Archive for December, 2011

More Austrian Economics

December 29, 2011 6 comments


Here is a perfect example of what I’ve been talking about regarding Austrian economists.  In this post, the author takes an observation that mainstream economists find puzzling and tries to convince you that it isn’t puzzling to Austrians and this is evidence that Austrian economics is superior.  But in the process he demonstrates total ignorance of mainstream economics, claiming that it does all sorts of things which it does not, and then proceeding to do exactly those things but in a simplified way that leads one easily into confusion.  Then he confusedly arrives at the conclusion that something puzzling actually makes perfect sense.

Let us begin by establishing what the endowment effect means.  The endowment effect is a phenomenon whereby an economic actor places a higher value on something if they own it than if they do not own it.  In other words their ordinal ranking of preferences changes merely because their endowment changes.  To put it in the form of an Austrian example, this means that a man who prefers an apple to an orange when he has an apple but not an orange may prefer an orange to an apple when he has an orange and no apple (holding all other things equal).  In either case he is not willing to trade.  Observing this should make you scratch your head no matter what economic philosophy you subscribe to, it’s just a thing that doesn’t make that much sense.  Look what I mean:

From a mathematical-economic point [sic] view, the endowment effect demonstrates the inability of formal economics to explain what drives human action. Indeed, the endowment effect seems to shift an actor’s indifference curves, and thus his subjective valuation of goods and services, depending not on qualities in the good itself or its price but on the contextual, circumstantial characteristics and psychological state of the instant and situation. The economic explanation to market valuation is therefore at odds with real valuation and the models need to be expanded to include psychological drivers of subjective valuation. And therefore economics must embrace behavioral studies and neuroscience.

He starts out correctly, well not the very start but once he says “the endowment effect seems to shift an actor’s indifference curves, and thus his subjective valuation of goods and services, depending not on qualities in the good itself or its price but on the contextual, circumstantial characteristics and psychological state of the instant and situation” he is saying something correct.  But this is not at odds with mainstream economic models.  There is no law in mainstream economics that subjective valuation can’t change based on “the contextual, circumstantial characteristics and psychological state of the instant and situation.”  It’s just that there isn’t much use in going around making models where people’s tastes change in random ways.  Therefore, classical consumer theory assumes that people’s tastes don’t change in the middle of the analysis.  This is not because we think people’s tastes never change it’s just that there is no way to base a scientific examination of human action on tastes which could be anything at any time.  But when we see tastes appearing to change in a systematic way that doesn’t seem logical we stop and scratch our heads and wonder what’s going on there.  We would like to come up with something better than just “well tastes change depending on whether or not you own something,” we want to find a logical reason why this would happen in a systematic way.  Maybe there isn’t one but it’s not crazy to wonder about.

On the other hand, we have here an Austrian who thinks he can explain it.  Here is a list of mistakes he makes.

Read more…


Money Creation

December 27, 2011 5 comments

Now we get to the real reason Austrian economics can’t save us from the Keynesians.  Austrians know that Keynesian economics doesn’t really make sense.  Unfortunately they don’t know that Keynesian economics kind of makes sense.  It’s just that they Keynesians are not very clear about what they are really doing.  They give things misleading names and explanations and make assumptions that are not very good but end up leading to conclusions which are right in many ways.  I don’t know whether they do this on purpose or not but if they explained what was happening in a way that made sense I suspect many people would become very concerned about the way our economy actually works.  So, ironically, this task falls to me.

To put it simply, the Keynesian conclusions that printing money or increasing government spending can increase output in the short run are correct but only because the economy is constrained by the monetary system and doing these things temporarily relax this constraint.  They don’t magically create more wealth and prosperity, they just diminish the destruction for a while.  To understand this requires a careful modelling of the money creation mechanism.  So let’s start there.

Consider the market for loanable funds.  By this I mean the market for borrowing and lending money.  This is not to be confused with the market for savings and investment in a real sense.  This market is depicted below.  The horizontal axis is dollars and the vertical axis is the nominal price of borrowing a dollar, namely the nominal interest rate (i).  At higher interest rates, more loanable funds are supplied and less demanded (holding all other things constant).

Figure 1

In a free market with a money supply determined by nature (such as commodity money), the nominal interest rate would be determined as that rate for which the quantity supplied and quantity demanded for loanable funds are equal or i* above.

When the fed “prints” money, they don’t just drop it from helicopters into the economy, they lend it into the market.  At this point we have to choose a way to speak about the Fed’s policy goal.  This is actually a source of a serious misconception in Keynesian economics which I will get to later but the issue that confronts us currently is to either say that the Fed targets an interest rate and creates the appropriate amount of money to achieve it or to say that they target the money supply and let the market determine the interest rate based on that money supply.  At this point these two approaches are interchangeable, so it doesn’t really matter which we choose.  I will choose the former.  So assume that the Fed chooses an interest rate below the market rate.  Call this i’. Notice that they can only lower the rate by lending.  If they wanted to raise it above i*, they would have to become net borrowers which would mean they would have to create a new kind of security that as far as I know has never existed so it is safe to say that the Fed always sets rates less than or equal to what it would be with zero money creation.

