Confessions of an Austrian Economist

There is a school of thought amongst economists called the Austrian School because it first came to the fore due to the teachings of Ludwig von Mises, Eugen von Böhm-Bawerk, and Gottfried Haberler, all well-known Austrian economists popular at the beginning of the 20th century. The Austrian School is founded on conservative, fiscally prudent principles that see credit as central to the business cycle. I have long been a devotee of the Austrian School.

As a result, I am skeptical of the current fiat money world we now live in and I reject the profligate, debt-inducing, easy-money policies of the Federal Reserve under Alan Greenspan. In fact, for quite a number of years I have warned that this experiment of debt, easy money and fiat currency would end in disaster. And so it has.

My Austrian School background has been useful as a lens through which to view the credit bubble and crash. Central to this view is the precept that easy money is the problem and not the solution. However, as the crash has unfolded, I find myself parting ways with the Austrians. I have always felt the Austrians are more useful for their economic framework. But they leave me underwhelmed when it comes to solutions for when problems occur. Their “Let them eat cake” approach comes dangerously close to Andrew Mellon’s draconian Depression era prescription and is more likely to end in a deflationary spiral and a worsening of the problem.

And so it is today. If we are to find our way out of this crisis — the worst in three quarters of a century — it will not be the ideas of Ludwig von Mises or Murray Rothbard which will guide us. It is more the work of John Maynard Keynes and his followers that is likely to offer useful prescriptions. As much as I would like to look to the Austrian School in this crisis, I cannot. These are the confessions of a former Austrian Economist.

If one looks back over the last quarter century or more of international economics, one cannot help but understand that debt and leverage have been central to the force that built up creating the calamitous financial crisis we are now experiencing. I have previously said:

The monetary stewardship of Alan Greenspan’s Fed and the credit bubble it created has manifested itself in several ways that parallel previous episodes of credit-engendered over-investment:

1. Inflationary monetary policy leads to an expansion of credit throughout the economy, the basic building block for a boom-bust business cycle.
2. In a credit boom, less credit is available for productive assets because credit and resources are diverted to marginal debtors and high-growth/high-risk activities. Low interest rates and expansionary credit environment gives the illusion of profitability to unproductive investments and high-risk activities in the economy, that would appear foolish in an appropriate monetary environment.
3. Companies, flush with cash, invest heavily to prepare for expected future growth. An investment and capital-spending boom ensues.
4. Higher asset prices lower the cost of capital, fuelling a further boom in investment and capital spending, creating overcapacity in goods and services industries.
5. The increase in asset prices produces the so-called ‘wealth effect’ for consumers: a decrease in savings and an increase in consumption.
6. As the whole episode rests on an excess creation of credit, debt levels increase greatly.
7. The inflationary monetary policy is extremely distortionary as it redistributes capital to economic actors whose costs rise after their income from those whose costs rise before their income. Those who live from a fixed and interest income like pensioners find their costs rising with higher inflation while their income decreases in real terms.
8. Runaway asset price/consumer price inflation ultimately demands higher interest rates and a contractionary monetary policy, whereupon the whole house of cards collapses.
9. When the asset price bubbles pop, revulsion steps in, credit contracts and the bubble currency depreciates, as hot money flees the depreciating assets.
10. Eventually, the inflationary monetary policy debases the fiat currency, leading to a relative appreciation of the prices of ‘hard’ assets (like gold and silver and commodities like oil and natural gas) relative to the home currency.
11. The result is a wealth effect in reverse, leading to a collapse in consumption, a secular bear market and recession.
12. An expansionary monetary policy in a post-bubble environment can cushion a hard landing but does only lengthen the period before full economic recovery.

And until recently, I might have rejected attempts to mitigate the crisis and the negative fallout it has on people’s lives because of the large potential for misallocating resources, feeding political patronage and special interests or for lengthening the crisis. In a previous post I said:

My economic viewpoint is founded on the Austrian economics. This framework rightly associates the business cycle with the credit cycle. Moreover, the Austrians understood that monetary authorities have limited resources to correct the excesses of an investment-led boom/bust and, that attempts to mitigate the credit cycle invariably reflate and exacerbate the bubble.

But, the Lehman (LEHMQ.PK) bankruptcy changed things significantly. We went from a festering problem to a full-scale deflationary spiral. We have entered a new stage where sitting on one’s hands as the Germans intend to do risks financial Armageddon. We cannot sit by and watch this crisis liquidate assets, taking down good companies with bad, throwing people out of work, wreaking havoc on their lives, and leading to a brutal and painful downward spiral of asset and debt deflation and depression. This is not a prescription for success, either economically or politically. This is the prescription for chaos, turmoil, civil unrest and perhaps worse.

