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Response To Pragmatic Idealist And His Article On Austrian Theory
From The Daily Capitalist
Dear Pragmatic Idealist:
I was going to let your post, “Repositioning Austrian Monetary Business Cycle Theory” pass, but it
contains so many misconceptions about Austrian theory that I have to answer it.
Please don’t take this the wrong way, but I see similar
critiques around the web, and I believe that most commentators haven’t actually
read any of the Austrian theory economists. I say that because you misrepresent
what it is and that leads me to believe that you haven’t read Mises, Rothbard,
Hayek, or any other Austrian theory economists.
You say:
However, the Austrian monetary cycle theory (ABCT) put
forth by the founders of Austrian economics fails to adequately explain a
variety of business cycle phenomena and, consequently, will probably never be
fully accepted by "mainstream" economists. ABCT does not incorporate
the very real fact that investors and consumers will and always have been swept
up in waves of euphoria or severe panic (i.e., tulip mania or thousands upon
thousands of convincing behavioural finance case studies and papers). ABCT does
not explain why rational economic agents (in the Austrian sense) make
irrational investment decisions en masse just because a government entity
purchases some treasuries. After all, such activity is highly transparent and
quantifiable.
That simply isn’t true. In fact it is just the opposite of
what Austrians believe. You may be confusing Austrian theory with Neo-classical
economics which believes that people act rationally. Austrians believe that
people never act “in a perfectly rational environment.” In fact, people are
faced with imperfect information every day about the world and the economy and
they frequently make bad choices. But it is the freedom of choice and ability to
succeed or fail that makes free market capitalism work. As I’ve written before
here, capitalism is a profit and loss
system and without losses, as Austrian Joseph Schumpeter noted, capitalism
wouldn’t work.
One of the best things about capitalism, Austrians say, is
that when economic actors make mistakes, such as entrepreneurs, the only ones
that pay for it are those that made the mistake and their investors. When
government makes mistakes we all pay for it.
Austrian theory works from the principle of individual action,
not the behavior of aggregates such as “nations,” “national exports” or “national
output.” This concept is called the “Marginal Revolution” of economics and went
a long way to explain economic behavior.
It is a given that at times all people can act rationally,
irrationally, be greedy, or panic. That is the human environment we live in.
Assuming that these are truths of human behavior, Austrians ask, what is the
best way for individuals to meet their goals in life, such as start businesses,
get capital, hire labor, make money, and expand while at the same time serving
the needs of the consumer? Of course we believe that is free market capitalism
which you continually misrepresent in your article.
Then you say:
It is argued [by Austrians] that manipulation of the
interest rate obscures the rate of time preference and therefore causes over or
under investment and consumption. However, if economic agents were absolutely
rational and calculative, any tinkering of the interest rate by the printing of
money and purchasing of treasuries and other assets should, in theory, be able
to accounted for. Banks should, as they are doing now, hoard most of the money
printed by the central bank and only lend out the portion that would allow them
to absord the expected future increase in the default rate as savers/investors
are able to make less money due to lower returns on investment and shift
temporal consumption habits accordingly. All of these effects are produced by a
known amount of monetary inflation and could be rationally accounted for.
Yikes, dude, that is definitely not Austrian Business Cycle Theory. You must think that we Austrians
think humans have to be perfect calculating machines with perfect knowledge. We
assert that we can never have perfect knowledge. That’s what the Keynesians and
Neo-classical economists think. Actually they must think that Ben Bernanke and
Tim Geithner have such knowledge because they want to give them more power over
the economy.
Let’s start over. Manipulations of money supply by the
central bank (the Fed), such as by setting a low interest rate to increase
money supply, do send false signals to businesses. It causes them to throw
money at projects which, but for the new fiat money, would not otherwise be
profitable. It doesn’t cause over or underinvestment, it causes malinvestment.
We just went through this (still are) with the housing market. Cheap money
stimulated developers to build houses, which, when the money stopped, people
didn’t want. The technical explanation does have to do with time preference of
savers, but, I don’t think you understand that and I don’t want to make this
too complicated.