At the target rate, the quantity of loanable funds demanded is greater than what is supplied.  In other words people want to borrow more at this lower rate but they want to lend less.  This is why this rate is not an equilibrium with zero money creation.  However, the Fed can solve this problem by simply printing the money and lending it.  In other words, they allow people to borrow money that nobody was willing to lend.  Thus the new money created is equal to the amount of the shortage in the loanable funds market.

Figure 2

Now my hypothesis, as I have tried to explain in the past, is that it isn’t really the interest rate which the Fed targets (or at least it shouldn’t be).  The problem is that they need to keep the money supply growing at an increasing rate.  If the money supply stops growing fast enough things fall apart.  I won’t try to convince you of this here just go along with it for now.  You can read some previous attempts though [1] [2].  This means that the shortage in the loanable funds market must be growing at an increasing rate.  There are essentially two ways it can grow.

The first way is if the Fed lowers the target interest rate.  This is what Keynesians call “monetary policy.”  If you lower the rate, holding supply and demand constant the shortage gets larger as in figure 3.

Figure 3

The other way is for demand to increase or supply to decrease (often the line between these two things is not very clear).  This would happen because of a change in the real economy, and would cause the shortage to increase as in figure 4.

figure 4

Just from thinking about monetary policy in this way we notice several things.  For instance, if the real economy is growing, the demand for loanable funds is likely increasing and the shortage is increasing at a constant nominal interest rate.  This is essentially what Keynesians count on during expansions.  If the economy is growing fast enough, they may even need to increase rates to keep the money supply from growing too fast.  On the other hand, if the economy is not growing fast enough, they would need to do something else to keep the money supply growing.

The most obvious approach would be to lower interest rates.  This works as long as interest rates are high enough to lower.  If you lower them all the way to zero though you can’t lower them any more.  This is the Keynesian liquidity trap but with a different explanation.  Instead of being able to increase the money supply without changing the interest rates, they are unable to change the money supply because they are unable to lower interest rates.  (Note that by “money supply” I mean the broader money supply not just base money) If this happens they must do something that changes the supply or demand for loanable funds.  In Keynesian economics they call this “fiscal policy.”

By far, the simplest solution to this problem is to have the government borrow more.  This increases the demand for loanable funds directly which increases the shortage and allows the money supply to grow.  It doesn’t matter what they spend it on, it is the monetary effect that is important.  This effect can exist along side the “broken window” effect.  This is what Austrians don’t get.  The wasteful effect of government spending is the Scylla to the Charybdis of monetary collapse.  It’s not that Scylla is good, it’s that the alternative is even worse.

Another alternative is to convince people that future inflation is coming.  This also increases the demand (and/or decreases the supply) of loanable funds, increasing the shortage and the money supply.  In the short run, this is a self-fulfilling prophesy because the new money will raise prices, causing the expected inflation to materialize.  Whether or not this is sustainable indefinitely is an open question, although I contend it is not.  At any rate this is why you see the Fed going out of its way to look like they have additional “arrows in the quiver.”

Finally there are a number of policy options that can cause an increase in the shortage without the government borrowing directly.  Chances are you would have never thought of these policies in this way but they provide a powerful part of the explanation for how this system has been able to go on for this long and present a frightening picture of how deep into this we are and how little is left to support the continued growth of money.

In the thirties, the government created Fannie Mae (and later Freddy Mac in 1970) “to expand the secondary mortgage market by securitizing mortgages in the form of mortgage-backed securities.”  Translation: to make it easier for people to get home loans thereby increasing the demand for loanable funds.

In 1935 the government created social security and in 1965 expanded it and added medicare.  These programs take money from workers when they are under 65 and pay it back to them when they are over 65.  This money goes into the general fund and is spent on whatever the government wants rather than saved/invested for the purpose of paying future benefits.  The expectation is that the future benefits will be paid out by future workers.  The effect of this is that workers don’t save as much (possibly nothing at all) in expectation of these future payments and this reduction in private savings is not offset by any increase in public savings.  In other words, the supply of loanable funds decreases which increases the shortage.

Unemployment insurance (also originating in the 30s) removes the incentive to save “for a rainy day,” thus decreasing the supply of loanable funds.

Federal student loan programs encourage people to go to college by borrowing money, increasing the demand for loanable funds.

The Dodd-Frank bill lowered the fees banks could charge on debit cards, making credit cards more profitable and leading to more incentives for people to use credit rather than debit cards.

Of course this is a very abbreviated list.  These examples go on seemingly without end and once you start thinking about things in this way you will notice them all over the place.  One result of this is that we treat waste as production because waste causes additional demand for money.  Another is that we are now a highly leveraged society and getting more so all the time.  Just as anyone whose life is financed by debt our reality will come crashing down around us when we run out of equity to leverage.  The man who finds himself in this situation is often surprised to learn that he doesn’t actually own anything.  We would do well to realize it before that point.