However, this is what the Austrians would have us do in the present downturn. It is the same wrong-headed prescription given to the Asians in 1998 and to Argentina in 2001. We squandered an opportunity for fiscal prudence when the economy was on more solid footing. With depression on our doorstep, is now the right time to start cutting back?

This would mean liquidating General Motors (GM), bankrupting Royal Bank of Scotland (RBS) and Citigroup (C) or allowing Iceland, Hungary and Pakistan to fend for themselves. In theory, each of these measures seem prudent. But, in practice, these measures would result in huge job loses, would induce further deleveraging and asset price declines, would deplete capital from an already fragile global baking system, and would lead to a probable depression of unimaginable severity. It is in such a bleak environment that dangerous despots and dictators like Hitler and Mussolini rose to power, taking advantage of the natural human need for ’strong’ leader in a time of chaos and uncertainty. Could we expect any different today?

Nevertheless, one must ask: “what does mitigating the effects of a burst credit bubble look like in economic and monetary policy?”

First, let’s look to the goals of stimulus:

1. Cushion the real economy effects of deleveraging so as to prevent the prospect of a downward spiral of unemployment, lowered consumption, lowered capital spending and production and more unemployment which could also engender civil unrest, revolution and war (see Greece to understand what I mean).
2. Restore liquidity to the financial system such that worthy profitable initiatives receive funding and promote economic growth — where they would not in an illiquid and capital constrained credit market.
3. Recapitalize the financial system through public and private funds to prevent systemic collapse as a result of deleveraging and restricted credit.

Deleveraging is what we should fear here because it creates a vicious spiral that reduces asset prices and credit availability sucking the entire economy into a deflationary spiral. I have discussed this at length in other posts. So I will gloss over this analysis here. But, please see the posts below for more on this issue:

• Credit deflation and the Japanese problem
• The Japanese Problem is now ours
• De-leveraging
• De-leveraging redux

The stimulus should therefore involve most of the following measures in order to mitigate the effects of deleveraging:

1. Supportive government spending in infrastructure (human and capital) - (the risk being malinvestment as government misallocates resources or shifts funds to special interest groups.)
2. Most controversially, it may involve quantitative easing, which is inflation and currency depreciation plain and simple. (The risk being extremely high inflation if the central bank cannot retract the excess liquidity once the economy has found its footing - and we should remember that inflation is essentially theft through depreciation of the currency’s purchasing power). I should also note that I am NOT a fan of massive interest rate cuts (easy money) as a policy response as it leads to bubbles and malinvestment - witness the current bubble in U.S. treasury and other G7 government securities. The goal is liquidity, not bubbles.
3. Other measures would include debt relief, debt workout provisions/ mortgage relief so as to mitigate the real burden of mortgage debt which began this crisis and which is most important to the electorate.
4. Bankruptcy law reform (in the United States in order to allow cramdowns on residential property). I have been advised by bankruptcy lawyers on the front lines that this is a major impediment to a residential mortgage workout. In all other scenarios in the U.S., a cramdown is possible. Only with residential mortgages it is not. This must be addressed quickly or we will continue to see many mortgage defaults.

Simultaneously, the financial system must be reformed quickly in order to speed the turnaround much as the Austrians wold say. Some of these steps have already been taken, but much remains to be done and it needs to be addressed comprehensively, not on an ad-hoc basis.

1. Liquidate or merge moribund financial institutions. This is the greatest oversight of the current policy response. It has been much too slow. An independent body should make a determination regarding the solvency of every single bank. This avoids the problem of having to bail out the Citigroups of this world. The faster the liquidation process is complete, the sooner confidence will be restored.
2. Create a Good Bank - Bad Bank split i.e. separate good assets from dodgy assets. This will bolster banks’ counter-party confidence. Lehman Brothers had it right when it attempted to do this. But, that was just before the company failed. The Swedes attempted this plan most successfully and it has been copied in the Citigroup bailout. It needs to be undertaken comprehensively.
3. Re-regulate to will prevent excessive leverage, imprudent lending, a favoring of debtors over savers, and the proliferation of dangerous unregulated markets like the market in Credit Default Swaps.
4. Create a global lender of last resort. The Fed seems to have taken on this role. However, they are beyond their depth. Their ability to reflate the entire global economy is limited. We need a true global lender of last resort as posited by Charles Kindelberger.

I have gone in to great detail regarding the need for a comprehensive solution in past posts so I will leave it there. For more on potential solutions, see:

• The U.S. financial system is effectively insolvent
• The $700 billion Paulson Plan is dead on arrival
• Lehman’s bankruptcy: putting the cart before the horse?
• The Swedish banking crisis response - a model for the future?

