Saturday, February 2, 2013

#19.4 The Austrian School, agreements and divergences – Part 4

Source -
Business cycles

Main article: Austrian Business Cycle Theory

The Austrian School is one of the few schools of economic thought that considers different forms of money to be "non-neutral" - meaning that changes in the money supply can have real economic effects, disrupting the price mechanism and causing "ripple" effects throughout the economy. Mainstream theories generally consider money to be "neutral" (in other words, they consider that changes in the money supply do not have significant effects on the real economy). According to Austrian School economist Joseph Salerno, what most distinctly sets the Austrian school apart from neoclassical economics is the Austrian Business Cycle Theory:[62]

The Austrian theory embodies all the distinctive Austrian traits: the theory of heterogeneous capital, the structure of production, the passage of time, sequential analysis of monetary interventionism, the market origins and function of the interest rate, and more. And it tells a compelling story about an area of history neoclassicals think of as their turf. The model of applying this theory remains Rothbard's America's Great Depression.

Fine, but as long as they are not even bothering to critically consider interest rates as a feature of a usury based lending system, nothing of importance results.

Austrian School economists focus on the changes in the money supply and the associated credit cycle as the primary cause of most business cycles. Austrian economists assert that the pernicious monetary effects of fractional reserve banking are the predominant cause of most business cycles, as the inflating effects of the practice result in lower interest rates than would prevail in a stable money system, thereby causing excessive credit creation, speculative "bubbles" and "artificially" low savings.[63]

We see the credit cycle as the essential mechanism of the banker's accordion like grip on the economy; first they puff it up, taking their cut as inflation goes up, then squeezing the money supply by calling in loans or as the result of defaults on loans precipitated by the same squeezing that diminishes business, therefore jobs. I note with considerable insolent glee, to use another of Ayn Rand's favourite words, that all the schools of economics usually do some research on the so called “business cycle” without ever getting to the root of the problem, the fractional reserve banking system and their puff and squeeze accordion like money maneuverings.

Let's parse this: as the inflating effects of the practice [fractional reserve banking] result in lower interest rates than would prevail in a stable money system, thereby causing excessive credit creation, speculative "bubbles" and "artificially" low savings.  

One of the things he's saying is that the money supply fluctuates as a result of these cycles. It's done quite deliberately as part of the banker's leverage on the actions of others. Seen this way, whether they are aware of it or not, all bankers must be the worst scoundrels. There is a perceived connection in the usury based monetary system between interest rates and savings because the bankers share some of their fraudulently obtained gains with savers. But of course since the money that pays the interest was never created along with the principle of the loan, and compounding interest makes things even worse, neither the banker nor the saver are really entitled to gain anything. There are legitimate ways to structure financial affairs such that no extra money is ever needed and yet everyone with a legitimate claim makes money. This subject will be fleshed out in the forthcoming post(s) on markets. 

According to the Austrian School business cycle theory, the business cycle unfolds in the following way:

Fractional reserve banking continually causes inflation through the "artificial" lowering of interest rates (compared to what they would be in a stable money environment).[64] This can occur indefinitely with the aid and assistance of the central bank.   

... as has been going on now for quite some time. The problem isn't that it doesn't work, but for who it does work. It hasn't worked for the vast majority of the rest of us. 

Low interest rates encourage fresh borrowing and new credit creation, thereby increasing the short term profitability of the banking system. But this expansion of credit also causes an expansion of the supply of money, through the money creation process in a fractional reserve banking system and misallocates resources, skewing production to "unwanted" capital goods industries and encouraging Ponzi-like speculation. This artificial increase in money and credit inevitably leads to an unsustainable "credit-fuelled boom" during which the "artificially stimulated" borrowing seeks out diminishing investment opportunities and causes widespread malinvestments, where capital resources are misallocated into areas that would not attract investment if the money supply remained stable.

Many of these hair-brained schemes actually attract a lot of money. Much of this is quite descriptive of present conditions.

Murray Rothbard used the concept of malinvesment and the distorting effects of bank-induced credit creation to study the Great Depression in his revisionist work, America's Great Depression:[65]

A credit expansion may appear to render submarginal capital profitable once more, but this too will be malinvestment, and the now greater error will be exposed when this boom is over. Thus, credit expansion generates the business cycle regardless of the existence of unemployed factors.

