Just when I think I have it nailed down, another one comes along.
The American Enterprise Institute’s James Pethokoukis has outdone himself with “Why Do Rand Paul and Obama Distrust the Free Market So Much?” (Thanks to Norm Singleton for the link. Or should I really thank him for this link?)
Let’s go through it (he says with a deep sigh).
Rand Paul and President Obama. One a libertarian, the other a left-liberal progressive. But they apparently have at least one thing in common: a belief that markets are fragile things. Both subscribe to the view that a speculative bubble caused the Great Recession. As Obama said in his recent Knox College speech, “But by the time I took office in 2009, the [housing] bubble had burst, costing millions of Americans their jobs, their homes, and their savings.” (Actually, it was passive Fed tightening in 2008, in a replay of the Fed’s Great Depression error, that turned a possible modest downturn into the Great Recession.)
Not off to a good start. Is the existence of the housing bubble really still debatable? Bernanke and Greenspan didn’t believe one existed, but surely now they do. It is hardly an indictment of “the market,” or an indication that one “distrusts” the free market, when a non-market institution like the Fed overrides market interest rates. The free market needs prices in order to work, and the Fed distorts those prices.
Pethokoukis simply repeats the Milton Friedman version of the Great Depression, in which the Fed was to blame for not doing enough. Why does Pethokoukis distrust the free market so much? Why does he think it can’t run itself without a government-created, monopoly central bank overseeing it? Blank-out, of course.
Between April 1924 and October 1929, the annualized return in the Dow Jones Industrial Average was 30 percent. Compare this to an annualized return of five percent from the beginning of the twentieth century through 2012. Is it reasonable to believe that these stock-market increases could have been sustained indefinitely? Might there have been something screwy about the economy of the 1920s? (That’s the question Murray Rothbard answers in America’s Great Depression, in which he details the Fed’s inflationary policies that sowed the seeds of the Depression.)
I talked about the Austrian and Chicago views of the Great Depression in this short video:
Pethokoukis continues:
That comment led economist Brad DeLong to call Obama a “neo-Austrian” or accidental Hayekian since Austrian economics — which can count Paul as a loyal devotee — contends the business cycle is driven by speculative excess leading to economic bubbles. Markets break down. Markets fail. Richmond Fed economist Robert Hetzel calls this the “market disorder” view of how economies work and the role government should play: “Adherents of the market-disorder view believe that sharp swings in expectations about the future from unfounded optimism to unfounded pessimism overwhelm the ability of offsetting changes in the real interest rate to stabilize economic activity.… The view that financial fragility produces real instability is associated with the belief that markets are inherently unstable. From this view, it follows that economic stability requires the regulation of markets through government intervention.”
I don’t particularly care what Brad DeLong called Obama, do you?
The Austrian theory of the business cycle does not contend that the cycle is “driven by speculative excess leading to economic bubbles.” Note that up to this point Pethokoukis has not mentioned anything about the Austrian emphasis on the role of the central bank in generating the cycle. He won’t mention it in the rest of his article, either. Austrians, he insists, think “bubbles” just occur more or less out of nowhere, and that such economists thereby demonstrate their lack of confidence in the market.
But who really lacks confidence in the market? If it were up to the Austrians, there would be no government intervention in money at all: no Federal Reserve, no “monetary policy,” nothing. Money would be produced the same way that all other goods are, under the cope of economic calculation. (More on that here.) Why does James Pethokoukis distrust the market?
Pethokoukis then unbosoms a perfectly irrelevant passage from a Fed economist, discussing people who think swings between excesses of pessimism and optimism drive economic activity. Again, this has nothing to do with the Austrians, who resolutely deny any such explanations of the cycle.
Here, in fact, Professor Jeffrey Herbener explains the fallacies in the optimism/pessimism view of cycles; it’s not clear why Pethokoukis would think Austrians subscribe to a theory they have dismissed out of hand from the beginning.
The economy is not a giant number that goes up and down, and which we need to keep up by means of various manipulations. What causes recessions is a series of micro-level maladjustments brought on by the activities of the Fed, a non-market actor. The Austrian theory describes a boom that is self-reversing. All the optimism in the world can’t keep it going.