Ultimately, my position on the cure to our economic ills is largely unchanged. We need to save more, spend less and reduce debt. We need to invest in our infrastructure, human and capital, and we need to make things people want - not turn into a mass of money changers and finance wizards.

However, I now recognize the very real need to mitigate economic fallout from this downturn through monetary and fiscal stimulus in order to prevent worst-case outcomes that result from the deleveraging downward spiral. This means government must be involved. And as such, there is always the potential for mischief when government inserts itself into the process.

None of this stimulus prescription is axiomatic. I have a tough time advocating large-scale government intervention. But, is there any other way out of this mess? Is stimulus just a recipe for government meddling? And are we wasting our time by trying to prevent the inevitable?

These are all questions that need to be answered because we are about to embark on an historic and global experiment in fiscal and monetary stimulus. Comments are appreciated.

Comments

[Steven Hansen:]

i have never been in one economic camp completely. use the austrians to keep the economy on an even keel, and the keynesians to get us out of downturns.

this recession was caused by america doing it backwards - using the keynesian to keep the economy going. and the house of cards came down. but the excesses are so great, you cannot rely on keynesian economics to get us out because the model never considered these massive excesses.

every mitigating step taken has consequences. okay, i would go as far as keeping the banking system afloat. and, from a logic point of view - the failure of detroit if not cushioned would destroy the economy like a wildfire left to burn. i did not say detroit needed to be saved, but that their deaths made peaceful over time.

the economy needs to be made healthy by working through the excesses. it is too early to be talking about stimulus. the mortgage crisis has not had all the shoes fall yet. the economy has open wounds - they need to heal.

piling on massive debt is illogical at this point. to me stimulus at this point is like throwing gasoline on embers.

2008 Dec 11 02:56 AM

[johngonole:]

To the hand: I liked your comments. I think there is much truth in them. If the Austrian economist were in charge there would be very very little need for the Keynesians. What the Keynesians never figured out is that while their theory of keeping people employed during downward economic cycles using government deficit spening works they must do the opposite during the economic upcycles. Simulate when things are going down and DEstimulate when things are going up. This would in theory help make free markets in general more stable. Problem is that the politicians can't restrain themselves and they just pile on stimulus on top of stimulus until finanical ruin which the Austrians correctly predict.

So we need the Austrians to be in charge. Until that happens the Keynesians will only manage to make the distances from peak to bottom (economic waves or frequency longer) in terms of time longer.

2008 Dec 11 03:41 AM

[Balderdash:]

Ever heard the old adage 'can't have your cake and eat it too??' I suggest you revisit this truism.

The malinvestments and inane monetary policies of our decades past have created losses that must be flushed through the system. No amount of fiscal stimulus is going to cure the inevitable correction. All the government can do is redistribute the losses amongst those who have done no wrong and create moral hazard.

An inflationary depression is far worse than a deflationary one. Imagine the job losses if people refuse to work for worthless dollars and demand gold, euros, or wheat? A full blown currency crisis is arguably worse than deflation and massive default.

2008 Dec 11 07:06 AM

[patio:]

Totally agree- nothing possibly worse than hyper-inflation.


On Dec 11 07:06 AM Balderdash wrote:

> Ever heard the old adage 'can't have your cake and eat it too??'
> I suggest you revisit this truism.
>
> The malinvestments and inane monetary policies of our decades past
> have created losses that must be flushed through the system. No amount
> of fiscal stimulus is going to cure the inevitable correction. All
> the government can do is redistribute the losses amongst those who
> have done no wrong and create moral hazard.
>
> An inflationary depression is far worse than a deflationary one.
> Imagine the job losses if people refuse to work for worthless dollars
> and demand gold, euros, or wheat? A full blown currency crisis is
> arguably worse than deflation and massive default.

2008 Dec 11 09:05 AM

[notsosmart:]

blah,blah,blah.nobody could have stopped this.even greenspan had he known(or admitted he knew) could have stopped this runaway financial train. all the theories from austria or timbuktoo do not deal with phony rated AAA worthless paper.when lying & fraud enter the equation(liars mortgages,phony appraisals,selling of debt,etc.) the history does not apply.its all distorted now.these authors,anal sts havent a clue & they dont know ,sadly,that they dont know anything.

2008 Dec 11 09:59 AM

[Smarty_Pants:]

"The malinvestments and inane monetary policies of our decades past have created losses that must be flushed through the system. No amount of fiscal stimulus is going to cure the inevitable correction. All the government can do is redistribute the losses amongst those who have done no wrong" - Balderdash

I agree with this 100%. These losses WILL find a home, the entire crux of the 'crisis' is playing financial hot potato to see where they land.

