"Ignoring the Austrians Got Us in This Mess"

Barron's columnist Randall Forsyth tips his hat to the Austrian school–shaped by libertarian luminaries Ludwig von Mises and F.A. Hayek–for providing a set of useful ideas about the Current Crisis that have been largely ignored:

What definitely is ignored in academe is the Austrian school of economics, especially for baby boomers brought up on Samuelson's economics text, which was pure Keynesian orthodoxy. I did not learn the names von Mises and Hayek or their ideas until a decade or more after graduation (with a degree in economics, by the way.)

…..The economy, if left alone, is self-correcting, say the Austrians. But central banks' inflationary expansion of credit produces booms and malinvestments, which inevitably lead to a crashes and depressions.

The only prevention for boom and busts are sound money, which is impossible with government-controlled central banks. Once the bust comes, the only cure is to let it run its course; allow the malinvestments go bankrupt and let the market reallocate the capital to productive uses……

The Austrian prescription, of course, was rejected first by the New Deal of Franklin D. Roosevelt, and now by massive response by both the purportedly conservative Bush administration and now the Obama administration. First came the $700 billion TARP last year to stabilize the financial system, followed by the $787 billion fiscal stimulus enacted last month. Across party lines, it's accepted that government's role is to prevent the economic pain that would come of "liquidate, liquidate, liquidate."

And while Alan Greenspan had his own, different, libertarian movement bona fides with his Ayn Rand connection, his monetary policy was a big part of the problem, in Austrians' eyes:

Austrians were the ones who could see the seeds of collapse in the successive credit booms, aided and abetted by Fed policies, especially under former chairman Alan Greenspan. While he disavows (again) the responsibility for the boom and bust, most recently on Wednesday's Wall Street Journal Op-Ed page ("Fed Policy Didn't Cause the Housing Bubble," March 11), monetary policy played a key role in creating successive bubbles and busts during his tenure from 1987 to 2006.

Greenspan always contended that monetary policymakers can neither predict nor prevent bubbles in asset markets. They can, however, clean up the after-effects of the bust—which meant reflating a new bubble, he argued.

That had a profound effect on risk-taking. Knowing that the Greenspan Fed would bail out the markets after any bust, they went from one excess to another. So, the Long-Term Capital Management collapse in 1998 begat the easy credit that led to the dot-com bubble and bust, which in turn led to the extreme ease and the housing bubble.

Austrian economists assert the current crisis is the inevitable result of the Fed's successive efforts to counter each previous bust. As the credit expansion pumped up asset values to unsustainable levels, the eventual collapse would result in a contraction of credit as losses decimate banks' balance sheets and render them unable to lend. That sounds like an accurate diagnosis of the current problems.

The Austrian economists' and their historical connection to the libertarian movement are explained at great length in my book Radicals for Capitalism: A Freewheeling History of the Modern American Libertarian Movement.

A variety of voices assessed the Greenspan legacy for Reason magazine in this November 2006 roundtable, addressing the question: Was Greenspan a bubble blower?