Tyler Cown explains it all (better than Clarissa!), An alternative theory is that markets are bubble-prone and that easy monetary policy was simply a trigger that set off an irrational speculative excess. The Austrian story is that “the government distorted price signals to the market.” Are those two accounts really so different? Do we need metaphysics to resolve that question? Take the classic “thin skull” case in the law. Austrians won’t describe it this way, but they are postulating a very thin skull for markets and then blaming government for the disaster which results from government’s glancing blow to that skull.
Keep in mind that no entrepreneur looks at price signals exclusively, rather they interpret prices in the context of the real economy and other bits of knowledge Was it so hard for investors to say to themselves?: “I see that one price (short-term rates) has changed in favor of greater housing investment. But other parts of my brain tell me that real estate prices won’t go up forever, levered positions are dangerous, and that I should be cautious.”
Let’s say that the government subsidized the price of bananas, you bought so many bananas, put them on your roof, and then the roof collapsed. Is that government failure or market failure? The price was distorted, but I still say this is mostly market failure. No one made you put so many bananas on your roof.
I never grasped what Caplan wanted here. Mises did not say the calc problem would be the one to destroy a socialist country FIRST. He agreed that there MAY be other problems that will bring the country to its knees before the calculation problem will do the job.
What he did say was something totally different. In his day, all the problems associated with socialism seemed to be [possibly] solvable, at least theoretically. Work effort may be solvable by educating and brainwashing. Innovation may happen even in a socialist country. Maybe an underground economy can be ruthlessly crushed. And so on. All the problems had solutions offered for them that seemed worth a try, at the least.
What Mises claimed was that EVEN IF YOU SOLVE EVERY OTHER PROBLEM, the calculation problem CANNOT POSSIBLY BE SOLVED.
That is the big difference. Other problems may be solvable somehow or other. There is no proof that they cannot be surmounted. But Mises showed that that there is one problem that can NEVER be solved, no matter what, in any socialist economy. The calculation problem.
This is pointless because everything neo-classicals come up with against ABCT is going to be based on everything neo-classical, which just takes us to an everything debate.
Pretty much. Almost all ABCT-loving Austrian economists sound like they could have written Irrational Exuberance, outright decrying the speculative dim-wittedness of entrepreneurs. Just read Bob Murphy’s Politically Incorrect Guide to the Great Depression, for an example. If human psychology is this weak, if entrepreneurs are this blind to external factors, then how can they even be so libertarian?
Hi, Neoclassical. Nice to have you on the forum. I’m glad you aren’t freaking out and yelling at people. I really like that bit.
Have you heard/read the one response to Caplan’s objection that describes the scenario in terms of game theory? The gist of it is, businesses take loans while the market is humming along fine and credit is cheap. The reason they take the cheap credit and expand is because if they don’t, their competitors will, and they will be beaten out. With the new credit, the competitors may then try to drive out the companies who did not expand in the meantime with the “relatively cheap” credit.
Thanks, Giant_Joe. Well, remember, we’re pretty much all libertarians here, so I still think you Austrians are 95% more right than most other people.
Your example, as far as I can interpret, gives a competitive edge to businesses that do expand production using cheap credit. Right? But then what happened to malinvestment?
The weather is even more unpredictable than our central bank. This will be my first assumption. Discredit it, if you need.
But assuming that, we see successful entrepreneurs (e.g., farmers, shippers, etc.) building correct forecasts to generate profit even with the unpredictable weather being a factor. Why isn’t there persistent booms-and-busts? Why don’t other forms of uncertainty lead to widespread, systemic irrationality, “speculation,” and malinvestment?
Conservative Home Builder says, “yes, interest rates are low, but I’m not going to fall into the trap of buying that 3000 acre plot of land in Arizona, this is a bubble forming”.
Conservative Banker also believes that interest rates are “too low” (we can’t know what that means, but let’s accept it for the example). He does not want to risk the bank’s capital in some sort of silly “housing bubble”.
Competitor Builder says, “So what, a bubble is forming. We’ll make a killing before it pops.”
Competitor Banker says the same thing and approves the loan to Competitive Builder.
Both Competitor Banker and Competitor Builder’s stock rises, because the homes are actually selling (see below). Wall Street loves those guys, and hates Conservative Builder and Conservative Banker whose stock lags or falls. The CEO’s of the conservative outfits are sacked, and guys who “know how to sell” are put into place. The industry bubbles along quite nicely, assisted by the central bank, exactly in line with the concept of malinvestment (not overinvestment, but malinvestment).
By the way, the homes sell because interest rates are low and the government created an entity that has the implicit, soon to be very real, guarantee by the U.S. taxpayer for bondholders.
In summary: It is not a matter of entrepreneurs being “thin skulled”. It is a matter of entrepreneurs being entrepreneurial, taking a risk. And the key to the whole thing is the risk pays off at first. Other entrepreneurs are left behind unless they jump on board.