Mainstream (Keynesian) Economics

December 22, 2011 1 comment

Since I recently took on Austrian economics, I would be remiss if I didn’t turn my ire on mainstream economics before moving on to my ultimate purpose.  First of all, mainstream micro is great (at least most of it), even though it sometimes falls back on cardinal utility.  My problem is with the macro.  Mainstream macro is essentially Keynesian.  I’m already on record as thinking the neoclassical synthesis is the worst thing that ever happened to economics.  I want to focus on a particular aspect of modern macroeconomics though which I think is the root of most of its issues.

In an economic model there are two types of variables.  There are certain variables representing the state of nature which are determined exogenously.  These exogenous variables represent the scarcity which is inherent in nature.  Remember this line about mainstream economics:

It begins with the premise that resources are scarce and that it is necessary to choose between competing alternatives.

This is key, we will come back to it.  Other variables are determined in the model (endogenously).  These are the result of the actions people take to deal with the scarcity inherent in nature and are the things the model tries to explain.  So in the model of the market for some good, incomes, tastes, prices of other goods, and costs of production are exogenous.  They represent the nature of the scarcity faced by these economic actors (buyers and sellers).  The model takes these exogenous variables and uses them to determine the endogenous variables price and quantity.  When the exogenous variables change the endogenous variables change in predictable ways.  This is economics.  Note that when modelling the market for a good, when the quantity of that good increases it comes at the expense of other goods which are not produced.

The Federal Reserve has had a subtle but pervasive corrupting influence on macroeconomics.  Pretty much every modern macro model treats interest rates as an exogenously given policy tool.  This is because that’s what they are….now.  The Fed sets interest rates (sort of).  Economists want to predict what will happen in the real world.  To us the “real world” is one in which interest rates are set arbitrarily by a handful of people in private with unknown motives.  In other words it’s exogenous to the economy under study.  Mainstream economists basically take this for granted.  After all it’s been that way their entire lives.  But this is not the natural role of interest rates.  Interest rates are a price: the price of money today in terms of future money.   In a free market, prices are determined in the market.  They adjust due to changing market forces (exogenous variables) in order to bring the system into equilibrium.  Once you make them exogenous you remove the whole mechanism by which markets allocate scarce resources between alternate uses.

This leads the thoughtful student in intermediate macro to some confounding paradoxes.  For instance: how is it that if savings equals investment and savings equals income minus consumption, that when you lower interest rates investment increases but consumption stays the same?  The astonishing answer, according to the model is that you just get more stuff.  Where did that stuff come from?  What competing use were these resources taken from?  There is no such competing use.  Income just increased.  Why?  Because it must have increased if investment increased and consumption stayed the same, and investment must have increased if interest rates decreased.  In other words, by making price (interest rates) exogenous, they have to let another variable adjust to bring the model into equilibrium.  Keynesians assume that this is output.  So in this model, you exogenously lower the price and this reduces scarcity.  The whole model is turned upside down!

To better see what I mean consider a simpler example.  You observe a dam on a river with a reservoire behind it.  Water flows out of the mountains and into the river from sources unknown.  You observe that the pressure with which the water flows through the dam depends on how high the water is in the reservoire.  You construct claculate an equation which gives the water pressure as a function of the height of the water behind the dam.  Let’s call this P=f(L) where P is pressure, L is the water level and f() is some function.  You declare that for any amount of water behind the dam the water pressure flowing through must be the value determined by this equation.  This is good science.

This is bad science.  You take the equation above: P=f(L) and declare that this must hold, therefore if you increase the pressure with which the water flows through the dam the water level behind the dam must increase.  You build a pump that forces the water through at a higher pressure and assume based on the above equation that this will cuase more water to flow down from the mountains from parts unknown and raise the level of the reservoire.  It’s the same equation but these relationships which make perfect sense when causality goes one way make absolutely none when it is reversed.

This same flaw leads to other head scratchers like: if the government increases taxes and spending by the same amount output increases.  Where do these additional resources come from?  The model doesn’t say anything about where output comes from (parts unknown….?) or what tradeoffs are involved.  It is just a set of monetary equations which must hold in equilibrium.  As it turns out the only real source of scarcity in the model is the tendency of people to save some of their income.  If people just didn’t save at all then money would keep circulating infinitely making everyone infinitely wealthy.  That is the actual implication of the model: infinite output if nobody saved.  So naturally, if the government takes some of your money and spends it all they are spending what you would have plus what you would have saved so this somehow magically causes more goods to come into existence.

This is why our whole economic understanding is upside down.  We treat spending as the genesis of economic activity not production.  I just heard my hero, Charles Barkley, say that they were helping the economy because they had to hire a translator for Shaq.  While hilarious, this is “turrable” economics.  We treat waste as production.  This is all because of an upside down model.

If you really want something to think about try this one: If the real rate equals the nominal rate minus the inflation rate, and the real rate is determined by real factors like time preferences and marginal productivity, then how is it that lowering the nominal rate increases inflation?

