Austrian Economics: Response to Noah Smith

I am delighted that Mr. Noah Smith has sharply criticized Austrian economics; he does so in 2014 and again in 2015. He may not know much about the subject (a little knowledge often leads to grave error) but he writes in an entertaining manner, he spells the name of this school of thought correctly, he is vociferous in his critique (actually pretty nasty, but that is ok), and, most important, he writes for a mainstream news outlet. As far as I am concerned, no publicity is bad publicity. Even unsuccessful attacks on the praxeological school such as his two articles help promote it; so, in my view, Austrians ought to be grateful to Mr. Smith.

What are the specifics? Let us start with his article of July 2, 2014, entitledAustrian Economists, 9/11 Truthers and Brain Worms.” First, what are “brain worms? Smith explains: The Inflation Crisis a... Henry Hazlitt Best Price: $3.33 Buy New $5.90 (as of 04:30 EDT - Details)

“In the film ‘Star Trek II: The Wrath of Khan,’ the super-genius villain puts alien worms into people’s brains in order to subvert them to his demented cause. I think Khan could have been an Austrian economist. To those of you who have run afoul of the defenders of Austrianism on the Internet, the analogy will be clear. The Austrian worldview is like a brain worm that has infected large swathes of our financial industry, commentariat and general public. Even you, dear reader, may carry one or two of its wriggling larva inside your gray matter.

“When the Austrian brain-worm invades, you start believing things like: 1) Federal Reserve money-printing is a government plot to boost big banks, 2) prices are rising much faster than anyone thinks, 3) real “inflation” means money-printing, not an increase in prices, 4) printing money can never boost the economy, 5) academic economics is a plot to use mathematical mumbo-jumbo to cover up government giveaways to big banks, etc., etc.”

Let us take these one at a time, but, before doing so, we must take note of the fact that our author offers no support of his contention that belief in these five beliefs is erroneous.  He quotes from no Austrian holding these views. He contents himself with merely iterating these supposed falsities, in the belief that their mere mention will demonstrate their utter worthlessness. Is this what they teach in schools of business journalism nowadays?

1. I know of no Austrian who explicitly calls it a “plot” that the Fed and its money printing helps big banks, but there can be little doubt that this claim is true. The Federal Reserve System stands behind obedient banks ever-ready to bail them out, particularly if they are “too big to fail.” Banks tend to be debtors, and not fully anticipated higher prices undoubtedly aid them.

2. It is difficult to determine who the “anyone” is, but official government statistics that ignore prices of housing and bonds and other such items tend to underestimate the degree of price increases.

3. There are two definitions of “inflation.” The classical one is indeed the degree of the increase in the stock of money; this is the one used by the Austrians. There is of course another newer definition which characterizes inflation in terms of price rises. See on this Hazlitt, Henry. 1978. The Inflation Crisis And How To Resolve It, New Rochelle, N.Y.: Arlington House

4. There is no Austrian economist who would deny that printing money can boost the economy. Indeed, that is a basic premise of Austrian Business Cycle Theory. According to ABCT the unwarranted creation of money is the very cause of the artificial boom (which inevitably leads to the depression, or bust). Of course, all praxeologists, and a goodly number of neoclassical economists too, are quite right in maintaining that printing money cannot help the economy in the long run. If it could, then the economy of Zimbabwe and that of Germany in 1923 would be roaring successes.

5. Again with the charge of “plotting.” There can be little doubt that modern academic economists use mathematical mumbo-jumbo. One peek at any of the mainstream journals will convince the curious reader that these scholars are some sort of mathematicians, not really economists. Do neoclassical economists support the Fed, the biggest bank of them all? They certainly do. Some of them use this sort of mumbo jumbo to make their case, others do not. For evidence on this claim, see White, Lawrence H. 2005. “The Federal Reserve System’s Influence on Research in Monetary Economics.” Econ Journal Watch, 2(2), pp. 325-354. Has Smith read this brilliant analysis and offered reasons for rejecting it? To ask this question is to answer it: of course not. He contents himself with unsubstantiated charges.

6.”The years 2011 and 2012 were to Austrians like sunrise is to a vampire. It was simply amazing to sit there and watch Austrians writhe and contort under the pure, burning light of extant reality. Massive torrents of Fed ‘money-printing’ failed to budge prices; this fact directly cracked the central foundations of Austrian thought. The history-book moment came when David Henderson of the Naval Postgraduate What Has Government Do... Murray N. Rothbard Best Price: $13.18 Buy New $6.00 (as of 12:45 EDT - Details) School defeated Austrian champion Robert Murphy of the Ludwig von Mises Institute in a bet about inflation.”

