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Discussion: (7 comments)

  1. Seattle Sam

    Governments are like the rich playboy who has lots of daddy’s money to blow on drunken spending sprees. The Fed acts like the butler whose job is to be a designated driver, trying to clean up his messes and make sure he doesn’t kill himself in a car wreck. All the while enabling the playboy to decide he never really has to grow up and deal with the consequences of his actions. Of course, at some point daddy’s money is exhausted. Then what?

  2. Austrian theory does not require “tight” money; as a matter of ECONOMICS, “tight” money does not generate unemployment or economic decay; and, the ECB is not proceeding according to Austrian theory. Hence, everything said here is wrong.

    But, before focusing on that, let’s focus on what’s right:

    IN AN OSSIFIED SYSTEM DIRECTED AT PRICE STABILITY, “tight” money can lead to unemployment, and that’s precisely what Britain had in the 1920s and 1930s. This is what led Keynes to develop his general theory, but when we analyze that theory, we realize it is not “general” at all because it rests on the assumption that the ossification (a byproduct of legal convention) is given and immutable, similar to a law of nature.

    Clearly, that is not true (all laws can be changed), so the General Theory is an HISTORICAL theory applicable to Britain (and anyone else) who tries to impose “price stability” (including wage stability) on a market BY FORCE.

    Such an understanding does not make reading Keynes today worthless (our systems today are very ossified, and Keynes really is quite bright). But, it does impose upon Keynes a limitation which makes him something other than a pure economist. Keynes is writing general HISTORICAL theory.

    Austrian theory, employing the method of praxeology, undercuts the historical record to develop purely economic laws. In so doing, it differs from “economic analysis” today by eliminating the artificial barrier to analysis imposed by panphysicalism and its resort to the methodology of statistical physics. Notice the difference:

    Statistical physics faces the absolute barrier of the quantum, which cannot be penetrated by any examination due to the complimentarity in the Fourier transforms. However, we do know that whatever the laws of nature that determine the quantum, they are laws of nature and, within our time and universe, immutable absolutes. Statistical analysis therefore works well on such a system because the underlying conditions never can be changed.

    It is different in economics. Yes, Keynes and the statistical approach of macroeconomics can tell us some things and allow us to predict others with some certainty (and that’s not bad). But, by founding this discipline not on the fundamental truth of human action but, instead, on the circumstances of an HISTORICAL record, macroeconomics never can be a science and instead only can be an exercise in history. Furthermore, by cutting itself off from the genesis of history, it never can penetrate the underlying foundation which, unlike the world of the quantum, is mutable at human pleasure.

    Austrian theory is not so limited, because we KNOW the underlying rule of human action (where action is defined as “purposive behavior”). Austrian theory therefore is the one theory which can analyze the historical underpinnings.

    Austrian business-cycle theory does not require “tight” money. What it tells us is what happens when the free market is frustrated by price fixers. The Fed’s failure does not lie in keeping interest rates low; the ECB’s failure does not lie in keeping interest rates high. The failure of both lies in their efforts to keep interest rates at a level OTHER than the level WHICH WOULD EXIST on the free market. No statistics ever can analyze this because no statistical approach can address data which does not exist. Before there can be a statistical array, there must be an array.

    John Hicks (certainly no Austrian) made the observation (in Capital and Time) that, for any viable concern, a depression in the pure rate of interest will raise the value of all capital possessed by the concern at every point along the input-output curve. (This is his Fundamental Theorem of Capital.) The result (when the rate is depressed) is a capital gain, and if anyone wants to see a classic example of this, look at the history of Union Pacific stock during the last five years. This is a company which is a great company with progressive management, but it does haul goods for eventual sale, and its stock has quadrupled in a depression!

    That cannot be the result of success in U.P.’s core business.

    Now, the problem here does not come from having a “low” interest rate. Rather, the problem is generated by an ARTIFICIALLY low interest rate. It is the credit expansion generated by the Fed, in the course of running its paper-money fraud, which drives down the rate and bubbles the value of U.P.’s capital plant. Everyone with U.P. stock is happy as a lark and dancing on the table top for as long as the interest rate remains ARTIFICIALLY low. After all, Bernanke & Co. are giving us “free” money!

    But, what happens when the Fed is obliged to raise interest rates higher?