Look, human factors such as greed and panic always exist in the market place; that
is who we are. The better question is, why, all of a sudden, do booms occur? We
believe it is because of new fiat money created by the Fed. We believe that
printing money doesn’t create wealth; it just creates more pretty pieces of
green paper that benefit some and hurt others (higher prices). But it always
must end in a bust.
Your last point about welfare is a statist, Keynesian view
of the world. You view welfare as being necessary to raise people out of
poverty and the “rich” ought to pay for it. You think it is the responsibility
of the state to oversee the economy and make it grow. Only capitalists
operating in a free market can do that. All the government can do is
redistribute the wealth. It can’t create anything. And as Maggie Thatcher said
about socialism, which does steal redistribute wealth, it is great until
you run out of other people’s money. Let me say that you, or anyone, do not
know enough to decide what to do with other people’s money. There is no
instance in history where government welfare has raised people from poverty.
In all of human history, free market capitalism is the only
system that has created the wealth to allow us to rise out of the muck. You
well know that if you go to any country without it; they are dirt poor.
Please do me a favor and read some books on Austrian theory before you criticize it.
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Well, Th Daily Capitalist was just removed from my RSS feeds. Not that I read it much but when a douchebag gets bent over this bad, it's probably not a good idea to associate one's self with him.
Actually, prior to the central banks in 1913, there were many booms and busts, but they were the result off the same monetarism we see today. The difference? The Banks were issueing their own money with a fractional reserve system. Gold backed? Yes, but as a fraction of what they were printing.
Some state banks did create very stable money systems.
Further, the introduction of greenbacks didn't help things either.
Austrians believe the introduction of unsound money creates booms and busts. This can be introduced by many sources- central banks just happen to be a great example.
All interventions in the market create distortions that muddy the waters of entrepreneurship and make decisions regarding profit points difficult.
All government regulation is written to favor those best able to contribute influence. This is why it never works as desired.
Most important, you want to inflict the violence of government action on citizens that DO NOT WANT IT. This is a violation of liberty. If you want a social net, find a group and create it, but don't ask me to contribute. If you want to abide by a "democratic" vote, fine, but don't ask me to. Democracy is one of the worse forms of government(read Plato). I have no problem with monopolies or cartels. Why? Because without government approval they have no power in a free market. If their prices become to onerous, people will stop participating. If their prices result in lower prices for the same good- please sign me up.
Rather than accept all the education you have received, start questioning some of the assumptions and see where they lead. There is not one service delivered by government that can be shown to be more efficient than a private market.
We have become enamored of government because it is easier than being responsible. It exists to give advantage to a few at the expense of the many. Have there been better governments than others? Sure. Overall, government is always the enemy of liberty for control cannot exist alongside chaos.
Econophile - I defer to your corrections about Pragmatic's description of Austrian theory but I think some of your logic has holes in it too.
You say "Look, human factors such as greed and panic always exist in the market place; that is who we are. The better question is, why, all of a sudden, do booms occur? " Pragmatic provided at least one exampe of a boom, tulip mania, in his article already that counters the thinking that ONLY central banks and monetary policy can lead to booms and busts. The 1800s in US were littered with booms and busts and had depressions, even when there was no central bank and far far less government economic meddling, very little spent on social safety net and there was a gold standard for our money!
I totally agree that government meddling in economy, (almost always on behalf of a special crony industry or sector) can lead to very wasteful concentration of resources. But this can also happen unregulated private markets. If the govt isn't calling the shots, at least as referee with power to enforce penalties, once someone concentrates a little wealth, its common for that to multiply and one or a few wealthy, powerful types (private business, families, oligarchs) become economic bullies as surely as a corrupt government can.
This is where I have a problem with most economic analysis I see, its all one thing or another, where as I see the checks and balances and moderation as the prize that seems to yield the best overal, common wealth for a county.
In political systems, we see this also this tendency to fixate only the bad we are currently experiencing. If you are having a revolution against a royalty and a few elites, you will tend to minimize the problems with anarchy and mob rule and everything, including trials, being decided by the vote of legislature. See France's revolution in late 1700s.