We tend to agree here too.

Credit expansion in the midst of unemployment will create more distortions and malinvestments, delay recovery from the preceding boom, and make a more gruelling recovery necessary in the future.

We have had bouts of quantitative easing, but the more important factors affecting the economies in the developed world are structural and affect the long term decline of American and European industrial production in a poor bargain to gain greater mutual entanglements and commercial hegemony. Factors that could break it would be severe long term unemployment, an episode of hyperinflation followed by bank failures, followed by the total imploding of the present financial world.

So what's the choice? We know what money is, what it looks like and how to use it. Why would we want to horse around with heavy precious metals disks in our pockets? That's for a barbarian age like the 4th century, an age of misery. What we need is a new monetary system designed from the outset to have learned from the faulty features of the old system, not to repeat them. We're sorry that Independent Exchange (IE) officers will not be able to live the gluttonous lives of some notorious bankers, but that's really going to be all for the best.

While it is true that the unemployed factors are not now diverted from more valuable uses as employed factors would be (since they were speculatively idle or malinvested instead of employed), the other complementary factors will be diverted into working with them, and these factors will be malinvested and wasted. Moreover, all the other distorting effects of credit expansion will still follow, and a depression will be necessary to correct the new distortion.
Yes, in a usury based system, the accordion must always repay the banker's losses with more of other people's possessions at less than original cost so that the banker can still resell them cheap and make a profit. THAT is what is referred to as a depression will be necessary to correct the new distortion. In other words they don't give a shit about you. A depression makes life hard and puts lots of people out of work, forces people to sell out their property to stay alive, etc.

Since we know all these things, the remedy is to start doing business through a non usury based monetary system without these features. Since there are no factors that would lead to any accordion like effects on business conducted through the Value  Exchange Network [VEN] (that's really what it's going to be
[I knew this would be a likely conceptual handle for discussion when I first wrote this]), there will be no business cycles. We'll probably see a lot better allocation of labour and resources too.
Austrian School economists argue that a correction or "credit crunch" – commonly called a "recession" or "bust" – occurs when credit creation cannot be sustained. They claim that the money supply suddenly and sharply contracts when markets finally "clear", causing resources to be reallocated back toward more efficient uses.

Isn't it wonderful when you finally change your perceptions, so you can see when someone is deliberately trying to snow you?  Bankers create both booms and busts, profit both ways and yet these are necessary to correct or clear capital and resource misallocations? What kind of justification for fraud do you prefer? "We need to ruin millions of people's lives because, well we allowed too many people to have too much money, so we have to start taking it back."  What rubbish!  These people are probably among the most despicable varieties on the planet! It's time we did what the universal message has always been; “come out of her, my people.”

Economist Steve H. Hanke identifies the financial crisis of 2007–2010 as the direct outcome of the Federal Reserve Bank's interest rate policies as is predicted by Austrian school economic theory.[66] Some analysts such as Jerry Tempelman have also argued that the predictive and explanatory power of ABCT in relation to the recent Global Financial Crisis has reaffirmed its status and, perhaps, cast into question the utility of mainstream theories and critiques.[67]

What a fabulous whitewashing here!

Monetary Reform
Main article: Debt-based monetary system

The Austrian School is currently the only major school of economic thought that advocates radical monetary reform and actively debates the efficacy of fundamental banking reform.[68]

All other schools of economic thought (including Keynesian, monetarist and neo-classical) implicitly accept the current monopoly fiat money and central bank-dominated financial system as optimal - or at least as not actively destructive of the economy. [69][70] This is based on the mainstream idea of "money neutrality" - the idea that inflation does not have real economic effects over the long term and does not significantly distort real resource allocation.[71]

Actually it directly affects saving. That too will be covered in detail in the post(s) on markets.

