Crude Economics

Central bankers in countries that have fallen into recession or are on the precipice have suffered seizures over the fall in oil prices. Most are mainstream economists or groupies who think that falling oil prices will deepen the plunge in prices, which they consider the ultimate evil, even while most consumers are cheering them.

Of course, mainstream economists will fall back on the old apologetic that says what is good for individuals can be bad for the nation as a whole. They claim it is a paradox and those types who love Eastern mystic nonsense like “the sound of one hand clapping” or “global warming will cause another ice age” love such inscrutable sayings.

The truth is that it’s not a paradox; it’s a contradiction. Mainstream macro contradicts a large part of the principles of microeconomics. And since micro has the firmer foundation that means a lot of macro is pure nonsense. Now mainstream macroeconomists aren’t dummies, so why do they love inflation when the rest of the sane world hates it? It’s because they know what inflation does: it transfers wealth from savers to borrowers (and they hate savers) and from workers to employers.

Abenomics' big fail and the sinking of the rising sun

Economists predicted a 2.25% gain in Japan’s GDP after the 7.3% fall in the second quarter. As usual, they missed it again. Japanese GDP fell 1.6% last quarter according to initial estimates. Mainstream economics’ theory of business cycles states that such downturns in the economy are random events, shocks to equilibrium. As the London School of Economics told the Queen, they had successfully predicted that no one can predict the onset of the worst recession since the great one. Still, they crank out GDP forecasts as if they could predict a recession. They irony is huge, but apparently unnoticed by most of the profession.

However, the most important part of the story was that Prime Minister Abe has been conducting a major monetary policy experiment. He promised to boost nominal GDP and achieve a minimum inflation of 2% by printing as much money as was necessary. No limits. Paleo-Keynesians like Paul Krugman were giddy. 

Abe also promised to reduce the deficit through tax increases and reform the structure of the economy. Partly as a result, the Japanese stock market climbed 55% and the value of the Yen fell 25% in 2013.

CAPE Fear

I recently finished Meban Faber's book, Global Value: How to Spot Bubbles, Avoid Market Crashes, and Earn Big Returns in the Stock Market, and found it to agree very well with the ABCT Investing philosophy. Faber is a co-founder and Chief Investment Office of Cambria Investment Management.

Faber aimed his book at the majority of individual investors who try to time the stock market on their own. Studies of the flow of money into and out of mutual funds prove that most individual investors wait to enter the stock market until it has reached the peak of a cycle and then sell when it is near the bottom of a collapse. In spite of this, most people think they are good investors. It's all part of the syndrome in which most people think they are better looking and more intelligent than average.

Burned by Bonds

Austrian economists can get forecasts wrong, occasionally. Many were wrong about inflation when the Fed stuffed its balance sheet with junk bonds. Inflation has remained asleep except in asset markets. That wrong forecast gave some of us a jaundiced outlook for bonds. The reasoning went that higher inflation and a greater demand for loans would force interest rates higher in 2014, and when interest rates rise the price of bonds fall. Also, the Fed was trying to go sober after multiple shots of QE. So I stayed away from bonds this year because the fall in value would erase all of the benefits from the interest earned. As a result I missed out on a great opportunity.

While most of the world was fixated on the choppy stock market, bonds were as stealthy as 007 while soaring. The October 20 Wall Street Journal (page C1) reported that the Wasatch-Hoisington U.S. Treasury Fund earned 28% for investors this year. Lacy Hunt, the fund’s chief economist, said, “I don’t think the Fed is going to raise rates. All they can do is hold rates here for longer and longer time periods.”

So where did Austrians go wrong? First, they didn’t take Hayek and Mises seriously when they warned against assuming the quantity theory of money works mechanically.  The monetarist Milton Friedman influenced too many Austrian economists. The quantity theory states that increases in the money supply will lead to consumer price inflation. That is always true, ceteris paribus, but things are never ceteris, let alone parabus. Many things can break the link between increases in the money supply and prices. Most importantly, we should temper our expectations of the quantity theory with the subjective theory of value. As Mises wrote, people may not always respond to increases in the money supply in the same way. That is the principle of subjectivism applied to money, something Mises is most famous for.