Now that almost all developed economies of the world are heavily managed by their governments, it seems many see this as the sole and only source of all economic evil. But abuses and problems exist with completely private, unregulated systems also. They devolve into trusts, monopolies, oligarchs..basically company towns of a 100 years ago in US, colonial planatations etc. Even the most ardent libertarians acknowldege there has to be some refereeing provided to make sure, say, monopolies don't take over.
If there must be a referee, doesn't it make most sense that it should be a democratically elected government that some reasoable checks and balances and seperations of power. Yes, government can be corrupted, lord knows we have seen that. But private businesses can be corrupted, and collude also. Greenspan seemed to be channeling Ayn Rand when he talked of the power of derivatives to price risk correctly in the early 2000s. Derivatives were a very private market with no regulation, and there was collusion and corruption and they did not self-regulate, they boomed and busted. Corrupt govt influence after the bust took money from average Americans and paid for some of the losses (of course most of this was wrong), but we still had a bust and contraction of money supply (credit/debt) and that would have been there without govt meddling.
When I look at different political economic systems in the world and in history it strikes me that the ones with a good balance between state power and private markets serve the common wealtht the best. Plantation economies and economies dominated by monopolies, oligarch or cartels make lots of money for a certain few and the rest are impoverished slaves or wage slaves. They are not innovating, flexible systems, rather they are stuck. Economies over-ruled by state, especially state that is not subject to democratic elections and checks of separations of power fail in a similar way, they are not innovating, fliexible systems, although they may be slightly better for the average worker.
But when I looked at economies that seem to have a good mix, I see the best successes. German workers, fair far better than Chinese (or former Soviet Union)workers, they have a pretty good middle class lifestyle in general, a decent social safety net. China, while a central planned economy to some extent, does like private markets run and provides little to no social safety net for their workers. So workers in China have to save, save, save. Germany also innovates well, is still a exporting power, all without a whole bunch quasi-empirical behavior around former colonies that inordinantly benefit many other western countries. And yet Germany is not a completely privatized economy by any means, certainly not compared to US. And Germany has a central bank. France is also quite socialized compared to US, and French middle class doing better than US and economy certainly no worse off than US.
I refuse to see it as all govt is evil and or all private, free market capitalism is evil. To me its finding the best mix and checks and balances that will avoid the worst excesses of any of these systems run amok.
MoneyMutt:
Sean7K has is right. Whenever I write this sort of thing, someone reminds me that the Fed came into existence in 1913 and so there! Sean is correct about the history of booms and busts. In fact Doug French at Mises.org has come out with a book on early financial crises and shows how debasement and inflation of the currency did create Tulipmania and other bubbles.
Thanks for the comments.
so its ALL government that is wrong, there is no other options, no gray area at all? what to my other comments? there is no role for government at all...what of comparisons to other countries, or times...I still don't get how a completely unregulated, ungoverned economy works, it just becomes bullies and monopolies just as unpoliced streets devolve...
Econophile, thanks for the piece.
When I studied Keynsian economics it never made sense. It was tortured logic warped by mathematical formulas in an equilibrium universe that doesn't exist. There were "truths", but the truths were always imperfect because the world was imperfect, information was imperfect and so models were used that could never represent real effects.
People complain about economists for good reason. They are incapable of making predictions. If the foundation for an argument is sand, it will be washed away by the first wave. When you start with fantasy, it is difficult to measure reality.
Once I realized that keynsianism was a theory propagated for the purposes of the central bankers and even then, only used in parts to encourage the use of debt and creation of greater and greater interest payments- it became clearer.
Once I studied Austrian theory and Classical Liberalism(Bastiat, Say, Contillion) economics began to make sense. It became predictive, the models were useful and the effects of monetarism were simple to comprehend. Economics stopped being a mystery and quickly became a force in all my decision making.
I realize there are millions of people heavily invested in Keynsian/Ricardo/Mills et al economic theory and it is unfortunate they have been mislead by the institutions we trust to educate us. Still, we have the opportunity to explore and educate ourselves. If you haven't read Austrian theory, may I suggest any title by Rothbard, The Road to Serfdom by Hayek and Von Mises Theory of Money and Credit.
