Austrians Win, Keynesians-Friedmanians Lose

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Niall Ferguson is an academic hotshot. He is a professor at both Harvard University and the Harvard Business School. This is unique. He is both an economist and an historian. This is rare. He writes very well. He writes widely respected books and very readable articles.

He is also on target about what happened to the American economy in 2009. This is simply astounding.

In a recent article in Newsweek, he compared the American Empire to the Ottoman Empire in its final stage of influence, 1850—1875.

Now he reviews 2009 to see which dead economists have benefited and which haven’t. This appears in Foreign Policy. He begins:

There is nothing like a really big economic crisis to separate the Cassandras from the Panglosses, the horsemen of the apocalypse from the Kool-Aid-swigging optimists. No, the last year has shown that all is not for the best in the best of all possible worlds. On the contrary, we might be doomed.

Academics rarely write like this. Hooray for Ferguson! He can do what he wants. He’s king of the hill: famous, tenured, and rich because of book royalties.

At such times, we do well to remember that most of today’s public intellectuals are mere dwarves, standing on the shoulders of giants. So, if they had e-mail in the hereafter, which of the great thinkers of the past would be entitled to send us a message with the subject line: “I told you so”? And which would prefer to remain offline?

Adam Smith has had a bad year. Karl Marx had had a good one.

OK, he’s kidding. A non-academic might not spot this. Marxism is not in a boom phase, and Smith has not lost all favor. But he is correct about men’s attitudes toward the reliability of the invisible hand. They also have more doubts about the indestructibility of capitalism.

A special mention is also due to early 20th-century Marxist theorist Rudolf Hilferding (1877—1941), whose Das Finanzkapital foresaw the rise of giant “too big to fail” financial institutions.

Yes, Ferguson is showing off. “If you’ve got it, flaunt it.” — Max Bialystok.

Joining Smith in embarrassed silence, you might think, is Friedrich von Hayek (1899—1992), who warned back in 1944 that the welfare state would lead the West down the “road to serfdom.” With a government-mandated expansion of health insurance likely to be enacted in the United States, Hayek’s libertarian fears appear to have receded, at least in the Democratic Party. It has been a bumper year, on the other hand, for Hayek’s old enemy, John Maynard Keynes (1883—1946), whose 1936 work The General Theory of Employment, Interest and Money has become the new bible for finance ministers seeking to reduce unemployment by means of fiscal stimuli. His biographer, Robert Skidelsky, has hailed the “return of the master.” Keynes’s self-appointed representative on Earth, New York Times columnist Paul Krugman, insists that the application of Keynesian theory, in the form of giant government deficits, has saved the world from a second Great Depression.

This is the way scholars should write for the public. Few ever do.

He says Friedman is suffering. Friedman explained general price changes solely in terms of monetary policy. But the Federal Reserve “has been printing money like mad,” more than doubling the monetary base. Prices have been negative. He’s wrong; they have begun to rise. But his main point is correct: no doubling of prices. (The reason is the increase in excess reserves held at the FED. Friedman sometimes used M-1 as his definition of money, and at other times M-2, but not the monetary base. He also relied on velocity, which has fallen.)


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He thinks Karl Polanyi (1886—1964) is in boom phase. Polanyi focused on market hysteria. “For what in classical economics could possibly account for the credulity of investors in Bernard Madoff’s long-running Ponzi scheme?”

He is on-target here:

“The biggest intellectual losers of all, however, must be the pioneers of the theory of efficient markets — economists still with us. . . . Now, with so many quantitative hedge funds on the scrap heap, their ideas don’t seem quite so capital.”

Who are the winners? The Austrians!

And the biggest winners, among economists at least? Step forward the “Austrians” — economists like Ludwig von Mises (1881—1973), who always saw credit-propelled asset bubbles as the biggest threat to the stability of capitalism.

He understands what has happened. He has a good insight about what is likely to happen as this episode unfolds into the next phase.

Of course, history offers more than just the lesson that financial accidents will happen. One of the most important historical truths is that the first draft of history — the version that gets written on the spot by journalists and other contemporaries — is nearly always wrong. So though superficially this crisis seems like a defeat for Smith, Hayek, and Friedman, and a victory for Marx, Keynes, and Polanyi, that might well turn out to be wrong. Far from having been caused by unregulated free markets, this crisis may have been caused by distortions of the market from ill-advised government actions: explicit and implicit guarantees to supersize banks, inappropriate empowerment of rating agencies, disastrously loose monetary policy, bad regulation of big insurers, systematic encouragement of reckless mortgage lending — not to mention distortions of currency markets by central bank intervention.

You won’t find a better analysis anywhere in a journal of liberal opinion.

He takes seriously Bernanke’s statement at Friedman’s 90th birthday. He knows that Friedman, not Keynes, is the guiding light behind the FED’s policy.

Consider this: The argument for avoiding mass bank failures was made by Friedman, not Keynes. It was Friedman who argued that the principal reason for the depth of the Depression was the Fed’s failure to avoid an epidemic of bank failures. It has been Friedman, more than Keynes, who has been Bernanke’s inspiration over the past two years, as the Fed chairman has honored a pledge he made shortly before Friedman’s death not to preside over another “great contraction.” Nor would Friedman have been in the least worried about inflation at a time like this. The Fed’s balance sheet may have expanded rapidly, but broader measures of money are growing slowly and credit is contracting. Deflation, not inflation, remains the monetarist fear.

This has been true from the beginning of the debate, which goes back to 1912: Mises’ Theory of Money and Credit. Mises attacked Irving Fisher’s ideas of a fiat money order. Friedman is Fisher’s intellectual heir. Ferguson should have mentioned this. Almost no one ever does.

He warns that the emergency policies be removed as soon as possible. This is easier said than done.

From a free market perspective, the vital thing is that legitimate emergency measures do not become established practices. For it cannot possibly be a healthy state of affairs for the core institutions of the Western financial system to be effectively guaranteed, if not actually owned, by the government. The thinker who most clearly discerned the problems associated with that kind of state intervention was Joseph Schumpeter (1883—1950), whose “creative destruction” has been one of this year’s most commonly cited phrases.

Schumpeter was an Austrian economist, but not an Austrian School economist. His theory of creative destruction was flat-out wrong. He had no theory of entrepreneurship as meeting customer demand by creativity, not by destruction. Murray Rothbard refuted him on this point back in 1987. Read it here.

Ferguson quotes Schumpeter. “But in the world of the big banks, there has been far too little destruction, and about the only creative thing happening on Wall Street these days is the accounting.”

“This economic system,” Schumpeter wrote in his earlier The Theory of Economic Development, “cannot do without the ultima ratio [final argument] of the complete destruction of those existences which are irretrievably associated with the hopelessly unadapted.” Indeed, he saw that the economy remained saddled with too many of “those firms that are unfit to live.” That could serve as a painfully accurate description of the Western financial system today.

In short, too big to fail. Bailouts. Sweetheart deals from Uncle Sam.

In a clever conclusion, he says that Charles Darwin is the greatest economist. He rested his case on competition. Nice try, Niall, but no cigar. The Darwinists known as the Progressives used Darwin to call for state planning by experts. That was left-wing Darwinism, and they are dominant today.

So, in this sense, Ferguson is correct. Darwin is dominant — just not through the competition side, which was a view that was defunct in academia and policy-making by 1900.

“Neither Cassandra nor Pangloss, Darwin surely deserves to top any list of modern thinkers, dead or alive.” He is right, but for the wrong reason.

Gary North [send him mail] is the author of Mises on Money. Visit http://www.garynorth.com. He is also the author of a free 20-volume series, An Economic Commentary on the Bible.

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