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Austrians Don’t Blow Bubbles

Remember the golden days of 2007, when we were all investment prodigies? Though I couldn’t balance a checkbook or drive a car, I had raked in 25 percent increases each year on my 401k since 2001, so I felt like a bookish Donald Trump. While I worked as a college English teacher at a school with 70 students, the nice man from Fidelity showed me how I could retire in 20 years with a nest egg of $1 million—heady stuff for a doorman’s son who’d never checked his credit rating. Dinesh D’Souza had published a helpful book, The Virtue of Prosperity, which explained to America’s Christians how to gather a spiritual harvest through our era of endless prosperity, and Karl Rove was counting the chickens who would build the Republicans’ “permanent majority.” Of course, we were also bringing modern constitutional freedoms to the whole Islamic world, so news was good from the colonies.  All this, in the reign of a president for whom English was a second language. (Bush, sadly, had no first.)

We know now that all those paper profits that puffed our portfolios were as solid as tsarist rubles and that the “compassion” which briefly infused conservatism was a bribe to get a few thousand seniors to vote Republican once—in return for leaving their grandchildren eyeball-deep in debt. But wasn’t it fun while it lasted? Who could have possibly predicted that all the experts who carefully managed the investment boom, and the technocrats in academia and government who enabled and cheered them on, would wind up as deeply discredited as Bernie Madoff’s word of honor?

Harry Veryser’s lively and readable new book has the answer: the Austrian economists, that’s who. In It Didn’t Have to Be This Way [1], this economist and entrepreneur shows how the current morass was the unavoidable outcome of specific policy decisions, some of which reach back decades—and how thinkers of the Austrian school of economics, exiled from academia and ignored by policymakers, accurately predicted how the crisis would come.

The basic narrative is not in dispute: banks, under pressure for short-term profits and goaded by regulators who wanted to enforce racial equality in home ownership, made hundreds of thousands of loans to people who… had never checked their credit ratings. Some of them had gone bankrupt. Others earned less in a month than the monthly mortgage payments they’d soon have to make. Many were middle-class people who’d already mortgaged the homes they actually lived in; they bought additional properties they could never pay for but hoped to “flip,” on the theory that real estate prices never go down. Such loans, which any sane accounting would tally as worthless, were sliced up, repackaged, and granted AAA ratings, then sold as securities—and our retirement plans duly purchased them, which is why you and I will be working until we are 80. We all know this much.

What boggles the mind is how Harvard MBAs, Wharton professors, Federal Reserve chairmen, and other types who convene at places like Davos to plan the global future could have believed things would turn out differently. What would make someone think that worthless loans, all mooshed together then sliced thin and sold, would somehow acquire value? Did these people believe in magic? Statists like Paul Krugman and Alan Blinder who failed to see this catastrophe coming are emerging from the woodwork now to explain in retrospect that this implosion was the result of too little regulation—the natural outcome of free-market greed, unguided by the visible hand of Uncle Sam. Veryser shows that this diagnosis is pristinely, perfectly wrong, like an autopsy report that blames a lung cancer death on “not enough cigarettes to kill the tumor.”

What in fact tanked our economy was something quite simple that Veryser explains in satisfying  detail: politicians eager to win votes tried to keep the economy hyperstimulated by feeding it with ever more money. As a result, there was too much money floating around with no good place to go, so banks lowered their standards and made ever riskier loans. Such “mal-investments” were doomed from the get-go, and the longer government policies tried to keep the pyramid scheme standing, the higher the tab would get. What happened in 2008, Austrians know, was nothing new; in fact, such artificial booms pervade our history, from the ultra-low interest rates Alan Greenspan gave President Clinton—which puffed up share prices for the dotcoms of the 1990s—to the stock and real estate bubbles of 1927-28. Because they direct resources to places where they don’t belong, investment bubbles amount to little more than paying people on your credit card to dig a bunch of holes, then borrowing still more to have them all filled in. Yes, this does boost employment, for a while. But what are you left with in the end?

March/April 2013 [2]Veryser points to such key Austrian theorists as Ludwig von Mises, Friedrich Hayek, and Wilhelm Röpke, who predicted that bubbles and subsequent crashes were the unavoidable result of politicizing the currency—of cutting the last ties between the money supply and tangible assets such as gold. It should sober boosters of the Republican Party that the last such link to gold—and hence to real-world discipline on politicians—was severed by Richard Nixon in 1971. Veryser also shows how economic, political, and international turmoil can be traced, in part, to the meddling of politicians in the otherwise self-correcting mechanism of the market: it is no accident, he says, echoing Röpke, that the collapse of international trade in the wake of the Great Depression coincided with the rise of aggressive nationalism. Either goods will cross borders or armies will; the golden age of free trade in the 19th century made possible the “long peace” that ended in 1914.

