Call That Austrian?
by David Gordon: Libertarian
Financial Crisis and the Free Market Cure: Why Pure Capitalism Is
the World Economy's Only Hope By John A. Allison
McGraw Hill, 2012 Viii + 278 pages
contains the oddest sentence I have ever read about the current
financial crisis, or for that matter about any financial crisis.
John Allison, President of the Cato Institute, writes,
thought of titling the book How the Critique of Pure Reason
by Immanuel Kant (1783) Caused the Financial Crisis, but
that was too obscure for most people, although it was more accurate,
since Kant was the major philosophical opponent of reason who
put an end to the Enlightenment century (1700s) that indelibly
shaped the founding of the United States. (p. 255, n.3)
It is not enough
that Kant lies at the origin of Nazism, as Leonard Peikoff so cogently
demonstrated in Ominous
Parallels. (It comes as no surprise that Allison admires
this great contemporary thinker and scholar. "Leonard Peikoff's
The Philosophy of Ayn Rand enabled me to integrate Rand's
philosophy and use it as a major competitive advantage for myself
and for BB&T." [p. 277]) No, he also caused the recession of
2008! The way in which this machine gunner of the mind brought about
the catastrophe is not altogether apparent. Perhaps, by weakening
confidence in reason, Kant's destructionism made people blind to
the errors of the inflationist doctrines that led to financial ruin.
But were not inflationist and mercantilist policies popular long
do not need to try to clarify this less-than-transparent causal
chain. Allison does not develop his intriguing remark any further.
To the contrary, his main line of approach seems much more promising.
He is a student of Austrian economics and proposes to use insights
from that theory to analyze what has gone wrong since 2008. He is
not only an extremely successful banker but, he tells us, an intellectual
I have tried
to personally exhibit the attributes necessary for life-long learning.
Every month, I read a difficult book (typically one that was not
directly-business-related) and referred the best books to our
senior leadership team.... I particularly studied Austrian economics....
A deep understanding of the Austrian economic school is a tremendous
competitive advantage in making long-term economic decisions.
(You should read Human
Action by Ludwig von Mises.) (p. 238)
to challenge so learned a scholar he reads a difficult book
every month but his knowledge of Austrian theory is
not adequate to the task he has set himself. Although he mentions
Mises and Hayek a few times, he never refers to anything they have
to say on the business cycle. He says, e.g., "Ludwig von Mises proved
the futility of central planning in his numerous books, including
Theory of Money and Credit (1913 [sic]), Socialism
(1922), and Human Action (1940 [sic])." (p. 34) Very
true, but in two of those books, Mises also discussed at some length
the business cycle: why not address what he wrote?
says about Hayek,
economist and Nobel laureate Friedrich Hayek highlighted a concept
he termed fatal conceit. This is the belief on the part
of elitist intellectuals that they are smarter than the reality
of markets. (p. 31)
were to look up the reason Hayek was awarded the Nobel Prize, he
would find a reference to the "theory of money and economic fluctuations."
Would it not have been a good idea for him to consult Hayek's relevant
works on the subject? Of course Murray Rothbard is not mentioned
at all: he is persona non grata at the Ayn Rand Institute.
neglect of the essential sources of Austrian business-cycle theory
leads him into error. He rightly notes that the Fed's expansion
of the money supply played the principal role in bringing on the
financial crisis, but he misconceives the central issue. From
him, the trouble lies mainly in the fact that the increased money
supply fueled a bubble in the housing market. Instead of investing
in capital goods, people foolishly sought to profit from speculative
ventures in housing, a consumption good.
not mention that, according to Austrian theory, the expansion
of bank credit temporarily upsets the balance between the gross
market rate of interest and the "originary" rate, determined by
people's rate of time preference. (If I am not mistaken, time
preference is never mentioned in the book.)
By upsetting this balance, the entire structure of production
is distorted. Businesses use the expanded bank credit to invest
in projects that cannot be sustained, given the existing stock
of capital goods. In the book that Allison rightly recommends,
conditions may be, it is certain that no manipulations of the
banks can provide the economic system with capital goods. What
is needed for a sound expansion of production is additional
capital goods, not money or fiduciary media. The boom is built
on the sands of banknotes and deposits. It must collapse. (Human
Action, Scholar's Edition. p. 559)
besides recommending the book to others, Allison ought to have
studied it himself.
does mention "misallocation of capital," for him this intricate
process has to a great extent been reduced to trouble in one sector,
albeit an important one, of the economy the housing market:
cause of the Great Recession was a massive malinvestment in
residential real estate. We built too many houses, too large
houses, and houses in the wrong places.... In other words, by
investing too much in housing, we invested too little in manufacturing
capacity, technology, education, agriculture, and other such
areas. (pp. 910)
his talk of "malinvestment" here, it is clear that Allison
considers buying a house spending on consumption.) It is entirely
right that, in Austrian theory, the expansion of bank credit can
cause a boom in consumption as well as production goods; and Mises
was adamant that the Austrian view be characterized as a malinvestment,
not an overinvestment, theory. It is going too far, though, to
pass off an underinvestment view as Austrian.
