ABCT Investing is based on the Austrian business
cycle theory, so I become mildly concerned when others criticize the
theory. I never become seriously concerned because I have learned over
the years that most critics are unbelievably lazy.
If they bother to read Mises or Hayek they do so through the lenses of
mainstream econ and fail to understand what the authors are actually
saying.
The Social Democracy blog has posted a long
diatribe against Ludwig von Mises, which I would normally ignore had
Paul Krugman not advertised it. Krugman even gets wrong much of what the
blog says, but the blog gets a few things wrong
so here are my responses:
Natural rate of interest
The blog is right that the “natural rate” of interest
doesn’t exist. Of course, neither does “equilibrium.” Both are
theoretical constructs to help us think about economics. Wicksell
defined the natural rate as
the rate of interest in a barter economy. Interest would exist if we were forced
to barter goods because interest is nothing but the opportunity cost of
giving up the use of something for a period of time. Austrian economists
picked up on the idea as a useful way to
explain how interest under barter differs from interest using money.
It’s a teaching devise. But if you don’t like it you can ignore it. It
helps teach the ABCT, but has little importance to the working of the
theory.
Mises and fascism
Like
FDR, Mussolini advertised himself as a defender of free markets and an
opponent of communism before he assumed power. Mises took him at his
word
and in 1927 congratulated him for defeating communism in Italy.
However, like FDR Mussolini turned into one of the greatest enemies of free
markets in the 20th century. Mises did not foresee the sharp turn to the left that Mussolini took.
The
last two sentences of the Mises quote are “Fascism was an emergency
makeshift. To view it as something more would be a fatal error.” Mises
criticized
fascism and communism consistently in most of his writing.
No
one claims that Mises was infallible. Keep in mind that the great
Keynesian economist Paul Samuelson praised the USSR in the last edition
of his bestselling
economics textbook before the collapse of the empire in 1989. Samuelson
claimed the Soviets would become wealthier than the US. Does
Samuelson’s blindness to the faults of socialism mean we should ignore
Keynesian economics? The author’s attack was
ad hominem and he should know better.
Business cycle
Krugman wrote:
First of all, as the blog tells it, von Mises, faced with the reality of depression, basically dropped Austrian business cycle theory...
Krugman is factually wrong. Mises
never abandoned his business cycle theory. The Great Depression was the
worst financial and economic crisis in the history of the US. The state
had created the Fed in 1913 to end the typical depression of the 19th
century, but the Great D was several magnitudes worse than anything any
economist had ever seen or read about. It went deeper and longer in the
US than in any other part of the
world, even though the US had tried Keynesian style state intervention
long before Keynes wrote his famous book.
Mises
and Hayek wrote that their business cycle theory could explain the
beginnings of the Great D, the primary depression, but did not explain
the tremendous
depth and length of it, which they called a secondary depression. Other
factors had to be considered in addition to the Austrian theory,
not in place of it. They correctly identified the problem of high real
wages as a major factor. Later, Keynes agreed
with Mises and Hayek and recommended using monetary policy to create
inflation and drive down the real wages of union workers in order to
boost employment. Even Krugman would admit that the whole point of the
Fed creating price inflation today is to reduce
the real wages of workers and goose employment.
The
Great D was so bad that it took decades for economists to figure out
what happened and most, like Krugman still haven't. Chief among the causes was the Smoot-Hawley tariff that
destroyed
international trade. Austrian economist Robert Higgs has written about
regime uncertainty, the uncertainty caused by rapid increases in
regulation by the state, as another major cause of the lack of
investment.
But
Hayek had the best explanation in my opinion – capital destruction.
Modern jobs require capital equipment. Few jobs exist for pure manual
labor. The
malinvestment of the boom, and the collapse in international trade,
destroyed the value of a great deal of capital plants and equipment. It became
worthless. Those who depended on that capital for jobs became
unemployed. It would take more than a decade for businesses
to save enough and rebuild new equipment in other industries before
employment could come back.
“The solution, then, for Mises was eliminating unemployment relief (presumably forcing the unemployed to starve and accept lower wages)...”