There is much more in this book than a stark diagnosis of economic crashes and a solid case for restoring some kind of gold standard; Veryser shows how most of the key principles that mainstream academics use to understand microeconomics were lifted—often without giving credit—from Austrian theorists, whose faithful disciples are frozen out of universities as “cranks.” We see how the Austrians predicted the implosion of the Soviet Union even as Harvard professors issued textbooks explaining how the Soviet model “worked.” Best of all, Veryser shows how the insights of Austrian economics can be uncoupled from the “anarcho-capitalist” politics with which they are often bundled. Ludwig von Mises didn’t favor restoring medieval Icelandic anarchy, but rather the Habsburg monarchy. There is plenty of room, in other words, for social and religious conservatives to learn from the sober analyses of the Austrians—the only school of empirical economic thought that takes seriously human dignity, personal responsibility, and the role of the natural virtues in promoting the common good.

John Zmirak is author of Wilhelm Röpke [3] and The Bad Catholic’s Guide to the Catechism [4]. 

80 Comments (Open | Close)

80 Comments To "Austrians Don’t Blow Bubbles"

#1 Comment By EliteCommInc. On April 3, 2013 @ 2:08 pm

My comments as they are. I am still a huge fan of the gold standard — without a doubt, in my mind, Pres. Nixon’s mistake.

#2 Comment By John On April 3, 2013 @ 2:20 pm

@ petebrown

Austrians understand the immense complexity and heterogeneity of intertemporal capital structure. The injection effect of central bank credit expansion causes the newly created money to enter through capital markets.

It does not only have to flood exclusively into housing, but rather long-term interest sensitive production processes such as durable goods like autos, stocks (see current stock boom and the Nasdaq and dotcom bubble), bonds (see now), and yes housing (see now). The suppression of the interest rate below natural market determined level, realigns the production structure in a manner that is inconsonant with consumer preferences. The pattern of this malivestment depends on innumerable uncontrollable factors and subjective evaluations of market participants.

How could we see housing come back and stocks flying through the roof with nonexistent saving by Americans and investment 10 percent lower than its pre-recession peak?

The Great Depression and the subsequent intervention by Hoover and FDR and preceding stock market boom of the 1920’s is perfectly compatible and accurately described by Austrian theory. If you want to read the best worst on the depression see here:

[5]

Even more “mainstream” economists such as Harold Cole and Lee Ohanian understand how government meddling in markets, particularly labor markets, prolonged the depression. See here:

[6]

#3 Comment By petebrown On April 3, 2013 @ 2:25 pm

@ John

Thanks for the response. I agree that there are limits to a purely aggregate notion of the economy. This is why micro-economics are important too.

But the story of distorted interest rate signals is just not plausible though. If entrepeneurs are so good (heuristically) at guessing or rapidly adapting to consumer preferences in the future, they should then be equally attuned to guessing the future moves of central bankers. But they strangely are not. Austrians never really explain this one. Are businessmen and entrepeneurs who live in interventionist economies really unaware of the phenomenon of inflation/deflation and how these affect the value of money. commodities and fixed assets and that interest rates changes are possible? implausible in the extreme!!

Think about what you are saying. You’re claiming that the artificially low rates led bankers and house builders and so forth to systematically overinvest in mortgages and housing. There’s no question that low rates can be a stimulant for this in the short term. But are bankers and builders really so dumb to behave as though low rates will last forever as some immutable law of the cosmos? Do they not rather look at the price and availability of money and interest rates in exactly the same way that copper miners look at the price of copper or oil drillers look at the price of crude. They all know that reversals are possible and to plan accordingly, slow to ramp up production and quick to unwind, always monitoring changes in the market . Builders do this too ordinarily.

No, what happened in this case was that all over the world (after the dot.com bubble) liquidity flooded into bundled mortgages–not just in the US where rates were low but in Spain, Ireland and many other places. They threw caution to the wind not because they thought low rates would persist forever but because banks bundled junk mortgages into large packages and used sophisticated portfolio theory to convince themselves that individual default rates did not matter. They had figured a way to make money on mortgages that no one hitherto had thought profitable. They had turned lead into gold. And for several years it worked and because it worked businesses and consumers began planning around its continued working as buyers and builders all tried to get in on the action too.

But the underlying problem was there was tons of money in the world chasing after high returns that seemed safe. Equities could no longer provide those returns. And so financial engineers came to the rescue. We know how that ended. Now all that money has nowhere to go but into sovereign debt since the growth of the worldwide economy has slowed so much. It’s not clear what we do from here. But it is clear that the recommendations of the “Austrian school” has little to offer on this score.

You can’t lay this one at the feet of central bankers. The problem is much larger than them.

