A cousin of my wife is an investor (his political beliefs are moderately conservative). I've been having a discussion with him about Austrian economics and the current events. He is clearly not an Austrian, and although I read articles on Mises.org, I am a biologist, and he is an investor, so he clearly knows more than I do. I was interested what people might say to some of his arguments (not so that I can rebuke him, but so that I understand more clearly why he is wrong).
I am quoting from his latest reply:
1. The money supply needs to increase along with the growth rate of the economy to get zero inflation. That way, there are more dollars out there when the total value of goods and services goes up. [In the previous e-mail, he claimed that while excessive inflation if clearly bad, some level of inflation needs to happen. So, once the government establishes that "healthy" level of inflation, things will be hunky-dory.] I agree that going off the gold standard caused much of the hyperinflation of the '70s. Since that was brought under control, inflation has been relatively tame. It was the transition to fiat currency that caused the hyperinflation, not being on it. Yes, the economy grew in the 19th century, but it was a tiny fraction of the growth we have had in the last 30 years! Lack of inflation doesn't lead to no growth, it leads to very slow growth. 2. It's just not true that most booms and busts are caused by monetary policy- throughout history there have been booms and busts, caused by various factors, including environmental, mercantile, emotional, etc. The great depression was before fiat currency, as was tulip mania in The Netherlands, countless famines, and hundreds of other crises of tremendous severity. Mistakes managing interest rates can cause booms and busts, but not managing at all practically guarantees them, and ones of much greater severity. 3. [I am particularly interested in a response to this point:] The national housing crisis is over already, so it's not possible for it to continue. Housing prices in much of the country have already begun to come up. The exceptions are places with unusually large numbers of forclosures, where it will be awhile before those can be worked through. Those areas will hinder growth somewhat in the near term, but will not have a huge impact. Many of those numbers cited were just the federal government giving a large enough backstop to banks and others so that the market would not question their ability to pay- those huge amounts never changed hands and never will. They could have doubled those numbers yet again and it would have zero impact. If students of the Austrian school had made all of those decisions in 2009 [to let the banks fail, etc.], we would be in a depression right now, because there would have been a domino effect among failing institutions, most large companies would be wiped out (including ones that were never in any danger under the scenario that actually took place), the unemployment rate would be about 10% higher, and the US government's balance sheet would actually be worse (because the depression would reduce tax receipts by much more than they "spent" on the bailouts and stimuli. We wouldn't be falling as long because we would have hit rock bottom too quickly. The economy might have begun rising more quickly (though I'm not convinced), but still would be way behind where it is now, and probably would be for another 5 years, because it would have fallen so far.
1. The money supply needs to increase along with the growth rate of the economy to get zero inflation. That way, there are more dollars out there when the total value of goods and services goes up. [In the previous e-mail, he claimed that while excessive inflation if clearly bad, some level of inflation needs to happen. So, once the government establishes that "healthy" level of inflation, things will be hunky-dory.]
2. It's just not true that most booms and busts are caused by monetary policy- throughout history there have been booms and busts, caused by various factors, including environmental, mercantile, emotional, etc. The great depression was before fiat currency, as was tulip mania in The Netherlands, countless famines, and hundreds of other crises of tremendous severity. Mistakes managing interest rates can cause booms and busts, but not managing at all practically guarantees them, and ones of much greater severity.
3. [I am particularly interested in a response to this point:]
Thanks...
This is his reply to my e-mail:
No, I don't agree that interest rates are determined purely by "time-preferences" in a completely free market. One obvious factor is market participants' expectations of the future time preferences of others, which is in turn affected by numerous factors, including emotional swings.
I don't think the Fed is perfect, I just know they are much better than nothing.
1. Allowing the money supply to shrink relative to the economy by keeping it fixed would cause a recession that would likely last as long as the policy were in place. One reason is that few participants would invest, knowing that they could just hold their dollars and allow them to appreciate.
2. The transition to a fiat currency caused significant inflation largely because the dollar had been artificially pegged at $35/oz of gold, which was fat below the market price, causing sudden inflation when the peg was removed. Inflation and monetary uncertainty both beget inflation, and this was much of the cause of the inflation of the '70s. Inflation in the last two decades, once that initial problem was resolved, has been quite tame.