There is a reason their theories were ignored during the Great Depression- they exposed the FED and would have led to a real correction in a shorter time with no debt creation. Unions would have been weakened, producers would have been forced to sell at market and government would have been marginalized. Everything we have today follows from the actions of the central bankers and government acting in collusion to transfer all wealth from America. This is why we should know Austrian theory- it is our only alternative to the status quo.
Amen and thanks! Good comment.
Well said, Econophile.
I hear this standard neoclassical criticism all the time about ABCT, "...why do entrepreneurs systematically err in the most expensive way possible?" When one strips it down, the argument reduces to, why dont economic agents obey the assumptions of our neoclassical models (perfect information, continuous clearing/liquidity, randomly distributed errors, and so on). The proper formulation of these NC criticisms should be, what is it about models that does not explain the world we see around us? The Austrians may not have every jot and tittle exactly correct, but theyre closer to the truth than so-called mainstream economists...which is why they will are not accepted by MSEs (they're a threat to them...pointing to a lifetime of wasted effort and intellectual impotence).
BTW, w/the Austrians, it's always money AND credit, not just money. This is where Murray Rothbard went off the rails in his book on the Great Depression, in my view.
"All the government can do is redistribute the wealth. It can’t create anything. "
This statement alone shoots diarrhea on his credibility on this topic. The govt cant create anything but it is the monopoly issuer of the currency that is the basis of everything. Yeah...
The whole "other people's money" angle is another stunner. This assumes the govt funds its operations via "other peoples money". In the real world, this is not how it works.
Propaganda at its best....
(Tw)Insanity,
You don't get it do you.
Issuing money=Stealing money
Taxes=Other peoples money
Im not really sure if you are serious or not...
if you have a fiscal deficit and are borrowing you are funding your operations with other peoples money - fact
if you debase the currency as a governmnet you are stealing from the citizens capital base - fact
the government produces nothing, they redistribute the production value of the citizenry - fact.
there is no government, there is no citizenry, they are us and we are them. so in this regard you might be right, but i just KNOW that this is not what you mean.
all your comments do is shoot liquid stinking poo all over your own face
I'll respond to just this comment but it applies to everyone who replied to my original post.
The ignorance of how the modern monetary system works is stunning. And this board is supposed to be filled with the best and brightest.
A couple of points:
-debt is issued not to fund operations but to match govt spending(which is in the form of credits in a computer in banks reserve accounts). These banks want interest on those reserves, so the govt issues debt. This is nothing more than moving funds from a checking account to a savings account. The same with China, they have a surplus of dollars earning nothing due to the trade imbalance. They want interest on it, ok here are some UST's. This notion that the US debt "funds" anything is retarded.
What funds govt operations is the computer they punch credits/debits into to change numbers on another computer. Stop conflating how your own life operates and the need to finance your spending habits in advance with a sovereign currency issuing nation which does NOT face such constraints. It's this paradigm which people just cannot understand, and don't want to since they've been brainwashed to believe the govt is all bad and anything that would allow the govt to play by different rules is just unacceptable.
- The govt spends first, then issues debt. If your model was accurate, why in the hell would anyone lend to a country that has such a high debt to GDP ratio? Why is the risk free rate still UST's? Why are people still lapping up UST's?
- Debasing a currency is not an automatic result of issuing more currency. This is such a falsehood embedded in everyone's financial education it's become a "fact' when it's complete horseshit. Currencies are valued against each other, not intrinsically. This is obvious.
- The government alone is the reason for the defense industry in this country. That's just one example of them "producing something".
-People need to understand how a fiat system works. The deficit is nothing more than an accounting ratio, and we should all know it's always about the cash flow. And when you can issue cash flow AT WILL, the balance sheet and income statement ratios are pretty much meaningless.
- The debate needs to shift away from govt spending to what govt spends money on.
Very interesting comments, thanks for taking the time.
I don't see how the end result is different though? If the government spends then issues debt, which is printed as dollars, its still stealing from the individuals who saved their own productivity no? They suffer from inflation reducing the purchasing power of their productivity? How is this different in your argument or is it not? You clearly know this topic pretty well so hopefully you can reply again.
You second point is again beyond me - country x prints more than y - their currency is debased against y and their own citizenry finds their purchasing power decreased versus before the government printed money - I need your help here, I just dont' get what your saying? Oh and what do you think of gold then and its recent year behaviour?
