A Viennese Waltz vs a Stumbling Drunk

Mark Skousen is one of my favorite living economists because of my bias for the practical. Skousen has a PhD in economics, but he chose to pursue a career in the private sector as an investment adviser rather than one in academia or government. We need more great economists like Skousen. Their impact will be much greater than that of academics because those of us who need practical advice are much greater than the number of people who will major in economics in college. Also, if you wander through the blogs of Austrian academics you’ll find that academics spend a great deal of time on Quixotic efforts like trying to change Fed policy or reform mainstream economics.

Laissez Faire Books has released a collection of essays by Skousen with the clever title A Viennese Waltz Down Wall Street: Austrian Economics for Investors. It answers the classic book A Random Walk down Wall Street, by Burt Malkiel that promotes the mainstream vision of the Efficient Market Hypothesis.

 A “random walk” is the term used by mainstream economists to describe stock market prices: they follow the stumbling of a drunk trying to walk, or in other words, are totally random and unpredictable. A Viennese Waltz, on the other hand, follows a very pleasing and discernible though often surprising pattern. And that distinction summarizes the book well. Skousen introduces his theory of investing which he derives from Austrian economics while contrasting it with the mainstream theories of investing derived from mainstream economics. 

Part I introduces the reader to the stars of Austrian economics from Carl Menger, the founder, to Murray Rothbard. Along the way he distills from each a principle that applies to investing. Part II covers a variety of topics, the best of which is the essay “Financial Economics.”  Part III offers a bibliography of newsletters, books and investment advisory services.

In the chapter on Friedrich Hayek, Skousen offers advice on finding the top of bull markets and bottom of bear markets. He writes that “Astute ‘Austrian’ financial analysts use several indicators...” or what I like to call omens. One is an inverted yield curve in which short term rates are higher than longer term rates. That omen says the Fed is trying to reduce money in circulation, which is bad for the stock market.

Another omen is the “Wicksellian Differential” (WD) developed by investment analyst Thomas Aubrey and detailed in his book Profiting from Monetary Policy: Investing Through the Business Cycle. The WD is the ratio of the return on corporate investment to the five-year moving average of five-year government bond yields. The WD widens as corporate returns outpace the yields on government debt and gives a bullish signal, while a shrinking WD is a bearish indicator. Of course, the tool isn't perfect, which is why good investors combine omens. Investors should add these indicators to mine, which follows corporate profits, and Spitznagel’s (Dao of Investing) MS indicator.

For feeling the bear’s bottom, Skousen recommends watching for the Fed to cut rates, but realizing that at least six months lapse between policy decision and its effect on markets. And he recommends waiting for a 50% decline as recommended by Jeremy Siegel, a professor of finance at the Wharton School and author of Stocks for the Long Run.

“The Downside to Austrian Economics: The Permabear Syndrome” is one of the more important sections. Yes, we all know that the Fed is destroying civilization with its monetary policies, but that doesn't mean we should expect the end of civilization every day as Christians expect the Rapture. Jesus said that no man knows the day or hour of his return. But markets are not that mysterious. Austrian followers can discern patterns so that investors can have a good idea of when to follow the crowd and when to be contrarian instead of getting stuck in the permafrost. The Fed may be destroying civilization like the Borg of Star Trek, but we can’t do much about right now other than get filthy rich from it.

Skousen’s book is full of memorable quotes, such as this one from Hyman Minsky, professor of economics at Washington University in St. Louis: “The neoclassical synthesis became the economics of capitalism without capitalists, capital assets, and financial markets.” Minsky got finance wrong, too, because of his devotion to Keynes, but that was a pretty good indictment of mainstream economics.

One of the best stories in the book is Skousen’s honoring of Milton Friedman while poking fun at his monetary theory. Skousen tore into pieces a twenty dollar bill that Friedman has offered as an example of modern money, causing Milton and Rose to blush a little with anger. When Skousen offered a $20 Saint-Gaudens double eagle gold coin to replace it, Friedman refused. Eventually, Skousen told Friedman that he had ordered the coin because it had been minted in the year of Friedman’s birth. The coin and the evening were intended to honor Friedman’s legacy of supporting free markets. Great story!

In addition to introducing Austrian investing, Skousen does a good job of contrasting mainstream economic and finance theory with it, which should help those who have been educated in mainstream theory to grasp the differences of the two approaches. I highly recommend Skousen’s book and anything else he has written, especially his Structure of Production.