This talk by Mises Institute President Jeff Deist was delivered on June 19, 2015 at a lunchtime meeting of the Grassroot Institute in Honolulu at the Pacific Club. The talk was part of the Mises Institute’s Private Seminar series for lay audiences. To schedule your own Private Seminar with a Mises Institute speaker, please contact Kristy Holmes at the Mises Institute.
First let me say that what we today call “Austrian economics” flows from the great legacy of classical economics, with the very important modification economists now call the “marginal revolution.” Austrian economics is also a term that describes a healthy and vibrant (though often oppositional) modern school of economic thought. It originated with intellectual giants like Carl Menger and Ludwig von Mises, names I’m sure many of you are familiar with. These economists were from Austria, hence the term.
There was a landmark conference at South Royalton, Vermont in 1974, attended by the likes of Murray Rothbard and Milton Friedman, that revitalized the Austrian movement and helped it regain prominence in the latter part of the twentieth century. Milton Friedman was in attendance, and that’s when he famously remarked that “There is only good economics and bad economics.”
And of course that’s true. Schools of thought should not be rigid, or dogmatic, or too narrowly defined. But classifying various economists and theories into groups or family trees does indeed help us make sense of economics. It helps us understand how we arrived at a time and place where Ben Bernanke, Paul Krugman, Thomas Piketty, and Christine Lagarde are viewed as modern mainstream thinkers rather than the radicals they are when compared to the whole history of the field.
Image courtesy of Peter Cresswell.
We supplied some photocopies that roughly trace the history of economic thought. Notice the split in the 1930s, not coincidentally during the Great Depression, between Mises and John Maynard Keynes. Up until then, from about 1850 forward, Austrian economics was mainstream economics. But as you can see, most of today’s mainstream economists fall somewhere under the umbrella of Keynes, and they tend to focus on variants of Keynes’s ideas about aggregate demand.
But at least they focus on something!
Ignorance of Economics Is not Bliss
Which leads me to my topic today: “Why Any Economics Matters.” I say “any” because at this point the entire subject appears to be lost on the average American. Economics is not a popular topic among the general population, it would seem. When economics is discussed at all, it’s in the context of politics — and politics gives us only the blandest, safest, most meaningless platitudes about economic affairs.
Bernie Sanders or Hillary Clinton simply are not going to talk much in economic terms or present detailed economic “plans.” On the contrary, they — will assume rightly — that most Americans just don’t have any interest beyond sloganeering like “1%,” “social justice,” “greed,” “paying their fair share,” and the like.
Candidates on the Right won’t be much better. They’d prefer to talk about other subjects, but when they do broach economics they’re either outwardly protectionist like Donald Trump or deadly dull. Who is inspired by flat tax proposals?
Americans simply aren’t much interested in the details, or even the accuracy, of the economic pronouncements of the political class. We want bread and circuses.
Consider what people talk about on Facebook: lots of posts about family. Lots of posts about celebrities, and sports. Lots of posts about food, health, and exercise. Some posts about politics, culture, race, and sex, but usually only to support one side or bash the other.
Not much, ladies and gentlemen, in the way of economics. And I submit that might be a very healthy thing. After all — we’re rich! Only a wealthy society does not have to focus on the subsistence-level concerns of adequate food and shelter, hot running water, clothing, electricity, and the like.
So let’s not be too hard on people for not spending their free time reading economics. Leisure itself is a very important activity, and represents a form of economic trade-off.
But economics matters very much, and we ignore it at our own peril. Economics is like gravity, or math, or politics — we may not understand it, or even think about it much, but it profoundly affects us whether we like it or not.
Economics as a subject has been captured by academia, and academics like Krugman are not so subtle when they imply that lay persons should leave things to the experts. It’s like team sports — we may be introduced to it when we’re young, but only the professionals do it for a living as adults.
Yet once we understand that all human action is economic action, we understand that we can’t escape or evade our responsibility to understand at least basic economics. To think otherwise is to avoid responsibility for our own lives.