#4 Comment By skoobie On April 3, 2013 @ 3:02 pm

petebrown asserts that the causal link between falling home prices and recession is the exact reverse of the story I told. Actually I think we are both oversimplifying.

In the real economy there is no single, clear cause linking one event to another. Both pete’s story and mine can be true at the same time — falling house prices and a preference for saving over spending probably fed upon one another in a cycle.

At the risk of being tarred as an “austerian” I claim that this cycle of lower house prices was not obviously a vicious one. Something — some combination of forces — needed to bring house prices back down to a realistic level reflecting their actual utility compared to other economic goods. The hundreds of billions in paper values that vanished in 2008 was not actually wealth being destroyed — it was illusory wealth that never really existed in the first place. The Keynesian “fake it ’til you make it” recipe is simply not capable of arranging labor and capital in ways that can actually bring that level of real, tangible wealth into existence. The only thing it can do is drive malinvestment from one sector to another, in a succession of speculative bubbles. Which is exactly what we are seeing today.

#5 Comment By Kill Bill On April 3, 2013 @ 3:07 pm

I dont think any financial/economic model is perfect given the human instinct toward murmuration.

A big problem not mentioned here is that some 80% of all loans go to real estate purchases and not productive job creating businesses. Wall street no longer funds creation of industry.

#6 Comment By petebrown On April 3, 2013 @ 3:48 pm

@ John

I think I answered the part about the distortion of interest rates in another post.

But you ask:

How could we see housing come back and stocks flying through the roof with nonexistent saving by Americans and investment 10 percent lower than its pre-recession peak?

me: Well companies are profitable, despite the fact that there are 16 million out of work. There are enough paying customers to report good earnings which is the main reason stock prices have come back from their 2009 depths. One reason is that companies have trimmed their work force to the bone. With housing prices–where the have rebounded you will see that unemployment has fallen. That and the normal churn has cleared alot of the surplus including us who just bought a condo as a short sale.

But there is little or no inflation which is what you seem to be arguing. Long term spreads for TIPS bonds which are set by the market are only around 2% for the ten year. So the folks with billions on the line are not expecting much in the way of inflation in the medium to long term. Same thing with corporate bonds also set by the market.

And the absence of inflation despite monetary expansion has been one of the things that has convinced be that the gold standard folks and Austrians are seriously wrong with the way they view things. At some point their prediction of runaway inflation has to confront reality that expectations general price level rises remains very low.

I reluctantly have had to admit that Krugman was right that there would be no inflation when we were in a zero bound. Facts are stubborn things.

@Skoobie

Well you have to confront the fact that wealth is accrued by society exchanging goods and services for little green pieces of paper that have no intrinsic value at all but are treated as “money” because, well, people expect that they will be valuable to them to buy other goods and services. There is no “real tangible wealth” at all in the sense you seem to mean and has not been for a very long time, if there even has been. Truth is gold in the ancient world functioned just as dollars do today.

So we lost in 2007-current not “paper wealth” but wealth as real as any. When people feel the value of their assets dropping they tend to feel poorer and thus don’t spend and invest as they did. If a whole society does this or a big part of it does, the nation as a whole cannot help but get poorer.

Seen micro economically your salary is dependent on others consumption. If they stop spending your salary must fall too, which means that your consumption will fall too which causes the earnings of others to fall. Then when others get wind of what’s happening they spend less and save more for fear it will happen to them and it does because the people whom they are buying less from were also the source of their earnings. Vicious cycle. It’s not really that complicated.

This is how you reach an equilibrium with idle factories, laid off workers and customers not buying…no one has any money because hardly anyone is buying anything. You have customers who would like to buy, businesses who would like to produce, and workers who would like jobs–all who are idle simply because of a lack of flowing money in the system. No good comes from this…none at all. It is a deadweight loss of not of “wealth” but of “real tangible resources”–people, goods, factories etc.

The most straightforward way of combating this is by putting more money into the system. If customers have money again they will spend, businesses will ramp up production and start hiring and then their employees will have money to spend again. Virtuous cycle.

All this bizarre fixation on “real tangible wealth” (gold coins? hard money??) obscures the fact that money is a necessary lubricant to commerce. If there is too little in the system moving too slowly the economy will become artificially depressed. And this is bad all around.

#7 Comment By skoobie On April 3, 2013 @ 4:27 pm

@petebrown — Sorry if I confused you by using the terms “real” and “tangible” as modifiers to “wealth.” By “wealth” I was referring to things like automobiles, Ipads, and bottles of wine — not gold coins. In my lexicon, “wealth” consists of consumer goods and capital goods while “money” is something that can be exchanged for wealth. I can understand why you might see some kind of fixation on hard money in those comments, since Austrians are associated with those ideas, but that’s a discussion for another time.

