Friday, April 10, 2009

Anatole Kaletsky on Austrian Economics

Cast doubts aside, G20 is right to borrow and spend | Anatole Kaletsky: Economic view - Times Online

I really could not say this better.

Many financiers have been calling, instead, for a “market solution” based on the so-called Austrian school of economic analysis: the seemingly common-sense view that a crisis created by excess debt cannot be treated with further borrowing but must instead be cured by cutting back inefficient spending and investment and liquidating insolvent businesses, households and banks.

The upshot, in the words of Murray Rothbard, the leader of the Austrian school after the death of its founder Ludwig von Mises, is that “recession is a painful but necessary process by which the market liquidates unsound investments and re-establishes the investment and production structure that best satisfies consumer preferences and demands”.

One does not have to go into the economic details of this argument to see why it makes no sense. Even if Keynes had not refuted the economic logic of the Austrian position back in 1936 in his General Theory, their prescription could never in practice be applied. Since the 1930s, when Andrew Mellon, the US Treasury Secretary, famously urged President Hoover to “liquidate labour, liquidate stocks, liquidate farmers, liquidate real estate”, no other government anywhere in the world has dreamt of doing anything of the kind.

Some politicians, such as Mr Cameron, have toyed with Austrian ideas while in Opposition; others, such as Ms Merkel, have used them as political slogans. But none has come close to putting them into effect. In fact, the strictest proponents of liquidation and austerity in response to financial crises have often presided over the biggest growth of public borrowing.

There are two reasons why austerity never works in response to financial crises — and is never seriously attempted, even by politicians who pay lip service to “liquidationist” Austrian economics or the libertarian market fundamentalism of Ayn Rand.

The first is fiscal accounting. A collapse in economic activity devastates public finances, as we are seeing in Britain today. And once a nation gets into deep deficit, the only way to reduce deficits is to restore economic growth.

Even the most dogmatic theoretical proponents of Austrian economics, once they are put in the practical position of managing public finances, realise that cutting public spending or raising taxes during a recession will dig the public finances into an even deeper hole.

The second and much more important reason why austerity economics has never been tried in practice — at least since the 1930s — is politics.

In democracies, preserving living standards and jobs, protecting savings and keeping people in their houses, take a much higher priority than abstract Austrian arguments against preserving the Austrians’ “unsound production structures” or the burdens of debt on future generations.

And this is also true in dictatorships such as China or prewar Germany, which have generally attached an even higher priority to rapid economic growth and social stability — and have therefore been even more zealous in applying Keynesian remedies for economic downturns.

Politically, therefore, Ayn Rand’s idea of a capitalist economy run on strict free-market principles, with painful recessions allowed to run their course in order to liquidate the excesses of the borrowing booms, is pure self-delusion. Capitalism and private property would be swept away politically long before “liquidationist” economic theories could ever be put into practice.

13 comments:

Bill said...

Austrian economics really seems like the solution to our problems. Over the past two decades we have seen government intervention in the economy distort incentives and create unprecedented number of boom and bust cycles. Peter Schiff is a prominent free market proponent and economist from the Austrian school. He is currentyl being drafted to run for senate in 2010. check out this site to learn more about him and his policies: http://www.schiff2010.com

Richard said...

In the free market, corrections are introduced as fast as distortions appear.

Businessmen do not want to fail. Overall, free markets and free-marketers are always directed at success. Some businessmen see declines in one market (say housing) as an opportunity to step in, turning the housing decline into a success of different kind of (e.g. by selling short). Their actions 'move' money to better markets. As a declining market becomes the subject of such tactics, businessmen tied to that market change their practices (still towards success) and rise to the top —the housing market recovers. Such processes clear the market of bad investments almost as fast as they appear.

In a free market, the recent financial crises and subsequent recession could not have occurred, at all.

It was government intervention —going back at least as far as the Jimmy Carter administration— that tried to fake the economics of mortgage lending so as to make houses available to all Americans, even to people with no savings, no job, and no money down. Conditions (regulations) were imposed on lenders through the Community Reinvestment Act, pressuring them to make loans (euphemistically called 'risky') to ridiculously unreliable borrowers. The addition of government guarantees further encouraged lenders to believe they were protected from the bankruptcies their activities would otherwise incur. Those who did not engage in such lending saw their businesses fall behind, and had to join in the lending frenzy. A very few banks (e.g. BB&T) found other ways to stay afloat, knowing that such lending, over the long run, could only bring misfortune.

In hopes of burying the costs of high risk mortgages amongst reliable mortgages, large scale financial instruments were created by bundling the mortgages together (especially via Fannie Mae and Freddie Mac). These new investment funds were given deceptively high ratings by government agencies, in part because of the government's own guarantees (!).

The house of cards piled up faster and faster. Even foreign investors bought these new investment instruments, and their own governments engaged in similar fiscal con games.

When the American mortgage system finally collapsed, it dragged down the entire unstable, financial web. Government efforts to distribute the wealth of home-ownership to those in need (socialism) lead the government to forcibly influence the means of production (fascism). And, it was all done democratically. So much for Democratic Socialism.

The proper correction can only come by repealing a host of financial rules and regulations, such that those worried about losing money can untangle the aforementioned web in as productive a manner as possible. It means lowering the minimum wage, so that more businesses can hire employees. It means reducing government spending at all levels, especially by eliminating a host of government 'make-work' projects. It means leaving the money in the hands of those who made it. It means NOT printing money out of the blue, so money continues to be the value it was when people earned it. One great idea put forth by the Ayn Rand crowd was to ease American immigration laws, giving priority to those who want to buy a home and qualify to do so on normal mortgaging principles.