While we shake our heads when twenty year olds can’t read at the college level or do simple algebra, we don’t worry much whether they never take economics. We would be alarmed if our children couldn’t perform basic math to know how much change they should get at a cash register, but we send them out into the world far more susceptible to being cheated by politicians. Why do we want our kids to learn at least basic geography, chemistry, and physics? And grammar, spelling, literature, history, and civics? We want them to know these things so they can navigate their lives properly as adults
But somehow we’ve come to believe economics should be left to academics and policy wonks. And worse yet, we don’t protest when kids grow up to become adults with little or no knowledge of economics, yet still have strong opinions about economic issues.
Ignorance of basic economics is so widespread that we ought to have a specific word for it, like we have for illiteracy or innumeracy.
The aforementioned Murray Rothbard had this to say:
It is no crime to be ignorant of economics, which is, after all, a specialized discipline and one that most people consider to be a “dismal science.” But it is totally irresponsible to have a loud and vociferous opinion on economic subjects while remaining in this state of ignorance.
I’m sure we’re all familiar with this phenomenon on social media, which seems perfectly suited to vociferous unfounded opinions.
Let’s consider the minimum wage issue, as one example that’s been in the news lately:
Wages are nothing more than prices for labor services. When the price for something rises, demand drops — and you have more unemployed people than you otherwise would. Pure and simple Econ 101.
Yet what percentage of Americans today have even seen a downward sloping demand chart in a high school or college class?
It is this great and widespread ignorance of economics that plagues our ludicrous political landscape. It allows politicians to attack capitalism, and make demagogues out of entrepreneurs. It allows politicians to blame free markets for the very economic problems caused by the state and its central bank in the first place — like the dot com implosion, like the housing bubble, like the Crash of 2008, like the unsustainable equity prices commanded by US stock markets today.
In short, ignorance of economics allows some very big falsehoods to be accepted as fact by large numbers of people. And it’s only going to get worse as the presidential election of 2016 unfolds.
The Economics of the Moment
But it’s not so much that the candidates and the media will focus on the wrong economics or bad economics-- but rather that they will IGNORE economics.
They will pretend economics doesn’t really exist, and they will propose outlandish things that cannot exist — like greater prosperity without real increases in growth, profits, capital accumulation, or productivity, for example. They will advocate things that only an economically illiterate audience would believe possible. They will not merely reject right-wing or left-wing economics, they will disavow economics altogether. The political class increasingly resists framing issues in economics terms at all-- precisely because the study of economics exposes the fallacies of collectivism.
In other words, politicians will propose a free lunch. And many, many people will fall for it.
So what I’d like to stress today is that economics matters, it matters profoundly, and we ignore the subject at our own peril. In fact, ignorance of economics creates its own de facto school of thought: the Economics of the Moment, or what we might consider economics by default.
This is the only school of economics today’s political class understands.
The Economics of the Moment isn’t discussed in textbooks. It has no theories, no principles, and no facts beyond the political expediency of the moment. The only goal when applying the Economics of the Moment is to live for today at the expense of tomorrow — which in economics terms means having high time preference.
In politics, it means borrowing, spending, or inflating today to stave off economic crises regardless of the consequences tomorrow. Buy now, pay later. But later often comes years after the offending politicians or central bankers have left office. And we all know how notoriously short the average voter’s attention span is.
The goal of the Economics of the Moment is not to create sustainable economic prosperity, but only to maintain political power. The goal is to kick the can down the road and sweep economic dislocations under the rug for future generations to deal with.
This produces the ad hoc lurching around that characterizes almost all federal government and central bank economic interventions in the twentieth century. Congress, the Executive, and the Fed all have a terrible track record of reacting badly to the crises du jour — whether the crisis is a stock market crash, high unemployment, stagnant growth, or the decline of a particular industry. Above all, the political class thrives on being seen as doing something — even when doing nothing is plainly the better course of action.
And what’s worse, practicing the Economics of the Moment almost invariably makes the current crisis worse, while setting the stage for more painful economic contractions down the road.
Instead of being allowed to pop, asset bubbles continue to inflate. Money continues to blunder its way into unsustainable asset classes. The term for this in Austrian economics is malinvestment. And every round of malinvestment makes it that much harder to clear out bad business decisions and bad debt to redeploy capital to its best and highest uses.