There is no Austrian, at least not any worthy of his salt, who ever claimed that money printing would necessarily lead to higher prices than the ones that existed before acts such as quantitative easing. Certainly, Smith quotes no praxeologist saying anything like this. In sharp contrast the position of this school of thought is that increases in the money stock will lead to higher prices than would otherwise have existed! The essence of Austrianism in this regard is based on the counterfactual. For example, the minimum wage law will boost unemployment for workers with productivity levels lower than that stipulated by this legislation to a higher level than would otherwise have occurred. Rent control will reduce the quantity and quality of housing below that level that otherwise would have prevailed. The Smiths of the world who are steeped in the fallacies of logical positivism will recoil in horror from this, since such Austrian claims are not falsifiable. That is, although they indeed shed great light on economic reality, they are not capable of being refuted by what actually happens. Why? This is because these insights are based on the notion of ceteris paribus, other things equal. Yes, other things equal, central bank money creation will indeed lead to higher prices, but other things are never equal in the real world. For example, while this was occurring, there could have been an unrelated increase in the demand to hold money, which would have reduced the severity of this effect, and/or, possibly, even reversed it. Similarly, worker productivity due to machines could have increased during the boost to the minimum wage, reducing or even obviating its unemployment effects, and this could also have cancelled out the negative effects on housing created by rent control.

As for Robert Murphy, Smith accurately depicts him: he is indeed an Austrian champion, one of the most gifted of praxeological economists on the planet. But, he did not make that bet in his role as Austrian economist. Rather, he did so as an economic historian. He was in effect betting that the increase in the money supply which leads to higher prices would over-ride all other effects held under the rubric of ceteris paribus, which would lead us in the exact opposite direction. He was wrong in this, as it turned out, but this does not lay a glove on the veracity of the economics of this school of thought.

On this issue see: Hulsmann, Jorg Guido. 2003. “Facts and Counterfactuals in Economic Law.” The Journal of Libertarian Studies. Vol. 17, Num. 1, pp. 57-102, January 1.

7. “When Austrians tried to redefine the word ‘inflation’ to mean something other than ‘a rise in prices,’ people duly recognized that Austrians were off their rockers.” This bespeaks an almost total ignorance of the history of economic thought. The first definition of “inflation” was indeed an increase in the money stock. It was later redefined so as to mean “a rise in prices.” Smith has his story exactly backwards. Again see Hazlitt mentioned above on this.

8. “The next blow against the brain worms came with the plunge in the price of gold, which by the end of last year had fallen more than 35 percent from its 2012 peak. Gold is central to the Austrian worldview. To them, the yellow metal represents freedom from government control — which, since Austrianism mixes politics with economics as shamelessly as unscrupulous Chinese companies mix melamine with milk, meant that rises in gold prices represented the triumph of good over evil.”

Here, Smith confuses Austrian economics with the libertarian political philosophy. True, most praxeologists are also libertarians (the inverse does not hold since in order to be an Austrian, one must first be an economist, and most libertarians do not fall into this category). A quick google search would have made clear this distinction to our intrepid journalist. Yes, the yellow metal does represent freedom, since, whenever people were free to choose they chose gold (sometimes silver), but this is only true for libertarians, not Austrians. As far as the latter are concerned, theirs is a totally value free positive science, not a normative value-laden one. If there is anyone who “mixes politics with economics,” that is, conflates them, it is our Mr. Smith. Defending the Undefend... Walter Block Best Price: $3.33 Buy New $10.80 (as of 03:20 EDT - Details)

9. Continues our author: “If you didn’t know that monetarists such as Milton Friedman — who strongly supported printing money to fight depressions, and had harsh things to say about the Austrians — were also strongly pro-free-market, you might buy into the Austrian line that gold is freedom and QE is slavery.”

No, Friedman did not “strongly” support printing money to fight depressions; rather, he did so adamantly, rabidly, vociferously, and continuously. Yes, he did indeed have very harsh things to say about the Austrians. But he was only weakly in favor of free enterprise, see here, here, here and here. And gold as a signal of freedom and quantitative easing the very opposite is a libertarian, not an Austrian insight.

10. Smith mentions “a bank-Fed conspiracy.” According to the old adage, I’m firm, you’re stubborn, he is a pig-headed fool. In similar manner, I enter into agreements, you engage in cartels, he conspires. This is mere name calling.

11. No smear of Austrians could be complete without that old chestnut, anti-Semitism, and Smith does not disappoint on this matter: “Out in the wider world, the Austrian brain-worm’s darker whisperings are music to the ears of the paleo-libertarian Ron Paul movement. Austrianism’s antiSemitic overtones are conveniently papered over by the fact that two of its founding figures (von Mises and Murray Rothbard) were Jewish. But it’s no coincidence that Austrianism carries great appeal for the more unsavory corners of American politics.”