3. a. [This is reply to the question of what happens if Fed fails to sell back all its assets.] Ok, but if they are only 98% successful and avoid a depression, while taking a small loss, that seems like a clear win to me. Again, it is not a perfect system, just much better than any other we know of.
b. [This is reply to analogy of what would happen if Fed started buying up Honda cars. Wouldn't that cause malinvestment in Honda and eventual bust?] My point was that it wouldn't have to go through a bust if they held the cars and let them out very slowly, essentially what has happened with the so-called "toxic assets." Since many of these pools were sound, once there was liquidity in the market and confidence that the US economy wasn't going completely down the drain, over time they have come back up toward their true value.
4. The media are sensationalists, because that is how they attract more readers/listeners/viewers. They focus on foreclosures, short sales, etc. In the nation as a whole, inventories are back down to what they werein late '05 to early '06, and home sales are back up to what they were in early '08. Median existing home prices are slightly down from 2009, as of early 2011- and if they followed trendlines since then (the data isn't available yet), is flat to slightly up since then. only the last clause was speculation- the rest was all factual.
The government is not propping up home prices in particular, other than tax breaks and mortgage guarantees that have been in place for decades.
[Here I asked for a proof of total market collapse if the government did not bail out the banks.]
Do you need proof that a sharp rise in defaults of large financial institutions would lead to defaults in those that rely on their guarantees, or that virtally all major financial institutions are intertwined and borrow and lend to and from each other as well as rely on each others' guarantees, or that virtally all major financial institutions failing would cause a depression?
EmperorNero:Jees, I know. I just wanted to explore this as a theoretical exercise, ok. But I guess that's not possible. You are so eager to throw your rehearsed lecture on basic economics at me that you can't have a theoretical argument.
oh boo hoo
I'm perfectly happy to have theoretical discussions, I just prefer them to have some basis in reality. I have little interest in pontificating "well if elephants were mice, and pigs could fly, but only on days when unicorns cry...what would the unemployment rate be?" I wouldn't have to lecture you on basic economics if your thread of thinking stayed in line with reality.
Some things that occur to me on reading the email.
[...] [I]nterest rates are [not] determined purely by "time-preferences" in a completely free market. One obvious factor is market participants' expectations of the future time preferences of others, which is in turn affected by numerous factors, including emotional swings.
All he is saying is that these extraneous factors affect his personal time preference rate.
The Fed has been a failure on its own terms.
Do you need proof that a sharp rise in defaults of large financial institutions would lead to defaults in those that rely on their guarantees [...]
80 percent of business borrowing was done outside of the banking system; plus, most firms could have paid off their liabilities solely through drawing on retained earnings. And credit did not "crunch" in the wake of the crisis. It continuted to increase, and then sort of plateaued as businesses eagerly anticipated bailouts. (Why sell an asset at $20 on the market when you can sell it at $30, $40, $50 to the government?) Absent a bailout, the only people who would have had trouble borrowing would have been Wall Street.
FlyingAxe:No, I don't agree that interest rates are determined purely by "time-preferences" in a completely free market. One obvious factor is market participants' expectations of the future time preferences of others, which is in turn affected by numerous factors, including emotional swings.
Emotional swings, and expectations of others' time-preferences have zero contribution to one's time-preferences? Hm, go figure.
The Gilded Age would disagree with you. Price deflation throughout and yet the fastest period of economic growth even if you're measuring by GDP, which is sympathetic to inflation.
Really people wouldn't invest? Once again the Gilded Age disagrees with him. People don't just hold onto their dollars without good reason. If their dollars are accumulating in value then they can afford to spend some and save some. People want goods, not pieces of paper. This is such a tired platitude of the inflationists. Yes people would hold onto some money, thus genuinely lowering interest rates, thus making investment cheaper, thus more investment in production, which is good. If savings is bad, then why is it that fed economists recommend slashing interest rates to stimulate investment? Doublethink much?
Pegged at 35/oz when? During FDR. After the mass theft. SecTreasury Henry Morgenthau said this:
As the Great Depression persisted, even Treasury Secretary Henry Morgenthau admitted that the New Deal had been a failure. On May 6, 1939, he confessed, “We are spending more than we have ever spent before and it does not work. . . . We have never made good on our promises. . . . I say after eight years of this Administration we have just as much unemployment as when we started. . . . And an enormous debt to boot!”
