Onion Eater

At the Campaign for Liberty blog, Ron Paul promises to defend the “Merits of the Austrian School” next week.

Very well. In 2004 I found seven serious problems with Hayekian economics. Let us see if Paul can defend Hayek on these seven points:

1) As discussed in Section II, Hayek was unclear whether his structure of production represents a yearly flow of goods or a distribution of wealth. Mises and Rothbard, like Hayek, seem to mean one and also the other. Skousen is at least consistent but, unfortunately, he is consistently wrong. He definitely means the amount of goods flowing by every year. This author’s work (1999) is about stock, not supply.

2) As discussed in Section III, Hayek’s triangle is printed sideways and backwards. The former problem can be corrected by rotating the graph but the latter problem is more fundamental. Hayek is speaking from the perspective of the owner of the final product looking back on his costs of production. He is speaking from Marx’s perspective. The perspective that we want is from right now, at time zero, looking forward into the future.

3) As discussed in Section IV, there must be some temporal measure or the Hayekian’s incessant references to “lengthening the period of production” would not mean anything at all. Their theory of business cycles depends on credit expansions lengthening the period of production and on the inevitable contraction shortening it. It is impossible to talk about something being lengthened or shortened unless one knows how to measure it.

4) As discussed in Section V, Hayekian theory depends entirely too much on the specificity of capital goods. In reality, many companies make products or provide services which are used in all of Hayek’s five stages – and they experience cyclical behavior too. Rothbard was wrong when he said “To the extent that the new money is loaned to consumers rather than businesses, the cycle effects do not occur” (1970, p. 940 footnote).

5) As discussed in Section VI, Garrison’s conceptions of the natural rate of interest is faulty. The Hayekians are naïve to cling to this mythical concept. There is no such thing as a natural rate of interest. In any case, credit limits are more important than interest rates. The necessity of a bust following boom times is adequately explained by the transfer of capital from smaller companies to larger ones.

6) In Garrison’s own words: “the [Hayekian] theory of the business cycle is a theory of the unsustainable boom. It is not a theory of depression per se. In particular, it does not account for the severity and possible recalcitrance of the depression that may follow on the heels of the bust” (2001, p. 120). In 1930, Hayek could explain how the depression started. In 1936, he could not explain why it still persisted.

7) Austrian economists seem naïve because their belief in a natural interest rate implies an ethical judgment on what is natural or unnatural, their discussion of the inevitable collapse of a credit expansion is typically presented as a sort of morality play and because they advocate an impractical 100% reserve requirement based solely on ethical considerations.

Seven strikes and you are out! Hayek’s horse fell dead underneath him in 1936. Seventy years later, his followers are still beating that horse saying “Get up! Get up! We have to finish the race!”

Source: Summary of the Critique of Hayek

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Website: www.axiomaticeconomics.com

Motto: Critiques and rebuttals are how science advances.

Gladiator

No 7, a Natural Interest rate, may find an example with the Federal Reserve keeping interest rates below the Natural interest rate, i 2008.

There may be several ways to determine the value of the current Natural interest rate, that may produced various results.

The value of Economic Theories is in how they are applied. It seems that the Austian system is being challenged to meet all applications. I find the concept of a natural interest rate a valuable concept.

If the US Dollar falls further as Bush prints more Dollars to keep interest rates low, and borrow more money for wars and advancing Republican prinicples, then the theory of the "Inevitable Collapse" will have been realized, at least in part.




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How did Our Oil get under Their Sand?

Onion Eater

In Section VI of my 2004 Critique of Austrian Economics, "The Natural Rate of Interest", I write:

“Credit limits are more important than interest rates and there are many people who cannot get credit at all. Interest rates only affect how much money is being transferred. They do not affect who gets it…

“Recently, Stiglitz and Greenwald have raised the same issue. ‘That some loans are not repaid is central… Thus, a central function of banks is to determine who is likely to default, and in doing so, banks determine the supply of loans.’ (2003, p. 3). This idea, that bank loans redistribute wealth from one class of people to another, is a fundamental departure from the classical view that banks merely divide the world into those who are willing to borrow at x% but not at x.1%, without regard to who those people are, their class or their importance to the government.”

Recent events have confirmed my belief that credit limits are more important than interest rates:

Alan Zibel writes, “Lenders [who must satisfy Fannie and Freddie] are demanding bank statements, big cash reserves and second appraisals before they approve a loan to refinance a home. Mortgage rates are hovering around 6.6%, about the same level as a year ago.”

Clearly, if mortgage rates are the same as a year ago but the housing market is so much different (and worse) than a year ago, then mortgage rates are not the best measure of the market. Credit limits are.

Martin Feldstein concurs, “The dysfunctional state of the credit market means that many individuals and businesses are unable to get credit. Lowering interest rates will not stimulate demand for those who cannot get credit.”

At the macro level, most economists agree that the Federal Reserve loaning money to investment banks and holding loan auctions to avoid shaming the recipients is far more important than the fact that they lowered the discount rate. Also, the repeal of the Glass-Steagall act in 1999 is widely seen as a precursor to the current credit crisis, yet it had no direct impact on interest rates.

