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Christopher Mahoney
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I spent eight years at Bank of America in New York (1978-86) covering Wall Street, then moved to Moody's Investors Service where I worked for 22 years, covering banks, sovereigns and corporates. I chaired the Credit Policy Committee for four years. I retired in 2007 as vice chairman. PLEASE... More
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Capitalism and Freeedom
  • The Unsound Doctrine Of Sound Money 4 comments
    Mar 19, 2014 9:06 PM

    There is a dangerous economic philosophy which threatens both capitalism and freedom. Like most isms, it is not the product of centuries of encrusted tradition, but is instead, like communism and fascism, based upon a radical philosophy which casts aside most of human learning and seeks to restore an imaginary golden age.

    The Austrian School

    This philosophy is called Austrianism, or the Austrian School, after Ludwig von Mises, Max Weber, Murray Rothbard, and other ultra-libertarian economists (but not Milton Friedman, a monetarist). Austrianism can be described as radical libertarianism, the antithesis of marxism (in fact it is a reaction to marxism). It is predicated on the notion that markets are perfect, and that government intrusion is always an error from both an economic and moral perspective. It is extreme capitalism, what was known in the 19th century as liberalism.

    One of Austrianism's chief tenets is that fiat-money central banks are among the most pernicious aspects of government intervention, and should either be abolished or replaced with the gold standard, private currencies (Bitcoin) or, as a last resort, a zero-discretion policy of price stability (e.g., the ECB). In the Austrian view, discretionary fiat money central banks are the cause of economic and financial instability, not their solution.

    Austrianism turns Anglo-American economics on its head. Austrians believe that everything that Anglo-American economists (Fisher, Keynes, Samuelson, Friedman, Krugman) have learned and taught about money policy over the past 80 years is wrong. The edifice that is the modern financial system--a central bank which controls the money supply, a regulated banking system, the financial safety-net, deposit insurance, moderate inflation--is rejected.

    The Austrian golden age was the period before central banks and deposit insurance. Such a golden age was 19th century America, when the dollar was bimetallic, bank charters were sold like lottery tickets, deposits and bank notes were understood to be risk assets, the money supply was determined by the credit cycle, and the only role played by government was the minting of bullion into coins of a specified metallic content.

    The Business Cycle Is Prophylactic

    Less extreme Austrians, today's sound money community (see: Bundesbank, WSJ, Rand Paul) accept much of the architecture of today's financial system, except for the notion that an appropriate role for the central bank is to encourage growth, employment or financial stability. The sound money community argues that price stability maximizes long-run growth and employment, and that the business cycle (including financial crises) is natural, prophylactic, and necessary: the instrument of Schumpeter's creative destruction. The business cycle is seen as an essential element of capitalism. (Marx saw the business cycle as an inherent contradiction of capitalism: the periodic instability and depressions which impoverish the proletariat.)

    In the realm of abstraction, I am agnostic on the sound money question. I understand the rationale, that the business cycle is necessary and prophylactic. How can I say such a thing, given what happened under Hoover? Because the US operated successfully with a hard money system from 1791 until 1933 (excluding the Greenback Era). From 1791 until 1933, the US experienced price stability (the dollar price of gold remained unchanged at $20) and also brutal decennial "business depressions". Despite these depressions, average economic growth rates were very high by any historical measure.

    Those periodic convulsions were prophylactic, purged the system of inefficiencies, and made room for innovation and efficiency. Impoverished workers were the necessary collateral damage. Wages and prices were flexible, employment was volatile but tempered by wage flexibility. Instead of starving, workers worked for less. Victorian liberalism.

    Of course, much of the growth of the US economy over this 140-year period can be attributed to immigration, continental expansion and the industrial revolution. But the fact remains that the US enjoyed strong growth in the face of hard money and periodic deflations. Real growth often exceeded nominal growth, something unimaginable today. The golden age of hard money really did exist. It wasn't a golden age if your family starved to death (as many did in the 1870s and 1890s), but society as a whole prospered.

    Democracy And The Business Cycle

    The problem with the golden age of sound money is that it was accompanied by increasing universal suffrage: the masses were increasingly allowed to vote, and they voted for inflation, wage stability and job security. By the mid-20th century, the masses had won almost all of their demands: a dual-mandate central bank, counter-cyclical monetary and fiscal policy, the right to bargain collectively, unemployment insurance and wage stability. American capitalism accommodated itself to the democratic revolution by producing the New Deal, which went a very long way towards addressing the marxist critique of capitalism, and staving off the communist alternative.

    In 1947, Congress passed the Employment Act which ultimately led to the dual mandate for the Fed: not only price stability, but also economic growth (full employment). That is how we got to where we are today, when we expect the Fed to smooth out the business cycle and prevent depressions. Anglo-Americans live in a world in which the Quantity Theory is a given: by controlling the money supply, the central bank can determine the rate of nominal growth. All English-speaking central banks believe this.

    Keynesians like Krugman, Summers and Obama believe that fiscal policy is an indispensable partner for monetary stimulus, but they do not discount the importance of monetary stimulus. Austrianism is almost nonexistent within the US economics profession, and--aside from a handful of Paulistas--almost nonexistent in Congress. The American debate is between the Keynesians (fiscal + monetary) and the monetarists (money alone). No one in America, besides the Austrians, is arguing for a single mandate which ignores growth and employment. To paraphrase Richard Nixon, "We are all monetarists now."