Austrian scholars, on the other hand, uniformly see coercive legal tender laws (which inevitably force people to use the national fiat currency as money) and the current fractional-reserve financial system as an extremely dysfunctional and disruptive influence on the economy. [72][73][74] Through the centralized control of interest rates, through the arbitrary diversion of scarce resources to repeatedly bail out the "too big to fail" banks, through the manipulation of financial markets via the buying of government bonds (so called "quantitative easing"), Austrian scholars see coercive legal tender laws, central banking and the current financial system generally as a source of continual disruption in the price discovery mechanism, misleading investors and market participants and ultimately causing continual and ongoing misallocations in scarce resource distribution, resulting in massive malinvestments and wrenching and disruptive business cycles.[75][76]

As things get worse, one is likely to see larger swings in markets as they attempt to cope with this basic idea; how much is something worth?  Eventually the fluctuations will dive to the low side and be slow to recover because more people will recognize that the paper chasing paper markets are valueless. Maybe it could have been different, but the problems have always been linked to limited liability and absentee ownership, both issues that will be absent from the Value Exchange Network (VEN).

However, Austrian scholars are divided on the optimal solution to this urgent problem.[77]

Some Austrian scholars advocate "free banking", where banks are permitted to engage in fractional-reserve banking activities provided they comply with the laws against fraud and are not supported in any way against the possibility of bank runs and are forced into bankruptcy should they not be able to pay their debts as and when they fall due.[78]

What good is this idea? You decide to perpetuate a fraudulent model of finance that most recognize as fractional reserve banking, provided they have no insurance against their Ponzi scheme eventually falling apart? “Free banking” is an utterly stupid idea!  Run, don't walk away from anyone advocating this.

Advocates of this system of banking include Lawrence White, Steven Horwitz, George Selgin, and Kevin Dowd, amongst others.[79]  

Good, at least we now know the names of the clowns, so we can avoid them.

F.A. Hayek also advocated the de-nationalization of money production and implicitly supported a free banking financial system in some of his works on monetary reform.[80]

Well what these clowns advocate is NOT monetary reform. What E. C. Riegel outlined was and is real monetary reform.

Other Austrian scholars advocate "full-reserve banking", considering fractional-reserve banking to be inherently unethical, disruptive and dysfunctional, akin to embezzlement. [81]

Yeah, that's essentially what it is. They sometimes offer to share some of their embezzlement with savers who are likewise not entitled to being paid interest for leaving their money idle. We will discuss ways in which VEN members can participate in financing that is ethical, constructive and functional to the economy.

Full reserve banking would require banks to retain in reserve all deposits that are legally available for immediate withdrawal, and permit lending only from longer-term deposits.

This is much more the flavour of (the or an) VEN.

Advocates of this system of banking include Murray Rothbard,[82][83] Jesus Huerta de Soto,[84] and Jörg Guido Hülsmann,[85][86][87] amongst others.[88]

Good for them! Their stuff might in that case be worth reading. But I said might. I have read so much over the years that I now regard as complete and utter garbage that I'd prefer a good re-reading of any of E. C. Riegel's books to anything by any other economist. I wish we had more Riegel to read and study.

Criticism of the Austrian School

Critics argue that modern Austrian economics generally lacks scientific rigour,[89] which forms the basis of the most prominent criticism of the school. Austrian theories are not formulated in formal mathematical form, [90] but by using mainly verbal logic and self-evident axioms. Mainstream economists believe that this makes Austrian theories too imprecisely defined to be clearly used to explain or predict real world events. Economist Bryan Caplan noted that, "what prevents Austrian economists from getting more publications in mainstream journals is that their papers rarely use mathematics or econometrics."  

We will use some mathematics to set up and maintain (the or an) VEN as will be explained in subsequent posts. 

There are also criticisms of specific Austrian theories. For example, Nobel laureate Milton Friedman, after examining the history of business cycles in the US, concluded that "The Hayek-Mises explanation of the business cycle is contradicted by the evidence. It is, I believe, false."[91][92][93] In addition to Milton Friedman's criticism, noted liberal neo-Keynesian economist Paul Krugman has criticized the theory.[94]
Jeffrey Sachs has argued that high tax rates and a "mixed" economy (with some "socialist" elements such as high levels of social welfare transfer payments) appears to have generated higher growth rates in the second half of the 20th century - which appears to run counter to the Austrians' assertion that strong deference to private property rights (and therefore low tax rates) are essential for a properly functioning free market economy. Sachs asserts that poverty rates are lower, median income is higher, the government budget has larger surpluses, and the trade balance is stronger (although unemployment tends to be higher).[95]

In response to Sachs' article, William Easterly states that Hayek, writing in 1944, correctly recognized the dangers of large-scale state economic planning. He also questions the validity of comparing poverty levels in the Nordic countries and the United States, when the former have been moving away from social planning toward a more market-based economy, and the latter has historically taken in impoverished immigrants.[96]

We consider that much of this may be so but for differences not considered by either the Austrians or the Keynesians, the dialectical pair deliberately set up to prevent us from paying attention to the core issue; usury and its cousins, fractional reserve finance (so called banking) and compounding of interest based on illegitimate claims for a return of that which was never created; the eleventh marble, etc.

