Skip to comments.A Primer on the Never-Ending Bust (Keynesians shown wrong again)
Posted on 06/10/2011 8:33:51 PM PDT by sickoflibs
With Friday's dismal jobs report showing a paltry 54,000 increase in nonfarm payroll employment in May more and more analysts are realizing that the so-called economic "recovery" is stalling. As Jeffrey Tucker recently pointed out in an important article, Austrians realize that the recession never left. This has all been smoke and mirrors for the last two years.
As John Papola and Russ Roberts's latest video underscores, the classic confrontation is still between the Austrians and the Keynesians. These contrasting visions are still the primary choice when the average person tries to understand why the economy seems broken, and when policymakers try to fix things.
Why the Prolonged Slump?
I have noticed recently that there is some confusion in public discussions about the Austrian take on recessions, even from sympathetic observers. So let me clarify how most modern Austrians certainly those of a Rothbardian persuasion would interpret what has been happening in the last few years.
First, the Federal Reserve's easy-money policies after the dot-com crash, in conjunction with other government policies, fuelled the housing bubble (see here and here). Many economists (not just Austrians) have now come around to this explanation, but Austrians were saying it well before it was chic. In addition to Peter Schiff's famous showdowns, the Mises Institute's own Mark Thornton wrote incredibly prescient columns as early as 2004 on the issue.
Now in the standard Austrian theory of the business cycle, the question is not "How do we get out of a recession?" Rather, the question is "How do we avoid the boom?" According to the Mises-Hayek theory, the preceding boom makes the corrective bust inevitable. The goal, therefore, is not to keep the boom going, but to avoid it in the first place, rendering the bust unnecessary.
Therefore, given that there had been a massive housing bubble for years, by 2007 it was unavoidable that the US economy was in store for a massive bust. That's why in October 2007 (relying on a forecast I had performed for a bank client in July of 2007) I wrote a Mises Daily called, "The Worst Recession in 25 Years?" As anyone can see from looking at that piece, I wasn't merely relying on my gut; it was a quantitative exercise looking at what Austrian business-cycle theory blames recessions on.
However, even though Austrians thought a recession was inevitable, the length of the recession and the strength of the ensuing recovery could definitely be influenced by policy. This is why Tom Woods and I spend so much time pointing to the depression of 192021 as an example of a severe but quick bust followed by a tremendous economic expansion. Far from providing a "soft landing" in that episode, the Fed jacked up the discount rate to a then-record high, and the government slashed spending an incredible 65 percent in one year! (This was following World War I, remember.) Prices fell half again as much during this depression as they did in any 12-month period during the Great Depression. And yet, as its name suggests, the Depression of 192021 was over pretty quickly.
In contrast, after the stock-market crash of 1929, Herbert Hoover began a series of then-unprecedented interventions into the economy. FDR of course upped the ante, coming the closest to full-blown socialism (outside of wartime) the country has ever experienced. As a result of these "cushioning" measures, the United States suffered the longest slump in its history.
In summary, the best thing for the Fed and government to do during a slump is get out of the way. Let interest rates signal the actual state of savings and investment demand, and let prices including the price of labor fall in order to clear markets. Malinvestments were made during the boom years, and they need to be liquidated. People who made entrepreneurial errors need to suffer the consequences of those decisions. If the politicians really want to "do something," they should cut spending and taxes, returning those resources back to the private sector, which is already on the ropes.
Why Should We Be Surprised That We're Stuck Now?
Given the Austrian views of history and the proper things policymakers should be doing during a recession, it's no surprise that our economy continues to sputter along. Again, this is not something Austrians have been saying after the fact: we've been predicting all along that the Bush and Obama "solutions" were only going to make things worse. With apologies for the narcissism, let me quote extensively from an article I wrote back in June 2009:
I am not going to be foolish and give annual rates of projected real GDP growth; let me simply summarize my view by saying that the economy will be in the toilet for a decade. (Consult another economics PhD for a precise translation of those terms.)
I really don't understand how even some free-market analysts on CNBC and the like can talk about the recession ending this year [in 2009], or who speculate that we've finally "hit rock bottom." If they really believe that, then I wonder why they spend so much of their careers praising free markets and blasting socialism? If all of Bush's and now Obama's enormous interventions only yield a few quarters of a moderately bad recession, then what's all the fuss about?
We have all been desensitized to the federal power grabs, because they have been so sudden and so sweeping. The human mind is able to adapt to any new environment fairly quickly.
