much more like our current crash than 1929,” Nelson said. “1873 was a mortgage meltdown, then bank failure, which then led to stock market collapse.”
Another historian’s view: Jeffrey Hummel Arguments against ABCT
I will seek out the contra-arguments to Austrian theory as a way to better understand the strengths and weaknesses of various economic theories and approaches. Is Austrian theory perfect? I don’t believe so, but it has been the best construct for me to understand how booms develop and end–so far. What do YOU think?
According to most mainstream economists, the Austrian business cycle theory is incorrect.
Some mainstream economists argue that the Austrian business cycle theory requires bankers and investors to exhibit a kind of irrationality, because their theory requires bankers to be regularly fooled into making unprofitable investments by temporarily low interest rates. In response, historian Thomas Woods argues that few bankers and investors are familiar enough with the Austrian business cycle theory to consistently make sound investment decisions. Austrian economists Anthony Carilli and Gregory Dempster argue that a banker or firm loses market share if it does not borrow or loan at a magnitude consistent with current interest rates, regardless of whether rates are below their natural levels. Thus businesses are forced to operate as though rates were set appropriately, because the consequence of a single entity deviating would be a loss of business. Austrian economist Robert Murphy argues that it is difficult for bankers and investors to make sound business choices because they cannot know what the interest rate would be if it were set by the market. Austrian economist Sean Rosenthal argues that widespread knowledge of the Austrian business cycle theory increases the amount of malinvestment during periods of artificially low interest rates.
Economist Paul Krugman has argued that the theory cannot explain changes in unemployment over the business cycle. Austrian business cycle theory postulates that business cycles are caused by the misallocation of resources from consumption to investment during “booms”, and out of investment during “busts”. Krugman argues that because total spending is equal to total income in an economy, the theory implies that the reallocation of resources during “busts” would increase employment in consumption industries, whereas in reality, spending declines in all sectors of an economy during recessions. He also argues that according to the theory the initial “booms” would also cause resource reallocation, which implies an increase in unemployment during booms as well. In response, Austrian economist David Gordon argues that Krugman’s argument is dependent on a misrepresentation of the theory. He furthermore argues that prices on consumption goods may go up as a result of the investment bust, which could mean that the amount spent on consumption could increase even though the quantity of goods consumed has not. Furthermore, Roger Garrison argues that a false boom caused by artificially low interest rates would cause a boom in consumption goods as well as investment goods (with a decrease in “middle goods”) thus explaining the jump in unemployment at the end of a boom. Many Austrians also argue that capital allocated to investment goods cannot be quickly augmented to create consumption goods.
Economist Jeffery Hummel is critical of Hayek’s explanation of labor asymmetry in booms and busts. He argues that Hayek makes peculiar assumptions about demand curves for labor in his explanation of how a decrease in investment spending creates unemployment. He also argues that the labor asymmetry can be explained in terms of a change in real wages, but this explanation fails to explain the business cycle in terms of resource allocation.
Hummel also argues that the Austrian explanation of the business cycle fails on empirical grounds. In particular, he notes that investment spending remained positive in all recessions where there are data, except for the Great Depression. He argues that this casts doubt on the notion that recessions are caused by a reallocation of resources from industrial production to consumption, since he argues that the Austrian business cycle theory implies that net investment should be below zero during recessions. In response, Austrian economist Walter Block argues that the misallocation during booms does not preclude the possibility of demand increasing overall.
Critics have also argued that, as the Austrian business cycle theory points to the actions of fractional-reserve banks and central banks to explain the business cycles, it fails to explain the severity of business cycles before the establishment of the Federal Reserve in 1913. Supporters of the Austrian business cycle theory respond that the theory applies to the expansion of the money supply, not necessarily an expansion done by a central bank. Historian Thomas Woods argues that the crashes were caused by various privately-owned banks with state charters that issued paper money, supposedly convertible to gold, in amounts greatly exceeding their gold reserves.