The defense industry - oh wow, this one i flat out disagree with - the ability to destroy life and capital is not a productive use of any resource, the machinery either rusts, is destroyed in use and in doing so destroys more resources and the skills sets aren't entirely transferable to any productive use.
Really interesting comments and a different perspective, but if you have the time i wouldn't mind some help getting them on board.
cheers
iwt
You are confusing Federal Reserve Notes with wealth. They aren't the same. In essence, when the government pays for something by "issuing credits" (fiat money) and not through taxation, they are essentially getting something for nothing. The concept of "money" is a bit more complicated than accounting entries. And the consequences have very serious implications.
Please see: "Money: A Semi-Fictional Fable."
As far as government spending, it is true that some things they support, schools, roads, justice system, defense industry, do confer benefits to taxpayers. But I would argue that such spending is largely wasteful and could be done better privately. As you know, most of such spending is politically driven without thinking about economics.
Thanks for your comments.
The whole "other people's money" angle is another stunner. This assumes the govt funds its operations via "other peoples money". In the real world, this is not how it works.
Then how dose it work with their money,
The gov is a consumer period. Stop the tax collection and they starve.
You can debate about weather they are needed or not but you can not say that they have anything form them selves.
Be it capitalist, workers, serfs, slaves or whatever first comes production then comes trade, and prosperity and usually gov to take the cream off the top. Or at as they put it to look out for our own best interest.
The political implications of Rothbard's reconstruction of welfare economics along Austrian lines are rather different from what libertarians commonly assume :
they lead to agnosticism about - not denial of - the benefits of statism.
There is a major flaw at the basis of Austrian economic theory, and that is the assumption that no preference can exist which cannot be revealed in action.
Obviously I can never reveal in action my preference for products at prices other than the market price, but it doesn't mean that I don't have such preferences and that by introspection I can know them.
This leads Austrians to reject the argument that the envy of a third party invalidates the principle that voluntary exchange increases social utility:
"We cannot, however, deal with hypothetical utilities divorced from concrete action. We may, as praxeologists, deal only with utilities that we can deduce from the concrete behavior of human beings. A person's 'envy.' unembodied in action, becomes pure moonshine from a praxeological point of view... How he feels about the exchanges made by others cannot be demonstrated unless he commits an invasive act. Even if he publishes a pamphlet denouncing these exchanges, we have no ironclad proof that this is not a joke or a deliberate lie."Power and Market, M. Rothbard
Not only is this patently false (At every moment, by introspection we are aware of preferences unrevealed by our behavior) but it can easily be reversed to claim that since there is no "ironclad proof" that third parties do not object to other people's voluntary exchanges, it is impossible to say whether or not they increase social utility.
You obviously have an interesting concept of preferences. It is not Austrian nor is it useful. How this invalidates austrian theory or cast aspersions against it is beyond me.
There is a good reason we cannot measure hypothetical preferences-they do not exist. Human action is the only thing we can measure, because it is the only action we can see. Further, without action, there can be no marketable effect.
Better still, preferences are choices between courses of action. If I choose labor or leisure, investment/savings or consumption, I show my preference through ACTION. If a third party has a preference as well and ACTS on it, it will impact the exchange of all three parties and price will be effected. Finally, your unwillingness to act on your preference reveals your preference can only be met at a different market price-which is the whole point.
How does a pamphlet on a preference effect an exchange? You are deliberately obtuse for the sake of argument. Worse, it does nothing to address the response by econophile to a very poorly written argument.
Social utility is advanced through human action because it is an exchange that both parties feel they have benefited from.
I am not sure why you would choose to defend ignorance with obfuscation. This merely generates more ignorance.
So what?
Hear hear, well said.
I'm not really sure how that article got through the filter.
It was "not even wrong."
It should be noted, however, that Hayek favored some form of social security. But he was writing in a different era.
Yeah and he also liked governmnet institutions and saw them as an integral part of a free society - he just prefered an organic 'evolutionary' development rather than the French rationalist - 'this shall be so' approach.
Best form of Social Security: Educate yourself financially, and invest YOUR OWN funds by yourself, for yourself, with NO Govt involvement.