All of these paradoxes are not paradoxes when the proper things are endogenous and exogenous.  But remember, the Fed was created in 1913.  Keynes was doing most of his damage in the 30s.  The change in economic thought is the result of a real change in the economic system.  It is this change in the system which really needs to be undone but in order for that to happen we will have to start analyzing the effects of this change, which means creating a model with real scarcity and causal relationships with the dependency going in the right direction.




A Bit of Finance

December 20, 2011 1 comment

Here is a concrete way in which the Austrians are confused.  They think when the economy collapses, that the stock market will go down and gold and silver will go up.  This is because they think the threat to the economy is hyperinflation.  When you see those gold commercials on TV they always talk about using gold to diversify your portfolio.  I get the feeling most people don’t really know what this means because I once saw Shepard Smith going off about how gold is not safe as though he thought that people think that gold is just inherently safer than other investments.  But that’s not the point.  Traditionally, gold is a hedge.  To put it simply, this means that gold goes up when other things, like the stock market, go down and vice versa.  Because of this if you hold both gold and stocks then you are less likely to suffer a large loss because large drops in one asset are usually offset by large gains in the other.

So if you buy into this logic, and you think a stock market crash is coming, it makes sense to invest in gold, not only as a hedge, but as a bet against the stock market.  But if you have been following the markets on a more-or-less daily basis as I have, then you may have noticed that these two things no longer move in opposite directions.  For some time (like 6 months to a year) when the stock market has gone up gold has gone up and when the stock market has gone down gold has gone down.  Unfortunately this is only a casual observation I don’t have data to show you but look into it, it’s true.

So why is this happening?  Gold and stocks are different in that they appeal to opposite attitudes about the real economy.  When people are optimistic about the real economy they buy stocks because they expect them to grow rapidly in real value.  When they are pessimistic, they buy gold because they figure gold won’t completely evaporate in real value like stocks are prone to do.  So they tend to move in opposite directions due to real shocks.  But gold and stocks have something in common.  They are both real goods.  Which means they are both subject to monetary shocks in the same way.  When the price level goes up, they both go down.  when the price level goes down they both go up.  So what we are seeing now is a real economy which is fluctuating mainly due to monetary shocks not real shocks.  This means that gold and stocks are no longer hedges for each other.  Inflation helps both but more importantly, deflation–which is what we should be worried about–kills both.  Think about this before you put all your money in gold.

Categories: Macro/Monetary Theory Tags: ,

Austrian Economics

December 20, 2011 8 comments

[A few disclaimers:  First, this post is very critical of Austrian economics.  For the record there are a lot of things I like about the school but I don’t think those things need to be said as much as these things.  The tone gets a little more hostile than I intended but that should give you some idea of the tension between Austrian and mainstream economics.  Second, these criticisms are motivated mainly by my interactions with the current “pop-Austrian” school that is all over the internet these days (mainly centered around  This is the version of Austrian economics that my readers are most likely familiar with but there may be some who claim this is not representative of true Austrian economics.  For a similar argument from someone much closer to the school check out this debate between Caplan and Boettke.  I started you off on part 4 because it basically summarizes my view of Austrian economics (though it’s a little more diplomatic).  I recommend watching the whole thing though, it’s pretty interesting.]

A friend recently asked me “if Austrian economics doesn’t believe in theory or empirics how can they ever win?”  My answer was that they can’t, although that’s not a completely accurate characterization of them.  She asked me this, I think, under the impression that I was an Austrian.  In fact I’ve been getting that a lot lately.  When I was interviewing for my last teaching job they asked me how I felt about UW and I said if I had it to do over again I probably would have gone someplace more fresh water and that I was more of a Milton Friedman-free market-type.  Admittedly, I went about it this way because I didn’t want to highlight my Austrian tendencies.  To my surprise, during my first week on the job one of the professors came into my office and said he had a couple of students that were into Austrian economics and he told them they should come talk to me as the resident Austrian.  I said, a bit flustered, “I’m actually not an Austrian… but that’s cool I’d love to talk to them.”

Then like a week later, another professor passed me in the hall with a brown-bag schedule (that’s where professors give a little talk to other professors about whatever they are working on) and he said “hey Mike, you wanna give one on Austrian economics?”  And again I replied “I’m not an Austrian, but I guess I can do that, although it will be largely about what’s wrong with it.”  For some reason everyone thought I was an Austrian!  But I never claimed any kind of affinity to this school.  What I did claim affinity for was free markets, as well as a general disdain for government meddling in the economy, including in the monetary system.  But then I thought about it: what else could I be?

Here is the Wikipedia page on modern schools of economics.  As you can see, there is mainstream, Austrian, Marxian, and institutional.  Let’s start with mainstream:

It begins with the premise that resources are scarce and that it is necessary to choose between competing alternatives. That is, economics deals with tradeoffs. With scarcity, choosing one alternative implies forgoing another alternative—the opportunity cost. The opportunity cost expresses an implicit relationship between competing alternatives. Such costs, considered as prices in a market economy, are used for analysis of economic efficiency or for predicting responses to disturbances in a market . . . Economists represent incentives and costs as playing a pervasive role in shaping decision making.