In 1969, economist Milton Friedman, after examining the history of business cycles in the U.S., concluded that “The Hayek-Mises explanation of the business cycle is contradicted by the evidence. It is, I believe, false.” He analyzed the issue using newer data in 1993, and again reached the same conclusion. Austrian economist Jesus Huerta de Soto argued that Friedman’s conclusions are based on misleading data (such as GDP). Austrian economist Roger Garrison argued that Friedman misinterpreted economic aggregates and how they related to the business cycles he reviewed.
“The attraction which inflation policies have for so many people grows, in part at least, out of what may be called the money illusions.” –Irving Fisher
In addition to the lectures you can watch or have watched from my last post: http://wp.me/p1PgpH-1aj you can add the one below to your education in money matters.
A reader writes, “I found the lecture above a great way to learn about Austrian Economics and an easy way to understand the key message from the important book, Money, Bank Credit, and Economic Cycles by Jesus Huerta de Soto. His lecture sets the subject in a modern day issue, the Euro Crisis, and Prof. de Soto suggests a anti-consensual conclusion.”
Editor: Prof. De Soto said (more or less) that Americans and Westerners do not want to live under an authoritarian political system, and they have the seen the collapse of centrally planned economic systems due to constant malinvestment by bureaucrats. However, they accept without protest a monetary system that is centrally controlled.
Jesus de Soto’s great work is here: http://mises.org/document/2745/Money-Bank-Credit-and-Economic-Cycles.
His recent articles:http://mises.org/daily/author/210/
Man, Economy and State: http://mises.org/Books/mespm.PDF
The Theory of Money and Credit by von Mises: http://archive.mises.org/4048/theory-of-money-and-credit-pdf/
www.valuewalk.com is a recommended blog. Several readers kindly sent me links to the Ron Paul vs. Paul Krugman debate. I am biased toward Ron Paul, but for the life of me I could not understand what Krugman was saying. Perhaps using reason will not convince a religious fanatic.
I stopped reading half way through the discussion, because I knew Ron Paul’s positions but couldn’t understand the logic behind Krugman’s contrary position. Do you? A few examples:
Krugman’s response to Ron Paul:
“You can’t leave the government out of monetary policy. If you think we’re going to let it set itself, it doesn’t happen. If you think you can avoid the government from setting monetary policy, you’re living in the world that was 150 years ago. We have an economy in which money is not just green pieces of paper with faces of dead presidents on them. Money is a part of the financial system that includes a variety of assets – we’re not quite sure where the line between money and non-money is. It’s a continuum.”
What is he saying. Getting the government out of monetary policy would be like regressing? A fall into a primitive state? Krugman makes an “Elephants can fly” assertion.
Has a monetary system worked without government control? Yes, in the brief period of a classical gold standard pre-WWI. However, fractional reserve banking (ponzi finance) operated so, of course, booms and busts would not be eliminated. Another assertion without facts. Fiduciary media existed during the gold standard era.
“History tells us that in fact a completely unmanaged economy is subject to extreme volatility, subject to extreme downturns. I know this legend that some people like that the Great Depression was somehow caused by the government or the Federal Reserve, but that’s not true. The reality is it was a market economy run amok, which happens repeatedly…I’m a believer in capitalism. I want the market economy to be left as free as it can be, but there are limits. You do need the government to step in to stabilize. Depressions are a bad thing for capitalism and it’s the role of the government to make sure they don’t happen, or if they do happen, they don’t last too long.”
So let me try to understand……an unmanaged economy is subject to extreme volatility. But with the Fed operating since 1913, we have had the Great Depression, Inflation of the 1970s, Ultra high interest rates of the 1980s, credit crisis of 2007-2009, a managed economy (the FED cartelizing the fractional reserve banking system and suppressing interest rates) is LESS volatile? What amount of failed economic policies due to intervention would you need to say–this is a failure?
The Federal Reserve helped inflate the boom: http://library.mises.org/books/Murray%20N%20Rothbard/Americas%20Great%20Depression.pdf
Since the inception of the Federal Reserve System in 1913, the supply of money and bank credit in America has been totally in the control of the federal government, a control that has been further strengthened by the U.S. repudiating the domestic gold standard in 1933, as well as the gold standard behind the dollar in foreign transactions in 1968 and finally in 1971. With the gold standard abandoned, there is no necessity for the Federal Reserve or its controlled banks to redeem dollars in gold, and so the Fed may expand the supply of paper and bank dollars to its heart’s content. The more it does so, the more prices tend to accelerate upward, dislocating the economy and bringing impoverishment to those people whose incomes fall behind in the inflationary race.
