how little they really know
about what they imagine they can design.
F.A. Hayek, The Fatal Conceit, 1988
The Austrian School of economics, for many years considered "fringe," or heterodox, has nonetheless proven startlingly prescient, as the quotes from two famous Austrians in the photograph above illustrates. Now, in the midst of the Great Recession, some attention is being paid once again to the school of economic thought that led Mises and Hayek to express their contrarian positions before the 1929 stock market crash.
The Austrian School of Economics
Briefly stated, the Austrian School argues that economics is a social science, rather than a physical one, that human behavior in the aggregate is so complex as to make economic modeling all but impossible, and that the proper approach to understanding economics is through the deductive discovery of fundamental laws of human action rather than through analysis of historical data.
Mainstream economists operate primarily from the latter, inductive, form of reasoning, while the Austrian School is built on a foundation of deductive reasoning from first principles, also known as axioms.
A simple example from euclidian geometry may prove enlightening. While it is possible to examine many examples of right triangles and develop the formula a2 +b2 = c2, the Pythagorean theorum can only be proven as correct in 100% of all possible cases through deductive reasoning based on first principles.
While we have yet to delve deeply into Austrian economics, many columns at The Tireless Agorist are written from an Austrian perspective, including a column about EconStories.tv that serves to illustrate the present differences between the mainstream and Austrian viewpoints. The Unseen in Economics - Part I, and The Perils of Paper Money are also worthy of note.
Bob Wenzel at the New York Federal Reserve
The recent increase in the respectibility of the Austrian School is exemplified by the recent invitation of Robert Wenzel to deliver a luncheon speech to the members of the New York Federal Reserve. As editor and publisher of EconomicPolicyJournal.com, Bob Wenzel is one of the strongest voices in support of the Austrian School today. This quote from his speech illustrates the fundamental conflict between the two viewpoints.
"I simply do not understand most of the thinking that goes on here at the Fed and I do not understand how this thinking can go on when in my view it smacks up against reality.His summation reveals the barely-concealed animosity between the two schools of thought as well, and gives you some measure of how the Austrian school views the current machinations of the Federal Reserve.
"In the science of physics, we know that water freezes at 32 degrees. We can predict with immense accuracy exactly how far a rocket ship will travel filled with 500 gallons of fuel. There is preciseness because there are constants, which do not change and upon which equations can be constructed..
"There are no such constants in the field of economics since the science of economics deals with human action, which can change at any time. If potato prices remain the same for 10 weeks, it does not mean they will be the same the following day. I defy anyone in this room to provide me with a constant in the field of economics that has the same unchanging constancy that exists in the fields of physics or chemistry.
"And yet, in paper after paper here at the Federal Reserve, I see equations built as though constants do exist."
The noose is tightening on your organization, vast amounts of money printing are now required to keep your manipulated economy afloat. It will ultimately result in huge price inflation, or, if you stop printing, another massive economic crash will occur. There is no other way out.Ron Paul vs. Paul Krugman
Let’s have one good meal here. Let’s make it a feast. Then I ask you, I plead with you, I beg you all, walk out of here with me, never to come back. It’s the moral and ethical thing to do. Nothing good goes on in this place. Let’s lock the doors and leave the building to the spiders, moths and four-legged rats.
Much of the revived interest in the Austrian School can be credited to Ron Paul, who has made Austrian Economics one of the cornerstones of his campaign for Presidency. In fact, he first entered politics when Richard Nixon ended the last link between gold and the dollar, in 1971. Throughout his long career in Congress, he has been warning of the risks associated with the current monetary system, including the spiraling national debt and the continual creation and destruction of asset bubbles such as the one that triggered the housing crisis. These predictions have their roots in Austrian Business Cycle theory.
For most of his career, the Austrian views of Ron Paul have been ignored and marginalized. That they are gaining respectability today underscores the failure of mainstream theory to explain the current economic crisis or to bring it under control.
Another example of the sharp differences between the two schools is apparent in the ongoing dispute between Ron Paul and Paul Krugman, Op-Ed columnist for the New York Times, and specialist in international trade theory. This dispute has been documented in a recent book, Ron Paul vs. Paul Krugman, Austrian vs. Keynesian economics in financial thought, by Jeremy Hammond. Jim Miles, reviewing the book at Foreign Policy Journal, gets directly to the core policy issue between the two men.
The central point under discussion here is the control by the government through its institutional affiliates of the interest rates. For Krugman, the simplified argument amounted to keeping the interest rates low in order to spur spending, and if that did not work, then lower the rates some more, and so on. Accompanying this intervention were and are the assurances given by the government—both rhetorically and in real financial support—that the financial institutions would be bailed out if the economy turned against them. For those with large amounts of unspent money, this would give license to deal with all kinds of risky financial behaviors.He then goes on to point out the fundamental difference between the two men, as exemplified by the their respective arguments.
For Ron Paul, his arguments were consistent and have been proven correct. Interest rates, subject to the market and its hopefully balanced demands for spending and saving, for building wealth and saving for the purchases of real goods that build the wealth, should not be held artificially low. Instead they should be allowed to rise and fall as the demands of saving and spending rise and fall.
Hammond quotes both figures extensively, comparing their words from one time to another time. In Paul Krugman’s case, it is a long series of changing his story, in one part to avoid responsibility for his part in the financial downturn, and for the other part—it is hard to ascertain—in order to sound like he still knows what is best, or what he is doing is correct. The differences between what he said at one time and says at a later date are numerous and obviously contradictory, and Hammond has no trouble juxtaposing Krugman’s waffling rhetoric.Based on my recent reading of this book, I believe that if anything, Miles is too kind to Krugman in his review. Krugman's non-stop support of ever-increasing government intervention in the financial system is glaringly apparent thanks to Hammond's compressing years of Krugman's cheerleading quotes into a rapid and insightful read. Highly recommended.
Ron Paul on the other hand is consistent with his message: we do not have free markets and we need to get to them. By controlling the interest rate and controlling and assisting the institutions with rules and bailouts, the free market cannot operate as it should, and by holding the interest rate near zero, we are only setting the economy up for an even bigger downturn in the future.
The three-minute video below presents many of the applicable statements of both Ron Paul and Paul Krugman over the last twelve years, an even tighter exploration of Hammond's thesis and Krugman's duplicity. Note particularly Krugman's calls for ever-lower interest rates from 2000-2007, one more drink for the drunkards until the housing collapse, when his song changed to "there's a serious market failure" requiring government intervention.
No mention that the market failure was triggered by the low interest rates he had been championing for the last decade; no mea culpa or admission of his role as the primary cheerleader for ever-lower interest rates, simply a cry for more government intervention to correct the problem created by government intervention. Krugman's solution to the weakness of the economy is to send the dollar along the path of the Continental.
One thing is clear: as the economic situation drags drearily along, mirroring 1929 rather than 1920, more and more people are awakening to the problems inherent in the current financial system, and more and more of them are aware of the reality behind the smoke and mirrors, thanks to Bob Wenzel, Ron Paul, and others working to expose the wizards behind the curtain -- and thanks to the Internet, which provides a medium of communication beyond the control of the gatekeepers.
As the latest "higher education bubble" continues to unwind, the housing market remains moribund, and the soon-to-be discovered "commercial real estate bubble" progresses, the argument for sound money outside the manipulatory control of the political system will become even stronger and more widely understood, and cheerleaders such as Krugman will have more trouble selling their particular brand of snake oil.
...and that's all I have to say about that.