OK, that’s great, sign me up!

 . . . Mainstream economics also acknowledges the existence of market failure

OK, no problem, that’s a given.

. . .  and insights from Keynesian economics

Whoa, hold on!  Keynesian economics?  Didn’t I read somewhere that Keynesian economics  is a model with no scarcity and no tradeoffs?  So if I don’t believe in Keynesian economics because it doesn’t “begin with the premise that resources are scarce and that it is necessary to choose between competing alternatives,” am I in or out of the mainstream?  Apparently this makes me out.  If I’m out then what am I?  I’m not an institutionalist and I’m certainly not a Marxist.  I must be an Austrian!  After all I like free markets and they like free markets.  I like free money, they like free money.  I don’t understand why everyone else thinks the previous two statements are not redundant, they don’t…….. well you get the idea.

Unfortunately there are some serious problems with Austrian economics.

Austrians don’t dislike models, they just don’t like math.  I think this is a major plus with a lot of casual economists.  The problem is that math is a really handy modelling tool.  Indeed, in the words of Sir Francis Bacon: “If in other sciences we should arrive at certainty without doubt and truth without error, it behooves us to place the foundations of knowledge in mathematics.”   Austrians come up with philosophical reasons to avoid using complex math but these often only make sense if you don’t know much about math.  And the problem is that avoiding math allows you to be very inconsistent.

For instance, Austrian economists supposedly don’t believe in cardinal utility.  Mainstream economists also supposedly don’t believe in cardinal utility.  The Austrian approach to the matter is to say that you can’t perform any mathematical operation on an ordinal value therefore you can’t do anything with a utility function so everything mainstream economics does with utility functions is inappropriate.  This seems very plausible if you don’t really understand what mainstream economists are doing with utility functions.  On the other hand here is an excerpt from my graduate micro text:

Toward the end of the nineteenth century, perhaps initially from introspection, the concept of utility as a cardinal measure of some inner level of satisfaction was discarded.  More importantly, though, economists, particularly Pareto, became aware that no refutable implications of cardinality were derivable that were not also derivable from the concept of utility as a strictly ordinal index of preferences.  As we shall see presently, all of the known implications of the utility maximization hypothesis are derivable from the assumption that consumers are merely able to rank all commodity bundles, without regard to the intensity of satisfaction gained by consuming a particular commodity bundle . . .

. . . To say that utility is an ordinal concept is therefore to say that the utility function is arbitrary up to any monotonic (i.e., monotonically increasing) transformation.

In other words, when mainstream economists say they are only using cardinal utility, they mean that all of their implications are robust to any monotonic transformation of the utility function.  This is quite reasonable if you are concerned about the philosophical implications of cardinal utility.  But if someone doesn’t know what “monotonic transformation” means, then they don’t realize that this is reasonable, and it is very difficult to explain it to them.  I don’t want to beat up on the guy I was talking to in that post, he’s not an economist.  But the reason that began was a post in which an Austrian unwittingly built a theory on cardinal utility and nobody noticed.  In fact, I was looking for that article just now (I thought the link was in my post but apparently not) and I couldn’t find it but I found this one.

In the above post, the author explains the diamond water paradox which is a famous economic problem that has been solved for hundreds of years.  But the explanation has a glaring error.  There is no law of diminishing marginal utility.  There is a law of diminishing marginal value.  If you substitute value for utility, then everything he says is correct.  But you can easily get diminishing marginal value–and therefore the diamond water paradox–with increasing marginal utility.  But Austrians don’t get the difference between value and utility because they don’t even think about it because they refuse to consider a model with a mathematical utility function.  This prevents them from realizing that they are actually using cardinal utility all over the place!

If this is over you head, I’m not surprised, this is complicated stuff and requires careful attention.  But that’s exactly the problem with this amathematical (if I may) approach.  It prevents you from focusing on it in a way that is really beneficial to understanding what is going on.  As a case in point take this guy.

Why do individuals pay much higher prices for some goods versus other goods? The common reply to this is the law of supply and demand. But what is behind this law? To provide an answer to this question economists refer to the law of diminishing marginal utility.

At that point, most people stop listening. Too technical for me! But in fact, it is not. The concept of marginal utility is the essential building block of a sound theory of human action as it applies in the science of economics. But too often, the mainstream theory is misleading. So I offer this Austrian attempt to demystify the idea.

The problem is, it sort of is rocket science.  Or at least it’s pretty difficult.  And he is making it seem simple because he doesn’t really get it.  And he is completely mischaracterizing the mainstream view.

Mainstream economics explains the law of diminishing marginal utility in terms of the satisfaction that one derives from consuming a particular good. For instance, an individual derives vast satisfaction from consuming one cone of ice cream. The satisfaction he will derive from consuming a second cone might also be vast but not as vast as the satisfaction derived from the first cone. The satisfaction from the consumption of a third cone is likely to diminish further, and so on.

