The Austrians Told You So
Canada's Financial Post sees "I told you so" opportunities for the Austrian school of economics in the Current Crisis:
Austrian economists hold that downturns are the inevitable aftermath of loose monetary policy, thus opposing explanations typically heard prior to the current crisis that attributed recessions to price shocks, underconsumption or central bank tightening of monetary policy.
But if, to rephrase a well-known Nixon quote, we are all Austrians now, it illogically only extends to the diagnosis of the crisis and not to the school's market-based cure. For it is just not consistent to simultaneously assign blame to Greenspan's easy money and then support government intervention to fix the damage, as so many of the business op-ed writers and talking heads on CNBC have.
As the Austrian tradition points out, the dilemma with easy money is that the central bank sets rates below that which the market would naturally set. The natural rate reflects people's willingness to trade present for future satisfactions. When the actual rate is established under this, entrepreneurs and firms are issued a false signal that people are willing to defer more consumption into the future than they really are. As a result, excess investments in capital goods industries, such as housing, are made on the expectation that these will pay off in the long-run. The boom ends when monetary conditions are tightened back to natural levels or the passage of time makes clear that the demand was never really there to sustain the investments made. At this point, a crisis takes place in which capital investments get liquidated and resources are shifted such that the economy's productive capacity more appropriately reflects people's time preferences.
The piece wraps up with an implicit call to make your reservations for Hooverville 2009:
Most commentators resist following the Austrian logic through to the end out of the fear of repeating the policy mistakes that led to the Great Depression. This reflects the orthodox interpretation of that period, according to which the economy fell apart in the early 1930s while U. S. president Herbert Hoover took a laissez-faire approach to the downturn and the Fed ran an overly tight monetary policy.
The truth is that the Fed at the time did try to add liquidity, lowering its rediscount rate until late 1931 and continuously increasing reserves under its control. Money supply nevertheless fell, but that was because people lost faith in the financial system and hoarded currency. Meanwhile, Hoover met the downturn with interventionist gusto. He passed the Smoot-Hawley tariff to help domestic industries and obtained the co-operation of business leaders to support wages and investment. We haven't gone down this protectionist and corporatist road yet but Hoover's attacks on short selling and his creation of the Reconstruction Finance Corporation, which among other things loaned money to banks, bear an eerie resemblance to the current policy response.
"We might have done nothing",Hoover said, "[but] we determined that we would not follow the advice of the bitter-end liquidationists." Thus has the Bush administration decided as well, having successfully cajoled a recalcitrant Congress to follow Hoover's example.
Matt Kibbe asked, what would (Austrian econ majordomo) Ludwig von Mises do? last week.
For lots of deep background into Austrian economics and its links to libertarianism, read my book Radicals for Capitalism: A Freewheeling History of the Modern American Libertarian Movement.