When the bubble bursts, as happened most recently in 2008, do we get remorse from politicians and central bankers? Do they ever say, “Sorry about that”? On the contrary, we get recriminations. The political class point fingers everywhere, except at themselves, and scramble to appease an angry public. And the whole cycle starts over.
So we should understand that democracy encourages and rewards politicians to have high time preferences. Bad economics is often good politics!
As a nation we have chosen to be willfully ignorant of economics, to “blank out” as Ayn Rand put it. As a result we find ourselves at the mercy of demagogues running for office and bureaucrats at the Treasury Department. We find ourselves at the mercy of bought and paid for think tanks, of central bankers at the Fed, and most of all a wide variety of organized interest groups vying for influence with Congress.
And thus this willful ignorance is very dangerous for our future. I’m sure we all agree on that.
Making Economics Matter
So what do we do to correct this? How do we make economics less dismal, and more relevant, so that we’re not a nation of gullible voters who fall for political nonsense? How do we convince younger people that economics matters? After all, it’s Millennials who will quite literally pay the price down the road for our mistakes today.
Here’s what Mises had to say, in his opus Human Action, about economics for laypersons:
Economics must not be relegated to classrooms and statistical offices and must not be left to esoteric circles. It is the philosophy of human life and action and concerns everybody and everything. It is the pith of civilization and of man’s existence. … Economics deals with society’s fundamental problems; it concerns everyone and belongs to all. It is the main and proper study of every citizen.
The economics profession bears the blame for transforming economics from the study of philosophy and metaphysics into a highly specialized, hyper-technical, math-based discipline.
As a result of this transformation, we must always be prepared to oppose academia’s self-serving agenda. Remember, academia has a vested interest in making economics seem more complicated than it is, and the media has a tendency to validate this by repeating academic-speak and deferring endlessly to “experts.” So we must always work to demystify economics and make it more approachable for lay persons. We need to treat economics like the social science it is, as a subset of philosophy and logic — instead of treating it like calculus.
We can learn a lot from our friends on the Left when it comes to selling interest in free-market economics. Progressives are not afraid to create visceral appeal for their policies, while we tend to take a purely intellectual approach to promoting liberty. When it comes to economics we can be high-minded and appeal to reason, but still appeal to the emotional part of the brain.
We might benefit from thinking about economics more in terms of Maslow’s famous hierarchy. I’m sure many of you are familiar with Maslow and his categorization of human needs into a continuum (represented by a pyramid), with our most immediate needs for food, water, and shelter forming the base of the pyramid. Our more esoteric needs, like love, acceptance, and intellectual stimulation, are higher up the pyramid and thus less immediate.
We’ve allowed economics to be viewed as too far up the pyramid. When in fact, as Mises says, economics is the very stuff of life. Every human act — from an individual stranded on an island like Robinson Crusoe all the way up to millions of people living in the most complex interdependent society — is economic at its core. Every human action involves scarcity and choice, every action has a consequence and a cost.
Economic choices brought us up out of caves and into skyscrapers, and they can take us back to caves again. But it is the sign of a rich society, or perhaps a decadent one, that we have become oblivious to what provides us with food, shelter, clothing, running water and plumbing, and energy, not to mention all the luxurious goods and services we take for granted.
When we view economics as the stuff of life, at the base of Maslow’s pyramid, we energize and humanize the subject. When we approach economics more like philosophy, as the study of general and fundamental human problems involving knowledge and reason, we create a whole new perspective. When we introduce logic and metaphysics into the discussion of economics, we make it a more vital subject that attracts more people.
Moving Down Maslow’s Pyramid
So our task is to move the discussion further down Maslow’s pyramid. We need to make people understand the prosperity around us is fragile, and perishable, and capable of being lost. If we remain in a state of ignorance, we risk suffering an economic calamity that will make the Crash of ’08 seem minor. And there’s nothing wrong with using the emotions of a potential economic calamity to stimulate clearer thinking.
So let’s create a sense of urgency and immediacy about economics, especially in young people. We might begin by asking some basic questions designed to provoke a visceral reaction:
- What kind of job and income do you realistically hope to obtain in today’s economy?