Let's think back just one year ago [to 2008]. Remember when plenty of people were worried about the "unjustified" intrusion of the Federal Reserve into the Bear Stearns takeover? Contrast that to today, when the federal government is literally acquiring outright common-stock ownership in major banks, where the precise accounting mechanism is a conversion of (TARP) "loans" that it forced some of these banks to take, and which the government (as of this writing) refuses to allow to be paid back.
Or how about this one: in the spring of 2008, the Bush administration pushed through a stimulus tax cut that cost a little more than $150 billion. Do you remember that at the time, this was considered a fantastic sum of money? Analysts on CNBC fretted about the impact on the deficit and interest rates.
"I think many free-market economists have forgotten just how big the government has grown."Well President Obama's stimulus package was $787 billion; the expected federal deficit this fiscal year is $1.8 trillion. The CBO projects that the federal debt as a share of the economy will double over the next decade, from about 41 percent last year [i.e., 2008] to 82 percent by 2019.
Beyond the massive shift of resources to the government, though, are the massive intrusions of federal power into various sectors. The feds have already partially nationalized the banking sector (a process started under that "laissez-faire conservative" George Bush); they have taken over one of the biggest insurers in the world (AIG) and two of the Big Three car companies; and they have taken over Fannie and Freddie and now control more than half of US mortgages.
On top of that, they are pushing through a plan to cap carbon-dioxide emissions which allows the government to control energy markets, and oh why not? they are trying to nationalize healthcare too. Just to make sure investors around the world stay clear of the American economy, the Obama administration has overturned secured-creditor rights in the Chrysler fiasco and has hired 800 new IRS employees to put the screws to wealthy filers with international business operations.
It is no exaggeration to say that the last time the government expanded this much, this quickly, was under FDR's New Deal. And we got a decade of misery during that particular experiment. Why would things be different this time?
The reason I bring these points up is that I think many free-market economists have forgotten just how big the government has grown recently. Before the financial crisis hit, it would have been inconceivable for the Treasury to be running such massive deficits, let alone to seize ownership claims in so many private corporations. Although the plan for an explicit cap-and-trade program failed (for now), the EPA is threatening to directly regulate carbon-dioxide emissions.
And yet, in spite of these incredible expansions of government power, we have free-market guys like David Beckworth laughing at people because their worldview would require the current economy to be much worse than the official statistics indicate. So my question to Beckworth and other free-market economists is this: If the economy really did just suffer a few bad quarters, even in the face of the biggest expansion of government power since the New Deal, then why are you bothering to spread the word on the benefits of economic liberty? Wouldn't your time be better spent educating people on the distinction between that and which?
The Formidable Keynesians
Thus far I've explained why I think the Austrians deserve serious attention in discussions for both the layperson's and the policymaker's understanding. Among free-market schools of thought, to my mind the Austrians have come out of this episode very well. (In contrast, some Chicago School guys are still denying that there even was a housing bubble. Their views are internally consistent and have a theoretical elegance, but I think most people can recognize that their conclusion is simply wrong.)
But I don't want eager Austrian fans to walk away shouting, "Aha! We were the only ones to predict this recession, and so everyone should listen to our policy advice." That's just not right, and it discredits the Austrian view when people say it.
For example, Nouriel Roubini was the Peter Schiff of left-leaning economists. He was making dire predictions earning the nickname Dr. Doom at conferences when few others thought there was a housing bubble or problem of debt overhang.
There is also the reigning Keynesian champ Paul Krugman. He too predicted the housing bubble, though it's an odd accomplishment since he called for its creation and then later confirmed (with caveats) that it had been necessary after the dot-com crash.
Krugman also correctly predicted that there would not be large rises in the consumer price index (CPI) in 2009 and 2010, even though many free-market economists (myself included) thought there would be. This situation is still playing out, and it may simply be a matter of timing. The huge injections of monetary base more in the last two-and-a-half years than in the entire history of the Fed up till that time went hand in hand with enormous increases in gold, silver, oil, and other commodity prices. Because the injections are largely bottled up as excess reserves parked at the Fed, their impact thus far has been primarily through expectations. I am still very skeptical that Bernanke is going to drain those reserves before they fuel undeniable CPI increases, and without crashing the financial sector.