would reply that he here is not endeavoring to expound Austrian
theory: he instead disagrees with it. Would he not then owe us
some account of what is wrong with Mises's position? He passes
it by altogether. Though I cannot prove it, I suspect he is unaware
that his view of the cycle differs from that of Mises.
insufficient knowledge of Austrian work on another issue. He accepts
Milton Friedman's claims that the Fed drastically contracted the
supply of money after the onset of the Great Depression, in that
way severely worsening conditions: "The evidence is clear that
the early phase of the Great Depression was primarily a liquidity
crisis, brought about by the Fed's arbitrary reduction in the
money supply" (p. 70). He does not mention Murray Rothbard's criticism
of this view; again, Rothbard must not be discussed or cited.
If he disagrees with Rothbard, should he not have explained why?
Again, I suspect that Allison is unaware of the controversy.
What has happened?
Why has Allison written an ostensibly Austrian explanation of the
financial crisis that displays so little acquaintance with Austrian
theory? The answer may in part lie in a remark in the acknowledgments:
"Richard Salsman assisted with a significant amount of research
and provided most of the footnotes" (p. 278).
Ayn Rand asked,
"Who is John Galt?" If, emulating her, we ask, "Who is Richard Salsman?,"
the answer lies ready at hand. He is an Objectivist economist who,
incredibly, takes Mises to be an enemy of the free market. In an
essay that appeared in The
Abolition of Antitrust, edited by Gary Hull, Salsman said
the myth that capitalists, in his own words, "are merely
parasites who pocket the dividends." For Mises, even entrepreneurs
merely buy low and sell high as a passive service to consumers
who, he claims, are the real drivers of the economy and profit.
(Abolition of Antitrust, p. 45)
sticks to topics that fall within his experience as a banker,
such as the effects of Freddie and Fannie on the home-mortgage-lending
business and the problems of fair-value accounting, his comments
are often insightful; he is after all a distinguished banker of
great experience. When he strays into Austrian theory, though,
he seems at a loss. If Allison relied on Salsman for his remarks
on business-cycle theory, his errors would be understandable,
given Salsman's egregious mistakes and prejudices. I freely acknowledge
that my suggestion is no more than speculation.
is not altogether satisfactory as an expositor of Austrian economics,
is he at least fully committed to the free market? He is an Objectivist;
and, whatever one's opinion of Ayn Rand's philosophy, must not
any fair-minded person acknowledge that she and her followers
stand among the foremost supporters of the free market?
his credit, Allison calls for a systematic move to "pure" capitalism,
his move falls short of this laudable goal. Robert Wenzel, in an
notice of the book in his Economic Policy Journal, has
already called attention to a number of Allison's questionable recommendations,
including his support for the flat tax and education vouchers and
opposition to the homeowner's deduction.
He says that
argue against the flat tax because they claim it would be easier
to raise the tax in the future. This is ridiculous. A properly
designed flat tax would be harder for Congress to increase because
the increase would have a negative impact on all voters. (p.
to have forgotten that Congress has on many occasions passed bills
that call for tax increases.
to the items Wenzel has so ably catalogued, I should like to call
attention to Allison's support for government unemployment insurance.
He thinks that the present program is excessive; but, he says,
many honest workers who would like a job, but who cannot obtain
employment because of the minimum-wage laws. It is unjust to
deny people work and, at the same time, not provide unemployment
benefits. (p. 213)
here appears to be that those disadvantaged by government intervention
may claim a compensating intervention in their favor. Is this
not a dangerous idea? Why not, in like fashion, a protective tariff
for businesses that compete with foreign firms that receive subsidies
from their governments? I leave it to readers to extend the list.
I find Allison's views on foreign policy disturbing. He wants
to cut the military budget and opposes the wars in Iraq and Afghanistan;
but opposition to these wars will enable us to confront the real
threats, such as North Korea, Iran, and "Islamic terrorism."
Like his mentor Peikoff, Allison stands among those who would
"busy giddy minds with foreign quarrels."
book's manifest mistakes about Austrian theory, it has attracted
praise from economists, including Tyler Cowen, Peter Boettke,
and Bruce Yandle. I take some comfort from the fact that none
of these endorsements mentions the Austrian School.
Interest is not, as Allison says, "the price of money" (p. 31)
The price of money is what must be exchanged to get money, i.e.,
goods and services. Interest, as David Friedman notes,
is the rent of money expressed in money.
review in the Mises Review.
© 2012 by the Ludwig von Mises Institute.
Permission to reprint in whole or in part is hereby granted, provided
full credit is given.
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