As painful as it may be I would still advocate the Austrian / Mellon approach. Liquidate them all. Put the assets into the hands of those who have show prudent and responsible handling of their own assets during the years when everyone else was playing fast and loose. Let the leveraged gamblers suffer and serve as an example for others in the future

Will that be painful? Certainly. But 'saving' the big Wall Street banks is akin to sending the person who robbed you an expensive gift card for Christmas.

While the possibility of "chaos, turmoil, and civil unrest" is real, perhaps it will lead to the eventual removal of the gub'mint interferences which lead to the problem we are facing.

IMHO there are a great deal too many people who believe that they are owed a comfortable living regardless of their efforts and who need to understand that "nobody owes them nothing".

The political response and incessant panic mongering is as much about retaining political control as it is about saving the economy. If the dollar collapses the FED collapses with it. Eventually our creditors will read the writing on the wall, give up on us, and write off their losses, leaving us to fend for ourselves.

What the economy really needs it to remove those political controls so the markets can reallocate the available resources in an efficient manner without initerference.

2008 Dec 11 10:04 AM

[Ferdinand E...:]

Well, in this world you can never avoid surprises. Urban Bäckstrom was probably one of the most incompetent central bank directors in the world when he was in command at the (Swedish) Riksbank. As a matter of fact, when he assumed that position he knew almost no economics at all, but I suppose that the government appointing him liked his politics, or if not his politics his attitude. Where this issue is concerned you can never tell, because the last Social Democratic government was as bad as the conservatives, and although I might be wrong, he may have been in charge at the Riksbank when the previous prime minister was selling this country to Brussels (i.e. the European Union).

As for praising Austrian economics, I haven't heard this sort of thing for years, or maybe decades, but one thing is certain. Anyone in my economics or finance classes who gets into my face with that kind of talk would be guaranteed a failing grade. What went wrong in the US was the election of the wrong president - although, admittedly, bad things might have happened to a good president, even if that president was named Kerry.

2008 Dec 11 10:15 AM

[Smarty_Pants:]

"As for praising Austrian economics, I haven't heard this sort of thing for years, or maybe decades, but one thing is certain. Anyone in my economics or finance classes who gets into my face with that kind of talk would be guaranteed a failing grade." - Fred Banks

No doubt. I would be willing to wager that there isn't a single college level economics textbook in wide use that goes into any sort of detail regarding why the Federal Reserve is the cause of the boom / bust cycle or why creating money from nothing is in reality stealing purchasing power from all pre-existing money holders. The gub'mint accredited college text gatekeepers would never allow such a text to be used. Can't have commoners thinking about such things now, can we?


"What went wrong in the US was the election of the wrong president" - Fred Banks

Ah, I see. So what you are implying is that the trillions of dollars that we created out of thin air were simply spent on the wrong things? It's not the actual creation of the debt, it's who got to spend it. Riiiiight.

2008 Dec 11 11:18 AM

[dscianni:]

"Ultimately, my position on the cure to our economic ills is largely unchanged. We need to save more, spend less and reduce debt. We need to invest in our infrastructure, human and capital, and we need to make things people want - not turn into a mass of money changers and finance wizards.

However, I now recognize the very real need to mitigate economic fallout from this downturn through monetary and fiscal stimulus in order to prevent worst-case outcomes that result from the deleveraging downward spiral. "

well, I guess here lies the prob: "We need to save more, spend less and reduce debt" means getting rid of current excess capacity (SUV, McMansion every other block, etc.) .. no stimulus will get you down that road, only take you on costly and longer sidepaths!

A change in habits is no economic affair, albeit it reverberates in the economy...

2008 Dec 11 11:53 AM

[John Lounsbury:]

There are so many good discussion points in this article and the comments, I don't know where to begin. I'm going to try to get something into the idea flow anyway.

Ed - - -

I found your discourse very thought provoking. One thought I had was that economic theory is like a skeleton, but it is pragmatism that gives the final being it's structure - lean and mean or obese. Whatever theory you follow, no matter how fundamentally sound, things can be screwed up by base human instincts. Pragmatism can be a way to channel these base instincts into positive channels or ultimately destructive channels. Economic and financial development is seldom accomplished with a complete cost/benefit analysis, including a thorough assessment of potential unintended consequences. Can economic theory be developed to such an advanced extent? Or does human nature doom us to stagger to advancements through a quagmire of narrow visions and shortsidedness?

The hand - - -

I have read enough of your writing to appreciate the complexity of your thinking. In this case you stated we should use "...the keynesians to get us out of downturns." I agree, but would emphasize the caveat written by johngonole: "What the Keynesians never figured out is that while their theory of keeping people employed during downward economic cycles using government deficit spening works they must do the opposite during the economic upcycles."