But even though some Austrians gave premature warnings about the imminent collapse of the dollar a warning that may yet come to fruition they unambiguously did better at predicting the impacts of the "stimulus" package. Daniel Mitchell of the Cato Institute recently put out an updated graphic showing the Obama Team's projections of unemployment with the implementation of his stimulus package, compared with actual history:
Let me address one obvious objection from the Keynesian camp: They might say, "Yes yes, Obama's team (headed up by Christina Romer) came up with rosy predictions. But hey, Krugman and a few others were saying all along that the stimulus wasn't big enough! So you Austrians weren't the only ones saying we were in store for years of misery."
In the first place, the rumors of Krugman's predictive accuracy during this recession have been greatly exaggerated. Here he is on November 14, 2008:
All indications are that the new administration will offer a major stimulus package. My own back-of-the-envelope calculations say that the package should be huge, on the order of $600 billion.
So the question becomes, will the Obama people dare to propose something on that scale?
Lets hope that the answer to that question is yes, that the new administration will indeed be that daring.
Of course, as things turned out, a mere two months later the Obama Administration was proposing a stimulus package that was $787 billion, so quite daring indeed. Now, it is true that Krugman (and Mark Thoma) were warning by this point that such an amount wouldn't be big enough. But go look at Krugman's analysis at the time. His point was not so much that the Romer team's numbers were wrong (though he did think their projections of what would happen without the stimulus were very optimistic). Rather, he was saying that on their own projections, they weren't anywhere near to closing the "output gap." In other words, in terms of the above graph, Krugman wasn't warning, "Guys, I think actual unemployment with the stimulus package will look like the red dotted line, so you need to spend a lot more." Rather, he was saying, "Guys, that blue line is still pretty miserable, and the Republicans might classify the stimulus as a failure. So you'd better spend more."
Therefore, when it comes to the effects of the "stimulus" package, the free-market economists (including the Austrians) were right, and the Keynesians were wrong: The economy suddenly got "a lot worse than we realized" after the stimulus kicked in. Now maybe it was a coincidence, but the episode is definitely a point in favor of the Austrians and against the Keynesians.
The Austrian School provides a coherent and realistic framework with which to understand the general operation of a market economy, as well as violent boom-bust disturbances. For those versed in the writings of Mises, Hayek, and Rothbard, the continuing economic slump has been no surprise.
If you realize both parties in Washington think that our money is theirs and you trust them to do the wrong thing, this list is for you.
If you think there is a Santa Claus that has some magic easy cure for the economy; someone who is going to get elected in Washington and fix everything just by cutting your taxes, investing (more government spending) a few trillion more we don't have and will never have, and who will just command some countries to lower their prices and others to raise their prices all to suit your best interests, then this list is not for you.
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The Austrian Economics Schools Commandments plus :From : link
1) You cannot spend your way out of a recession
2) You cannot regulate the economy into oblivion and expect it to function
3) You cannot tax people and businesses to the point of near slavery and expect them to keep producing
4) You cannot create an abundance of money out of thin air without making all that paper worthless
5) The government cannot make up for rising unemployment by just hiring all the out of work people to be bureaucrats or send them unemployment checks forever
6) You cannot live beyond your means indefinitely
7) The economy must actually produce something others are willing to buy
8) Every government bureaucrat should keep the following motto in mind when attempting to influence the economy: First, do no harm!
9) Central bank-supported fractional reserve banking is an economically distorting, ethically questionable activity. In particular, no government should ever do anything to save any bank from the full consequences of a bank run, no matter what the short-term consequences.
10) Gold is Gods money.
1) Businesses don't hire workers just because of demand for products or services, they hire because it makes them money. Sorry to have to state the obvious.
2) Government spending without taxing is still redistribution
3) Taking one man's money and giving it to another is not a job.
4) Paul Krugman and Bernake have been wrong about everything, as well as the other best and brightest Keynesian's who have been fixing our economy for over a decade.
5) Republicans in the minority (esp out of the White House) act like Republicans, in the majority they act like Democrats .
Equity bubble rules:
1)If something goes up too fast, it is going down faster,
2) By the time it looks like everybody is getting rich, its too late, stay out!
3) To get rich you have to get in early start of recovery and get out at the first really 'bad' news, and ignore the experts that claim that they will stop the next crash(our buddy Bernake.).
4) Don't invest money you will probably need, or worse money you don't really have.
Just a note, we all know that the clueless public and power seeking politicals make it impossible to let the economy recover because it involves short term pain, rather than the endless mess we are stuck in. You notice Bernanke stopped QE AFTER the election?