If you reject Austrian Capital Theory, the Structure of Production, etc, then the above explanation will make no sense.
[EDIT: I see other replies were in process when I was writing mine, ie, Giant Joe’s game theory. Nonetheless, I offer my example free of charge]
I usually screw up some details on these things, but here I go:
The story is, this malinvestment is revelaed when the bust starts. As the factors of production for the higher-order stages of production increase in price, and as credit tightens, these large projects (which are more interest rate sensitive) start to suffer/go under.
I know when I was reading through some of the books on this most recent crash, especially the one on the Lehman Brothers, the author was saying of how the company was following exactly that policy and not only expanding their derivatives branch, but shrinking the standard ones as they were following the idea it was a bubble and should burst soon.
I guess we could say that these factors from nature and other unpredeictable phenomena can cause “booms” and “busts”. The ABCT is more concerned with a general business cycle effecting an economy.
What comes into play in explaining why some of these investments are “malinvestments” requires an explination/understanding of the structure of production and the role that savings plays in an economy.
There are some slides here by Roger Garrison that I think will be helpful in giving a breif overview of what happens according to the Austrians:
I don’t know if I can give a blanket statement and say “Yes, they all do.” but there are critisims against it, and I don’t think it’s used in developing the Austrian theory.
chloe732, what does “a bubble is forming” actually mean. What does that look like.
To quote Eugene Fama, Does a credit bubble mean that people save too much during that period? I don’t know what a credit bubble means. I don’t even know what a bubble means. These words have become popular. I don’t think they have any meaning. . . . It’s easy to say prices went down, it must have been a bubble, after the fact. I think most bubbles are twenty-twenty hindsight. Now after the fact you always find people who said before the fact that prices are too high. People are always saying that prices are too high. When they turn out to be right, we anoint them. When they turn out to be wrong, we ignore them. They are typically right and wrong about half the time.
In essence, you are agreeing that market participants are “thin skulled,” since you actually described the “greater fool theory” (http://en.wikipedia.org/wiki/Greater_fool_theory). And, once again, if this is true, then market participants should be just as irrational during non-bubbles. Clearly, if there is an impending bust, they are taking bad risks, right? Why are they so stupid? There are bad risks to be made all the time.
Encouraged by your praise of my other post, I’ll taker a stab at this one:
Not exactly. This version is very dangerous [besides being incorrect]. It is saying “People are fools. Any glancing blow can set them off. This time it was the govt, next time it will be some thing else. Obviously, the best thing is to take the money away from the common man, for his own good of course, and let wise benevolent govt planners run the show for him.”
What Austrians are saying is that markets do not have a thin skull. They are saying that there is exactly one guy out with a very powerful hammer, the govt.
Sure, people are full of irrational speculative excess, all the time, 24/7. BUT THEY DONT HAVE MONEY. What normally happens in a normal economy is that the guys who don’t know any better and also have money lose it very quickly. The combination of a fool and his money is pretty rare, and short lived. There are not enough fools with money to be able to go out there and create a bubble. I mean, we are talking about big bucks here, enough to disrupt a whole country and bring it to recession.
Austrians claim that EVERY SINGLE TIME you find enough fools with enough money to create a business cycle, there is exactly one reason: More money has entered the system, much more, than there used to be. In other words, inflation [using the word in its classical meaning of money inflation, not price inflation]. In modern times, this has always happened because the govt printed money. Without the govt printing money, the fools would not have enough of it to create a bubble [that will of course burst]. That’s what I meant by the govt being the only one with the heavy hammer. Although I guess in theory if there was a successful counterfeiter who managed to forge as many dollars as the govt prints before bubbles happen, it would have the same effect.
The low interest rates fooling wise investors is just one way the drama plays out. It can also involve downright foolishness, like the dot.com bubble. But the element always needed for the drama to take place is printing money. So that if we wish to be rid of bubbles, we can either make everyone smart, or we can stop printing money.
All that is true if you are using your hard earned money. But if you got it for free, which is what inflation does, you won’t be as cautious. At least most people won’t.
The phrase “market failure” is a brilliant piece of sophistry. It makes it sound like there is some way other than the market that will avoid failures [which is of course a big lie]. And that there is no one at fault but the silly old market [also a lie].
If the govt knows in advance that people will put those bananas on the roof, but goes ahead and subsidizes bananas, is that not govt failure? What defense does the govt have? “We knew you would all destroy your homes, but we decided to do it anyway. We did it for your own good, so you could have bananas.” Of course, the real reason the govt did it, by which I mean printing money, is so they would have free money to spend. They don’t care what happens to us as a result.
Lehman did exactly what entrepreneurs should have done given the “opportunities” presented to them by government intervention (Greenspan’s monetary expansion + Fannie Mae = Boom like an H-Bomb).