Also
' When Roosevelt told Morgenthau he was thinking of raising the price of gold by 21 cents, his entourage asked him why. "It's a lucky number," Roosevelt said. "Because it's three times seven." As Morgenthau later wrote, "If anybody knew how we really set the gold price through a combination of lucky numbers, etc., I think they would be frightened." '
Far below the market price? Geez so when it was pegged at $20.67 for a century it must have really been below the market price huh?
Inflation became much more tame when he started measuring it more conveniently (hedonics, geometric weighting, price substitution).
How is that an answer to your question? Anyways there's no way in hell that the market is going to pay for the Fed's shitty assets at the rate that the Fed bought them from the market. Thus inflation built-in.
There probably would have been a lot of intertwined default problems. Good riddance, then there wouldn't be such constant inflationary pressures on the taxpayer.
I don't think he understands why inflation isn't happening right now. The banks are holding onto the cash because they're afraid that when the chain reaction of derivatives comes around, they won't have the cash to back their deals. So it's really a Catch 22. Either you somehow get safely out of this debt crisis and the economy starts flowing again, the reserves come out and massive inflation ensues, or you get the great debt unwind and the only people standing at the end will be the banks with the right pals.
The Anarch is to the Anarchist what the Monarch is to the Monarchist. -Ernst Jünger
FlyingAxe's wife's cousin:No, I don't agree that interest rates are determined purely by "time-preferences" in a completely free market. One obvious factor is market participants' expectations of the future time preferences of others, which is in turn affected by numerous factors, including emotional swings.
You're in luck. The Pure Time-Preference Theory of Interest just hit the Mises Store and (free) .epub format literally within the last couple of weeks.
The introduction can be found here. If your friend needs a refutation of his amateur conjecture-without-reasoning-or-analysis, send him a link to the book. He can download the PDF or the epub (to read on his eReader) completely free of charge.
As Tunk said, he's not even really refuting anything. It's just like when he tried to claim "there have been booms and busts, caused by various factors, including environmental, mercantile, emotional, etc." or when the pony tried to claim "The ABCT explains a particular kind of financial crisis and why that particular crisis is caused by the fed. It does not rule out recessions, panics, crisises, or lower prices altogether."
In your friend's case he just keeps isolating various things that play into the larger overall cause. (And of course as I pointed out in the pony's case, she goes a step farther and literally just lists synonyms as if they were different things.)
Oh he "knows" this. I'm on the edge of my seat for this one.
In a free market no one would "keep" the money supply doing anything. I love the way people purport to attack "free market" and then go on to describe something else as they knock it down.
Also, I'm wondering how this genius would explain all the economic growth that occurred when there wasn't centralized manipulation of money supply. According to him, history was one big perpetual decline, with the only times of prosperity being when we had the manipulation. (Which of course were (in reality) the only times we had boom-busts.)
2. The transition to a fiat currency caused significant inflation largely because the dollar had been artificially pegged at $35/oz of gold, which was fat below the market price, causing sudden inflation when the peg was removed.
Uh. So let me get this straight. The money supply was constrained by a link to gold, meaning the value of a dollar had a roughly stable value in terms of gold. It was only when this link was cut, and the central bank could print all the money it wanted out of thin air...it was only then that the "true" value of the dollar was revealed, and a "market price" was reached.
Does he even listen to what he's saying?
Inflation and monetary uncertainty both beget inflation, and this was much of the cause of the inflation of the '70s.
Inflation begets inflation. Mmmkay. So how is the first inflation begotten?
Inflation in the last two decades, once that initial problem was resolved, has been quite tame.
Again, he means "since the way inflation is officially measured was changed, official measurements of inflation have been relatively tame", right?
a) I'm sorry, "avoid"? Because the past 3 years has been such a walk in the park.
b) Yeah yeah...don't tell me. "Oh but it would have been so much worse". Again, the very government he claims is intelligent enough to centrally plan the economy is the one that literally said the unemployment rate would be lower than it has been if they hadn't done the stimulus. (Why do I keep having to link the same damn things?)
c) "98% successful". I'm wondering what this means. The whole reason the Fed bought all this stuff was because no one wanted it...as in, it was virutally useless...as in, it had no market value...it was "toxic". And this guy is suggesting that somehow, now the market will want to buy crap that has no value? And for a premium? (Or at least the premium the Fed paid for it)? Seriously? Why?
d) And also let's not overlook the fact that this guy is literally arguing that putting a gun to your head, taking your money and giving it to someone else is perfectly fine, so long as the thief hires an economist to issue a statement telling you it's for your own good, and "trust me, you're better off."