Of course, the very kind of thinking that caused the crisis can hardly be expected to solve it, but that is what this G20 meeting entailed! The G20 was a meeting of culprits not of 'leaders'.

Paul Halsall said...

It's odd that the supporters of "pure" markets always seem so sad.

Richard said...

Yes, 'pure' markets are a socialist Platonic fantasy that set a false standard for serious free market advocates. The latter still see the value of free markets, but reject Platonic influences.

The socialist Platonists' sense sadness due to their own perspective; it's an aspect not necessarily present in free market advocacy. That said, in a world of Keynesian Platonism it is sad to see good people destroyed by bad ideas such as socialism, be it democratic or dictatorial.

rtaylortitle said...

Another so-called "intellectual" strawman. Who and when were the Austrian economists put in charge to realize cutting public spending and raising taxes dug a deeper hole? When did this happen...never. The ploy of creating a scenario that has never been tried is fraudulent!
After retiring from the title insurance industry for 34 years as an "escrow officer-closer", I saw and closed many of sub-prime loans. I could look at the buyers/borrowers loan application and tell they were "over-buying" based on their income...it didn't take a genious to see their disposable income was very, very tight.
But, the lenders were forced and encourage to make a percentage of bad loans BY THE GOVERNMENT thanks to Carter, Clinton, Franks and Dodd. That's where your criticisms should be focused. When I explained, at closing, to these "predatory Buyers" that the "teaser" fixed rate would go away in two or three years either under a 2/28 or 3/27 mortgage and their payments could jump, possibly dramatically, they didn't care! The only thing they questioned was the amount of their new monthly payment now and when their first payment was...period.
These "toxic" mortgages were then bundled into derivatives, hedge funds, etc. building a house of cards that would inevitably come down.
The bailout is morally wrong as is the F.D.I.C., F.N.M.A., F.D.M.C., I.R.S. and the Federal Reserve - they are all Platonic "dreams" based on the concept of "force" and "faith". Force because the government carries a gun if you don't abide...Faith because the statists hope that this time things will work out, somehow.
We need true laissez-faire capitalism wherein there is separation of economy and state similiar to the separation of church and state. The spontaneous order that's produced by the billions of economic decisions that Americans make daily will then produce proper signals to individual investors and to corporate interests. The interest rate will "float" to reflect true supply/demand of capital needed at what cost.

Paul Halsall said...

You closed the sub-prime loans, eh?

Well you know, I worked for a few months in the same industry in late 2006 and did not close any loans. Why? Because I told people what the loan costs were. I also told them that house prices could not be counted on to rise for ever. And I was embarrased by the "brokers" fee, which was simply free money for the broker.

If you closed such mortgages, YOU are the one morally responsible.

Richard said...

I have to endorse rtaylortitle's comment, with one addition. He commented on "cutting spending and increasing taxation".

Any increase in taxation contributes to market distortion and economic decline, but reduction in taxation should only be achieved by a JOINT process of decreased legislation AND decreased spending. These two can be coordinated to maximize citizens' economic success to such a degree that the culture can recognize the benefit in reducing government intervention!

Richard said...

I repeat, "The addition of government guarantees further encouraged lenders to believe they were protected from the bankruptcies their activities would otherwise incur. Those who did not engage in such lending saw their businesses fall behind, and had to join in the lending frenzy."

On this basis, I think it important to understand the moral context of lending decisions. In this case, rtaylor (US) was working in a very different context from Bill Halsall (UK).

Paul Halsall said...

I'm not "Bill Halsall".

And I was working in the US in 2006.

Richard said...

Sorry, Paul... I had the first commenter's name in mind. Ok, you were in America in 2006... but you did not say how long you were there and above all, whether you were working. The latter is obviously germane.

Paul Halsall said...

I was there for 20 years, mostly as an academic. But in the autumn of 2006 I was working for a mortgage broker.

bgprior said...

I meant to respond to this much earlier, but I wanted to back it up with facts. This prompted me to go back and read up the histories of the Great Crash and Depression, and I haven't had time until now to get through it all.

Kaletsky is a bit of a joke now, isn't he? Isn't this the same guy who was telling us everything was fine, long after it obviously wasn't, even to true believers like him? No wonder he's now having pops at other philosophies, as the traditional distracting tactic of interventionists when the complete failure of their philosophy is being exposed.

The main point I wanted to address is the common claim that Hoover pursued liquidationist policies following the Crash. I have posted a summary of Hoover's record at http://www.pickinglosers.com/blog_entry/bruno/20090418/hoover_austrian_or_interventionist

Clearly, Hoover was an interventionist, not an Austrian, and it was this approach that failed. By Kaletsky's own logic, interventionism should now be discredited for all time.

There are many other points in this miscellany of nonsense that I would like to address, and hopefully may do some time, but I will limit myself here to the other point in that early paragraph, where Kaletsky distorts the history of the 1930s. In a comment on the Times web-page, I invited Kaletsky to tell us where in the General Theory Keynes successfuly refutes "the economic logic of the Austrian position". You are welcome to do the same. Or, if this is simple assertion without evidence, we can treat this as an indicator of the credibility of the author.

Richard said...

I have to support bgprior's argument. Everywhere Keyne's ideas have been implemented, they have failed. The only places they are not seen as failures are in 1) academia where they are never tested, 2) in politics where all outcomes are spun (see #3) to political advantage, and 3) in the MSM where the 'benefits' of wealth redistribution are all they care to report.

I wish I could say that the above was 'tongue-in-cheek'.