George Washington’s Blog
Friday, March 13, 2009
Barron’s is finally admitting what few in the mainstream have been willing to acknowledge: the Austrian school of economics was right.
The Austrians have been saying for well over a hundred years that big bubbles lead to big crashes, and that – if you want to avoid depressions – you have to avoid the bubbles.
In today’s article, entitled “Ignoring the Austrians Got Us in This Mess”, Barron’s agrees:
The credit crisis and the ensuing global economic contraction have failed to make an impression on academe, where free-market orthodoxy still reigns supreme, the New York Times asserted in an article in arts section recently (“Ivory Tower Unswayed by Crashing Economy,” March 4.)…
What definitely is ignored in academe is the Austrian school of economics, especially for baby boomers brought up on Samuelson’s economics text, which was pure Keynesian orthodoxy. I did not learn the names von Mises and Hayek or their ideas until a decade or more after graduation (with a degree in economics, by the way.)
The Austrian view is a mirror image on the right to Minsky’s from the left. The economy, if left alone, is self-correcting, say the Austrians. But central banks’ inflationary expansion of credit produces booms and malinvestments, which inevitably lead to a crashes and depressions.
The only prevention for boom and busts are sound money, which is impossible with government-controlled central banks. Once the bust comes, the only cure is to let it run its course; allow the malinvestments go bankrupt and let the market reallocate the capital to productive uses….
But the Austrians were the ones who could see the seeds of collapse in the successive credit booms, aided and abetted by Fed policies, especially under former chairman Alan Greenspan. …
Greenspan always contended that monetary policymakers can neither predict nor prevent bubbles in asset markets. They can, however, clean up the after-effects of the bust — which meant reflating a new bubble, he argued.
That had a profound effect on risk-taking. Knowing that the Greenspan Fed would bail out the markets after any bust, they went from one excess to another. So, the Long-Term Capital Management collapse in 1998 begat the easy credit that led to the dot-com bubble and bust, which in turn led to the extreme ease and the housing bubble.
Austrian economists assert the current crisis is the inevitable result of the Fed’s successive efforts to counter each previous bust. As the credit expansion pumped up asset values to unsustainable levels, the eventual collapse would result in a contraction of credit as losses decimate banks’ balance sheets and render them unable to lend. That sounds like an accurate diagnosis of the current problems.
While Barron’s acknowledges that the Austrian school is right about how to avoid depressions, it doesn’t agree with the other main tenet of the Austrians: that the quickest way to get out of a depression is to let the bad investments clear themselves out of the markets by letting the companies which made dumb decisions fail. (The sub-title for the article is “Their ideas warned us of the bubble; their prescription for the bust is too harsh, however“; and the article ends with the phrase “Make us non-interventionist, but not yet.”)
Readers have written to me saying the same thing: the Austrians might be right, but their remedy for an economic crisis is too draconian and we have to do something to help the people.
I am all for helping people and doing something that will speed up a recovery. But remember the 2,000 year old medical wisdom of Hippocrates: “First, do no harm”.
The two leading economists of the 20th century – Friedman and Keynes – were both wrong, and so all of the approaches being implemented by economists right now are actually making things worse.
Advocates of the Austrian school – such as Marc Faber, Ron Paul, Peter Schiff, Mish, and others – argue that any interventionist approach by governments will only prolong the economic crisis, and that there really is no choice but to let the gunk clear out of the system.
At the very least, everyone – liberal and conservative alike – should demand that:
(1) The federal reserve be eliminated (as Ron Paul, Mish, and others propose) or at least reigned in so that it cannot blow any more bubbles; and
(2) That no “medicine” be administered to the economy – whether Keynesian spending stimulus, Friedmanite monetary stimulus, or anything else – unless it is proven (using Austrian economic models) to do more good than harm.