The financial crisis has led many people to doubt the merits of free markets and a liberal economic regime. They blame markets for the financial and economic crisis and demand tighter regulation and, in effect, more central planning by governments as a remedy. We shall argue that both the analysis on which this view is based and the policy recommendations are flawed. This crisis has been caused by too much reliance on the effectiveness of economic and financial planning. ~ Thomas Mayer, chief economist of Deutsche Bank Group, writing in “I am an Austrian in economics”
h/t ThinkMarkets
Source link: http://archive.mises.org/18452/18452/
“I am an Austrian on economics”
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No mention of Mises.
This is an “okay” read. Mayer keeps talking about liquidationists during the Great Depression, but liquidationists like Mellon never had their way. The “rot” was never liquidated and purged from the system. Mayer is also a little too favorable toward regulation. (I suppose he means government regulation, as opposed to free market.)
And, yes, Mayer doesn’t mention Mises, but just as noticeable, he doesn’t mention Rothbard. Murray has been gone long enough now where some reverence, acknowledgment, and attribution is in order, particularly for his insights to the Great Depression. He is every bit as deserving and accomplished as Mises and Hayek. I’ve noticed that most Austrians are quick to mention Hayek (I supposed because he is more politically correct) but less so to mention Rothbard.
Is Murray still too radical for mainstream consumption?
Hayek developed and refined ABCT more than any other Austrian economist, ABCT is mostly Hayek’s work. When discussing macroeconomics, Murray’s “radicalism” doesn’t mean anything. We aren’t talking about the feasibility of an anarcho-capitalist society, but business cycles and depressions.
Recognition still needs to be given to Rothbard’s synthesis of Hayekian-Misiean capital structure theory had not been attempted before. One must give props when they are due.
Hayekian-Misesian-Wicksellian*
I have to disagree; I think Rothbard’s anachro-capitalist views motivate Chicago School and Keynesian economists to dismiss his views in other areas. Man, Economy, and State isn’t radicalism, but sound economic exegesis (this isn’t to say radicalism can’t be sound and rational), yet few outside the Austrian School refer to it.
This is because being Austrian tends to result in having the right insights to make the most money, ala Peter Schiff.
Comments by Mayer make me doubt he fully understands Austrian economics; such as, “What the Austrians seem to have missed is that an economy paralyzed by extreme risk aversion may need a jolt by confidence-building economic policy measures.” (p. 4) or “instead of more regulation we need more intelligent regulation” (p. 7) – he says this after repeatedly admitting the pretense of knowledge flaw.
Is it just me, or does he get deductive vs. inductive mixed up? p 8 says “for too long, we have tried to be like natural scientists….developing theories with the method of deduction – start from a few axioms and describe the world in mathematical terms from there…”
Or how about outside comments made this week: “What we need is a sort of European monetary fund that can go in and stabilize the system with the backing of the central bank,”
http://www.bloomberg.com/news/2011-08-11/eu-heads-for-eurobond-clash-amid-german-dread-over-looming-fiscal-union.html
Nevertheless, there is some good stuff.
CK you’re on to something:
” For us economists, the lesson from recent events should be to rely less on the
development of theories by ―deduction‖ (like in natural sciences) and to apply
more ―induction‖ (like in social and historical sciences). Failure to study history
makes us repeat the mistakes of the past.”
This statement at the very beginning seems contradictory.
Austrian economics is purely deductive, it just so happens that empirical evidence supports Austrian claims.
Should we email him, politely, to tell him that contrary to his writing, Austrian Economics is purely deductive?
Very nice comment.
Indeed, what he means is that Austrians are sort of onto something, but a little regulation is okay as long as its his kind of regulation.
I thought I hit reply but apparently not. Meant my note to be referencing CK’s.
Is it possible that the reversal of the terms (“inductive” and “deductive”) is an artefact of translation? Otherwise, their misuse can only be due to a complete misunderstanding what it means to be an “Austrian” economist (OR else the well-known medical phenomenon accurately if inelegantly described as a “brain fart”).
I agree, he is not an Austrian, YET
I wrote a email to Mr Mayer, saying that I think it was a real exercise of intellectual honesty. I noticed, however, the missing links on his account of the Great Depression, and asked if he knew of the works of Rothbard and Higgs on that specific field. This was his answer:
“Many thanks for your reply and your good suggestions. I was not aware of the authors you mention and I’m grateful for the references”.