- Will you spend your adult life paying back college loans?
- Will you be able to get married and have children?
- Will you have a lower standard of living than your parents?
- Will there be fewer and fewer good jobs available, and will competition for those jobs be intense?
- Will your real wages and purchasing power decline during your lifetime?
- Will medical care get worse during your lifetime, in terms of availability, quality, and cost?
- Will your standard of living decline significantly during old age?
- Will you be able to leave an inheritance for your children?
- Do you have any faith whatsoever that the people “running” the country know more than you, or care about you at all?
The Austrian Perspective
When we ask the right questions, when we provoke a visceral gut response, we begin to change the way people think about economics. We do a better job of connecting with people’s intellect by appealing to their emotions.
From my perspective, the Austrian school of economics provides the best framework for asking and answering the right questions. And when we apply this framework, we both demystify economics and show how economics affect us at a level further down Maslow’s pyramid.
So how can Austrian economics help us relate to people on a more fundamental, philosophical level? Here are a few examples:
First: Property rights are the basis of prosperity.
As Rothbard explained, human rights are property rights! Just as we own our minds and bodies, we justly own the material products of our minds and bodies. Property rights are a corollary of self-ownership. It’s no coincidence that wealthy societies are founded on establishing the rule of law to protect property and enforce contracts.
Second: Booms and busts are not inevitable or natural.
The seemingly mysterious cycle of economic expansion followed by recessions is thoroughly predictable and explainable, even though the timing of booms and busts depends on countless variables.
Austrian business cycle theory enables us to completely unravel the official story about what causes economic contractions and expansions. The Great Depression, the stagflation of the 1970s, the recession of 1981/82 recession, the tech stock bubble of the early 2000s, the housing bubble of the mid-2000s, the Crash of 2008 — these are all predictable, and explainable events!
Austrian business cycle theory is quite simple, and is based on the systemic effects of artificially low interest rates throughout the economy. Artificially low interest rates occur both because of monetary expansion by the Federal Reserve, and because of credit expansion due to fractional reserve banking. They cause banks and entrepreneurs to make bad business decisions about the future, which results in malinvestment which can take decades to unwind
Consider that lots of business ideas look good when the cost of borrowing money is cheap — see the M&A boom of the early 2000s! But when credit begins to contract, as it must, the dislocations appear. And all the ideas that looked so smart, like so many dot-com startups, are exposed as unprofitable.
So we can debunk this terrible falsehood that capitalism is inherently prone to violent boom and bust cycles.
Third: Inflation is bad, and caused by the Fed. Deflation is good, and caused by the market.
Don’t let the talking heads confuse you. Inflation is bad, and deflation is good.
Price inflation is a symptom of monetary expansion. Inflation occurs simply because the supply of money in the economy is growing faster than the supply of goods and services available. Inflation may not be uniform across categories of goods, it may happen in fits and starts. But it is engineered as a matter of policy by the Federal Reserve.
And this policy doesn’t make us richer! Early recipients are often crony industries, and they benefit from new money that has not made its way into the general economy. But merely increasing the total amount of money in an economy does not create any new goods or services.
James Grant points out that deflation, which the Fed absolutely hates, is another word for getting richer. This is what happens in productive societies with sound money — things get cheaper, and thus become more readily available to average people. Example of benevolent deflation are all around us: personal computers, DVD players, big screen TVs, and laser eye surgery.
Fourth: Bubbles can’t last — that’s why they’re called bubbles.
How often have your heard someone wonder why a one bedroom condo in Honolulu or San Francisco costs a million dollars? Bubbles are directly related to the boom and bust cycle already discussed — bubbles exist in asset classes where the greatest amount of malinvestment occurs.
Herbert Stein was an economist, and Chairman of the Council of Economic Advisors — a kind of cheerleading squad — for presidents Richard Nixon and Gerald Ford.
Herbert Stein came up with his own law, known as Stein’s law. It goes like this: “If something cannot go on forever, it will stop.”
It sounds simple. He used it to describe economic trends. And it’s a great tool to apply to determine whether a particular trend is really sustainable.