I am aware of the conventional wisdom that injecting more money into the system will stimulate the production of wealth. This is what I call the “fake it ’til you make it” recipe, and in my opinion it is a recipe for malinvestment.

I disagree that “wealth” (using my definition) is accrued by the process of people buying things — regardless of whether they use gold coins or paper. I believe that wealth is created by production — Japanese assembly lines making automobiles, Chinese sweatshops making Ipads, Sonoma county illegal immigrants picking wine grapes, etc. And yes, I am aware of the Keynesian idea that “stimulating demand” will have a salubrious effect on these processes of production. I just don’t think it’s a very good way to stimulate those processes over the long run, because of its indiscriminate nature. Putting it simply, some kinds of production are more important than others, and stimulating aggregate demand does not recognize that fact.

#8 Comment By Jon Marcus On April 3, 2013 @ 4:40 pm

Correct me if I’m wrong, but weren’t there frequent panics and bubbles in the “golden age of free trade” that was the 19th century? Quite a few more that there were in the “over-regulated” 3/4 century between the Great Depression and the Great Recession?

#9 Comment By John On April 3, 2013 @ 5:11 pm

@ petebrown

“But the story of distorted interest rate signals is just not plausible though. If entrepeneurs are so good (heuristically) at guessing or rapidly adapting to consumer preferences in the future, they should then be equally attuned to guessing the future moves of central bankers. But they strangely are not. Austrians never really explain this one.”

Actually they do explain this phenomenon. Entrepreneurs are not omniscient eunuchs that are lightning calculators of pleasure and pain. They rely on relative price adjustments and differentials in prices of complementary factors and anticipated prices of future products. They are not infallible but respond to relative price signals and profit-loss accounting. If these are subverted and manipulated then they are prone to errors.

The rational expectations theory has become an aggregate variable describing all entrepreneurs as a homogenous blob of superhuman policy wonks. They are postulated as encompassing all the knowledge of Monetarist economists and armed with intellectual tool kit of the quantity theory of money.

This has led to implausible theory of perfect markets as wrongheaded as the extreme theory of constant market failure. The reality is somewhere in between and economic actors rely on many institutional arrangements (private property, relative prices, and profit-loss wealth calculus) that filter the decisions in a sound direction and coordinate economic activity. When the interest rate is falsified and arbitrarily pegged by a monetary politburo, systemic dis-coordination is engendered throughout the capital structure.

They cannot be in the head of monetary central planners like Greenspan and Bernanke.

“And the absence of inflation despite monetary expansion has been one of the things that has convinced be that the gold standard folks and Austrians are seriously wrong with the way they view things.”

Inflation is not absent and is significantly underreported. Commodities, producer goods index, stocks, houses and bonds are inflated and deeply manipulated by the Fed’s money printing bonanza.

Besides, Austrians believe there is a kernel of truth in the quantity theory of money, but they do not believe in the mechanistic Monetarist version where the general price level corresponds uniformly to the expansion of the money supply.

Monetary inflation is a process that materializes in a ragged means of relative price adjustments. Central bank credit expansion is injected in capital and money markets. Early receivers of the artificial credit are benefited at the expense of the late receivers who see their prices rise because of the redistribution effects of expansion of the money supply

Austrians and “gold standard folks” have predicted the patterns of these boom-bust cycles and asset bubbles and have gotten much more right than Monetarists or Keynesians.

“There’s no question that low rates can be a stimulant for this in the short term. But are bankers and builders really so dumb to behave as though low rates will last forever as some immutable law of the cosmos?”

Yes because central bankers and politicians tell them so. The interest rate and yield curve is being manipulated by the wizards at the Fed so investors follow their moves instead of responding to market prices that convey real information. Remember the so-called Great Moderation where central bankers and economists claimed they tamed the vaunted business cycle? That’s the signal the unsustainable boom is near its peak.

#10 Comment By petebrown On April 3, 2013 @ 10:22 pm

@ Skoobie

Thanks for your thoughtful reply. i would reckon wealth somewhat differently. It’s more the aggregation of real resources—human beings with skills and talents, a society that can cultivate talent and cooperation, factories that can make things, land that can yield useful crops, the natural environment, and yes money too. in fact in a modern economy there has to be money for people for the other thing to function.

Creating the right amount of money to prevent economic activity from falling artificially is not “fake it till you make it.” It’s what a central bank is necessary to do. Most of the time it can go on relative auto-pilot as long as inflation stays low and deflationary pressures are absent. But it is absolutely necessary to provide extra liquidity in times of financial panics. Because so much of our money in a modern economy is in various forms of fractional reserve accounts, things can collapse very quickly if people start demanding money very quickly and the fed doesn’t provide it. Then you have far worse problems than (hypothetical) asset bubbles: depression, war, civil unrest. It’s happened before and it will happen again. Then were going to need far more difficult interventions by the government.