The Austrians vs. the Keynesians. Is this the same as the Fresh Water School vs. the Salt Water School, that my boyfriend mutters about as the market gyrates.
Sadly I must agree with your aheeemmmm, additional list.
The Fresh Water and Salt Water Schools are both variations of the Keynesian School of Economics.
The Fresh Water bunch (led by Chicago and Carnage Mellon) are more conservative and believe the answer to prosperity lies in government tinkering of monetary policies.
The Salt Water bunch (led by MIT, Harvard, Princeton, Columbia, Yale, and Cal-Berkley) are more liberal and argue for fiscal intervention by the government. Obama's pork package and Bernanke's Quantitative Easing disasters are classic Salt Water solutions.
As pointed out by the author of this article, the Austrian School is almost the complete antithesis of the Keynesian School. The Austrian School, although still considered heterodox, is rapidly gaining supporters if for no other reason than its accurate predictions concerning our current economic disaster. The Keynesian School will probably remain orthodox given the liberal tendencies of academic elites, but is nevertheless gaining a reputation of failure and thus rapidly losing its credibility.
Which is why we now have the neo-Keynesians. Tinker around the edges with the distorted views of the vulgar Keynesians, but leave the original mistaken core intact. They never give up.
I read your response to my boyfriend and I am still trying to digest what he said. I think I will go eat something and get my brain working better.
Meanwhile, however, I would like to postulate something that I have been thinking for some time. It seems as though Americans have been buying so much STUFF, that we have become rather saturated with it. In addition to the really cheap stuff from China, this has caused a real reduction in the buying of stuff made in the USA. Also well made stuff is lasting longer. For example my 1986 Caravan began to need lots of replacement parts around 100,000 miles, but I am told my 1996 Caravan will probably by economically viable for many more miles than that. When people refuse to bow to “planned obsolescence”, then manufacturers don’t sell as much and don’t need as many workers.
I am wondering if with the more recent efficiencies in manufacturing we don’t need to reduce the standard working hours. In the period of great manufacturing advances during the period 200 to 100 years ago, working hours were gradually reduced from 70 or 80, or even 100 hours per week to 40 and 50 hours per week. Perhaps the 35 to 40 hour week with 2 or 3 weeks of vacation is becoming obsolete.
My thought is that if this is true, then it would probably not make sense to cut the work week by much, but rather have much more time off. This could enable the vacation and recreational sectors of our economy to expand and hire more workers. For example, people could plan long vacations in one area and spend less on gas making repeated trips to and fro. More and larger home improvement projects could be planned and executed. I could go into more detail, but my stomach wants to go to the kitchen.
I said many times that Obama will compromise his socialist positions to get re-elected. It's seems like these Democrats really DON'T want private sector jobs and don't understand Obama's re-election is related to the economy.
Zero will throw anyone under any bus, anytime.
The fiscal and monetary stimuli have been targeting the maintenance of financial, legal, and regulatory leeches on our society. It has made it worse, not better. The productivity gap used to be close by printing money an sending it to producing nations. Now the dollar has dropped and that does not work either.
I agree with you, but that is a tough sell in our society that believes if you are not at work doing your useless little bureaucratic job you are not productive. Funny how the Germans have 6 weeks of vacation a year, including the entire month of August. France is similar, but in addition has a 35 hr work week. And their nuclear power electric production is at about maximum useful capacity of 85% of total electric demand.
We Americans could learn a lot from others.
The only way in which market speculators generate wealth is by buying goods when there is a relative surplus and selling them when there is a shortage. Once speculative buying starts to cause a shortage, further speculative buying will destroy wealth. Many people seem to regard as meaningful the mathematical product of the number of units of something in existence and the marginal price of an additional unit, and so figure that actions which increase that figure generate wealth. When speculative demand falls and this in turn causes prices to fall, people seem to think that the falling prices represent a destruction of wealth. In actuality, the (total quantity)*(marginal price) figure never represented any real wealth to begin with, so the fact that the imaginary wealth represented by that figure evaporates proves nothing beyond the fact that it was imaginary to begin with.
The biggest rule to remember, IMHO, is that falling prices for goods which will have future demand should be a "buy more" signal, and rising prices should be a "buy less" signal. People generally have no trouble figuring out such behavior patterns when buying goods for their own immediate use; when buying speculatively, however, people all too often get the signal reversed.