Actually, Keynes very clearly stated that deficit spending stimulus in downturns must be reversed to deficit reduction starting once the next upturn is well underway. The weakness of keynsian theory implementation has been through fiscal mismanagement during recoveries and boom times. The same is true for supply-side tax cuts. Again the stimulus side of theory has been implemented without a deficit reduction correction in better times (excepting the late 1990's). The problem, as I have seen it, is that we have for the past 28-30 years overly depended on monetary policy for economic stabilization and not exercized effective fiscal policies. The success of Paul Volker early in this time period gave perhaps too much confidence in the ability of monetary policy to do it all.

Finally, Steve, I agree the biggest factor in straightening out this mess is time. On the critical side, though, I sense you are quite conflicted in your thought process and you did not really state that outright in your comment.

Balderdash and johngonole - - -

You both also recognize the importance of time in the correction process. You do not, however, offer any critical analysis of how your contention than keynsian stimulus can only extend the time to the bottom (johngonole) or how likely inflationary depression actually is (Balderdash). These potential problems you raise are subject to the same questions I asked at the end of my comments to the author, above.

Finally, the correct analysis is perhaps beyond our capabilities to carry out. (Beyond anyone or group?) We certainly do have a great time taking our stab at it though. After all, it is obviously a grand experiment to our policy makers, so let's keep looking at the experimental data.

2008 Dec 11 12:59 PM

[carey_jim:]

Just to add perspective and not to try to debunk or support any one economic theory, I think it is interesting that Austria, Britain and France were in the process of losing their world political and economic power when Keynes, Walras and the Austrian School rose to prominence.

Austria had just been reduced to a small province after being one of the most brilliant cultural and intellectual centers of Europe, certainly the rival of Paris if not superior to Paris. Britain was losing its preeminence to the United States and Germany was in, as it turned out, its death throws as a burgeoning world empire.

Marxism, in the form of the Russian Revolution and socialism in England, France and Germany (and even to some extent in the United States) threatened to engulf the entire world by the 1930s.

The Marxists themselves admitted that the Austrian school was the best defense of capitalism against socialism and Keynes expressly said that he constructed his economic theory to help prevent the socialists in England and Europe from taking control of the English and European economies. As we all know, Hitler claimed that Russian Communism was his principle enemy and that the Slavs were, along with the Jews, untermenschen which he wanted to enslave or exterminate.

We need to keep historical perspective. We are still not certain whether Soviet communism and European socialism failed because of a cold (economic) war which they lost, or whether the "collapse" of communism was due to its inherent weaknesses.

When we judge economic theories, we have to see that they are based on theories of human nature, of theories of morality and political theories and that these "theories" are also ideologies that are enforced by custom and law.

The history of religious rule should teach us that human behavior is not just a matter of economic theory, whether we are looking at the history of Catholicism, Islam or the Jewish diaspora.

As Hamlet said,

There are more things in heaven and earth, Horatio,
Than are dreamt of in your (economic) philosophy.

2008 Dec 11 02:21 PM

[Ferdinand E...:]

When you look at all those TEXTBOOKS in any library in any country in the world, Mr Smartypants, try to find something about 'Austrian Economics'. It's so rare as almost to be classified a crank concept, however please understand that I am not saying that you or the author of this article are wrong in dredging up this concept and trying to apply it to the present US economy. It may contain some useful advice, such as work hard, save, get to bed early, and stay away from prescribed substances. I only know that I taught macroeconomics for many years, from books that I and others selected, and I don't remember seeing ANYTHING about Austrian economics.

As for Mr Carey_Jim, Walras does NOT belong in this discussion at all. He has nothing to contribute, although I admit that I was fascinated by his work when I began to study economics, because for a few fool years it made me think that economics was as much a science as thermodynamics. But, if you are trying to say that history is as important in economics as mathematics, or for that matter more important, I agree completely. Moreover history is important in finance. As you may know, Shumpeter may be the best known of all the Austrian economists, but he also had qualifications in history, and once said that if he could it all over again, he would concentrate on history.

2008 Dec 11 03:31 PM

[carey_jim:]

Fred Banks: I was not passing judgment on any economic theories, from Marxism to polytheism, simply pointing out historical and other connections.

By the way, Joseph Schumpeter said that Leon Walras was "the greatest of all economists" but Schumpeter didn't use advanced mathematics which he thought was of marginal usefulness.

I put Walras' name on my list because the Austrians learned a great deal from both Walras and from one of his French speaking "students" Wilfred Pareto, not because I was defending the importance of mathematics in economics which is beyond my competence (even though I happen to be a mathematician and computer scientist by training.)