Saying you won’t create more money in a panic because it might produce asset bubbles is like saying you won’t administer penicillin when someone has a life threatening infection on the grounds that in the long run the medicine itself might make the patient sick.

Austrianism is the triumph of ideology over common sense.

#11 Comment By petebrown On April 3, 2013 @ 10:54 pm

@John

Thanks for your reply.

You write:

They cannot be in the head of monetary central planners like Greenspan and Bernanke.

me: interest rates change, John, even under the gold standard. The fed only sets one rate–the interbank rate. All other rates are set by the market where borrowers and lenders effectively gauge the cost of money/ inflation premium that will be necessary to induce them to borrow and lend. no doubt there will be harm to the economy if central bankers behave in arbitrary ways. this is why modern banks try to behave in very predictable ways. But I think you’re ignoring the broader reality is that America over the past century has done as a whole very very well…despite some feckless central bankers and even a few colossal mistakes. We had far bigger mistakes by the fed in the 60’s and 70’s in terms of inflation. But we had alot of growth then too and no “asset bubbles.”

You write:

Inflation is not absent and is significantly underreported. Commodities, producer goods index, stocks, houses and bonds are inflated and deeply manipulated by the Fed’s money printing bonanza.

me: you provide no evidence for this contention at all and ignore mountains of evidence that cut against it. Commodities go up and down because of supply and demand too; increases in price are not necessarily indicative of inflation. You have in China 90 times as many cars as in 1990 and a similar story in Brazil and India. So is it any surprise that with many more people eating and driving more that prices for oil and food have tended to rise? There is no bubble in housing?!?! Check Case-Schiller.
In the stock market today the PE ratio is 17.5. Since 1890when the PE ratio was 26.5 the ratio has usually hovered in the 20’s though it has dropped as low as 5-6 . By contrast in the tech bubble the ratio was 35-46 and in 2007 the ratio got up to over 120. That’s what a bubble looks like. I’m sorry but you’re just seeing ghosts if you see a bubble today. No evidence for it at all despite that nutty fact free David Stockman op ed over the weekend. Its not to say the market cannot fall. But its prices today are not out of historic norms. Please John check historic price levels so that you don’t make assertions that are demonstrably untrue!!!

And if we are having all this inflation why is this not reflected in soaring interest rates. Forget “price indices” TIPS bonds explicitly price in expected future inflation. You can compare their rates to normal treasuries. The spread is a measly 2%. You simply can’t explain this on a hypothesis of run away inflation. And I can tell that you wisely haven’t even tried.

I don’t mean to be rude. But how is it Austrians see what people and institutions with literally trillions on the line don’t see. At some point this ideology needs to touch ground and examine some empirical facts.

And when you do you’ll stop being an Austrian.

#12 Comment By SGT Caz On April 3, 2013 @ 11:54 pm

@ petebrown

You were souding good until: “The most straightforward way of combating this is by putting more money into the system. If customers have money again they will spend, businesses will ramp up production and start hiring and then their employees will have money to spend again. Virtuous cycle.”

This can’t possibly work when labor has been so devalued that the newly printed money goes directly into the stock market and gets used to create new asset bubbles in commodities, as opposed to funding new businesses. The average American can’t benefit from a virtuous cycle if he has no part in it. If you said this somewhere earlier, then apologies, I must have missed it.

#13 Comment By skoobie On April 4, 2013 @ 2:49 am

You know how some left-leaning folks might look at the title of this website and reflexively assume its readers share every opinion of Rush Limbaugh and Ann Coulter? Some critics do a similar thing with the label “Austrian” — as if it were an all-encompassing philosophical worldview, rather than a perspective on certain economic problems.

Statements like “Austrianism is the triumph of ideology over common sense” and “examine some empirical facts… when you do you’ll stop being an Austrian” would be more appropriate in a forum like alt.politics.

#14 Comment By petebrown On April 4, 2013 @ 10:31 am

@SGT Caz

Well the relative share of labor in the total national income is kind of another issue. And yes…you’re right in the sense that maintaining enough money in circulation to keep nominal growth on a set trajectory does not solve all economic ills.

But the average worker is hurt immensely by monetary contraction. There is a broad consensus among economists across the spectrum that contraction is what caused the Great Depression and could have been combated much more effectively if we had not been on the gold standard or even if we had abandoned it earlier.

And I think if you read a good market monetarist blog like [7] you will find that workers have been hurt immensely in this recession by the slowdown in money velocity too, that has come because of the financial crisis. All this money that has been created is not causing bubbles. It has been sterilized. Banks are holding it on their balance sheet and are actually being paid interest to hold onto it. They’ve been given money and then paid rent to hold onto it…nice work if you can get it. If that money gets flowing in the real economy you’ll see the unemployment rate drop pretty quickly. No, it wont solve all the problems of low wages but its better than sitting on the couch everyday looking for jobs on Craigslist.