David Burton


Seminal works 


Principles of Economics (1871) by Carl Menger
Capital and Interest (1884–1921) by Eugen von Böhm-Bawerk
Human Action (1940–1949) by Ludwig von Mises
Economics in One Lesson (1946) by Henry Hazlitt
Individualism and Economic Order (1948) by Friedrich Hayek
Man, Economy, and State (1962) by Murray N. Rothbard
Competition and Entrepreneurship (1973) by Israel M. Kirzner 

See also 

The Austrian School of Economics
An Introduction to Economic Reasoning‎
An Introduction to Austrian Economics
The Historical Setting of the Austrian School of Economic

Austrian Economics: An Anthology

Economic Science and the Austrian Method



1. ↑ Keynesians Can't Predict, L. Albert Hahn, The Freeman, October 6, 1952

2. ↑ School of Thought: The Austrian School of Economics, Online Library of Liberty, retrieved 2011-05-19

3. ↑ Jörg Guido Hülsmann. "Ethics of Money Production", online version, Introduction p. 12, referenced 2009-05-10.

4. ↑ 4.0 4.1 4.2 "FAQ: What is Austrian Economics", Mises Institute, referenced 2009-04-27.

5. ↑ Jeffrey Herbener. "Frank A. Fetter (1863-1949): A Forgotten Giant", Mises Institute, referenced 2009-04-28.

6. ↑ 6.0 6.1 6.2 Murray N. Rothbard. "Ludwig von Mises (1881-1973)", Mises Institute, referenced 2009-04-26.

7. ↑ Mark Thornton. "Benjamin Anderson (1886-1949)", Mises Institute, referenced 2009-04-26.

8. ↑ Shawn Ritenour. "Wilhelm Röpke (1899-1966): Humane Economist", Mises Institute, referenced 2009-04-27.

9. ↑ Mark Thornton. "Biography of Fritz Machlup (1902-1983)", Mises Institute, referenced 2009-04-27.

10. ↑ "Between Mises and Keynes An Interview with Gottfried von Haberler (1900-1995)", The Austrian Economics Newsletter Spring 2000 Volume 20, Number 1, referenced 2009-04-27.

11. ↑ Peter Kurrild-Klitgaard. "The Viennese Connection: Alfred Schutz and the Austrian School"(pdf), The Quarterly Journal Of Austrian Economics Vol.6, no.2, referenced 2009-04-27.

12. ↑ Jörg Guido Hülsmann. "Richard von Strigl (1891-1942)", Mises Institute, referenced 2009-04-27.

13. ↑ Richard M. Ebeling. "The Discovery of the Lost Papers of Ludwig von Mises", The Future of Freedom Foundation, March 1997, referenced 2009-04-28.

14. ↑ David Gordon. "Murray N. Rothbard (1926-1995)", Mises Institute, referenced 2009-04-28.

15. ↑ The Great Society: A Libertarian Critique, Murray Rothbard

16. ↑ The Noble Task of Revisionism, Murray Rothbard

17. ↑ The Fallacy of the 'Public Sector', Murray Rothbard

18. ↑ For a New Liberty, Chapter 3

19. ↑ Tax Day, Murray Rothbard

20. ↑ Rothbard, Murray. The Mystery of Banking Ludwig von Mises Institute. 2008. p. 111

21. ↑ "Has fractional-reserve banking really passed the market test? (Controversy).". Independent Review. January 2003.

22. ↑ The Case for the 100% Gold Dollar, Murray Rothbard

23. ↑ See also Murray Rothbard articles: Private Coinage; Repudiate the National Debt; and Taking Money Back

24. ↑ Ron Paul Interview, National Review Online

25. ↑ Ludwig von Mises "The Principle of Methodological Individualism", Human Action online edition, Mises Institute. Referenced 2009-04-24}.