In my book (Aguilar, 1999) I write:

"The concept of a “natural” rate of interest, which the actual rate of interest (charged by banks) tends toward, is a trap that virtually every established school of economics has fallen into.... However the “natural” rate of interest is defined, if it is defined at all, the concept has led to some of the most serious mistakes in economics (1999, pp. 156, 157)."

In 2004, specifically in regard to the Austrian position, I write:

"Garrison has the interest rate determined by the supply and demand of present goods, labor for wages: “Labor services represent future consumption goods.... The sale of labor services, then, constitutes the demand for present goods and the supply of future goods” (1978, p. 175). The accompanying figure is reprinted here as Figure 5. This implies that production is not the complicated structure it was originally described to be, but is really quite simple: All labor is used at the high end (not spread throughout the structure), is paid for entirely with borrowed money and borrowed money is used for no other purpose (like buying capital) except paying wages.

"First an ill-conceived change of variables, then a horizontal axis labeled with time running backwards and now a definition of interest that involves only present goods! Garrison’s Diagrammatical Exposition (1978) is certainly the low point in Hayekian economics. Twenty-three years later, Garrison would write that “it continues to appear on Austrian economics reading lists” and is “largely compatible with the graphical exposition offered in the present volume” (2001, p. xii). Frankly, that is hard to believe."

REFERENCES

Aguilar, Victor. 1999. Axiomatic Theory of Economics. Hauppauge, NY: Nova Science Publishers, Inc.

Garrison, Roger. 1978. “Austrian Macroeconomics: A Diagrammatical Exposition.” in New Directions in Austrian Economics, edited by Louis Spadero. Kansas City, KS: Sheed, Andrews and McMeel

——. 2001. Time and Money: The Macroeconomics of Capital Structure. New York, NY: Routledge

Stiglitz and Greenwald. 2003. Towards a New Paradigm in Monetary Economics. Cambridge, England: Cambridge University Press

Onion Eater

I have written a poem illustrating this point. Perhaps this will inspire the Austrians to defend Hayek.

Ode to an Economics Troll

Troll sat alone on his seat of stone,
And critiqued what the Austrians did enthrone;
For Hayek had got his triangle backwards, clear
But a rebuttal was hard to come by.
Done by! Gum by!
In a cave in the hills he dwelt alone,
And a rebuttal was hard to come by.

Up came Bob with his big boots on.
Said he to Troll: “Pray, what is yon?
For it looks like Prices n' Production o' my nuncle Fritz.
As should be a-lyin' in the graveyard.
Caveyard! Paveyard!
This many a year has Fritz been gone,
And I thought his books were lyin' in the graveyard.”

“My lad,” said Troll, “Hayek’s triangle you extol
But what be a theory with a logical hole?
Thy nuncle was dead as a lump o' lead,
Afore I wrote my Critique.
Weak! Shriek!
He can spare a share for a poor old troll,
For he don't need his theory whole.”

Said Bob: “I don't see why the likes o' thee
Without axin' leave should go makin' free
With the books or the larning o' the Austrian's kin;
So hand the old book over!
Rover! Trover!
Though dead he be, it belongs to he;
So hand the old book over!”

“For a couple o' pins,” says Troll, and grins,
“I'll refute thee too, and gnaw thy work’s withins.
A bit o' fresh theory will go down sweet!
I'll try my polemics on thee now.
Hee now! See now!
I'm tired o' gnawing old books and skins;
I've a mind to refute mod' Austrians now.”

But just as he thought his reputation wrought,
He found his hands had hold of naught.
Before he could mind, Bob slipped behind
And gave him the boot to larn him.
Warn him! Darn him!
A bump o' the boot on the seat, Bob thought,
Would be the way to larn him.

But harder than stone is the flesh and bone
Of a troll that sits in the hills alone.
As well set your boot to the axiomatic root,
For the seat of a troll don't feel it.
Peel it! Heal it!
Old Troll laughed, when he heard Bob groan,
And he knew the young Austrian could feel it.

Bob's reputation is game, since home he came,
And his doctorate degree is lasting lame;
But Troll don’t care, and he’s still there
With the rebuttal he boned from its owner.
Doner! Loner!
Troll’s old seat is still the same,
And the rebuttal he boned from its owner!

You see, Bob pushed his analysis to caveman days,
But Troll insisted that value in the future lays.
Value is always subjective, not intrinsic at all,
And supply is not the same as stock, he explained.
Reigned! Deigned!
The Economics Troll won, Hayek’s triangle he did raze,
As Axiomatic Theory prevailed, Austrianism waned.

Axiomatic Economics by Victor Aguilar: Austrian, Chicago and Keynesian Rebuttals to Aguilar

American

Why don't you read the Constitution? Congress sets the value of money.

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It's Obama's fault!

Onion Eater

Austrians! Take heart!

Phillip Mabry of the Mises Institute has stood up for Ron Paul! No longer must the Good Doctor's economic theory go undefended! Like Hercules performing his twelve labors, Mabry has undertaken to reply to not just one but all seven of my questions!

Check it out: Actual Politics forum.

Is he winning? You decide! The fate of Austrianism rests on his shoulders!