@Skoobie

I don’t mean to be offensive I really don’t. I shouldn’t demonize the term “austrian”. Hayek is an Austrian who has had a great deal to contribute to pricing theory for instance and of helping remind the dinosaur Keynesians of the importance of expectations feedback loops and so forth.

But “internet Austrianism” is simply toxic for the GOP, conservatism and the country as a whole on many different levels.

#15 Comment By skoobie On April 4, 2013 @ 2:22 pm

Adherents to Keynesian dogma are fond of asserting, with an air of dismissive superiority, that their economic theory is rigorously scientific, and thoroughly grounded in hard empirical data. You can hardly slog through one of Krugman’s columns these days without running into some form of that claim.

On the other hand, Austrian praxeology is said to be a bunch of superstitious knuckle-draggers, ignorantly scrawling magic incantations on cave walls, utterly divorced from the rigorous scientific method of Keynes.

Now the hallmark of a scientific theory is making falsifiable predictions, and testing those predictions against experiment. No theory can ever be proven absolutely true, but if a theory makes a whole lot of falsifiable predictions and fails to be proven wrong each and every time, then it can be said to be “empirically verified” in proportion to the number of times it’s stuck its neck out there and survived the trial.

I understand how good it feels to believe that you’re all modern and scientific, and your intellectual opponents are backward and primitive. I get that. But if you’re truly interested in the truth-seeking enterprise, and not just being on the winning side of Internet shouting matches, I really think you should dig into this question some more:

Exactly what falsifiable predictions does my theory make? How many times has my theory made a truly falsifiable prediction, gone head-to-head with the evidence, and survived the trial?

What evidence can I imagine that would shake my own faith in this theory?

[8]

#16 Comment By John On April 4, 2013 @ 2:45 pm

@ petebrown

We need less “internet monetarism”. You have not responded substantively to any of my critiques of your interpretation of data i.e. economic theory.

You have just thrown around a bunch of useless aggregates and price levels.

For example you wrote:

“The spread is a measly 2%. You simply can’t explain this on a hypothesis of run away inflation. And I can tell that you wisely haven’t even tried. ”

I never even mentioned runaway inflation. I said that inflation is underreported because the CPI does not include very relevant prices of food and oil. It also has changed the formula with a substitution method that conceals actual price increases of goods that have utility to consumers. We also export a lot of dollars and hence inflation, as well as recent interest payments by the Fed on excess reserves of banks.

Also, bond prices and yields run inversely and my point is that treasury yields are too low because of the Fed being the main purchaser and manipulator and hence inflated prices of treasuries and a bond market boom!

How is this not a distorted market?

Last:

“I don’t mean to be rude. But how is it Austrians see what people and institutions with literally trillions on the line don’t see. At some point this ideology needs to touch ground and examine some empirical facts.”

How come people like you have not thoroughly investigated the Austrian Theory of the Business Cycle. It has predictive and empirical validity, albeit in looking at patterns of phenomena. When was the last time the Monetarist or Keynesians (do I repeat myself) predicted or diagnosed a speculative bubble? Milton Friedman’s monetary theory was wrong about the Depression and he missed the most recent boom in Housing and on Wall Street.

Again, how did be people get with “trillions” of dollars engage in speculative mania in the Housing bubble, Nasdaq Bubble, the gyrations on Wall Street in the 90s with Long-Term Capital Management and Mexican bailout, Stock market crash of 1987, stagflation of the 1970s and Fed generated credit and stock market boom of 1921-29?

The interest rate is extremely crucial price and when it is fixed artificially low by the Fed it generates excessive consumption, debt, leveraging, malinvestment, distortions of relative prices, falsification of profit-loss and wealth calculation. People respond to prices and incentives and are not omniscient like you assume.

Do you really believe the interest rate determined by the Fed does not filter out and influence the complex array of interest rates on the market?

At some point you need come to grips with reality, but let us agree to disagree.

#17 Comment By John On April 4, 2013 @ 2:49 pm

@petebrown

One caveat. Some Keynesians actually call for a strong inflation and housing bubbles. So I guess they inadvertently diagnose and encourage the business cycles (see Paul Krugman).

#18 Comment By petebrown On April 5, 2013 @ 10:45 am

@ Skoobie

You write:

Exactly what falsifiable predictions does my theory make? How many times has my theory made a truly falsifiable prediction, gone head-to-head with the evidence, and survived the trial?

me: well, what about the part about constantly asserting either that we have high inflation (that strangely none of the market indices measure) or were are about to get runaway inflation. Yes, the gold crowd has been on that one since back to the second Bush term in fact and the chorus has only grown louder since the financial panic How long before the statute of limitations runs out on that prediction? Inflation is at a postwar low. This whole thing is like yelling fire during day 27 of Noah’s flood.