Wow!
I love this!
Get him on board!!! Tell him about Mises too!
It is disappointing that many commentators merely reference that the author is sometimes inconsistent with pure Austrian principles, without actually refuting his arguments. It’s as if everyone just treats the correctness of Austrian principles as self-evident and immutable, which clearly they cannot possibly be. Could someone please actually refute his central argument against the ‘Austrians’ – that recovery in after the market crash of ’29 only occurred after deposit insurance was introduced and banks were re-capitalized by the government? It’s a strong argument, and goes against a central tenet of Austrian theory.
It sounds good, but Robert Higgs already refuted that argument. See, the GDP recovered after 1933, untill 1937, and it went down again in 1938. But it was a “no longer a full-employment” level, since the rate of unemployment was of 11,3 percent. Actually Gross Private Investment recovered by a 64 percent of it loss from the 1929´s levels. And it went down again and never recovered until the end of the WWII. The “Great Duration”, as Higgs calls it, made the crisis last longer than ever before. The experiments of made by FDR never worked, only created new illusions. Why? Because the Government did not give the first and most essential ingredient of real prosperity: certainty about the regime. During those years of 1931 and after, most of the investment was made by the Government for the first times in history. That only changed again from 1946, when private investment was larger that public investment.
There has never been such thing as deposit insurance. It’s not an insurance, it’s a government guarantee to bail out depositors of failing banks and it makes matters worse. Insurance is based on risk assessment and pools together people with similar risk. Banks were failing because they indulged in FRB, courtesy of the State that loves it. Such implicit government bailout only makes matters worse as unsound banks cannot not be easily liquidated. And just how can State “insure” a FRB bank that is by definition insolvent without the State going bankrupt as well or resorting to printing press?
“Recapitalization of banks” with inflation? Good thing there was still some link to gold so the State could not inflate as much.
And lastly, increase in GDP or employment isn’t necessarily a recovery if it’s induced by inflation and banking gimmicks rather than reallocation of resources in the economy and liquidation.
Thanks for the thoughtful reply. I think the author completely agrees that the fiscal stimulus of the new deal was a complete failure (as do I). I also completely agree that regime uncertainty is a – if not the – key component impeding recovery. But, there is still nothing that says that the moves to strengthen banks through intervention – i.e., deposit insurance and recapitalization – were not helpful, and perhaps critical, in allowing for some sort of recovery. It seems sensible to think that recovery will be impeded to the extent the conduits for converting savings into investment – i.e, the banks – lack basic funding (deposits and capital), and that such funding may not arise absent ‘intervention’, owing to a heavy fear of future losses in the aftermath of the bust bloodbath. So the question is, even given a stable/minimal regulatory environment (a big given, granted, but necessary to isolate the discussion), and lack of government interference in prices, supply, demand, interest rates, etc., how does an economy recover in a reasonable time from a sudden, sharp, and widespread writedown of assets, when the asset holders find themselves much poorer, once bitten, and twice shy, without any sort of ‘coordinated’ action/intervention? Does the Austrian Belief that ANY form of intervention – really it is kind of a dogma – is harmful create a blind spot here? Can there not be an exception to the rule, in this case that ‘intervention’ may be called for in the wake of widespread, sharp, and sudden writedowns that leave the banking sector – and its funding sources – mortally wounded and fearful of further action, which must of necessity impede investment and therefore economic activity and growth?
I think you would need to be more specific on the premise of “sudden, sharp, and widespread writedown of assets”. You must first ask: “Why did that happen?”
Juraj – I don’t quite understand your claim of how it’s not insurance. You could affix the same ‘bailout’ tag on any sort of thing we typically call insurance. If I have auto insurance, and I crash my car, then surely my insurance company will ‘bail’ me out of the expense of repairing it. It’s still what we commonly refer to as insurance. You seem to want to frame definitions to suit your purpose. It’s not a recovery if it doesn’t occur in the manner you prefer? It’s like saying a win by a sports team isn’t a win if it doesn’t occur by the specific style of play that you favor. What’s more, the paper suggests that, in the case of the ’29 crash aftermath, the process of liquidation failed to work effectively in a reasonable time. Once more, I ask a simple question, which I don’t think you’ve answered – how do you refute that, three years after the crash of ’29, no recovery had taken hold, and once those two specific measures – deposit insurance and recapitalization of banks – were put in place, a recovery started to take hold?