The Austrian theory further shows that inflation is not the only unfortunate consequence of governmental expansion of the supply of money and credit. For this expansion distorts the structure of investment and production, causing excessive investment in unsound projects in the capital goods industries. This distortion is reflected in the well-known fact that, in every boom period, capital goods prices rise further than the prices of consumer goods.
See what Graham and Buffett had to say about booms and busts:A Study of Market History through Graham Babson Buffett and Others
Krugman is constantly shifting arguments:http://mises.org/daily/5086
“I want to say something about Milton Friedman here because if you actually read what he wrote in his writing for economists, as opposed to some of his loose popular writings, he actually said that the Federal Reserve was responsible for the Great Depression because it didn’t go enough. Friedman’s complaint was that the Federal Reserve did not print enough money. I know this. When Ben Bernanke was talking about the helicopter, he was taking that from Milton Friedman. That was really his idea. The state of the economic debate in America right now Milton Friedman would count on the far left of monetary policy.”
Milton Friedman was advocating for the government to intervene and prevent the market clearing. But why was a non-interventionist policy during the vicious 1920/21 depression so successful:http://www.youtube.com/watch?v=czcUmnsprQI. Both theory, common sense and empirical evidence expose Krugman’s and Friedman’s nonsense.
Here is a seven minute video that explains booms and busts: http://www.youtube.com/watch?v=d0nERTFo-Sk
We’ve long felt that the only value of stock forecasters is to make fortune tellers look good. Even now, Charlie and I continue to believe that short-term market forecasts are poison and should be kept locked up in a safe place, away from children and also from grown-ups who behave in the market like children.–Warren Buffet
Oh no, an Irish journalist, Vincent Browne, asks ECB bankster, Klaus Marsuch, about the ELEPHANT in the room. Browne asks, “Why do Irish people have to pay billions to a DEFUNCT bank to bail-out UNGUARANTEED bank bondholders?” Say it ain’t so! Do you think the bankster answered his question?
Question to Readers: “If central economic planning has been shown to repeatedly fail as shown by North Korea, Cuba, Soviet Russia, Eastern Europe, etc., why do Americans and Europeans tolerate a CENTRALLY planned financial system ruled by the FED and the ECB? Why tolerate a perpetually flawed financial system?
Must watch: http://www.youtube.com/watch?v=HAf7J4a_T1g
David Stockman’s gruesome interview: The US is supersaturated with debt. http://www.usatoday.com/money/economy/story/2012-03-03/david-stockman-says-economic-disaster-lurks/53339644/1
For beginners: Robert Murphy Lectures on Austrian Economics: http://www.youtube.com/watch?v=hkDYsRDah3I&feature=related
For more advanced students: Roger Garrison’s Lecture on the Austrian Theory of the Trade Cycle (“ABCT”) http://www.youtube.com/watch?v=jFqtTj7TeO0
Advanced students: Prof. Kizner’s Lecture on ABCT: http://www.youtube.com/watch?v=uhdNmHONY-E&feature=related
Current article on 17 years of debt-fueled boom and bust:http://mises.org/daily/5938/Seventeen-Years-of-Boom-and-Bust
Treasury Secretary Timothy Geithner charged in a Wall Street Journal op-ed that those who oppose the Obama Administration’s regulatory regime for the financial services industry “seem to be suffering from amnesia about how close America came to complete financial collapse under the outdated regulatory system we had before Wall Street reform.” Au contraire, Secretary Geithner, it is you who choose to ignore and misrepresent the lessons of the financial crisis by perpetuating the myth that the source of the crisis was a lack of regulation.
Full article here: http://www.forbes.com/sites/charleskadlec/2012/03/05/tim-geithner-covers-for-corruption-on-pennsylvania-avenue/