@ John

The ABC cycle theory fails on its own terms. It’s predicated on the assumption that guys like you have figured out that the “spiked punch bowl” will one day be taken away but that all the actors in the field somehow are too blind or stupid to realize this.

Hint: beware of esoteric theories that purport to contain secrets that are outside the ken of the rest of the world.

Markets are now forecasting very anemic growth and very low inflation. (you also ignore the fact that i refuted your assertion that the stock market is a “bubble.”) Folks buying trillions of treasuries know better than you that the fed is buying some of these on the secondary market and have already factored in the implications of this for the value of the nominal dollars with which they will be repaid. You know nothing that these guys don’t. (And frankly I think you should entertain the possibility that they know things that you don’t.) And right now they are willing to lend at practically zero real interest rates because they don’t see much growth or inflation and just need a safe place to park money.

Is it possible that they are drunk again from all the “spiked punch”? I suppose. Markets can be wrong. Indeed maybe they will change tomorrow to call for higher nominal growth and higher inflation. The trouble with your theory is that for it to work they not only have to be wrong this time but have had to be wrong consistently over decades and you have to be in possession of secrets of the temple that ought to have made you famously wealthy by now.

Put your money on the [email protected] John [email protected] Skoobie. If US treasuries are really the mother of all bubbles waiting to burst as you seem to think or as ABC theory seems to tell you, go way way short on them!!! Then when investors from all over the world figure out that you were right all along and yields soar and you both become sultans of brunei, I’ll become an Austrian.

But beware….contrarianism has a few who’ve made great riches…but a cellar full of many corpses.

Cheers

#19 Comment By Barry On April 5, 2013 @ 10:54 am

And if we roll back through the 1800’s, with less and less government intervention, we still find booms, busts and crashes.

For the USA, at least, the post-New Deal situation was far better than the pre-New Deal situation.

#20 Comment By petebrown On April 5, 2013 @ 11:08 am

@John @Skoobie

One other thought. Go back to your assertion that the stock market is a bubble. It’s not of course by historic standards but nonetheless you and David Stockman and others think that it is

Still the market might collapse to close to its historic lows at say 5-7 PE ratios that we last had in the early 80’s.

But what will be conclude from that? Nothing really. It does not prove that it was a bubble before the crash and neither does it prove that it now at its correct levels post crash.

The moral of the story is that 1) not only is it hard to know when assets are increasing in price because of fundamentals (better earnings, long term growth prospects etc.) or because of speculative mania fueled by too much money, or too many animal spirits or whatever 2)conversely it is hard to know when falling assets are falling because of fundamentals (bad earnings and prospects) or because undue pessimism has befallen investors.

In short Skoobie before you go around touting past “bubbles” as vindication for the ABC theory ask yourself (as an empirical control)”how do I know what a “bubble” really looks like in the first place? How do I know that many of the alleged “bubbles” were not simply 1) large bad business decisions that soured quickly once new information became available (which is the market working not a “bubble” bursting) or 2) an undue bout of panic that ignores salutary long term conditions (the 1987 crash which had no lasting effect is a good example of this one as is the “flash crash” in 2011) and not a “bubble” at all.

#21 Comment By Craig On April 6, 2013 @ 8:08 am

krugman, dean baker and others repeatedly warned greenspan in 2006 that a housing bubble might be looming. they noticed that house prices had gone up much more than incomes but that rents hadn’t. so it was obvious to them that demand for houses was largely speculative. greenspan replied that you only know if you’ve got a bubble after it has burst and that, in any case, raising interest rates was a blunt instrument which would harm other parts of economy. krugman et al responded that there were many ways of taking heat out of housing market without raising rates eg: lowering loan to values. greenspan didn’t respond. it’s of note that greenspan got his job because he was willing to go along with derugalation. volker wasn’t , and lost his.

If bubble and crash were caused by too much money slushing around how come inflation was so low, and still is?

#22 Comment By Craig On April 6, 2013 @ 11:09 am

tying dollar to gold was not particularly effective in preventing bubbles/bursts but Glass-Steagal Act was, for about 30 years; separating bank lending from speculation is the only tried and tested way of minimising this problem. breaking up banks which are too big to fail would also help, or at least making them pay an insurance premium for luxury of being too big too fail. economists estimate this premium should be about $ 60B pa. in a free market system the tax payer should not have to gift $ 60B to Wall Street, every year. the problem is Wall Street doesn’t like free markets because it impacts on their profits and with their lobbying power they will be able to continue distorting markets indefinitely.