Paper over? How many Jews did Hitler admire? Not too many one would imagine. Other Austrian economists who are Jewish include me, the author of the present article, as well as Israel Kirzner, David Gordon, Irwin Schiff, Steve Horwitz and Larry Moss. Are we all self-hating Jews? Here, Smith goes so far as to mention “the paleo-libertarian Ron Paul movement.” Ron Paul is indeed one of our keenest Austrian practitioners, but Smith does not appear to realize the enormous philosophical gap between the two very different universes of discourse. That is, there is a giant chasm between the libertarian political philosophy and Austrian economics.

Let us now explore some of the fallacies perpetrated by Noah Smith in his second scurrilous attack on the good ship Austrianism. There is substantial overlap between the two, so I will only counter what is new in this later essay of his.

1. He starts off on the wrong foot with his claim that “The Austrian school usually hold(s) that fiat currencies are doomed to fail, that a return to the gold standard is inevitable.” Again, he does so without ever quoting any member of the praxeological school in this regard. These claims are mistaken. Economists of this school of thought subscribe to the notion that such a thing as “human action” exists, and that as such, nothing is “doomed” or “inevitable.” Whether fiat currency can long continue depends upon, among other things, just how greedy are the government counterfeiters. If they stay within rigid, niggardly, bounds, for example, do not increase the money stock at all, or only by miniscule amounts, that system can long endure. As for a return to gold being inevitable, this simply cannot be deduced from any basic premise of this economic philosophy. Smith is quite correct in attributing to Austrians the view “that central banks are responsible for bubbles, market crashes and recessions” but clearly does not believe any such thing (thinks it akin to a hoax). He takes no pains to undermine this claim, presuming that the mere mention of this is sufficient to show it fallacious.

2. “Then there was the bursting of the gold bubble. Gold was the Austrians’ big asset play — the hedge against the end of the modern economy and the return of the 1500s. That hasn’t worked out too well.”

No Austrian economist, qua Austrian, ever recommended that anyone purchase gold, or did any such thing himself. Yes, people who are Austrians did so, along with millions of others, but that is entirely a different matter. It is the mainstream neoclassical economists who intellectually live or die based on their predictions. But, Austrianism is not an empirical science, as the logical positivists require; rather, it is a branch of logic. The Privatization of R... Walter Block Check Amazon for Pricing.

Suppose a chemist bought some gold, and its price fell. Would that emasculate the science of chemistry? Not a bit of it. To think so is to entirely misconstrue the function of that science.  Suppose a doctor smoked cigarettes and died of cancer. Would this call into question the entire profession of medicine? If you believe it would, there is a place for you, too, on the lists of those who denigrate the Austrian school of economic thought.

3. Smith does, however, see a place for Austrianism in the analysis of China’s economy. However, he continues to exhibit his misunderstanding of this perspective. For example, he says: “What’s interesting to me, however, is that events in China are actually bearing out some of the classic predictions of Austrian thinking.” But Austrians, in their professional capacity, do not “predict” anything. Their analyses are of the counterfactual sort: X causes Y, on the assumption that nothing else in the world changes, stipulating we can isolate this connection from everything else. We can indeed do this, but only as a theoretical construct, in our mind’s eye, as a gedanken experiment. The real world does not admit of other things ever being equal, let alone always.

4. Smith continues: “…the original ‘Austrian school’ thinkers — Ludwig von Mises and Friedrich Hayek — had some (good) ideas… And some of these might be useful for thinking about China.” But what about the “brain worm?” How did it happen all of a sudden that Mises and Hayek escaped from that dread malady? We are given no explanation.

5. Smith avers that the Austrian idea of “malinvestment” is helpful. “Austrian thinkers such as Mises contend that recessions happen because too many resources are funneled into assets that won’t actually be productive in the future. By the time businesses realize that they have made a mistake, they are locked into bad lines of business, or bad business locations.”

But wait. The reason for the malinvestment is that the central bank engages in monetary creation, it inflates the currency, which not only leads to higher prices, but also to lower interest rates. It is precisely the latter that engenders the “malinvestment.” This is the essence of the Austrian Business Cycle Theory (ABCT). However, Smith spends an awful lot of venom attacking the praxeological analysis of the Fed; he celebrates the contribution of Milton Friedman, a bitter opponent of ABCT. How, then, can he turn around and support ABCT? No explanation of this blatant logical contradiction is forthcoming.