Also, for what it's worth, neither Walras nor Pareto (except in his later years) were popular with their contemporaries.

I made some comments on economics as a modeling science, in another post, if you are interested.

2008 Dec 11 04:28 PM

[happysoul77777:]

The problem with any economic theory is that nobody has been able to build an economic model that incorporates human behavior and regulations. Therefore, any prediction that is based on any economic theory is just an educated guess.

To cure the negative impact of de-leveraging is easy. Suspend the pro-cylical FAS 157 or modify it so that it won't erase the capital of financial institutions.

The problem of the securitization process begins when buyers do not want to buy plummeting assets (afraid of having to marke the assets down right away.) Prices keep plummeting, and sellers cannot sell their assets (receivables) through the securitization process at reasonable prices, thus the whole process stops.

The FASB accountants need to have common sense. They are doing the job for Al Quaeda without knowing it.

2008 Dec 11 09:49 PM

[John Lounsbury:]

Great discussion by some very knowledgable commenters.

A comment on the discussion topics of carey_jim, Fred Banks and happysoul77777: Discussion of economics as science and how mathematics is used (or misused) relates to a fundamental question.

Why is it that economics is strewn with theories and models, whereas physical science is defined by laws? I think the discussion here does a lot to answer that question. Good job.

2008 Dec 11 11:21 PM

[austrian63:]

Very interesting article and comments. To Mr. Harrison's article: I applaud your honesty in "confessing" your lack of belief that Austrian economics cannot offer any solutions to our current economic predicament although I disagree. Most economists, professional business people, etc. also do not believe Austrian economics has any validity. Let's look at it this way: Suppose we are following a map. Did Austrian economic theory or policies get us here? The answer is no. Did interventionist and Keynesian, or Keynesian type economic thoeries and policies, get us here? The answer is a resounding YES. If this is so, and I believe it is, how can Keynesian policies get out of here when the map leads us to where we are? We followed the map, and it was not an Austrian map, and we are now in a place we fear and do not want to remain yet you are recommending we continue to use the same map. Will it not continue to lead us in circles in the same place?

Mr. Harrison, you stated about the Austrian framework "But they leave me underwhelmed when it comes to solutions for when problems occur." You also state that "it is more the work of John Maynard Keynes and his followers that is likely to offer useful prescriptions." But was it not their prescriptions, intervention by politicians and government, massive money expansion via low rates and easy credit that made us sick? How will the medicine that made us sick suddenly make us well, i.e. cure us? My argument here is as much one of logic as it is economics. One of your recommendations is "Liquidate or merge moribund financial institutions." That is what Austrian economics would recommend but not what John Maynard Keynes or other interventionist economic policies would recommend. In fact, that is what happened to Lehman but earlier in your article you stated this should not have happened. I am a bit confused.

I understand your concern about massive job losses and political uncertainty however once again you have chosen to seek a cure from the very people and institutions that created current crisis. In fact I would describe Alan Greenspan as a Turbo-Keynesian and even some of the talking heads have lately criticized his tenure at the Fed as a disaster and a primary cause for our current situation.

If the jobs that will be lost if we "do nothing" can only be maintained if we "do something" then would it not be cheaper and more efficient to let the companies liquidate and then mail checks to the workers who lost their jobs? Think of the absurdity of keeping bad firms afloat with government funds merely so they can pay their workers salaries even though no one wants to buy the products or services they make. Just mail them a check if you want to "do something" but please don't funnel the money through the companies first.

I also disagree with your fear of deflation. When you take real estate and equities out of the mix where is the deflation? I have asked the following question several times on this site and received no reponses: Are your (1) homeowners and car insureance premiums going down? (2) food costs at the grocery store going down?, (3) medical insurance going down? (4) auto repair costs going down? (5) professional fees by the hour - attorney, CPA, etc. goling down?, (6) dentist and orthodontist costs - if you have kids - going down? (7) college tuition costs going down? This could go on forever but these are the costs most Americans must pay on a monthly basis and they are not in a deflationary spiral. Long term sustained deflation is not possible with a fiat currency.

The comments about Schumpeter and Austrians in general were good as they related to the Austrian school's skepticism re: economics as a physical science. Mainstream - Keynesian - economics, considers economics as a physical science that can modeled accurately by mathematics. The Austrians recognize this is not possible because economics deals with humans who act on free will whereas physics deals with atoms which do not act out of free will but are acted upon. Hayek called this the "pretense of knowledge." It always causes unintended consequences. In fact, the current "financial crisis" we are all talking and blogging about is the unintended consequence of that great Keynsian, Alan Greenspan, who colnvinced everyone who mattered that he could "manage" our economy and provide "soft landings." Ask the folks who worked at Lehman how much they enjoyed the managed economy and the soft landing.