I have no idea what he thinks he's talking about. I want to see the data. I want to see the reports that show people have been buying these securities and the Fed has been "slowly" selling them at a market price. I would also like to see what these "sound pools" were.
Where is he getting this from? Again it sounds like he's just making shit up the way he thinks it should go/the way he was told it should go/the way he would like to be.
1) Source please. (Also see my last two sentences directly above.) If you don't feel like waiting for him to come up with an excuse as to why he can't actually provide the evidence to support his claim, you can include this graphic. Be sure and tell him that you're just a naive [whatever you do], but you could have sworn 5.4 million is more than 3.8 million.
2) His numbers are just like this other friend of another member here. What's the relevance of 2009? Why not 2008? 2010? 2000? And even though he's wrong on the actual numbers, why is he looking at "late '05 to early '06"? Why not 2002? Why not 1982?
As if committing the sharpshooter fallacy was bad enough, this guy doesn't even do it right. He picks the worst time to compare (and he's still wrong). He's literally looking at the height of the housing bubble and saying "hey look...inventory is the same as what it was then. All good." (The reality is it's currently more than 42% higher than even that, but still). As A. Gary Shilling points out here, if you actually look at a historical average and not at some single few-month time frame, new and existing inventories listed for sale have averaged about 2.5 million. And this friend of yours wants to look at the peak of the biggest glut in home building in history, and say that matching that inventory (which is 52% higher than the historical average) is just dandy.
This is what happens when people who don't have a clue think they know everything.
Bullshit. [1][2][3] (And that's just what I came up with in 30 seconds)
[Here I asked for a proof of total market collapse if the government did not bail out the banks.] Do you need proof that a sharp rise in defaults of large financial institutions would lead to defaults in those that rely on their guarantees, or that virtally all major financial institutions are intertwined and borrow and lend to and from each other as well as rely on each others' guarantees, or that virtally all major financial institutions failing would cause a depression?
No, I need proof that things would be worse if money wasn't taken from the public and handed over to corporations that essentially made terrible bets because they knew they wouldn't be on the hook when they lost. I need proof that a company is "too big to fail" as opposed to "too big to bailout". I need proof that simply letting the people who lost, actually suffer their own losses, and letting the remaining good assets come under new ownership would cause a world collapse from which there is no return. I need proof that somehow simply not having the same people in charge of assets would mean the end of the world as we know it.
You know. Just proof of anything you've said.
P.S.
As for his nonsense article, I'd like to first go back to his premise about how necessary the Fed is. Oh yes, it's been all sunshine and lollipops since the Federal Reserve has been in existence.
But that article asks: "abolishing the Fed only raises the bigger issue: What would-or should-be in its place?"
Thomas Sowell answers that question perfectly by the end of this segment:
Thanks for the response. Most of the answers make sense to me except the first one:
I don't think he will read the whole book. I am reading it and will get through it eventually, but what is the specific response to his point?
I think he is saying that when market participants invest long-term vs. short-term, they don't just use interest rates on a loan they can get from a bank as judgement, but they also try to predict the consumers' time preferences. Which prediction, he says, can be based on emotions (for instance, if the government creates a lot of "housing mania", then the investors may erroneously predict, independent of the interest rates, that the demand for housing will continue). I would add, if I were to try arguing on his side, that the investors might look at the ongoing situation on the market -- for instance, spending habbits of the consumers.
If I am considering investing long-term vs. short-term, and I see that local stores' and restaurants' revenues are steadily going up, why would I predict that the consumers are saving right now and planning to spend in the future? Even if lower interest rates (thanks to Fed) make some thusfar unprofitable long-term projects profitable, would I really use only that to make a decision where to invest and ignore all the other signals that the markets are sending?
FlyingAxe: If I am considering investing long-term vs. short-term, and I see that local stores' and restaurants' revenues are steadily going up, why would I predict that the consumers are saving right now and planning to spend in the future? Even if lower interest rates (thanks to Fed) make some thusfar unprofitable long-term projects profitable, would I really use only that to make a decision where to invest and ignore all the other signals that the markets are sending?