26. ↑ Ludwig von Mises, Nationalökonomie (Geneva: Union, 1940), p. 3; Human Action (Auburn, Ala.: Mises Institute, [1949] 1998), p. 3.

27. ↑ Hans-Hermann Hoppe, Economic Science and the Austrian Method (Auburn, Ala.: Mises Institute, [1995] 2007), p. 63.

28. ↑ Skousen, Mark (2005). Vienna & Chicago, Friends or Foes?. Washington: Capital Press/Regnery Pub. ISBN 0-89526-029-8.

29. ↑ Frank van Dun. Natural Law: A Logical Analysis. Etica & Politica, 2003.2. Dipartimento di Filosofia, Lingue e Letterature, Università di Trieste.

30. ↑ Keynesians Can't Predict, L. Albert Hahn, The Freeman, October 6, 1952

31. ↑ What is the Current State of Economic Science?, Erwin Rosen

32. ↑ Over To You H. Parker Willis, James Grant

33. ↑ What is the Current State of Economic Science?, Erwin Rosen

34. ↑ You Heard It Here First, Mark Thornton, LRC

35. ↑ Business Cycles and Prediction, Mark Thornton

36. ↑ Saving the System, Robert K. Landis

37. ↑ Brodie, Lee (2009-08-17). "Is This Market Heading For A Serious Correction?". CNBC.

38. ↑ Inflation is There, Peter Schiff

39. ↑ "Values are not seen (as they are in Marshallian economics) as jointly determined by subjective (utility) and objective (physical cost) considerations. Rather, values are seen as determined solely by the actions of consumers... Cost is seen (by Menger, and especially by Wieser...) merely as prospective utility deliberately sacrificed (in order to command more highly preferred utility)." Israel M. Kirzner, "The Austrian School of Economics", The New Palgrave: Dictionary of Economics (1987)

40. ↑ Skousen, Mark (2001). The Making of Modern Economics. M.E. Sharpe. p. 284. ISBN 0-7656-0479-5.

41. ↑ "The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 1974". Nobel Foundation. 1974-10-09. Retrieved 2008-10-12.

42. ↑ Steele, G. R. (2001). Keynes and Hayek. Routledge. p. 9. ISBN 0-415-25138-9.

43. ↑ F. A. Hayek, (1935), "The Nature and History of the Problem" and "The Present State of the Debate," om in F. A. Hayek, ed. Collectivist Economic Planning, pp. 1–40, 201–243.

44. ↑ Is Higher Inflation Inevitable?, Thorsten Polleit

45. ↑ The Economics of Legal Tender Laws, Jorg Guido Hulsmann (includes detailed commentary on central banking, inflation and FRB)

46. ↑ Why Deflation Is not Inevitable (Sadly), Gary North

47. ↑ QE is Nothing New, Mike Hewitt

48. ↑ QE is Nothing New, Mike Hewitt

49. ↑ Shostak, Ph.D, Frank (2002-03-02). "Defining Inflation". Mises Institute. Retrieved 2008-09-20.

50. ↑ von Mises, Ludwig (1980). "Economic Freedom and Interventionism". In Greaves, Bettina B.. Economics of Mobilization. Sulphur Springs, West Virginia: The Commercial and Financial Chronicle.

51. ↑ Ludwig von Mises Institute, "True Money Supply"

52. ↑ Joseph T. Salerno, (1987), Austrian Economic Newsletter, "The "True" Money Supply: A Measure of the Medium of Exchange in the U.S. Economy"

53. ↑ Frank Shostak, (2000), "The Mystery of the Money Supply Definition"

54. ↑ Lew Rockwell, interview on "NOW with Bill Moyers"

55. ↑ Ludwig von Mises Institute, "The Gold Standard"

56. ↑ Ron Paul, "The Case for Gold"

57. ↑ Saving The System, Robert K. Landis

58. ↑ Murray Rothbard, "The Case for a 100 Percent Gold Dollar"

59. ↑ Ludwig von Mises Institute, "Money, Banking and the Federal Reserve"

60. ↑ Rothbard, Murray. The Mystery of Banking, p. 261

61. ↑ von Mises, Ludwig (1981-07-01). The Theory of Money and Credit. Liberty Fund, Inc.. Chapter 21. ISBN 0-913966-71-1.