Mainstream economics doesn’t have a law of diminishing marginal utility.

In the mainstream way of thinking it is not individuals but a given hard-wired valuation scale in their minds that decides what is good for them. The prices of goods in the mainstream way of thinking are established by mechanical shifts in supply and demand curves. This framework depicts human robots rather than human beings.

If the selection of goods is set mechanically, how in the world can one talk about utilities and choices? Without conscious, purposeful conduct, the use of the word “utility” is a contradiction in terms. After all, the benefit that a good provides must be in relation to individuals’ particular ends and their particular set-up.

Contrary to mainstream thinking, the Austrian framework shows that it is the importance of various ends that determine the selection of goods by individuals. The means-end framework also shows that the prices of goods are not set mechanically by some kind of supply-demand curves but by the goal-seeking choices of individuals.

Supply and demand curves are determined by the goal-seeking choices of individuals!  These choices are necessarily dependent on a “given hard-wired valuation scale in their minds that decide what is good for them.”  There’s no difference between these two approaches.  OK I’m getting heated reading this and it’s turning into a rant so I will resist the temptation to critique every line in the post.

For the record, I should say that mainstream economics frequently invokes diminishing marginal utility as well.  And admittedly they probably don’t realize it a lot of the time.  But if I went to one of them and pointed it out, I’m pretty sure that in fairly short order we would come to the understanding that they were in fact doing it and they would shrug and say “ok but it still makes my point, and I could do it with ordinal utility it would just be more complicated.”  And most of the time I would agree.  But you can’t even have this conversation with Austrians.

The Austrian refusal to consider any model containing any but the simplest math has two serious consequences.  First is that they make mistakes.  Second is that they don’t really understand what mainstream economists are doing.  So when a mainstream economist reads a critique from an Austrian he gets a paragraph in and decides that the Austrian doesn’t really know what he’s talking about and there’s no point in arguing with him or paying attention to him.  So there’s basically no communication possible between these schools.  Their critiques are not targeted at mainstream economists.  Thy are targeted at non-economits.  This brings me to my next big criticism.

Austrian economics is not a science it’s a religion.  What I mean by this is that it is not attempting to discover how the world works.  It thinks it knows how the world works and all of its energies are focused on gaining converts to their ideology.  This is not meant as a backhanded swipe at religion, but religions should stay in their place and sciences should stay in theirs.  There are definitely valuable insights in Austrian economics.  Many of these are incorporated into mainstream economics.  Some of them are undeserving overlooked.  But Austrian economists don’t spend any effort questioning them so it is impossible for them to come to the conclusion that Carl Menger might have been mistaken about something.  Doing this would be like a Christian saying “I agree with most of what Jesus taught but I think he was wrong about _________.”  This is not allowed.  That meme works alright if the person/entity in which you put your faith is right about everything but unfortunately Carl Menger is fallible.

As an illustration of this phenomenon check out this correspondence between myself and reproduced word for word:

Me: Regarding your post looking for people to write for the Mises blog, are you interested in things that are not entirely “steeped in Austrian tradition?”  I’m very friendly to the basic tenants of Austrian economics but I would like to challenge some of the finer points.  I think I could generate some good discussion.

Them: I’m sure you can find libertarian venues for such pieces, but that is not what Mises Daily is looking for.

The consequences of this are twofold.  First, the discipline does not evolve.  And indeed I suspect that Christian theology has advanced more in the last 50 years than Austrian economics.  To see what I mean just go to and ask a question about anything and I can almost guarantee you that their response will be to tell you to read a 50-year-old book.  Second, if you only listen to Austrians you are listening to the same arguments people were having a hundred years ago (sometimes more).  This would be fine if the other side were still making the same arguments that the other side was making a hundred years ago but this is not the case.  So an Austrian will hear Paul Krugman claim that more government spending is needed to save the economy and launch into a lesson on the broken window fallacy [follow up] [follow up 2].

The broken window fallacy is a perfectly good lesson and it is worth everyone learning.  But it’s not the end of the story here.  This is because the other side has spent a century building a system that doesn’t function like a natural economy.  In the early stages of this, Austrians objected based on well-founded notions of how a natural economy works.  But the boat left without them and it turned into a religion.  So it is stuck in that place.  It is a strange combination of reasonable (though not flawless) analysis of natural economic systems and warnings about the danger of erecting a system that was erected a hundred years ago.  But these things are not adequate for analyzing the short-term workings of that machine.   And because of this they are not adequate for combating that machine.  In order to do this the theory would have to evolve.

When Paul Krugman calls for more government spending, it’s not the same argument that Bastiat was facing.  But Austrians just hear “government spending” and assume it is.  They are right about the big things but they are wrong about the details.  They are right that government spending doesn’t create wealth and that the monetary system is destructive but they refuse to put the two together and admit that it’s possible that government spending could mitigate the destruction.  I’m not saying that is a good justification for it, but once you see it that way it is a good justification for escaping the whole system.  Unfortunately Austrian economics cannot communicate this to mainstream economists because they don’t speak the same language and they can’t communicate it to the masses because most people will see that they are wrong about the details and assume they are wrong in general.