How can you know that because people are eating at restaurants that they're not saving? Perhaps they've shifted spending patterns and are spending and cutting different places? Interest rates are thought of as a good indicator, even though with a Central B they're not. Keep in mind that the vast majority of people do not acknowledge business cycle theory and so will interpret low rates as necessarily a good time to invest. Accounting for the principle of market competition, if your competitor leaps forward, you will be impelled to follow suit or be outdone.
FlyingAxe:I don't think he will read the whole book. I am reading it and will get through it eventually, but what is the specific response to his point?
Again, he just doesn't fully understand the economic principles. Like I told you before, he's not even really refuting anything. He doesn't realize that what he's talking about is not anything different, it's just a part of what we're talking about.
Maybe he'll read a (albeit somewhat lengthy) article? I think this will help you understand as well. It's actually perfect for your question, as it ties in time preference, interest and business cycle theory all together in an easy analogy. Sorry I didn't link it sooner...
OK, I read the article. But I am still not sure how to debunk his argument.
I understand that you're saying that everyone's time preferences are included in the interest rates. But what my cousin-in-law seems to be claiming is that entrepreneurs do not just look at the interest rates to anticipate the customers' time preferences. They look at something else (I guess I could ask him what he means). Furthermore, he claims that sometimes entrepreneurs' expectations are affected by emotions (which, in an of themselves, can be affected by a number of things, e.g., governmental propaganda), not rational calculation of time preference.
In what way is he wrong?
Can you recommend a relevant chapter from the book you recommended or from this book that describes what entrepreneurs' calculations are based on? (I'll take a look myself later; gotta run now.) Or any other written or visua/auditary material specifically on this question?
Thanks.
FlyingAxe:In what way is he wrong?
He's not wrong per se, he's just not refuting anything I'm saying.
I never said entrepreneurs are looking at interest rates to anticipate time preferences. I said they're calculating how much it will cost them to borrow to see how much a project will ultimately cost.
I agree entrepreneurs' expectations can be affected by emotions.
I don't see how any of this contradicts anything I've said or what is described in the article or what is outlined in Austrian business cycle theory. Perhaps you can enlighten me.
Can you recommend a relevant chapter
Let's try good ol' Human Action.
Well, for example, imagine my mom comes to an investor ten years ago and says: "I am looking for a $20 million loan to buy a fish-breeding facility that will breed organic salmon and also organic fish food for other facilities. It will take five to ten years to start producing fish for the market." The investor refuses to invest.
Now, ten years later, the interest rates are lower, so she figures she will try again. He refuses again. She asks: why? He answers: "Because I don’t think that five years from now, the demand for salmon on the market will justify the investment. At any rate, I can invest in kosher chickens, because the demand for kosher food seems to be rising, and they just put a kosher chicken factory owner in prison for hiring illegal immigrants."
Now, imagine that kosher chickens trend is just a fad, and people realize that kosher chickens are not any healthier; they are just slaughtered according to religiou ritual rules. Furthermore, the factory owner gets pardoned and gets out of prison, and people decide to buy his chickens rather than competitors’.
So, the investor ended up malinvesting. But his decision to invest in the kosher chickens rather than my mom’s salmon was not dictated (solely) by interest rates -- it was dictated by his expectations of other people’s preferences.
I guess one could argue (from the Austrian side) that while investors don’t blindly sink their money in any given steel industry project as soon as interest rates drop, the drop makes it more likely to invest long-term, while this increased likelihood of higher-order investment is not justified by change in the customers’ time preference towards future.
And, I guess, the empirical support for this is that during the bust periods, capital goods industries suffer the most. (Is there empirical evidence that shows that lowering of interest rates leads to a greater amount of investment in long-term projects?)
Re: Human Action: thanks, I’ll read it.
FlyingAxe:One reason is that few participants would invest, knowing that they could just hold their dollars and allow them to appreciate.
If everyone held their dollars, instead of investing them, how exactly would said dollars appreciate?
FlyingAxe:So, the investor ended up malinvesting. But his decision to invest in the kosher chickens rather than my mom’s salmon was not dictated (solely) by interest rates -- it was dictated by his expectations of other people’s preferences.
But you're talking about customer's taste in chicken. What does this have to do with time preference?
Putting Austrian Business-Cycle Theory to the Test
Can Austrian Theory Explain Construction Employment?
Sorry if I'm dumping too many links on you, but I think they actually offer insight into your questions (if not directly address them). I hope you are finding them helpful.