    Germany Is Austrian

    In Germany, it's different. In Germany, both monetarism and Keynesianism are not only discredited, but seen as heretical. Most German economists and politicians--on both the right and left--are Austrians. They believe that price stability (the hard Deutschmark) was an essential component of the postwar wirtschaftswunder, and that price stability will--over time--bring the rest of Europe up to German standards of discipline and prosperity. The Germans believe that what is happening in the eurozone is prophylactic, that the excesses of undisciplined fiscal and monetary policies are being squeezed out, and that the faster they are purged, the sooner Europe will start growing again. Hence Draghi's constant refrain that the resumption of growth depends on deeper structural reform.

    What Germany wants to do is to to usher in a new golden age of sound money in which the business cycle is allowed to operate, wages are flexible, and parasitic state-dependency is abolished: Mellonism.

    Andrew Mellon, Hoover's economist, saw the Great Depression as necessary and prophylactic, and saw no reason to interfere with it. The millions of unemployed were necessary to drive down wages (now termed "labor market flexibility"). Mellon may not have been aware that the US money supply was contracting on his watch, but he would have agreed with the Fed that this was a natural consequence of the cycle: there is less demand for money during a depression.

    Our interwar experience was the opposite of Germany's. Germany experienced hyperinflation, while we experienced deflation. (Germany experienced deflation too, but doesn't choose to remember it; it was deflation that destroyed Weimar, not inflation.) Hence, Germany is Austrian, while we in the Anglosphere are all monetarists and/or Keynesians.

    The Anglos and the Teutons approach the macroeconomy from such different perspectives that we can barely talk to each other. Our universities teach economics differently, and we don't translate enough literature into each other's language. Germans don't use our textbooks and vice versa. Bismarck was right about the language barrier.

    The Fed's mantra is that it is doing everything it can to stimulate growth and employment, while the Bundesbank's mantra is that any attempt to use monetary policy to address the current eurozone depression is dangerous and will destroy the progress that has been made and remains still to be made. Imagine Janet Yellen explaining to Congress that high unemployment is a necessary feature of her monetary policy! Weidmann and Draghi have no problem explaining that high employment is a necessary consequence (or predicate) of structural reform. Our economists inhabit different planets and respond to very different public expectations.

    I won't say that Austrianism is wrong, per se, because it worked in the past and actually functions today in Hong Kong. What I will say is that, after the experience of the Thirties, those who desire to preserve capitalism and free markets must oppose Austrianism because it is the handmaiden of welfare socialism (Obamaism). Andrew Mellon thought that he was restoring the golden age, when what he was really doing was forcing the proletariat to choose between welfare socialism and starvation. The masses chose welfare socialism by a landslide, in five consecutive presidential elections.

    The Anglosphere has learned the lesson that depressions feed welfare socialism; Europe hasn't. Free market capitalism is being discredited in Europe today, as the masses are forced to endure penury in pursuit of "structural reform" and "labor market flexibility". The ECB's debt-deflation policy is a very blunt instrument to use against market rigidities and fiscal indiscipline. Fiscal austerity and structural reform--if they are really needed--must be offset by strong monetary stimulus, such that NGDP and employment continue growing. (The higher the rate of inflation, the less fiscal austerity is required, which no one on either continent understands.)

    Europe is (or should be) slowly learning what the Anglosphere learned 80 years ago: democratic capitalism requires prosperity and and a dampening of the business cycle. That means competent monetary policy which delivers moderate inflation and moderate nominal growth. Price stability in an environment of sticky wages is deflationary and leads to depression and welfare socialism.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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Comments (4)
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  • phil from Edmond
    , contributor
    Comments (192) | Send Message
     
    "Europe is (or should be) slowly learning what the Anglosphere learned 80 years ago: democratic capitalism requires prosperity and and a dampening of the business cycle."

     

    Isn't this the lesson the Social Democrats of Germany taught the Anglosphere?

     

    Thanks for your articles.
    21 Mar 2014, 09:42 AM Reply Like
  • Christopher Mahoney
    , contributor
    Comments (1137) | Send Message
     
    Author’s reply » Phil,
    The revolution against laissez-faire began in the Depression. In the US, you had the New Deal and FDR's reflationary policies. In Germany, you had Hjalmar Schacht and National Socialism, which pursued similar policies. In France, you had Leon Blum and the Popular Front. In Britain, you had Ramsay McDonald and Labour. The SDP came ten years later.
    29 Mar 2014, 02:02 PM Reply Like
  • phil from Edmond
    , contributor
    Comments (192) | Send Message
     
    Thanks for the reply. You only mention successful programs. There was a Social Democrat movement prior to WWI which would have been successful but for the war. Also, the Fabians in Britain.

     

    I enjoy your articles. The Puerto Rico series was insightful. Thanks
    9 Apr 2014, 10:17 AM Reply Like
  • blueice
    , contributor
    Comments (3701) | Send Message
     
    In your disclosure, you should have stated
    what your chief economic tenets are.

     

    You have entered a debate, without a personal
    declaration leaving the reader befuddled.
    2 Apr 2014, 09:26 AM Reply Like
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