If you reread the excerpt from my economic text above, you will see that the issue of cardinal vs. ordinal utility was settled a century ago and Austrians won!  But they are still fighting that battle because they don’t realize that they won because they don’t get what mainstream economists are doing with utility because they refuse to do any real math.

Finally, as a result of the two above shortcomings: aversion to math and inability to evolve, Austrians, while correct that the system is doomed to failure, are wrong about the way in which it will fail.  In fact they have it exactly backward.  I have written about the details of this so I won’t go into it here.  And I even tried pretty hard to explain it to Austrians.  I even read the 50 year old book they told me to, and carefully critiqued it.  And I know that some of them looked at it because after I posted that on I had the most hits in the history of this blog.  But nobody (at least no Austrians) bothered to either refute or agree with what I said.  And if you spend much time on their site, you know that this is an unusual occurrence.  They were more than happy to argue with me when they thought I was making the typical Keynesian argument that they have been combating for 100 years.  But once it becomes clear that I actually know what I’m talking about they get suspiciously silent.

So how can they win?  This really depends on what you mean by win.  If winning involves the advancement of economic though they are simply not built for this.  There are two kinds of people in the world: people who want to be good and people who want to get better.  As a school the Austrians are the former.  They wake up each day thinking about how they can convince people that they are right.  They don’t wake up and think about how they might be wrong.

If winning means gaining a lot of followers, they can’t win because their details are wrong.  [Haha I tricked you it doesn’t depend on what you man by win at all!]  They are gaining support recently largely because they predicted a financial crash.  But they’re pretty much always predicting a crash.  If the economy comes back their support will disappear.  I don’t think that’s going to happen any time soon but it’s not impossible.  Furthermore, a lot of the things they advocate for would cause another crash.  This means that they are incredibly vulnerable to economic events.  For instance, if the government cut spending or the Fed stopped printing money like crazy, holding all other things equal, it actually would crash the economy.  When this happens the other side will say “see look, we tried it your way and it was a catastrophe, now we have to do the Keynesian thing and expand the government and monetary authority.”  And what will the masses do then?

Ultimately, in order to win in either of the above ways, a school of though, like a person, must be both consistent and correct.  The Austrian school, alas, is neither of these and, in my opinion, is incapable of becoming them.  And I say this as someone who genuinely wants all the things that Austrians want.  So what is a freedom-loving economist to do?

For the casual economist, I’m not saying you shouldn’t study Austrian economics but don’t get sucked into it.  Make sure you keep an open mind and look at other points of view.  There isn’t much else out there if you are into things like liberty, and free markets unfortunately.  For my part I will try to provide such an alternative.  Stay tuned for more on that front.

Newt Gingrich

December 17, 2011 1 comment

Beating up on Newt Gingrich is becoming kind of an unoriginal blog topic but I can’t help myself.  I’ll keep it brief though.  If you want an exhaustive list of reasons not to vote for Newt Gingrich you can go here.

First, this should terrify you.  I’m so sick of being called a fascist by people on the left.  Can we please not nominate a Republican who in fact is a fascist?  It’s really making us look bad.  The preservation of liberty is an exercise in restraint.  I don’t like a lot of the things the courts have done too.  I agree that someone who thinks “one nation under God” is wrong shouldn’t be on the court.  But that doesn’t mean I want the president to go and kick them off.  There is a process that determines these things and it is carefully designed to protect against tyranny.  If we don’t want these people on the courts we need to not put them there in the first place.  If we don’t like their rulings we need to address it through the legislature.  We can even change the constitution if we have to.  What we must not do is let the president just decide  which courts are acceptable and which are not based on some arbitrary standard like “attacking American exceptionalism.”

And notice what he says is their problem.  They are “grotesquely dictatorial, far too powerful and … frankly arrogant in their misreading of the American people.”  This is a statement I can almost get behind but the ending is all wrong.   If Newt was not a progressive, this quote would go like this: “grotesquely dictatorial, far too powerful and … frankly arrogant in their misreading of the constitution.” The purpose of a justice is not to read the people, it is to read the law!  Furthermore, the trend in the balance of power over the last 100 years has not been in favor of the courts, it has been in favor of the president.  So right now we have Barak Obama railing against an obstructionist legislature and a Republican front-runner railing against a tyrannical judiciary.  One is playing on our frustration with the separation of powers and the other is playing on our healthy distrust of concentrated power but they are both doing it in order to further concentrate power in the executive branch.  At least our side should see through it.

