Deck the halls with macro follies

In case you missed it, here’s another gem from

In an article reprinted at, John Papola explains:

Each year, our attention turns to the holidays… and to holiday consumer spending! We’re told repeatedly that, because consumer spending is 70 percent of measured GDP, such spending is vital to economic growth and job creation. This must mean that savings, the opposite of consumption, is bad for growth.

This view of macroeconomics was first popularly asserted by Thomas Malthus in 1820, nearly 200 years ago. Malthus believed recessions were caused by “underconsumption” because there was a “general glut” of goods unsold. To recover from a recession and grow, we needed to stop all the saving and spend more to buy up all the goods on store shelves. Savers are like the miserly Ebenezer Scrooge. If you want a happy holiday, you’ve got to clear those shelves and give people a reason to produce more and create jobs. Or so Malthus thought.

John Maynard Keynes resurrected this approach and built on it with his influential “General Theory”, which now underpins much of our government policy and public discussion of spending and economic growth. Keynesians believe aggregate spending drives the economy and savings is a “leak” out of the flow of spending. Indeed, this economic philosophy underpins many people’s widespread obsession with retail sales each holiday season. Keynesian Macro Santa’s sack is filled with spending.

But there is another view on recessions, recoveries and growth.

Classical and Austrian economists such as Adam Smith, Jean-Baptiste Say and Friedrich Hayek viewed savings as the vital lifeblood of economic growth and production as the means by which we live better and consume more in the long term. Our savings aren’t simply taken out of the economic system, but become the source of capital that entrepreneurs use to create new goods and increase productivity. These economists believe this increased productivity is the key to a wealthier world. Before we consume, we must effectively produce what others value — at prices that cover the costs. This fundamental idea, that our demand for goods is enabled and constituted by our supply of other goods came to be known as the “Law of Markets” and later “Say’s Law”. For classical and Austrian economics, recessions happen when producers make mistakes. They create goods that can’t be sold at a profit. These malinvestments tend to cluster in a recession as a result of systematic problems, such as disruptions in the financial system and often government interventions in the economy.

Recovery and growth in the classical and Austrian view is driven by restructuring production so that entrepreneurs discover again the best — i.e. the most valuable and sustainable — ways to serve customers. That process is led by new entrepreneurs and driven by savers who make capital available to fund new investments and new ventures. Sustainable saving and investment means creating more value for others while using fewer resources. This process lies at the core of healthy economic growth, including better job opportunities and a rising standard of living.


The fight of the century redux: Murphy vs. Smith

Exciting news from

The great debate between Keynesians and Austrians enters the digital age with the Mises Academy’s first ever online formal debate, between economists Karl Smith and Robert P. Murphy.

Resolved: Government Spending Can Play an Important Role in Boosting Economic Growth

Smith will argue in favor of this resolution, and Murphy will argue against.

The debate will be held by Webex, and costs $20. It will take place Friday, September 2nd at 1pm UK time, but will be recorded for later viewing.

See here for more details.


Hayek vs Keynes debate rebroadcast

Back in the ’30s, at the time of the original Keynes-Hayek debate, Hayek had a solid methodological system that could explain the causes of the recession of the late ’20s and early ’30s, and it’s subsequent gyrations, up and down.

The root cause was excessive credit creation by the world’s main central banks, and their fractional reserve private sector mints, the banks. This bank credit was loaned out to businesses who bought extra kit to produce goods and services more efficiently. The boom in producer sectors bid up relative prices for their resources. Higher wages for labour meant more consumption, boosting consumer sectors. This in turn pushed up relative prices in those sectors. Competition for resources bid up prices until no one believed the prices were sustainable — pop goes the mega bubble, and boom turns to bust. This is called the Austrian Theory of the Business Cycle.

At the BBC LSE Hayek v Keynes debate, Lord Skidelsky told us that everyone knew it was excess credit that caused this boom, and that this was called the “Treasury View.”

This of course is not true; the noble Lord is misinformed. The Treasury View was advanced by members of the Chancellor’s department saying, in short, that for every increase in public expenditure advocated by Keynesian types to alleviate the Great Depression effects, there would be an equivalent reduction in private sector expenditure that would mean that the net effect in the economy is zero.

Whilst I hold that this is a valid view, it is not one that gives us the theoretical tools to understand why boom and bust happen in the first place. Mises and Hayek gave us these tools with the Austrian Theory of the Business Cycle.

Neither the Treasury View, as expounded by the likes of Ralph Hawtrey, nor the Keynesian view were based on a series of logical deductions from root causes. The best Keynes could offer as an explanation for boom and bust was “animal spirits”.  He is Theory Lite in this respect.

Unfazed by his shaky foundation, Keynes confidently prescribed how to correct an animal-spirit-induced bust.  We are told to spend when the private sector is not spending. Who does this? The government on our behalf.  The Treasury View makes clear that it’s futile to tax the private sector in order to spend, so we have the cries from modern day Keynesians to carry on borrowing and spending in order to force a correction . If you haven’t got the correction you desire, you have not borrowed enough! So say the likes of Krugman and Skidelsky, drunk on the intoxicating work of Keynes.

The faulty logic than runs underneath this way of thinking is called the “Circular Flow of Income.” This is now bread and butter in any economics text book. One person’s income, when spent on goods and services, becomes another person’s income. Cut one and you cut all. Therefore, a series of cuts or austerity measures is exactly what you should not be doing at a time of bust; you need to keep everyone’s income up.

Hayek held that relative prices and income where what mattered, not gross aggregates . If a man has an income of £100 and costs of £90, we can say he has a profit of £10. Then recession hits and he has an income of £85 and still costs of £90, so he is sunk by £5. Thus the aim of the man in question, with income of £85 is to get his costs down to under £75 and restore his profitability. As this is done, the foundations for recovery are laid. Even better, if he can get costs to £74, on lower income and a lower costs base, he is in fact more profitable than in the glorious boom times!

In the 5 mins each speaker had in this debate to present their case, some of this came across and some of it did not. Jamie Whyte and George Selgin did a fantastic job at putting forward the case for Hayek. Skidelsky sadly did not represent Keynes very truthfully, for the reasons I have outlined above. Selgin picked him up on various other errors and misrepresentations.

This debate is very relevant for today as no doubt we will be told the current market corrections are “Animal Spirits”, and that the answer is further government intervention.

The BBC tell us the debate had over 1 million listeners and was in their top 5 podcasts. In all my years studying at the LSE and as a donor to it, I have never seen three lecture theatres full of public and students alike. Not even for visiting Heads of State!

This is the debate of our times.

I am delighted to say that the program will be re-run, and they expect another 1.5 millions viewers.  Our friend at the Mises Institute, Stephan Kinsella, has blogged all the details here. If you want to educate yourself a little more on these matters, or even if you think you are very familiar with all of the issues, the debate is definitely worth a listen.  If you can’t wait for the next BBC broadcast, you can find it online as an MP3.

Since the original broadcast, the debate has continued online.  On the 3rd of August, PrimeEconomics published a list of eight alleged fallacies in the Keynes/Hayek debate, drawing a number of responses, including some from George Selgin.  On the same day, Selgin posted his own account of the debate at  More recently, on the 18th of August, Selgin took up Skidelsky’s suggestion that “no government has ever achieved a speedy recovery from a recession by clamping down on its spending or reducing its indebtedness”, citing the US recovery from a deep recession in 1920.  The following day, Skidelsky published his account of the Keynes-Hayek rematch at Project Syndicate, declaring

Except to Hayekian fanatics, it seems obvious that the coordinated global stimulus of 2009 stopped the slide into another Great Depression.

You can read Selgin’s response at

Personally, I look forward to the day when Paul Krugman will come and stand on that same stage where Hayek delivered his famous Prices and Production lectures, and engage in serious debate with Austrian economists. How many lecture theatres would that fill? What global TV audience would it draw?

For those at the BBC and for those at the LSE, I think my next Distinguished Hayek Fellowship Teaching Programme event the LSE should be just this debate, and I would be happy to support and fund whatever I can. I repeat, this is the debate of our times.  Only someone of the stature of Krugman can represent Keynes, we need to move this debate up and along now.

Related articles
  • Hayek vs Keynes at the LSE – John Phelan, 27 July 2011


Fight of the Century: Keynes vs. Hayek Round Two

John Papola and Russ Roberts, of EconStories, gave themselves a difficult problem when they created their first incredible Keynes vs. Hayek video.

It was like your first girlfriend being Miss World, your first rugby match being the World Cup final between England and Australia, or your first cricket match being an Ashes decider starring Freddie Flintoff.

How do you top that?

Well, it’s just about impossible. But you can at least attempt to match it, and in doing so, you may even surprise yourself, sneak up on the outside, and outdo the original without really meaning to.

So, here’s the latest video in the sequence.

While you decide if Mr Papola and Mr Roberts have matched (or even possibly bettered?) their first contest between Keynes and Hayek, look out for the Chairsatan himself, the Ben Bernank, whose dissembling conference yesterday pushed gold up to new record heights:

Here’s the EconStories description of the video above:

Fight of the Century

According to the National Bureau of Economic Research, the Great Recession ended almost two years ago, in the summer of 2009. But we’re all uneasy. Job growth has been disappointing. The recovery seems fragile. Where should we head from here? Is that question even meaningful? Can the government steer the economy or have past attempts helped create the mess we’re still in.

John Maynard Keynes and F. A. Hayek never agreed on the answers to these questions and they still don’t. Let’s listen to the greats. See Keynes and Hayek throwing down in “Fight of the Century”.


BBC Radio 4: Radical Economics: Yo Hayek!

Cobden Centre readers may want to set their radio clock alarms for 8:30pm on Monday evening, on the 31st of January, when Jamie Whyte takes a look at F A Hayek and the Austrian School, on BBC Radio 4:

My ‘Inner Rothbardian’ quails at that radio station branding a little, but if nobody tells Professor Hoppe then I’ll be able to listen too.

Hayek shares a joke with Mises

Here’s the BBC’s programme description:

Was the economic crisis caused by fundamental problems with the system rather than a mere failure of policy?

Over two weeks, Analysis investigates two schools of economics with radical solutions.

This week, Jamie Whyte looks at the free market Austrian School of F A Hayek. The global recession has revived interest in this area of economics which many experts and politicians had believed dead and gone. “Austrian” economists focus not on the bust but on the boom that came before it. At the heart of their argument is that low interest rates sent out the wrong signals to investors, causing them to borrow to spend on “malinvestments”, such as overpriced housing. The solution is not for government to fill the gap which private money has now left. Markets work better, Austrians believe, if left alone. Analysis asks how these libertarian economists interpret the state we’re in and why they’re back in fashion. Is it time to reassess one of the defining periods of economic history? Consensus would have it that the Great Depression of the 1930s was brought to an end by Franklin D Roosevelt’s Keynesian policies. But is that right? Jamie Whyte asks whether we’d all have got better quicker with a strong dose of Austrian medicine and whether the same applies now?


Hayek vs Keynes @ Buttonwood

Readers, if you saw the first video of Hayek v Keynes and the explanation of their key contributions in the rap format, then watch this Part Two, you will love it. If you haven’t seen the original, I urge you to watch Part One.



Huerta De Soto on Entrepreneurship and the Division of Knowledge

The Subjectivist Revolution in Economics Continues

Humans act and they act purposefully: this is the axiom of action proposed by Ludwig von Mises, teacher of Hayek. From this he claimed that the whole of economics could be deduced. As Mises shows, in order to be, we act purposefully. Not being, we would not act, indeed we would not exist. We act upon satisfying our most urgent needs first, then our second most urgent needs, and so on and so forth, ranking our preferences, with the most urgent needs/demands being satisfied first, the least urgent, and the furthest away in time. From this hierarchy we derive the law of demand, the downward sloping demand curve, the law of diminishing marginal utility (see here for a good illustration) and on and on it goes. Lord Lionel Robbins in a masterful 1932 book, The Nature and Significance of Economic Science shows in very clear terms how all the laws of Economics are derived from the a-priori thought process.