Mitch – I think it’s clear what happened in both the crash of 29 and the recent turmoil – investors suddenly discovered that the assets on their books weren’t worth near what they thought they were, and this was widespread across large sectors. And my question wasn’t ‘why did this happen’ – I think we all would agree that it was because of an easy money policy. But again, that answer doesn’t address the simple question I posed above, which is why it seems that intervention worked better in the case of the ’29 crash than ‘natural liquidation’.
George,
The FDIC is not insurance because the banks have full control over whether or not they put themselves in a position to need the FDIC bailout. This moral hazard problem is present to some extent in almost all insurance schemes (thus we have insurance fraud), but on the free market where legitimate insurance is offered there are strong measures taken to reduce the temptation to “want” the bad thing to happen for the insurance pay out. The first and best example of such measures is the deductible. The insurer makes sure you are going to feel SOME of the financial pain if you leave your car out in a hail storm so that you’re more apt to move it into the garage as the storm approaches. With the FDIC this is not the case, there are no checks in place to insure that banks are still motivated to remain (somewhat) solvent even though they’re insured against insolvency.
A shorter (and perhaps better) answer would be that real insurance is a contractual arrangement between private parties agreeing to the terms of the contract. The FDIC is tax payer funded and so can hardly be called insurance, since the American people are forced to agree to this scheme even if they recognize it’s a highly flawed idea. It’d be like my pointing a gun at you and saying “Like it or not you’re going to insure me against stubbing my toe, if I stub my toe you owe me $10,000″. It has the form of a valid insurance arrangement, except you’ve not been given any choice in the matter, which makes it just an obtuse form of theft should I in fact manage to stub my toe (and obviously I’d probably be much more likely to do so given the financial incentives).
As far as the crash of 29. The process of liquidation failed to work because there wasn’t any. Hoover intervened aggressively and energetically precisely to prevent the corrections needed in the economy. This doesn’t mean there weren’t businesses allowed to fail, rather it means across the economy the federal government and state governments (at Hoover’s urging) intervened repeatedly to prevent or retard the market’s efforts at correction.
I also think you’re being a bit charitable saying that the New Deal, or specific aspects of it, should be credited for the recovery. For one it’s fallacious to say that just because the recovery followed the creation of the FDIC that the FDIC caused the recovery. Also, note that recovery didn’t really take hold until a looooonng time after FDR had given up on his various New Deals and moved on to intangling the US into WW2. In fact, the recovery didn’t really get going until after FDR’s death. I won’t adopt your logic and credit the recovery to FDR’s death, but its at least as probable of a possibility as saying that the FDIC etc. were the cure.
I’m pretty sure that a bank’s equity and bond holders, get wiped out before the FDIC has to pay out to depositors. Wouldn’t this be the deductible you speak of, which creates the incentive to avoid default? After all, deposit insurance has been in place for a long time, and it’s not like it’s been invoked in any large measure for that time. Also, I think the FDIC is funded primarily by fees received from participating banks, and not taxpayers. Of course tax payers have to back it up if the fund runs dry, but I don’t believe it’s ever happened (TARP notwithstanding – that’s a different issue that I’m not trying to debate, where bond holders and equity owners were indeed bailed out). And so yes, some taxpayers could be coerced into funding the FDIC, and it’s a valid point, but again it doesn’t answer my question. You could make the argument that it’s better to let a depression just run and run than to force anyone to backstop a deposit insurance requirement, but that’s a different argument. Let’s leave aside the arguments for and against anarchy for now (although one thing I am finding odd about this site is that it really is pretty anarchist, while Mises was not at all an anarchist, and from what I’ve read did believe in a limited republican/democratic state – perhaps the institute should be renamed for Rothbard, as it’s more in line with his philosophy and not Mises), and focus on the questions I asked, which again you didn’t really answer. Also, remember these aren’t my arguments – I grabbed them from the paper – but it wasn’t the New Deal in its totality that the paper credits for recovery, it’s the two specific factors I identified. And you can’t prove cause and effect with precision in these sorts of things, but dang, the economy slumped for three years, and then seemed to start to recover shortly after the measures were introduced. What more can you ask for? Simple questions – can it be that recoveries are retarded by excessive fear of loss, and therefore excessive withdrawal of investment (e.g., money under mattresses), and that this may be remedied by a form of collective credit (deposit) insurance? If not, why? What else may be done? If so, is there a non-state alternative that works as well, or not?