62. ↑ Salerno, Joseph (1996). "Why We're Winning: An Interview with Joseph T. Salerno". The Austrian Economics Newsletter 16 (3).

63. ↑ Thorsten Polleit, Manipulating the Interest Rate: a Recipe for Disaster, 13 December 2007

64. ↑ Is Higher Inflation Inevitable?, Thorsten Polleit

65. ↑ Murray Rothbard, America's Great Depression, 2005, 5th Edition, Ludwig von Mises Institute, Chapter 1, The Cluster of Error.

66. ↑ Hanke, Steve H.. "The Fed's Modus Operandi: Panic". Retrieved 17 July 2010.

67. ↑ ABCT and the GFC: Confessions of a Mainstream Economist by Jerry Tempelman

68. ↑ See for example these Murray Rothbard articles: What Has Government Done to Our Money?, The Case for the 100% Gold Dollar; The Fed as Cartel, Private Coinage, Repudiate the National Debt; Taking Money Back, Anatomy of the Bank Run, Money and the Individual

69. ↑ Sound Money, Lew Rockwell

70. ↑ Our Money Madness, Lew Rockwell

71. ↑ Senior Fed Economist Calls Ron Paul a Pinhead, Robert Wenzel

72. ↑ Is Higher Inflation Inevitable?, Thorsten Polleit

73. ↑ Sound Money, Lew Rockwell

74. ↑ Our Money Madness, Lew Rockwell

75. ↑ Is Higher Inflation Inevitable?, Thorsten Polleit

76. ↑ The Faults of Fractional-Reserve Banking, Thorsten Polleit

77. ↑ Free Banking, review by John P. Cochran

78. ↑ Free Banking, review by John P. Cochran

79. ↑ Free Banking, review by John P. Cochran

80. ↑ Free Market Money System by F.A. Hayek

81. ↑ See for example these Murray Rothbard articles: What Has Government Done to Our Money?, The Case for the 100% Gold Dollar; The Fed as Cartel, Private Coinage, Repudiate the National Debt; Taking Money Back, Anatomy of the Bank Run, Money and the Individual

82. ↑ The Mystery of Banking, Murray Rothbard

83. ↑ The Case for a 100% Gold Dollar, Murray Rothbard

84. ↑ Money, Bank Credit, and Economic Cycles, Jesus Huerta de Soto, First English edition (2006), pp. 98-114

85. ↑ The Economics of Legal Tender Laws, Jorg Guido Hulsmann (includes detailed commentary on central banking, inflation and FRB)

86. ↑ Free Banking and the Free Bankers, Jörg Guido Hülsmann, Quarterly Journal of Austrian Economics (Vol. 9, No. 1)

87. ↑ Interview with Jörg Guido Hülsmann, The Lew Rockwell Show

88. ↑ The Faults of Fractional-Reserve Banking, Thorsten Polleit

89. ↑ White, Lawrence H. (2008). "The research program of Austrian economics". Advances in Austrian Economics (Emerald Group Publishing Limited): 20.

90. ↑ Walker, Deborah L.. "Austrian Economics". Library of Economics and Liberty. Retrieved 2010-01-23.

91. ↑ Friedman, Milton. "The Monetary Studies of the National Bureau, 44th Annual Report". The Optimal Quantity of Money and Other Essays. Chicago: Aldine. pp. 261–284.

92. ↑ Friedman, Milton. "The 'Plucking Model' of Business Fluctuations Revisited". Economic Inquiry: 171–177.

93. ↑ Friedman, Milton. "The Monetary Studies of the National Bureau, 44th Annual Report". The Optimal Quantity of Money and Other Essays. Chicago: Aldine. pp. 261–284. "The Hayek-Mises explanation of the business cycle is contradicted by the evidence. It is, I believe, false."

94. ↑ Krugman, Paul (1998-12-04). "The Hangover Theory". Slate. Retrieved 2008-06-20.

95. ↑ Sachs, Jeffrey (October 2006). "The Social Welfare State, Beyond Ideology". Scientific American. Retrieved 2008-06-20.

96. ↑ William Easterly (2006-11-15). "Dismal Science". The Wall Street Journal. Retrieved 2008-09-07

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