2008 Dec 12 01:10 AM

[woodsey:]

Very thoughtful, Mr. Harrison. Thank you. I am much more simple minded though I have dabbled in economics ( e.g. Leontiev ). You get the drift. My take is as follows: During the Great Depression people took care of one another (I was there; mother fed the hoboes who never asked for food). That culture of caring was killed by the US congress in 1980. They passed a measure that effectively overrode state laws against usury. This was the signal that greed is good.

No matter what the outcome of the present crisis, greed will persist.

2008 Dec 12 11:35 AM

[Smarty_Pants:]

"I only know that I taught macroeconomics for many years, from books that I and others selected, and I don't remember seeing ANYTHING about Austrian economics." - Fred Banks

Is this not what I stated in my post? To repeat myself:

"I would be willing to wager that there isn't a single college level economics textbook in wide use that goes into any sort of detail regarding why the Federal Reserve is the cause of the boom / bust cycle or why creating money from nothing is in reality stealing purchasing power from all pre-existing money holders." - Prior Smarty_Pants comment indicating that Austrian Economic ideas are not presented

Those books you were allowed to choose between were screened via the 'rules' for use at accredited schools. Those rules were and are promulgated by folks who don't want to see a free discussion about whether gub'mint intrusion or regulation of the economy is a good or bad thing, or whether having a central bank issuing fiat currency is a good or bad thing. These acts are what underpin the political power over the economy and therefore, by the definition of the accreditors, are good.

To allow discussion of such concepts is to permit others to point out the faults in the "accepted" fallacies. Since Austrian Economics holds that fiat currencies and gub'mint regulation are a hindrance to the economy it stands to reason that you will NEVER see such things in a textbook.

In the same vein, you will never see a business license described as the local gub'mint's means of extorting money out of businesses, but that's what it really is. The local gub'mint in essence tells the businessman he must pay a fee to operate in their 'territory' or face financial penalties or arrest. The local gub'mint isn't providing any real service for that fee other than to defer possible violence until next year when the 'license' comes up for renewal (much like the mob's "protection" racket in the era of gangsters - pay us and we won't hurt you).

I am not trashing economics or the teaching thereof. I only wish to point out that the short list of 'allowable' ideas for teaching does not include Austrian concepts, much as there is little or no tolerance for presenting creationism vs. evolution, or natural climate variations vs. global warming, or seccession vs. slavery for the cause of the Civil War.

When it comes to textbooks, the deck is always stacked in the gub'mints favor. By design.

Just because a topic isn't found in a textbook doesn't mean it isn't closer to the truth than what does appear in the textbook. This is the point I was trying to make.

BTW, great discussion in general on this article. Lots of thoughtful input to consider and weigh.

2008 Dec 12 11:54 AM

[JEHeer6231:]

I understand where you're coming from when you say:

"I have always felt the Austrians are more useful for their economic framework. But they leave me underwhelmed when it comes to solutions for when problems occur."

In these economic conditions, it's very difficult to find a job. And while the Austrian advice of getting government out of the economy makes the most logical sense, most politicians/msm-outlet... do not want to hire/interview an economist that basically says government should stop doing what it's doing. Now, I probably shouldn't be so harsh on you, as you more than probably do have a decent job. I just can't stand this mentality that we have to be proactive for the sake of being proactive. As if this sense of "security" that results from government action is supposed to somehow magically fix the economy.

Now, you complain about the Austrian prescription leading to a deflationary spiral, but deflation is exactly what we need. Easy credit has allowed individuals, who normally could not afford to, to bid up the prices for land and capital goods. The easy line of credit to these individuals need's to be stopped with a sensible banking system (100% reserves), and these prices need to come down to a reasonable level (whatever the market decides).

2008 Dec 12 01:08 PM

[Robert Nabloid:]

I'm with smarty, every word of what he said from the Austrian economics not being taught to the fact that natural climate change vs. man made global warming is never given a thought! Our schooling, our education system, it's all lame. I'm a product of it. They only teach you what they want you to know - that much is crystal clear to anyone that thinks a little more independently and critically.

Austrian economics is the solution to this problem (this situation would never have arose under the Austrian system, so the Austrian system wouldn't need to worry about correcting it in the first place!!!!!!) BUT IT WON'T BE WITHOUT SEVERE PAIN. There is no way around the pain. The problem has been Keynesian economics all along. We never stopped using Keynesian economics and it has taken us too far off the real economic path - the proof is in the pudding and one need only look at where we stand today to see we got into problems with debt. It's almost like we applied Keynesian economics to our personal lives and were told we should all go out and personally get big loans and mortgages and buy consumer items we don't really need in order to "prop" up the economy. None of that was sustainable and to think more Keynesian economics will fix this is absolute nonesense.