I appreciate the comments re: that Hoover did not truly allow a liquidation. I found this interesting line in an article linked at cafehayek consistent with this argument: “The Depression was the first time in the history of the U.S. that wages did not fall during a period of significant deflation,” Ohanian said.”
http://www.eurekalert.org/pub_releases/2009-08/uoc–hps081909.php.
I do understand the coercion argument, though, but I don’t think it’s so clear cut. The Austrian theory works beautifully in so many ways, but I don’t think Mises et al addressed the problem of external costs and benefits well at all. If a vast majority of a section of ‘society’ believes that some form of coordinated action would be beneficial – say, deposit ‘insurance’ – and they are willing to pay for it, and there is no reasonable way to exclude those that don’t believe such, then what is to be done? Is the majority to forego the benefits to placate the holdouts so as to not coerce? I could go on with stronger examples, but really there is a shortcoming in the area of externalities here.
Also, ah, I think there was an attack on Pearl Harbor, no? Having no army, never waging war, only works if every other group of people in the world agree to same… don’t think that’s going to happen.
A lot of the criticisms are mounted at FRB, and it is interesting, since obviously there are a lot of problems and lot of the potential instability results from FRB, but isn’t it also the case that FRB allows for the acceleration of capital formation and investment? Without FRB, wouldn’t there be a lot of idle savings – really just commodity hoarding – that wouldn’t be translated into productive investment? Is there really a historical model of a non-FRB regime that can be shown to have outperformed FRB?
Well, Mises was wrong on this and inconsistent although he did allow for anarchy in some of his writing (unlimited secession).
And you can’t prove cause and effect with precision in these sorts of things, but dang, the economy slumped for three years, and then seemed to start to recover shortly after the measures were introduced
We have praxeology. We know that State imposed “deposit insurance” of a banking cartel is bad. We also know that bailing out failing banks (recapitalization) is also bad. These two measures can worsen the problems.
If someone wants to insure his demand deposit, let them do it privately. Such person has no right to coerce others into paying for his deposit in a shaky bank that doesn’t charge him for it and gives him higher return because it’s essentially already bankrupt since it lent out demand deposits.
but isn’t it also the case that FRB allows for the acceleration of capital formation and investment?
No it’s not. FRB is inflation. Money created by FRB does not represent saved resources (capital) in the economy. All it does is pushes prices up, redistributes purchasing power and creates bubbles. FRB was first used by bankers as a form of embezzlement and that is its true nature. The State legalised it because it suits its needs.
Without FRB, wouldn’t there be a lot of idle savings – really just commodity hoarding – that wouldn’t be translated into productive investment?
When people save a lot, interest rates fall. It makes it easier for entrepreneurs to borrow. Also, if people just hoarded money into socks and under mattress, prices would adjust according to supply and demand for money.
Is there really a historical model of a non-FRB regime that can be shown to have outperformed FRB?
Bank of Amsterdam was successfully running at 100% for about 170 years until the Dutch state messed it up.
“If a vast majority of a section of ‘society’ believes that some form of coordinated action would be beneficial – say, deposit ‘insurance’ – and they are willing to pay for it, and there is no reasonable way to exclude those that don’t believe such, then what is to be done? Is the majority to forego the benefits to placate the holdouts so as to not coerce? I could go on with stronger examples, but really there is a shortcoming in the area of externalities here. ”
Most people on this site will not be persuaded by this. If the vast majority sees a benefit in something let them find a peaceful way to exclude the minority, allow the minority to “free load”, or just do without. Your example is chosen well to disguise how logic justifies far too much, as the exact same argument can be made for slavery, mass theft, genocide, etc.
