Republican nominations - Page 502

What I get out of reading some Austrian economic pieces is that the central argument is that Federal Reserve policies caused the crisis, rather than that they exacerbated. The assertion seems to run that without the monetary and policy manipulation engineered by the Federal Reserve, there would have been no bubble. That this had a hand in the crisis I don't doubt. But the argument (from what I gather from a Thorton paper posted at the Mises institute) is that Depressions are caused by the federal reserve and policy problems, and can be solved by eliminating regulations and the federal reserve altogether. This ignores over a century of history in the American West, where booms and busts in the business cycle happened incredibly frequently, and government intervention was almost non-existant. The country still ran under a gold standard. The Austrian response seems to be that hey look, there were private banks in that era that expanded monetary supply too rapidly. But since the creation of the Federal Reserve (after the Great Depression disaster), the booms and busts have become more stable, not less. And who's supposed to do the capital financing, if not private banks in a gold-standard world, even in complete absence of a federal reserve? I could not find a convincing answer.

Another problem I have with the Austrian explanation is that there is no mention, anywhere, of the role that financial instruments played in creating the crisis, and that private markets engaged in a lot of destructive behavior. To understand the crisis, it's imperative, for instance, to understand the Black-Scholes equation that private market players and banks used to spread risk (which of course, ultimately imploded and took the economy down with the banks). This was exacerbated, of course, by Federal Reserve policies that created a balloon in the housing sector; but the financial industry's misuse of such tools was not caused by the government. The fundamental error was that banks simply did not believe the risks existed, regardless of US monetary policies; not that they thought the Fed's policies somehow negated all risk. That the bankers blindness to the downsides of these financial widgets caused the implosion is exactly what I've been told by traders from the hedge fund DE Shaw, at their presentation to a mathematics program that I worked at in 2011. Absent was any mention of the federal reserve; that's the scoop from inside the financial industry. This goes against the grain of the Austrian thesis, which is that private markets will always price and allocate perfectly absent government intervention, and I wasn't surprised to see an absence of discussion of this in Austrian circles.

Finally, I'm not really convinced about their predictions. Yes, I do suppose that some in the Austrian school (just like quite a few in the Keynesian belief) saw the housing crisis coming. But their recent predictions definitely predict inflation. "There Will Be (Hyper)Inflation", one title on the Mises institute reads, from April 2009. This is not the outlier; many other pieces echo the same sentiment. The Austrian economist Robert Murphy says more or less the same thing, and warns about hyperinflation from early 2009, right up to today. To these economists, it's "only a matter of time" before the "Genie is let out of the bottle". In 2009, he and other Austrian economists declared they wouldn't be surprised at "inflation running at double digits" by the end of the year. In fact, inflation was -1.4 percent. We are still waiting.

A final disbelief I have with the Austrian school is that they don't seem like looking at empirical evidence. No, i'm not talking about "Oh look, here's something that happened, let's draw conclusions as fast as possible", which is the kind of reasoning that seems to be emanating from their camp. Their dismissal of Keynesianism seems to be done in a highly slipshod manner, one that doesn't even try to account for a lot of the variables in play. This is the kind of reasoning that politicians do for a cheap political points, the kind that pundits do to advocate for action (yes, Krugman falls into this camp, but only in his blog and media pieces; his actual work is much more nuanced). It's not scientific at all, and that's what the profession sorely needs. The pieces that I'm seeing are not carefully calibrated (if any Austrian has one in written form, I'd love to see it) to account for multiple variables in their analysis, like Christina Romer's piece carefully attempts to do. Keep in mind that Romer started from a neutral point of view, and is carefully willing to consider herself wrong. It could just be I'm bad at searching and could not find the pieces that are out there; but I would love to see an Austrian piece attempt to do the same, in writing (I don't have audio on my computer, unfortunately). You want to look at depressions to compare to the modern one? Don't use 1921 or 1979. Those recessions had nothing to do with the housing and financial implosions we're seeing today. Try the Panic of 1897, caused by a housing collapse that had nothing to do with government or the federal reserve, in a country still on the gold standard, in which employment took nearly a decade to recover. Or the Great Depression, brought along by a deregulation of banking, moderated (or prolonged, it's unclear which without additional evidence) by the New Deal. Yet when you look at how countries around the world got out of the Depression, especially the United States or Nazi Germany, a clear pattern emerges; the more you spend, the faster you get out of the hole. Whether austerity would have healed the same wounds seems unclear at best, in absence of compelling empirical arguments; but huge government outlays worked pretty clearly, in the Second World War. If this is the benchmark to which we are comparing any government action, I'd be all ears for a solution.