    The answer (per Hicks, not just the Austrians), is that now the physical plant of U.P. is worth less, and the value of the stock declines because of the capital loss. Then the faces of all the U.P. train nuts (like me) turn sour, especially if we were lured into buying the stock when it was being artificially inflated. We have become victimized by a bubble.

    These kinds of asset bubbles appear in all sectors of the economy influenced by ARTIFICIAL interest rates. (Notice that I did NOT say “high” rates or “low” rates but “artificially high” or “artificially low” rates — it is the meddling with the free market which is the sin here, not the level of the rate.) In 2007-08, the bubble was focused into the housing market, and when the bubble had to be popped, everything blew up.

    The EU is going through that same crisis now, but with some significant differences. In Greece, the banks were leveraged into unsustainable sovereign debt which eventually Greek taxpayers would not support. Greek (and eventually Cypriot) banks with major exposure here then collapsed, imposing a drag on the rest of the banks tied into the system. In Spain, there is the added drag of a housing crisis of their own almost identical to what we experienced here, and this has led to the collapse of some of Spain’s big banks, further weakening everyone.

    Now, it is a principle of banking that, under fractional reserve, a banking system can create money from thin air by counting some of the money more than once at the same time. This is an accounting trick supported by a legal flaw (“money deposited with a banker belongs to the banker, regardless of the form of deposit”); and, it allows the money supply to be inflated artificially by as much as the reciprocal of the reserve requirement.

    This also artificially can depress an interest rate (by artificially increasing the supply of loanable funds), and it’s what a central bank manipulates when it engages in open-market operations.

    What then happens should a big bank fail? Then all of the money created by its accounting trick is annihilated in the bankruptcy (it never was more than a book entry to begin with), and systemically, a violent contraction of the money supply can occur, leading to a new money relation and, in effect, a raising of the general wage rate. If the system remains ossified, so that the wage rate cannot adjust rapidly downward, then the Keynsian HISTORICAL condition is satisfied, and widespread unemployment will result.

    That is what we are seeing in Europe today.

    Why not just have the ECB step in and refloat the system with, e.g., QE forever? Because the ECB is controlled NOT by Austrian theorists but by the international treaty which erected the ECB. That treaty is designed to PROTECT the taxpayers of one country from depredations by other governments party to the treaty but unwilling to discipline their financial ac tivities by the treaty’s requirements. So, the range of action allowed to the ECB is far less than the range of action which can be employed by the Fed or Bank of England. The ECB must be concerned (by law) with the danger of “break-out” inflation, and it also is required to discipline member states which refuse otherwise to comply with their international obligations.

    That’s not bad! After all, why should German taxpayers have to bail out Cypriot banks on behalf of Russian depositors who have parked their money in Cyprus precisely to avoid Russian taxes? The problem is not, and never was caused by “Austrians.” Rather, what we have here is a problem generated by the inherent inefficiency of European socialism coupled to the underlying legal flaw of fractional reserve. (Technically, that’s not even a central-bank problem — as I’ve said elsewhere, central banks EXACERBATE these situations, not cause them.)

    Austrian theory is not responsible for the problem. Rather, Austrian theory allows us to analyze the problem stripped of the artificial barriers erected by panphysicalism and (one would hope) eventually fix it!

    1. Simply wonderful explanation for the uninformed Keynesians.

      I kinda think it’s time that Pethokoukis broke down and READ something by the Austrians before he asserts that what they believe about economics won’t work. I also have to wonder what a Keynesian is doing on a Conservative website. Do his managers simply not understand his gross limitations?

    2. juandos

      Thanks for that explanation…

  3. James Ashby

    A gold dollar, a gold euro and no central banks is what’s needed. The public controls prices, not government, all that matters is what the dollar and the euro are, fiat money or not. Fiat-money supporters’ price-haggling and price-control schemes are all in vain.

  4. It’s too bad AEI doesn’t still have Allan Meltzer to provide analysis of central banking policy.

  5. Oddly enough, Hayek believed that barring private money, the best option was NGDP targeting.

    Meanwhile, in today’s enlightened conservatism, saying such words automatically brands you as “a Keynesian” (the irony is delicious).

    And, of course, the way forward is commodity money – because demand-side deflation never hurt anyone, right ?

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