The deformation of the capital structure brought on by interference with interest rates means there is a mismatch between the structure of production and the preferred saving/consumption ratio on the part of the public. Neither optimism nor money creation can make this real mismatch go away. Only a reallocation of resources in line with consumer preferences can solve the problem.
Pethokoukis again:
Where Friedrich Hayek and JM Keynes, Paul and Obama, disagree is what should happen when markets fail. Keynes-Obama argue for fiscal stimulus, Hayek-Paul for liquidation — “Let the banks fail!” — to purge the rot out of the system.
Pethokoukis then quotes Milton Friedman, who condemned the “do-nothing” views of the Austrians.
So let me get this straight. Rand Paul’s problem is that he doesn’t believe in markets, but now — three paragraphs later! — his problem is that he believes in them too much? Paul doesn’t want intervention in order to save failing institutions, which means he favors a market-driven solution, but Pethokoukis is now saying this, too, is wrong. A real supporter of free markets, evidently, avoids any kind of systematic approach, and instead consults James Pethokoukis to uncover which ad hoc policy he is advocating today.
Back to Pethokoukis:
Milton Friedman (and Adam Smith) had a different view of markets from Keynes/Hayek/Obama/Paul, that they were sturdy and self-regulating if the price system was allowed to work.
Just when you think his article can’t get more Orwellian, Pethokoukis goes and writes that.
The whole point of Ludwig von Mises’ classic argument against socialism is that the central planner would lack prices for the means of production, and thus would have no way to engage in economic calculation. How could prices be more central to the Austrian outlook?
Of course the Austrians believe markets are self-regulating if the price system is allowed to work. Agree or disagree with their view, but that’s what they think. I have never encountered anyone, until now, who would presume to lecture the Austrians about the greatness of markets when prices are allowed to operate freely.
And of course, that’s precisely the Austrian critique of the Fed. Its interventions alter relative prices and distort the attractiveness of different kinds of production projects, thereby giving rise to an unsustainable configuration of resources. So if the Fed’s interventions do not allow prices to function properly, the resulting problems are not the fault of the free market.
So Pethokoukis is lecturing the Austrians for having insufficient confidence in the price system, when the Austrians’ critique — which fully takes for granted the indispensability of the price system — is that the price system is being distorted by the monetary authority. Pethokoukis can’t or won’t hear this point, given his own preconceptions.
Here’s how Pethokoukis starts winding up his article. Recall that he has been lecturing the Austrians for their alleged lack of confidence in markets.
Hetzel and today’s “market monetarists” want the Fed to follow a monetary rule that provides for a stable nominal anchor — like nominal GDP — and allows market forces to determine the real interest rate and other real variables amid a stable monetary backdrop. Indeed, economist Scott Sumner has proposed letting Fed policymakers determine a goal of monetary policy, such as stable growth in nominal GDP, and then having markets, via a futures market, “implement the policy by adjusting the monetary base until it’s at a level where the expected 12-month forward level of NGDP equals the policy goal.” Basically, market-driven central banking.
“Market-driven central banking.” Take that, Austrians!
Central banking is in and of itself opposed to the market. The central bank is an extra-market institution, which operates on the basis of government privilege. It is the Austrians who ought to be lecturing James Pethokoukis, who thinks he’s being a radical capitalist by calling for “a market-driven monetary policy.”
(Here, by the way, is an Austrian critique of NGDP targeting.)
A real capitalist favors a free-market “monetary policy,” which means no monetary policy at all, apart from allowing money production to take place within the ordinary nexus of commerce and contract.
Pethokoukis concludes by saying that Rand Paul, instead of calling for ending the Fed, should call for “ending the Fed as we know it.” James, let up already — I can’t take all this radical capitalism you’re firing my way.
(For more on the Austrian theory of the business cycle, you can watch this brief video, this longer, more academic presentation, or consult the business-cycle section of my LearnAustrianEconomics.com. I also cover it in my 2009 book Meltdown (read Ron Paul’s foreword), which managed ten weeks on the New York Times bestseller list.)