“American Exceptionalism” is an empty vessel.  Just pour in whatever you think is good, chill and enjoy.  It sounds good to everyone (at least everyone on the right).  But what you think it means might not be the same thing that Newt thinks it means.  This is a standard progressive tactic and it reeks of Newt’s favorite modern president FDR, who managed to force his outrageously unconstitutional New Deal through the courts by threatening to pack the supreme court.  They want to redesign the system.  In order to do this they have to break the rules of the system.  In order to do this they have to get the country to not mind that they are completely ignoring the rules and to do this they simply claim that they are doing it in pursuit of something the people want.  We have to stop taking that path: the quicker, easier, more seductive path.

Secondly, nobody who is not a progressive would say this.  Newt thinks Romney should give back the money he earned while laying off employees.  Sometimes, in a free market, employees should be laid off.  This is not an immoral act.  Anyone who thinks it is does not believe in the free market.  They don’t believe that employment is a mutually beneficial, mutually voluntary agreement but that working for someone gives you a claim on their life and their assets.  That employees are the wards of their employers and that if it stops being beneficial to the employer and they end the agreement that they are committing a great injustice.  This view is entirely incompatible with free markets and private property.   It is, however, entirely compatible with progressivism…..

Ron Paul

December 17, 2011 2 comments

Ron Paul could actually win Iowa.  When I saw the poll yesterday I suddenly thought to myself: “geeze what if he won the first primary and was the leader in actual delegates?  Then the press would have to take him seriously.”  This thought was dashed almost immediately when I saw Chris Wallace on Fox News, when asked “what if Ron Paul won Iowa,” respond with a cringe that it would discredit Iowa!  And as you can see in the link above, they are calling a vote of Paul a “protest vote” even when he’s a close second in the polls.  So if you are faced with this dilemma between voting for Paul whom you actually think is the best candidate and voting for Newt Gingrich in order to avoid nominating Mitt Romney here are a few things to consider.

1.  While Mitt Romney is pretty bad, Newt Gingrich is an absolute nightmare.  If the next president is any of the following men: Mitt Romney, Newt Gingrich, Rick Perry, Barak Obama, there is no chance of the country changing course in any meaningful way.  Repealing the healthcare law (which I bet none of them would do) and building a pipeline and passing another tax cut isn’t going to fix our problems.  We need to make a new commitment to individual liberty, limited government, and the rule of law.  If you think this will happen with Newt Gingrich you probably aren’t paying attention.

2.  Voting for candidates we don’t really like but whom the powers that be in the parties and the media tell us are acceptable is exactly how we got into this mess.

3.  This is the big one:  Ron Paul has the best chance of beating Barak Obama!  Think about it.  If Ron Paul actually got the nomination, for one thing, the press would have to take him seriously.  Sure they would try to tear him apart.  But this guy has actually been consistent his whole career.  You won’t find him contradicting himself because the things he says are based on principles not pandering to one interest group or another.  Like them or not, these are the things he actually believes.  So he’s not a “flip-flopper.”  Are they gonna claim he’s in the pocket of big business and special interests?  Maybe, but if people pay attention at all (granted, this is a big if)  it’s laughable.   Yeah, they’re going to claim he hates children and wants to kill old people etc. but if we’re not ready to stand up to that, then there’s no hope for us.  And you may recall that they did their best with his son, including calling him a racist, to no avail.

What’s more Ron Paul will get a lot of people on the left who are disenchanted with Obama.  Paul is for ending the Fed, legalizing marijuana and bringing the troops home.  He would probably get more OWS types than Obama.  And in the end conservatives, if faced with the choice between Paul and Obama would mostly suck it up and vote for Paul even if they’re not thrilled about all those positions.  In fact I recently saw Ann Coulter say Ron Paul was fantastic on domestic issues.  There are really only two things that he gets beat over the head for: not wanting to invade Iran, and wanting to legalize heroine.  So basically all he would have to do to beat Obama by 20 points would be to say the following two things:

1.  I don’t believe America should be meddling in other countries business, especially with the military, unless they are a clear and present danger to the United States or her allies–including Israel.  I don’t think we should be in Iraq , Afghanistan, Libya, etc. and I am very concerned that there are some currently preparing to start a war in Iran that might not be necessary.  However, I do agree sometimes the use of force is necessary and if Iran got the bomb it would be a catastrophe so it may be necessary to use force to stop them, but it would only be used as a last resort and even then it would only be for the purpose of preventing them from getting nukes and not to conquer and occupy the country. ”

2.  “I think all drugs should be legal but seriously people this is not our biggest problem right now.  I get that most of you don’t want to legalize heroine.  I actually think most of you are ready to legalize pot.  But the main point is that we don’t need a big Federal apparatus enforcing these things.  We should just get the Feds out of the drug business and let the states handle it.  Then you can each legalize whatever you want and keep whatever you want illegal.  Meanwhile the president will be able to focus on more pressing issues.”

The second one, I’m sure, would be quite simple and pretty much eliminate the issue.  Also, I think if I were a Ron Paul advisor I could get him to say it.  I don’t know if I could get him to say the first thing.  That’s the problem with men of principle, they won’t always say what they need to in order to win an election.  But after all, isn’t that what we’re really looking for America?

Categories: Politics Tags: