To be an Austrian

For those of you who may be wondering what all the fuss is about when we talk about being ‘Austrian’, here’s something I wrote in late 2004 and which was, at that time, one of the most-read articles on Ironically, it was polished up out of an e-mail originally sent to a well-known investment commentator in the attempt to show him how, out of his own lack of understanding, he was attributing Austrian views to people who had very little conception of what the school actually stood for.

It might explain why I and my fellows abhor blind, empirical data-bending such as econometrics; why we despise mainstream aggregative macroeconomics at its pseudo-scientific worst; and why we deride the whole, Y = C + I + Ex-Im + G-taxes, GDP worship which most others in the business waste so much time upon even though all of them – almost without exception – were (again) totally blind-sided by the very fact of the late Crisis, as well as by its subsequent severity, and all of which phony determinism has continued to inform those making the many  wrong policy recommendations which still hamper a genuine recovery today.

Despite the ongoing series of falsified predictions of how things will unfold under their guidance, and regardless of the rare bout of existential soul-searching originally conducted in public by some of the Cult’s leading lights – acting  under the embarrassment of the discipline’s wholesale failures of the past four years – the urge to mechanize economic understanding and the greater temptation to offer both political and investment advice with a spurious degree of intellectual rigour remains sadly undiminished.

PS None of this implies you are a gold-bug, a bullion fund peddler, Michigan Militia member, or someone who focuses monomaniacally on the demise of the US dollar v-a-v its just as flawed fiat counterparts

To Be an Austrian: A Primer

To be an Austrian has become oddly fashionable in recent days, judging from the number of news reports thus describing commentators on economic and financial affairs. Because there is no trademark on the name, and the Mises Institute issues no Seal of Austrian Approval, our only real hope is that these good people take time off from talking to the press and spend  more time reading.

Man, Economy, and State by Rothbard, and Human Action by Mises, are both online, but the opportunity costs of such deep study are high. The same is true of the expansive Austrian Study Guide. There is a quiz to help, and 20,000 have taken it—all to the good. But even the quiz and audio prove too much in our times of instant everything.

So in the interests of broad public understanding, I present an admittedly imperfect Austrian Economics in one article:

Philosophically, the idea is that Man is a rational actor insofar as he tries to increase his well-being, or to decrease his “unease,” through purposive Action.

However, each man’s individual motivation in Acting—his pleasure/pain scale, if you will—is wholly different to that of his neighbor’s and it is an ordinal one—with little scope for quantitative measurement and certainly none for aggregation.

In this focus on the subjective elements of a man’s choice, all value – and, hence, all utility—originates. These are constructs of the human mind and explicitly not some derived property of the physical world.

Value is thus a specific, not a generic, quality and varies according to time, place, and circumstance—e.g., a thirsty man in the desert is glad to exchange gold for water, while a tourist may be happy to be seen paying 10 francs for a cup of coffee in the Hotel Baur au Lac.

Developing this idea, Austrians were in the forefront of the Marginalist revolution; an advance which realized that choices are made (and hence valuations formed) “at the margin.” This alone was enough to correct errors which had long confounded both classicists and Marxists.

By marginalist, Austrians mean that a person makes an exchange only after making a favorable, subjective mental comparison of the cost of forgoing the most willingly surrendered (the most “marginal”) tradable quantum of his existing property with the benefit he expects to enjoy from the corresponding, first quantum of goods offered for it by his counterparty, as well as with those which might accrue from trading for another’s, different, goods instead, should this be an option.

Austrians know better than to believe in the sterile, zero-sum games of some schools, since exchange, though conducted at a single price, does not therefore preclude the derivation of mutual benefit from the act.

More emphatically, the very fact that there may exist an overlap between the two counterparties’ subjective valuation scales is what allows for the emergence of mutual benefit and so motivates the process of exchange itself.

This clearly refutes Marx’s crude exploitation theories by revealing that the costs which went into providing a good can have no influence on its subsequent circumstantial valuation and hence on the price these goods can command on the free market.

Indeed, it is the entrepreneur’s particular skill—as well as his essential service to society—that he has an enhanced ability to put temporarily underpriced combinations of resources to a more nearly optimal use than can other men.

These insights are said to be made a priori and Austrian reasoning is thus deductive, not inductive, or empirical. Economics is, then, evidently a discipline where mathematical abstraction can play little part.

Politically, Austrians are classic Manchester liberals, firmly behind a policy of laissez-faire and many today thus shade into minarchism or even what Rothbard called anarcho-capitalism.

Mises himself single-handedly destroyed any attempts to construct a socialist rationale in the famous “calculation debate,” showing that, without private property and an unhindered price mechanism, production can never be properly coordinated to allocate scarce resources to their best and most urgent uses.

Hayek joined Mises in showing that there can be no room for compromise, that a “mixed” economy inevitably leads to an erosion of freedom and the growth of the state to the detriment of all those not in, or patronized by, the ruling classes (of whatever caste, creed, or form).

Menger and Boehm-Bawerk, et al.,derived the most satisfying theory of the origins of interest—the so-called natural rate being, essentially, a measure of mortal man’s inherent impatience with any delay in the gratification of his wants and needs. This is greatly influenced by the degree of plenty and comfort which he already enjoys.

In turn, this implies that capital-rich economies with bounteous productive capabilities tend to have higher levels of present satisfaction and so lesser impatience, more saving, and hence lower natural rates of interest.

Therefore, the Austrian realizes that low interest rates naturally arise amid abundance—an abundance based upon a wide division of labor and a capital-rich layering of specialized productive means.

He also knows that abundance can never be entrained merely through forcing money market interest rates lower by fiat.

Austrians know something cannot be had for nothing, nor can the element of time be ignored—Bastiat’s fable of the “broken window” is often cited as a starting point for argument.

Hazlitt, developing this theme, wrote that the “One Lesson” of economics is that there is no such thing as a free lunch and that we must always look beyond the immediate results of an action to see its hidden and indirect influences before we pronounce it a success or a failure.

Mises developed a comprehensive “Theory of Money and Credit” which irrefutably showed that inflation always leads to ill effects and, together with Rothbard, campaigned for a system based on 100% commodity reserve, free-banking, meaning no FDIC, no Fed, no fiat, no fractional reserves!

Out of this arose the Austrian Theory of the Business Cycle which discusses in detail how an inflationary infusion distorts price signals—particularly intertemporal ones.

By lowering market rates below the natural one, credit expansion severs them from that which is compatible with the availability of real capital and with the concomitant willingness to save while more “roundabout”—but potentially more productive—methods are employed.

Thus, the builders of plants and the makers of equipment base their return calculations on low rates, but are blinded to the fact that these do not signal the necessary limitation of end-consumer competition for the factors of production which they, or those downstream from them, will need to secure the required return on their efforts.

At some point these factors will be bid away to other, more urgent uses, more compatible with consumers’ time preferences—which may in fact have been increased (their demand for goods enhanced)—by the same lower rates which entrepreneurs have implicitly taken as meaning that such an appetite has diminished.

These distortions will lead to bottlenecks in skills, staff, resources, equipment. They will mean a consistent price path from high-order to consumer goods will not be possible. It will mean losses and the revelation of widespread “malinvestment”—not necessarily “over-investment,” but misdirected and sub-marginal investment, e.g. Global Crossing, Nortel, AT&T and many others in this past cycle!

Credit expansion will therefore sow the seeds of its own destruction as soon as any initial slack in the system is taken up and as soon as the rate of inflation (excess monetary addition) ceases even to accelerate (a process needed to keep the producer borrowers surfing ever ahead of the breaking wave of the faulty price/preference matrix in the economy).

Developed in the earlier part of the century, the standard exposition implicitly assumes that most large scale borrowing is done by producers, not consumers—the former thus got the first, most beneficial use of the inflationary influx (spending the money before prices rose) and they could bid resources away from the latter as a result of this legalized fraud.

This has had to be modified slightly to take account of today’s institutional framework where the consumer is a major borrowing force also, but the principles have not been challenged by this expanded scenario.

Moreover, it has to take into account the internationalization of the economy and recognize that Asian savers, for example, can substitute for US ones, for so long as they are willing to do it.

Austrian theory is thus dynamic, not static; logical, not empirical; individualistic, not aggregative; libertarian, not statist; it does not confuse money with wealth; it knows that production delivers prosperity, not consumption.

It recognizes consumer sovereignty, places prime importance on the capital structure of the economy, apotheosizes the entrepreneur, despairs of government and utterly disdains Marxists, Keynesians, Chicagoites, and all other Historicists and pseudo-Natural Scientists.

In their ignorance, these latter, naturally, return the compliment and since these schools can all be used by the State as an excuse for its ever-widening interference in our lives—whereas Austrians demand the minimum possible intrusion upon private property and personal liberty, for solidly economic, as well as for ethical grounds—guess who gets most of the air time?

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2 replies on “To be an Austrian”
  1. I agree that artificial interference with interest rates is not a good idea. On the other hand, it is debatable as to what effect such interference actually has. For example:

    1. There is evidence that there is no relationship between central bank base rates and the rates charged by credit card operators. See:

    2. The Radcliffe report into monetary policy in the 1960s concluded that “there can be no reliance on interest rate policy as a major short-term stabiliser of demand”.

    3. Any potential borrower (business or house buyer) makes a big mistake if they just look current central bank rates, because short term rates do not have much effect on long term rates. As to those so called “fixed rate” mortgages, none of them last more than five years in the UK.

    4. Even if artificial interference with interest rates does depress rates by say two percent, this is a minor consideration compared to the total costs of operating most investments: depreciation, energy consumption and so on. It is also a minor consideration compared to the profit or loss that is commonly made in investments: doubling your money in a few years is far from unheard of, and losing the whole lot in a few years is also not unheard of.

    1. Ralph, I have a lot of sympathy with what you say. I would say that although the bank base rate is low today, no one in business borrows at this low rate. There is indeed a disconnect. With regards to mortgages based on trackers, banks can only offer these as they can discount them at the central bank and thus insure liquidity all the time. If this part of the market was not political, then these rates too would be much higher. The point is, although there is a disconnect between what happens when real business borrows money in a boom subsidised by cheap credit, they pay a lower rate and gear up more than they can afford. When the boom goes the other way, the interest element may not kill you, but the ability to pay the capital sums themselves often is a problem.

      No political messing and you have a much more stable market with time preferences matching as much as they can in an always moving market place.

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