Of
course, the author wants to paint all Austrians economists as heartless
and wanting to see the unemployed starve to death. Another
ad hominem attack. Keep in mind that wages were too high relative to consumer goods. Prices,
especially of food, had fallen dramatically while wages had not. The
author should understand that is the meaning of “high wages.” So if
workers took lower paying jobs they would not starve. Their standard of living would remain what it was before
the depression.
“How else could such suppression of trade unions be realistically achieved except by government coercion?”
Well, you could do as Keynes recommended: print money and create price inflation to reduce real wages.
“Whatever lowering of demand for labour that might have been caused by higher wage rates during the depression could have been overcome and rendered irrelevant by effective expansion of aggregate demand.”
So
the author is saying that Mises is wrong because Keynes was right.
That’s pretty much Krugman’s response as well. The author takes it for
granted that
1) the state or Fed can cause aggregate demand to expand and 2) if such
expansion was possible it would turn excessively high wages into normal
wages.
Of course, the debate between Austrian and Keynesian economics
is whether #1 and #2 work. Austrians say
the economy doesn’t work that way. In fact, Austrians say that
increasing demand for consumer goods is what kills the recovery. The
author assumes his conclusion, another common fallacy with Keynesians.
The US tried Keynesian policies long before Keynes wrote his book, and they failed to end the Great D. See Robert Higgs for a debunking of the myth that WWII ended the Great D. The failure of Keynesian policies during the Great D should have resolved the debate. If not, the failure of Keynesian policies in the 1970’s and since 2008 should have shamed Keynesians. It seems they are beyond shame.
The US tried Keynesian policies long before Keynes wrote his book, and they failed to end the Great D. See Robert Higgs for a debunking of the myth that WWII ended the Great D. The failure of Keynesian policies during the Great D should have resolved the debate. If not, the failure of Keynesian policies in the 1970’s and since 2008 should have shamed Keynesians. It seems they are beyond shame.
“Mises was blissfully unaware of what many economists were to discover in the 1930s and what Gardiner Means had already discovered: that real world price rigidities are mainly caused by the private sector itself, because most businesses adopt relatively inflexible mark-up/administered prices.”
Mises
was not ignorant of private sector price rigidities. The author would
understand Austrian economics if he would not take the attitude from the
beginning
that Mises was just stupid. After all, Hayek won the Nobel Prize
largely for his advances of Mises’ business cycle theory. All Mises said
was that a large part of the price rigidity came from taxes and
regulations. Businessmen can easily overcome their self-imposed
rigidity, but they have no power to overcome the rigidities caused by
the state.
“The type of price setting required by Mises’s economic theory is largely shunned by the private sector itself, so that the price flexibility Mises thought would clear markets cannot be attained.”
The
author is blissfully ignorant of the history of prices in the world up
to the Great D. Mises wasn’t. They were very elastic until the state
made them
inelastic with stupid policies, taxes and regulations.
“Even though many nations saw price deflation in the Great Depression, even in the 1930s mark-up prices were significant and relatively inflexible as compared with other markets...”
So
after proclaiming that businessmen prevent prices from falling, the
author has to explain why prices fell in the Great D. Of course
commodity prices
fell more than retail. Prices have always done that. Still, they fell,
which makes the author refute his own comment. Retail prices may not
have fallen as much because wages remained so high. But commodity prices
always fall a great deal more because they
supply the capital goods sector, and according to the ABCT, the capital
goods sector, not the retail sector, gets hit the hardest in every
recession. The latest recession was no exception. The blog author would know that if he would actually learn Austrian economics.
“For if debts remain fixed and wages and prices fall (or even more disastrously if wages fall but prices are less flexible), then it is likely that debtors will face severe problems as their burden of debt soars, and most probably deflation will induce bankruptcy of debtors and then bankruptcy of creditors and banks.”
So
the author thinks no businesses went bankrupt in the Great D, or in the
Great Recession? Businesses that borrow too much, and banks that make
too many
high risk loans, are supposed to go bankrupt. That’s how the market
gets rid of bad businessmen and rewards good ones. It’s how efficiency
increases and our standard of living rises.
If businesses need inflation
to survive and pay their debts, they’re bankrupt.
Letting bankrupt businesses go bankrupt is how the market frees up
capital that was badly invested in boom so that entrepreneurs can put it
to better use. Keeping failing businesses alive through price inflation
ensures a zombie economy like that of Japan
for the past 20 years.
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