Response To Pragmatic Idealist And His Article On Austrian Theory
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Response To Pragmatic Idealist And His Article On Austrian Theory

Posted by archive 
Submitted by Econophile
08/20/2010
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From The Daily Capitalist

Dear Pragmatic Idealist:

I was going to let your post, “Repositioning Austrian Monetary Business Cycle Theory” pass, but it contains so many misconceptions about Austrian theory that I have to answer it.

Please don’t take this the wrong way, but I see similar critiques around the web, and I believe that most commentators haven’t actually read any of the Austrian theory economists. I say that because you misrepresent what it is and that leads me to believe that you haven’t read Mises, Rothbard, Hayek, or any other Austrian theory economists.

You say:
However, the Austrian monetary cycle theory (ABCT) put forth by the founders of Austrian economics fails to adequately explain a variety of business cycle phenomena and, consequently, will probably never be fully accepted by "mainstream" economists. ABCT does not incorporate the very real fact that investors and consumers will and always have been swept up in waves of euphoria or severe panic (i.e., tulip mania or thousands upon thousands of convincing behavioural finance case studies and papers). ABCT does not explain why rational economic agents (in the Austrian sense) make irrational investment decisions en masse just because a government entity purchases some treasuries. After all, such activity is highly transparent and quantifiable.

That simply isn’t true. In fact it is just the opposite of what Austrians believe. You may be confusing Austrian theory with Neo-classical economics which believes that people act rationally. Austrians believe that people never act “in a perfectly rational environment.” In fact, people are faced with imperfect information every day about the world and the economy and they frequently make bad choices. But it is the freedom of choice and ability to succeed or fail that makes free market capitalism work. As I’ve written before here, capitalism is a profit and loss system and without losses, as Austrian Joseph Schumpeter noted, capitalism wouldn’t work.

One of the best things about capitalism, Austrians say, is that when economic actors make mistakes, such as entrepreneurs, the only ones that pay for it are those that made the mistake and their investors. When government makes mistakes we all pay for it.

Austrian theory works from the principle of individual action, not the behavior of aggregates such as “nations,” “national exports” or “national output.” This concept is called the “Marginal Revolution” of economics and went a long way to explain economic behavior.

It is a given that at times all people can act rationally, irrationally, be greedy, or panic. That is the human environment we live in. Assuming that these are truths of human behavior, Austrians ask, what is the best way for individuals to meet their goals in life, such as start businesses, get capital, hire labor, make money, and expand while at the same time serving the needs of the consumer? Of course we believe that is free market capitalism which you continually misrepresent in your article.

Then you say:
It is argued [by Austrians] that manipulation of the interest rate obscures the rate of time preference and therefore causes over or under investment and consumption. However, if economic agents were absolutely rational and calculative, any tinkering of the interest rate by the printing of money and purchasing of treasuries and other assets should, in theory, be able to accounted for. Banks should, as they are doing now, hoard most of the money printed by the central bank and only lend out the portion that would allow them to absord the expected future increase in the default rate as savers/investors are able to make less money due to lower returns on investment and shift temporal consumption habits accordingly. All of these effects are produced by a known amount of monetary inflation and could be rationally accounted for.

Yikes, dude, that is definitely not Austrian Business Cycle Theory. You must think that we Austrians think humans have to be perfect calculating machines with perfect knowledge. We assert that we can never have perfect knowledge. That’s what the Keynesians and Neo-classical economists think. Actually they must think that Ben Bernanke and Tim Geithner have such knowledge because they want to give them more power over the economy.

Let’s start over. Manipulations of money supply by the central bank (the Fed), such as by setting a low interest rate to increase money supply, do send false signals to businesses. It causes them to throw money at projects which, but for the new fiat money, would not otherwise be profitable. It doesn’t cause over or underinvestment, it causes malinvestment. We just went through this (still are) with the housing market. Cheap money stimulated developers to build houses, which, when the money stopped, people didn’t want. The technical explanation does have to do with time preference of savers, but, I don’t think you understand that and I don’t want to make this too complicated.

Look, human factors such as greed and panic always exist in the market place; that is who we are. The better question is, why, all of a sudden, do booms occur? We believe it is because of new fiat money created by the Fed. We believe that printing money doesn’t create wealth; it just creates more pretty pieces of green paper that benefit some and hurt others (higher prices). But it always must end in a bust.

Your last point about welfare is a statist, Keynesian view of the world. You view welfare as being necessary to raise people out of poverty and the “rich” ought to pay for it. You think it is the responsibility of the state to oversee the economy and make it grow. Only capitalists operating in a free market can do that. All the government can do is redistribute the wealth. It can’t create anything. And as Maggie Thatcher said about socialism, which does steal redistribute wealth, it is great until you run out of other people’s money. Let me say that you, or anyone, do not know enough to decide what to do with other people’s money. There is no instance in history where government welfare has raised people from poverty.

In all of human history, free market capitalism is the only system that has created the wealth to allow us to rise out of the muck. You well know that if you go to any country without it; they are dirt poor.

Please do me a favor and read some books on Austrian theory before you criticize it.