To try to refute it, you cannot, as you act purposefully to do so. Just as Pythagoras’s Theorem is implied in the concept of a right angle triangle – and we knew about the concept of the right angle triangle before Pythagoras “discovered” his Theorem – so, too, do the laws of economics flow from the one irrefutable axiom that humans act purposefully. It is a bit like saying Darwin “discovered” the Theory of Evolution, when what he actually did was articulate it and find very plausible data sets to help explain it to the sceptical mind. Evolution was always there.

So What can this Axiom tell us About Entrepreneurship?

When we act, we choose to satisfy our most urgent needs first, and we forego other opportunities which form our subjective costs. Action implies a sacrifice: what opportunity you forgo is your cost, and what you hope to gain is more than your cost: this is your entrepreneurial profit. This entrepreneurial profit does not have to be measured in money; it can be the choice between going to the theatre or staying at home and watching a TV program.

The entrepreneur is someone who is good at generating entrepreneurial profit, not only for himself but in the way he/she can help many more others in achieving and consuming the results of entrepreneurial profit. He is more alert at spotting opportunities that will satisfy people’s most urgent needs in quicker and in better formats, and for this he is rewarded usually with more money for his efforts.

According to Jesus Huerta De Soto in his book called Socialismo Calculo Economico Y Funcion Empresarial” 1992 soon to be published in English by Edward Elgar in Association with the IEA and called: “Socialism, Economic Calculation and Entrepreneurship” 2010, there are six characteristics of the information and knowledge that the entrepreneur captures to use to provide better goods and services to all in society.

Knowledge is Subjective and not Objective and Scientific

I have just watched my local farmer bring in a grass crop frantically in 3 days as he assessed a window of opportunity for him to do so, since rain was coming. He could not send this up to a State planner to make a decision for him – only his local knowledge about this particular time and circumstance, and his informed intuition regarding the weather could lead to this decision. He has crop that he can sell now. A planner in Whitehall would neither have all the information necessary nor respond quickly enough to make this all happen.

Knowledge is Exclusive and Dispersed

In my farmer example, this knowledge about when to bring the crop in is exclusively his and resides in him alone.  In the same way, knowledge across the whole economy is broken up into little pockets of subjective knowledge held by millions of different people.

Knowledge is Tacit and it Cannot be Articulated

My farmer’s knowledge is tacit and in him, yet he probably cannot objectively articulate why he is doing it. Michael Oakeshott in “Rationalism in Politics”, 1962, gave us a very good example of a chef who is after all only following a formulaic procedure of putting together a recipe — add X of this to Y of that and cook at 200 degrees for 10 mins. But the instincts and unconscious background knowledge of an uber chef like Gordon Ramsey will allow him to produce outstanding food which I cannot hope to match simply by following the same recipe.

Entrepreneurship is Creative

There is no cost to an entrepreneurial idea, it is created ex novo. Bill Gates, when he created his first operating system, had his vision and his thought process, the idea, and then he got creating.  Profits are thus created new and from nothing.

The Creation of New Information

Each creative new act of entrepreneurship creates new information which is used by others to profit them as well. A new software solution developed by the creative minds of Apple alerts all their users to new ways of doing things that benefit them in a quicker, faster and better way.

I recently had a conversation with a potential entrepreneur who has identified an abundant source of farm waste product that could be excellent for fish feed. If his business is developed, farmers will suddenly be made aware that what was once a cost can now be a source of revenue for him. Thus he will adapt his farming processes to now harvest this waste and costly product for profit. The fish farmers will eagerly await this new source of protein and adapt their newer and better buying accordingly.

The Transmission of Information

Although the price system is objective and allows the allocation of resources, the fish farmer does not need to know all the subjective information of the entrepreneur who has developed the new feed out of the farms’ waste, just that he can buy it.  Likewise, the farmer does not need to know the detail of how it is going to be made useful to the fish farmer. All this knowledge is subjective and the briefest communication of it happens to facilitate trade.

Entrepreneurship is the foundation of society in that it insures the co-ordination of individuals’ behaviours. Without it, society would not exist.

