Wednesday, October 20, 2004

Financial Times on Austrian Economics

The bubbling up of Austrian analyses

By John Dizard

The criminal and civil suits brought in New York against the insurance underwriters and brokers for alleged anti-competitive practices started with a warning flag raised in this column last December 15.*

I had my doubts that officialdom would follow up on the industry's conflicts of interest, but here we are. All that concerns me now is whether I should look under my car before turning the ignition key.

A fair number of my libertarian friends, the more eccentric ones, that is, have for years described their economics theories as "Austrian". That means they subscribe to a set of analyses based on the works of Ludwig Von Mises and Frederick Hayek, along with their colleagues and successors. The Austrians were pretty much eclipsed from public attention by the Keynesians, the Chicago monetarists and, of course, the Marxists from the 1950s to the 1970s. It was only with the revival of market economics in the 1980s that the Austrians' work was treated as anything other than a joke.

The first real victory for the Austrians came with the collapse of communist regimes, something predicted by them and by Ronald Reagan, who had been mocked by mainstream thinkers for many of the same reasons. Reagan made the Austrians' case that market economics was the basis for political freedom, which became one of the tenets of the Clinton administration's foreign policy - uncredited, of course.

However, "serious" monetary economists still acted as if the real work was to be done by the quantitative analysts and bond desk jockeys at the Federal Reserve. The Austrians might be good enough propagandists for the unwashed in the Third World but what did they know about the real world of managing the US and global economies?

In Wall Street, though, the Austrian theory of the business cycle began to make its way into speculators' thinking. In the words of Roger Garrison, a contemporary Austrian economist: "The Austrian theory is a recognition that an extra-market force [the central bank] can initiate an artificial, or unsustainable, economic boom. The money-induced boom contains the seeds of its own undoing: the upturn, by the logic of the market forces set in motion, will be followed by a downturn . . . for Mises and Hayek, monetary expansion engenders a boom, which eventually leads to a bust."

The problem with any official recognition of this is that it implies that the Federal Reserve, and its chairman Alan Greenspan, could be capable of error. That is just what the "Austrians" say, sometimes without apology.

"It's the Fed, stupid!" howls the headline on the current edition of Grant's Interest Rate Observer. Jim Grant, whose publication is celebrating its 21st birthday, confesses under interrogation to having been an Austrian since the 1970s.

"The Austrians see a fundamental problem with a subsidised rate of interest," Mr Grant says. "They have a deep distrust of the idea of 'price stability', saying that in a time of productivity growth prices should be falling."

This was not a very interesting point of view to many people as long as they were all making a lot of money directly or indirectly off cheap credit. They also were not sympathetic to criticism of the Fed, which was considerately protecting everyone from the consequences of disasters such as Russian debt, Long Term Capital Management and the Asian crisis.

But things have changed.

"Hayek's The Road to Serfdom no longer has dust on it thanks to the 2000-01 recession and the end of the tech bubble," says Jim Bianco of Bianco Research. "You can tell by the use of the word 'bubble', as in real estate bubble, dotcom bubble, bond bubble, and so on. I became an Austrian in the early to mid-1990s."

One friend of mine in the financial markets who communicates regularly with a Fed governor, says that in the dark night of the governor's soul he has guiltily begun to think Austrian thoughts. Thoughts along the lines of: "Maybe we've created a mega-bubble with all our bailouts and monetary management. How are we going to get out of this without going through the mother of all crashes?"

Apparently, though, Mr Greenspan, before whose wisdom the two main presidential candidates both bow, has no such doubts. That might seem odd, considering his libertarian past. But I have noticed that people at the end of their careers seem to look forward to the prospect that, after their departure, all will turn to dust.

So, for the moment, the Austrian interpretation of the business cycle does not prevail on Independence Avenue. Instead, its adherents are, so to speak, conducting cattle raids and sacking provincial towns at the edge of the empire, towns such as Fannie Mae and Freddie Mac.

But by the next recession they might be among the contenders for influence over US monetary policy.

* See dizard-insurers

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