The little guy can't get more loans to keep propping up the economy - and with many nearing the age of retirement it was going to come to an end anyways. No one in their right mind will take on more debt when they retire in just 5 years or less... People near retirement don't have future earnings to borrow against and now they don't even have much in the form of retirement savings either... the Keynesian system died but some are putting it on life support and giving it steroids hoping it will pick back up to prevent any pain.

The author was never a true Austrian economic believer or he would see how we NEED to get back to that and stop screwing around with Keynesian policies that never work - but only just buy time by passing the buck onto the next generation such as a pyramid scheme... the beauty of the Austrian system is that we would not be in our present mess had we used it. Using more Keynesian economics will not solve the problem either. We need to go toward Austrian economics - failure to do so will result in an eventually crash - it might not be this decade or this century - but it will happen as soon as the population stops growing. Infinite growth is not possible and not sustainable.

I'd rather have some severe pain or crash now and get it over with than delay it and end up with an even bigger crash later on. Keynesian economics died. We just don't want to admit it and hold the funeral. The truth hurts. You can't handle the truth! lol

2008 Dec 12 04:19 PM

[woodsey:]

You guys left out Marx. The crisis of overproduction ought to be considered.

Housing boom?

2008 Dec 12 05:02 PM

[mlyn:]

Since fiscal stimulus appears inevitable, a better and rapid stimulus might be in buying commodities for reserves like base metals, oil, natural gas, etc. because they are cheap now. Long term infrastructure completion takes too long for a fiscal impact.

2008 Dec 12 07:09 PM

[austrian63:]

Woodsey,

What caused the "crisis of over production in housing?" Were artificially low interest rates and easy credit partly to blame? The very type of intervention that Mr. Harrison now believes in caused the malinvestment the brought us to the current "crisis."

I guess we need a fiscal stimulus package so we can continue to allocate resources in ways that prolongs the crisis of over production.

2008 Dec 12 09:18 PM

[Brian Macker:]

Edward Harrison,

It's clear that you never actually understood Austrian economics. As an example this sentence.

<em>"In theory, each of these measures seem prudent. But, in practice, these measures would result in huge job loses, would induce further deleveraging and asset price declines, would deplete capital from an already fragile global baking system, and would lead to a probable depression of unimaginable severity."</em>

Banks don't hold "capital". They hold money, which are markers against capital. The capital is already "depleted". What's happening right now is a shell game to see who's left holding the bag. Republicans and Democrats have decided that those who are harmed by inflation will be left holding the bag, and certainly not the bad actors who precipitated this crisis.

So they print up seven trillion new markers against capital and hand them out to those who have already squandered massive amounts of capital.

The "depletion" actually a shortage, was caused by holding interest rates below market for a very long time. Price ceilings, in this case a price ceiling on interest, always cause shortages. That's because price ceilings do not allow the markets to clear. Under a price ceiling consumers, in this case borrowers, will consume more than would be produced by a free market, and producers, savers in this case, produce less than would be produced by a free market. The gap between savings and borrowing increases and the difference is made up by consumption of capital.

Why on earth would a Keynesian policy of lowering interest rates solve a problem that was caused by low interest rates?

The other "solutions" being acted on are similarly wrongheaded. Handing cash to bad financial actors is the wrong move.

Government spending on infrastructure is exactly the wrong move in a time of depleted capital. You don't work on your house when you are having a hard time getting enough to feed your family. Instead you work on generating food.

2008 Dec 13 11:00 AM

[Mark Anderson:]

Either you, sir, are a complete and total fraud, masquerading as a former Austrian, or you don't even understand Austrian economics, thus rendering your analysis as invalid.

You say that Austrians see that CREDIT is central to the business cycle. That is a gross contortion of our position. First of all, it isn't that anything is a PART of the business cycle. The business cycle is a wholly synthetic process, brought on by governmental interference with the marketplace.

Secondly, all credit is, is a way to invest. Austrians have never had a problem with CREDIT. What we have a problem with is INFLATIONARY credit expansion, which is wholly different than just CREDIT and that is where the seeds of the bust are sown. You see, investment MUST come out of savings, thus people must FOREGO present consumption in order to invest. The beginning stages of inflation trick people into believing that can both dispose of wealth (i.e., consume), AND INVEST IT. It doesn't work that way, since producers must be able to consume in order to sustain investment.

Your article demonstrates that you have NO UNDERSTANDING of the structure of capital.

2008 Dec 13 03:04 PM