#23 Comment By ottovbvs On April 7, 2013 @ 9:07 am

Actually it’s a matter of record that in 2005 Krugman was predicting a major housing bust. He may not have understood at that time the extent to which securitization of real estate debt and speculation in it would extend the crisis throughout the financial system but by early 2007 he and several others certainly had and were warning of the dangers. Heck even I’d figured it out and was acting accordingly. By contrast most conservatives and Republicans were engaged in happy talk for the entire period 2004-2008 and amazingly some were still bullish in the spring of 2008. Unfortunately, this commentary is filled with similar questionable assertions. From my personal experience I visited the Soviet Union for commercial reasons several times in the 70’s and it was obviously moribund. Alas the entire Austrian theorem is undermined by the simple fact that since the dawn of modern capitalism at the start of the 18th century “perfect” markets have never existed and it’s a pipe dream that they ever could. I also find unpersuasive the assertion that looser regulatory regimes and adherence to the gold standard would magically smooth economic cycles. Didn’t seem to work in the case of the Jay Cooke crash of 1873 which ushered in a slump that lasted for 20 years; the 1907 panic; or the mother of them all in 1929.

#24 Comment By Lese Majeste On April 8, 2013 @ 5:35 am

Until we get rid of the illegal and immoral Federal Reserve, we will continue to have these boom-bust cycles, which keep stealing money from the poor and middle-class and give it to the rich and super-rich.

There’s no sane reason why Americans should pay around 400 BILLION a year in interest to the private banking families that own the FED, interest paid to borrow OUR OWN MONEY.

#25 Comment By Craig On April 8, 2013 @ 11:58 am

Some argue against QE because “the markets know best” and so the FED shouldn’t lower bond rates – only the rational market should decide on bond rates The very same people also claim that the 20% drop in bond rates between 2000 and 2006 caused the 100% rise in house prices over the same period, and so caused the crash. But if that’s true, then the markets were very irrational (a 20% rate drop can’t justify a 100% house price increase). So the markets didn’t know best at least during this period. In which case what’s wrong with QE?

#26 Comment By Craig On April 8, 2013 @ 12:18 pm

Lese Majeste: you are righter than you think. When the Fed prints money to buy bonds, the coupons the Fed receives on these bonds are paid largely by people earning around the median income, including people not working and on benefits who don’t pay income tax but pay other taxes. Their income is their total benefit package. So we are talking about people earning about $ 20K pa. Because the Fed is privately owned, this means that a lot of poor people are paying money to fewer very rich people and they have no choice about doing it and get nothing in return. What kind of “free and fair” transaction is that? Doesn’t sound like capitalism to me – more like legalised theft and, what’s worse, from poor to rich. God help the American people. I hope we in Britain never end up like you.

#27 Comment By Craig On April 8, 2013 @ 12:27 pm

before someone thinks my last 2 posts contradict each other, i should add that there is nothing wrong with QE as long as the Fed is not privately owned. It’s a useful tool . But if Fed is privately owned , then QE is theft.

#28 Comment By skoobie On April 8, 2013 @ 2:33 pm

Pete at least deserves credit for doing something that Krugman has been unwilling to do: he has given a specific, concrete real-world condition that would cause him to change his mind about theory.

So if interest rates on US Treasuries ever “spike” above zero again — from now until the end of time — Pete has agreed that he will become an Austrian.

Fair enough.

#29 Comment By Chick Dante On April 12, 2013 @ 5:08 pm

Clint: Mr. Wallison was the General Counsel in the Treasury from 1981-1985 under Ronal Reagan. Ironically, the Father of Reaganomics was an Assistant Secretary of the Treasury named Dr. Paul Craig Roberts. He is an actual economist, Phd holder, former editor of the Wall Street Journal editorial page, and professor. He was actually instrumental in helping to solve the problem of ‘stagflation’ through a correction of Keynesian demand side economics by balancing the supply side. At any rate, he often describes the 2007 Recession (which officially started in December of that year) as being caused, at least in party, by the collapse of the housing bubble which, in turn, owed much to deregulatory capture by mega banks and other elites. He describes the world economic crisis today as the 1% stealing as much as they can from everybody else. Though formerly a Republican and a conservative, this narrative agrees with many, many other economists including Michael Hudson and especially Dean Baker both of whom Dr. Roberts has made mention on several occasions.

Here is a video in case you are interested:
[9]

And for more info, How The Economy Was Lost and The Failure of Laissez-faire are Dr. Roberts’ most recent books. Anyone on this site is highly encouraged to check out this important figure in American history.

#30 Comment By Craig On April 13, 2013 @ 12:36 pm

If you like Dr Roberts video you will like “Stiglitz – The Price of Inequality” on youtube (50mins)