6. Not so fast. It turns out that Smith, broken field runner that he is, once again changes direction. Now he offers his misgivings about ABCT: “It has never been very clear exactly why malinvestment causes an economic hangover. Why don’t businesses just cut their losses and immediately start investing in something more useful, as soon as they realize that they’re doing the wrong thing? Austrian theory has never been particularly clear on that (and its notorious refusal to use precise mathematical models certainly doesn’t help).”

The reason entrepreneurs cannot instantaneously “cut their losses” is that a significant amount of investment is in fixed capital equipment (buildings, locomotives, steel) that either is misplaced, or cannot be completed, such as in China the “ghost cities and overcapacity in various manufacturing industries” that Smith himself mentions. Also, re-allocating misallocated capital is never costless nor instantaneous.

No, it is not true that “at least Austrianism embraces the possibility that businesses might make big, systematic mistakes.” On the contrary, this is the very essence of ABCT. Smith speaks truth when he says: “That possibility is essentially ruled out by most modern mainstream models, which use ‘rational expectations’ as their jumping-off point. It also requires that productive capital come in multiple forms, while mainstream macro usually assumes that all forms of capital are interchangeable.” But how did Austrianism suddenly emerge from its “worm” status?  We must all wallow in ignorance on this issue, as far as Smith is concerned.

Why the Austrian opposition to mathematical modeling. To be brief, calculus requires smooth curves, which means that human action can Toward a Libertarian S... Walter Block Best Price: $13.46 Buy New $14.00 (as of 11:30 EDT - Details) be infinitesimally small. On the contrary, people’s behavior is discrete, not infinitesimally tiny. Results emanating from the smooth curve assumption lead to very different results, particularly in the case of monopoly and anti trust economics, than what is realistic. Austrian economists oppose the mathematical dog waving the economic tail. For practitioners of this discipline, it should be the other way around.

7. “That brings us to another interesting Austrian notion — the instability of financial markets. Mainstream macroeconomics is only just barely starting to deal with the idea that financial markets may have a natural tendency to boom and bust. Austrians have been saying this for almost a century. The seeming inevitability of the reversal in Chinese real estate and stock prices looks like one more slap in the face for bubble skeptics.”

Oy, oy, oy. This is a twisted pretzel interpretation of ABCT.  Austrians oppose the view “that financial markets may have a natural tendency to boom and bust.” Members of this school of thought have been long battling this idea that this constitutes an inherent market failure of the free enterprise system. It is precisely the followers of “mainstream macroeconomics” such as right wing monetarist Keynesians such as Friedman and left wing fiscalist Keynesians such as Krugman and Keynes himself, who have been upholding the view that there is “instability of financial markets” under laissez faire capitalism. If Smith had tried to mix things up on purpose he could not have done a better job.

8. Our author concludes his essay on a very confusing note: “So there are some interesting Austrian ideas out there that might help to explain the Chinese economy. Unfortunately, this would require Austrians themselves to pick and choose from among the beliefs in their canon — studying financial instability and malinvestment while discarding the notion that economic crises are inflationary. While a few academics — progressive Austrians such as George Mason University’s Peter Boettke — might manage this kind of flexible, evolving world view, most probably won’t be able to discard the disproven pieces of the package sold a century ago by Mises and Hayek. So if these ideas are going to conquer the mainstream, it will be mainstream macroeconomists who do it. The Austrian orthodoxy, sadly, is just too fossilized.”

Whoa, whoa, whoa. Mises and Hayek started out as worms, took on the role of good guys in midstream, and now are exposed, once again, as lowly worms? And this with no explanation whatsoever about their denigration, promotion, and then finally their denigration again? In like manner, Austrian economics starts out worm-like, is them complimented for its analysis of the Chinese economy, and then gets demoted, back again, to worm status, again with no explanation for its rise and fall.  Smith knows enough about Austrianism to realize there is a tension between Boettke and Mason on the one hand, and Bob Murphy and the Mises Institute on the other, and yet is so utterly confused about ABCT, counterfactuals, prediction, Friedman, etc? How can that be?

Defending the Undefend... Walter Block Best Price: $38.15 Buy New $44.36 (as of 04:10 EDT - Details) Let me conclude with some free advice for Smith. Based on his picture, he seems like a young man. We all make mistakes. If he is truly interested in the Austrian school of thought as he seems, after all, he has written twice about it, I suggest he start off his education by reading these two short essays on the issues he discusses.

Rothbard, Murray N. 1963. What Has Government Done to Our Money? Auburn, AL.: Mises Institute

Rothbard, Murray N. 1996. “Economic Depressions: Their Cause and Cure.” The Austrian Theory of the Trade Cycle and Other Essays. Auburn, AL: The Ludwig von Mises Institute, pp. 37-64.  http://mises.org/daily/3127/Economic-Depressions-Their-Cause-and-Cure