There's a good body of evidence that pure capitalism will not always produce the best long-range outcomes (exactly not what the Austrian school declares). For one, "privatize privatize privatize" was the name of the game in 90s Russia. And look how well that turned out. Milton Friedman, a godfather of capitalism, declared in his dying breaths that liberal counterpart Joseph Stiglitz was right and that he was wrong; privatization did not cure Russia's maladies. Murphy, I see, is a fan of anarcho-capitalism; yet this is an inherently unstable equilibrium. Companies will inevitably grow to dominate their competition, and in so consolidate power around themselves. The enterpreneurial spirit and innovation that brought these companies to such great heights becomes no longer necessary to stay on top, when you can squeeze out opposing companies with other means. Look no farther than the trusts of the Gilded Age to see this (by the way, if the government did not exist, these companies would have taken on a power of their own equally as expansive).

So what errors of capitalism? Internalizing externalities is one. The "tragedy of the commons", Milton Friedman's famous thought experiment, is about making sure everything is priced. Pollution cannot be dumped on community grounds; it needs a price tag. Property rights need to be secured. Public goods, like gardens, need to price in the benefits to the community that it would bring; that, or else citizens would need to aggregate to pay their money for such goods (which is exactly government).
Another error is that capitalism will not fund basic research well. Yes, there are Ford's, Edisons, and Teslas who did end up making a living through the private market. But there are so many researchers who would have received about 0 private dollars. Who funded Werner Von Braun, Oppenheimer, Schroedinger, Pauling, Rutherberg, Einstein, Planck, Maxwell, or Watson and Crick? To have any incentive to fund such investment, investors would need a guarantee of intellectual property that comes out of the research, and to be able to hold it for years. This would be terrible, since in the meantime that basic research is denied to any other aspiring academics or theorists. Second of all, capitalism is notoriously bad at rebalancing 'power'. The ideal capitalist society supposes that workers, consumers, and companies all have relatively equal power. That is, when a company underpays for labor, workers can move to a different company; when an informed consumer doesn't like a good, it will switch to a better company. When a company charges too much for a product, another existing company can undercut the price, or a frustrated consumer can start a new company which will eventually do so, and win out in the long run over an existing company. The allocation based on market laws of supply and demand will, the reasoning goes, perfectly allocate the resources to where they need to be met.
This does not stack up empircally. Companies can outcompete others for reasons that have nothing to do with price quality. Firms that have gotten big by good decisions made by CEOs 70 years ago can squeeze out new competitors with schemes like "we'll match any price!" Monopolies and trusts inevitably aggregate power. Look no further than the Gilded Age for evidence of this. (Yes, I know the government was involved; but if it wasn't, what kind of realistic pathways would have stopped Carnegie's steel from taking over every small firm? There is none.)
Additionally, markets are good at allocating resources, but notoriously poor at balancing power, which is a lot of what government investment tends to do. For instance, building poor communities and raising children is something absolutely essential for society, yet a free market system will never invest in this, even absent child labor laws and government investment. In countries were child labor is legal, private markets have jumped on families and exploited htem mercilessly. Raising children adds value primarily to the individual, and thus is not measured or necessarily reclaimable in dollar amounts, making such investments unpalatable to private market creditors; hence the need for significant government spending. Even so, private creditors have the power behind them; private markets aren't exactly lining up to finance poor communities, and thus any creditor can charge with impunity, thus erasing any individual gains and giving them to the creditors and nearly them alone.
Third of all, there are pretty clear examples of government financed initiatives, in the face of recessions, that have done our country a lot of good. Who can argue that the Hoover Dam, the Apollo Project, or ARPAnet were not ahead of private investors at the time? The private market is not the engine of good ideas; it's the medium. A technocratic government can easily do a good job with finding good ideas and bringing them to prime time. The key is to have a solid mechanism that incentivizes government to do so.

So what do you do during a recession? The Austrian argument is to cut. Why aren't companies expanding? It's clear from all polling taken on them that demand doesn't exist. So the Austrian argument appears to be to let everything that is going to go under, go under (really, I couldn't find an Austrian source out there defending the bailouts). Now I don't doubt that this eventually leads to a recovery; anything will. We saw to a small extent what happened when the government decided to let Lehman fail. It led to a market implosion, that caused a 2,000 point fall in the Dow Jones. So how does the growth happen, and when? After Goldman, Bank of America, Citigroup, Chrysler, and General Motors go under? This is a colossal chain reaction, that depresses demand even further. And it's clear to anyone, from the mouths of the businesses themselves, that demand is what's holding the recovery back. Letting the financial firms go under leads to businesses unable to find capital for years, until another bank is ready to build itself up and take the old one's place. The shuttering of the auto industry would lead to a chain reaction shuttering factories, which would lay off workers, depress demand for goods further, shutter companies in related sectors, and soon you see the lights go off in an entire region, and workers, people, and firms having to start from bankrupcy and scratch. That's when the recovery, according to the Austrian school, starts. Compared to this, the results of an inadequate Obama stimulus look positively heartwarming. And I strongly doubt, and I'll put a lot of money on this, that the auto industry is in a bubble because of the bailouts (this is exactly what the Austrian school argues, by the way; that bailouts simply misallocate resources unsustainably, further).