So much of what we accept as normal in today’s economy falls apart when we apply something as simple as Stein’s law to understand government- and central bank-created bubbles:
- The $18 trillion Federal debt (only $1T when Reagan took office, $5.5T when Bush II took office), which is rising much faster than real GDP.
- A policy of quantitative easing that has quadrupled the Federal Reserve’s balance sheet since 2008 (from $8.7B to over $4T). This is historically unprecedented.
- Effective negative yields on certain bonds, and discussions of paying nominal negative yields on certain Euro government bonds. Holders are effectively paying someone to hold their money.
- A Dow Jones average that has tripled since its low in 2009. Where is the GDP, earnings, and productivity growth to support this?
- Housing prices in places like Honolulu and San Francisco. Are they truly the result of simple supply and demand? Or is inflation flowing unevenly into venture capital and real estate?
Finally: We need separation of money and state.
Unlike so many “policy” areas, there is an immediate and ready solution to the issue of sound money: simply allow competing currencies to coexist. Let the fiat Federal Reserve dollar compete.
In the Austrian view, money arises in the market as the most readily exchangeable commodity. When governments or central banks create money and credit, a market commodity becomes a political tool of central planners. Just as we scoffed at Soviet planners who attempted to determine how much wheat should be produced in the economy, or what a factory worker’s wage should be, we should reject so-called monetary policy.
The Fed’s most powerful tool is interest rate targeting. Interest rates are supposed to serve as prices — and price signals are the critical piece of information at the heart of a market economy. The lack of price and profit signals is why socialism fails. The price of borrowing money — interest rates — should be determined by the relative time preferences of lenders and borrowers.
The Federal Reserve is often accused of “printing money,” but the reality is more complex. For purposes of our discussion, the Fed’s biggest sin today comes in the form of quantitative easing, a process whereby the Fed buys asset from commercial banks (both US Treasury debt and lower-grade bond debt).
This process artificially boosts the demand for US Treasuries, allowing yields to remain lower (and saving Uncle Sam from disastrously increasing interest payments as a percentage of annual federal spending). It also leaves commercial banks flush with bank reserves, which means they don’t have to borrow from each other overnight. So the overnight bank borrowing rate, known as the Federal Funds Rate, is effectively zero.
All commercial interest rates — e.g., the interest you pay on your mortgage — flows from the Fed Funds Rate on a cost-plus basis.
But when the Federal Reserve effectively keeps interest rates lower than they would be naturally, it creates a terrible disconnect between lenders and borrowers. And this disconnect causes unbelievable distortions throughout the economy. As David Stockman says, because of central banks there is no honest pricing of goods anywhere — we simply don’t know, for example, what a barrel of oil or a bushel of wheat should cost. The Fed has distorted the single most important price in the entire economy — the Federal Funds rate.
Cheap money is one-half of every transaction! When you effectively leave control over one-half of the economy to a handful of Fed governors, you can’t say the results represent free-market capitalism.
Conclusion
In closing, let me summarize by saying that we don’t have to abandon intellectual rigor to “sell” free market economics. But we do have to make economics more relevant and vital to the average person, by reclaiming it from the academics and asking the visceral questions: Why are we so rich? And What if this went away?
Remember, our economic future is unwritten. The US economy has very serious structural problems, particularly with respect to debt, the dollar, and entitlements. These problems cannot be solved by politics.
But our biggest challenge is mindset. There is no reason on paper that America cannot prosperous. Despite all the problems with American schools, we still have one of the most educated workforces in the world. We have abundant and sparsely populated land. In fact, we have more arable land than any other nation — about 17 percent of all US acreage can be farmed. We have 500 million acres of timber. We have two huge coastlines, with access to both eastern and western markets. And we have huge amounts of cheap energy in the form of oil and natural gas- the Obama administration’s Interior Secretary announced in 2013 that with the Bakken formations in the Dakotas and Montana, we have double the amount of oil and three times the natural gas than previously thought.
So our problems are of our own making, primarily caused by politics, high time preferences, and economic ignorance. I hope you share my belief that economics matters, and that we ignore it at our peril.