Competition and Entrepreneurship

There is always a competitive and  on-going process of rivalry and discovery as this society-wide coordination process happens. It is limitless and produces progress if left uninterrupted. It is the single most important process which unites society and permits its harmonious advancement.

The Division of Knowledge v the Division of Labour

The division of labour as suggested by Adam Smith shows us how, in a pin factory, if people concentrate on certain tasks and specialise, more production happens. This is an objective measure. Underneath this, and prior to it, is the subjective division of knowledge. In-depth knowledge is held in widely dispersed formats, often tacitly, precluding its articulation across society; thus it is impossible for any one person body or machine or government department to know all of this information. Also, only tiny amounts need to be communicated to make coordination in society possible. So Huerta De Soto introduces a new concept into the body of knowledge concerning economics: the universal division of knowledge that exists as a deduction from the axiom that humans act and takes the subjectivist revolution started by Menger into our very understanding of the division of labour. He also moves man on from being the Robbinsian homo oeconomicus to the homo empresario. Acting man is entrepreneurship.

Once again Huerta De Soto has given some great new insights into economics in the field of economics. He has stood on the shoulders of Adam Smith, Mises, Hayek and Kirzner to great effect to knock the objective division of labour off its pedestal and put in its place the division of knowledge. This is what Einstein did to Newton in physics. Both still have their place, but the latter being of more fundamental importance.


The Road to Serfdom, Amazon best seller

To our great delight, The Road to Serfdom, by the outstanding thinker F.A. Hayek, was this June the No. 1 best seller at and still retains a very good ranking. Hayek was one of the key figures in the Austrian School and the US populist news commentator Glenn Beck has given us a very good boost as we try to further the Austrian School of Thought.

The Editor of Hayek’s Collected Works is Professor Bruce Caldwell at Duke University. He has supplied us with two very good interviews about this book:

Also, we are privileged to be able to share with our readers a PDF copy of Bruce’s Introduction to The Road to Serfdom (Definitive Edition). Plenty to choose from if this is your first taste of Hayek, or indeed a valuable guide if you seek to reread it. So enough from me, I will let the expert speak to you about the legendary foresight and relevance of Hayek today.

Introduction to The Road to SerfdomIf you want to read more from Hayek himself, you may be interested in the condensed version of The Road to Serfdom (published in the Reader’s Digest, April 1945), available as a PDF from the IEA.


The Emperor’s New Clothes: How to Pay off the National Debt & Give a 28.5% Tax Cut

I offer a £1,000 reward for anyone who can tell me why this logically won’t work, practical politics, for now, being another matter.

What follows is an attempt to show you that this can be done.

Remember the story about the Emperor whose only concern was not the welfare of his people but the state of his clothes?  Lacking a new outfit for his procession, he instructs the finest clothe-makers to propose designs.   Step forward Slimus and Slick, promising that only clever people will be able to see their splendiferous garments; they will be invisible to anyone stupid. In exchange for gold coin – real money – they make something special for the King. The King, seeing nothing when presented with these designs made out of thin air, worries that he must be stupid because he pretended to the fraudsters that they were wonderful. Word goes round that only clever people can see the garments, so everyone cheers the naked King during his procession.  It takes a small child, on top of his father’s shoulders, to exclaim: “the Emperor has got nothing on!” Everyone falls silent. Then, one by one, they start muttering, “the Emperor is naked!”

I am going to tell you that our Emperor – the government – has no clothes and is indeed naked with respect to our money. The sooner we realise this the better.  Then we can make real progress and prevent the imminent misery. Indeed, the realisation of its nakedness should reveal that we have a unique moment in history to do something very special: to make banking secure, pay off the national debt, and even enable a 28.5% income-tax cut.