“Also, ah, I think there was an attack on Pearl Harbor, no? Having no army, never waging war, only works if every other group of people in the world agree to same… don’t think that’s going to happen. ”
FDR spent years provoking Japan to attack us, and made sure that the pacific fleet was as vulnerable as possible (what were they doing at Pearl harbor anyways?). By the attack on Pearl Harbor the US had already committed numerous acts of war against Japan. Including cutting off their oil imports. This is a side issue and I’d rather not get further distracted by it, but the view that the US was just minding it’s own business right up until Pearl Harbor when Japan just decided to attack without provocation (and to the absolute shock and horror of the American leadership) is one rooted in propaganda, not history.
“but isn’t it also the case that FRB allows for the acceleration of capital formation and investment? Without FRB, wouldn’t there be a lot of idle savings – really just commodity hoarding”
It’s not true. FRB can drive down the interest rate through fractional reserves and allow for a great deal of new money to be borrowed and invested, but it CANNOT increase the supply of all that stuff the money is going to buy. There’s the same supply of pig iron, computer programmers, heavy machinery, lumber, land, project managers, etc. whether FRB is in effect or not. What the artificially suppressed interest rate does is deceive businesses into thinking there is a greater supply of goods available for their use than is actually the case. The low rate says “there’s a lot of savings (i.e. deferred consumption) out there looking for investment, now is the time to invest to improve long-term productivity” in reality consumption HASN’T been deferred and supply of goods is not adequate to support the wave of investment spurred by the low interest rate. The bust comes when prices shoot up as it becomes clear that the supply of goods is not adequate for the planned demand.
The interest rate is just a price much like any other. It needs to be determined by the interplay of market factors, not by government intervention. And just like any other price, when the government gets the price wrong the consequences are severe, particularly with a price that is so integral to the proper functioning of the market. Imagine if brick masons bought, sold, and stored bricks at “brick banks” which gave them “brick notes” they could redeem at such banks for bricks anywhere in the nation. Now imagine the brick banks started selling 10 brick certificates for every brick they actually held. The price of bricks would plummet as the supply would APPEAR to have increased by a factor of 10, the use of bricks for houses, patios, roads, flower beds, blunt-trama weapons, you-name-it would increase. At the same time the production of real bricks would plummet as the going price was much lower. BUT, remember the “brick bank” has done nothing to increase the actual supply of bricks… and ultimately that’s what people want, not certificates redeemable in bricks. Sooner or later then a brick mason is going to go to buy some bricks and find out there are no bricks to be had. The story is the exact same with dollars under the FRB system… just substitute dollars for brick certificates and every good availible in the economy for bricks.
This is not about words. I’m explaining how you seem to think that FDIC is insurance. It’s not.
FDIC – customers who put money into shakier banks do not pay higher premiums. It incentives banks to take high risk. There is no connection between the soundness of a bank and customer’s fee for such “insurance”. It’s supposedly paid in taxes. FDIC only keeps a tiny fraction of cash of all the deposits it’s “insuring” so it can’t even deliver on its promise if wide-spread bank run occured. And I say it again: how can someone insure an insolvent bank? Because any bank that engages in FRB is insolvent at the moment it lends out its demand deposits. When you pay for an auto insurance, the insurance company assesses your risk and pools you together with similar people, so you get certain premium based on your risk. Young, reckless drivers get higher premiums.
We’ve just shown that FDIC and bailing out banks does not help, it make it worse. Now, how do you know that a “recovery” is occurring? Do you look at GDP, PPR, CPI, employment? Intervention cannot work better as the central planner does not know how to reallocate resources in the economy and which projects need to be liquidated. Only evaluation and action of millions of market participants can do that effectively. If you haven’t, read Rothbard’s America’s Great Depression.
I sent him an e-mail about the absence of Mises in his paper and got the following reply:
“Many thanks for your comments. I should of course have mentioned von Mises and will do so in future articles on the subject.”
Anyhow, I deeply appreciate Mr Mayer’s exercise of intellectual honesty and humbleness, even when I do ot share everything he said. For someone in his position is really hard to make such as strong statements about his colleagues as he did. Maybe, he is following he is own advise and getting deeper into AE theory as we talk here. Let give him time to read Mises (Human Action is really long, could take a year to digest,) and I am sure he will give much more interesting reports.
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