We all know what notes and coins are: money, or cash.  It allows us to exchange the fruits of our work for the goods of others. When we deposit cash in Bank A – say £100 – we lend this money to the bank. This may come as a surprise to most, as we think what we deposit in a bank actually remains “ours” beyond this point.  But as soon as you make a deposit it becomes the bank’s i.e. “theirs.” They then lend what is called credit of £100 to an entrepreneur, who banks it in bank B. Like magic, we now have you, who have a claim to “your” £100, and the entrepreneur, who also has an equally valid claim to “his” £100. This happens 33 times for every £100 deposited in the UK economy on average, meaning that for every £100 deposited, it is lent out to 33 people. Some of the banks did this up to 60 times. This cash cannot exist in two places at the same time, let alone 60 places at once. So what bank A does, is write you an IOU. Yes, your bank-statement is a mere IOU, the bank saying “ bank A owes you £100 on demand.” This is called a demand-deposit. We now see that demand-deposits are created out of thin air! Indeed, these are just ledger-entries from one bank customer to another.

Tesco groceries can be paid by electronic transfer. All we are doing is moving our bank’s IOU to Tesco’s bank in exchange for their groceries. This is how the world works.  Do we care that we are buying goods and services out of thin air? Like the Emperor, does he care – as long as all believe he is clothed? Well, the customers of Northern Rock did. So when more than a small percentage of them asked for their IOUs from Northern Rock to be repaid – or, as they thought, for “their” money back – it could not be, as the bank had already lent it many times, making it impossible to reimburse all they owed. Indeed, if the government had not pledged to underwrite all deposits, then there would be a very good chance that the whole system would have collapsed.

If we accept that the Emperor is naked then the path to solving all our current financial problems becomes clearer.

Consider this following programme of reform:

  1. Print cash and replace all the demand-deposits/IOUs that exist in the system with that cash. This means the government printing approx £850 billion in cash and injecting it directly into the vaults of the banks and into the accounts of individuals. Thus, if you deposited £100 once thinking it was “yours,” it now really exists in cash, with the bank acting as custodian of your money.
  2. Mandate all banks to hold your cash (100% reserved) on demand at all times.
  3. Wipe from the bank ledgers all the demand-deposits/IOUs as banks would not owe you money anymore. This means the “thin air” money disappears, to be replaced exactly with cash money.  Note: this is not inflationary, as the cash replaces the demand-deposit which acted as money. As we have established, it is only thin-air that the banking system has created to facilitate the multiplicity of lending of the same bit of money, so its total replacement with cash would mean the money supply stays exactly the same.
  4. Require all banks to lend real savings that people knowingly place with banks to lend to businesses to get a return of interest and capital back when the business repays that loan. This is nice, simple and safe utility banking. This is what Mervyn King advocates.
  5. As you are not a creditor of the bank anymore, the banking system will only have its assets and its capital, i.e. no liabilities. This means that there never again could be a bank run.
  6. As for the banks, not having you the depositor as a liability anymore, they will suddenly be £850 billion better off, with no current liabilities and only assets (loans to business etc), post reform. The government can now put those assets into Mutuals, which would then immediately pay off the national debt, and leave the banks in exactly the same position net worth wise as they were prior to the reform, owned by their existing shareholders. As the national debt is still just under the £850 billion, which would be available as surplus assets of the banks, this could still be achieved.
  7. No national debt means no interest costs (currently £40 billion p.a) associated with paying for our borrowing. Therefore, give an immediate 28.5% income-tax cut. Total income-tax raised is £142 billion.

The boy in the story stood on his father’s shoulders. I stand on the shoulders of great men who have advocated part of this reform: Irving Fisher, the greatest American economist, the Nobel Prize winners Soddy, Hayek, Buchanan, Tobin, and Allais. Recently, Kotlikoff of Boston University has published an excellent book, “Jimmy Stewart is Dead” advocating a similar reform. It is endorsed by more Nobel Winners: Akerlof, Lucas, Fogel, Prescott, and Phelps. I count 36 endorsements from the great and the good for the book. All endorse Kotlikoff’s move to what he calls Limited Purpose Banking which is another way to get 100% reserved (i.e. secure) deposits backed by cash rather than thin-air.

The Economist Huerta De Soto, in “Money, Bank Credit & Economic Cycles,” has seen the opportunity that presents itself to reform for 100% money while also paying off the National Debt. Following on from this, I suggest a substantial wealth-creating tax cut for the people. Just like the boy in the story, I do hope that people start to realise that the emperor really has no clothes, and that an enlightened approach can address this.