This post is dedicated to CVL, my new found brother !

“Fear the boom and bust”. It probably refers to the economical cycles we are so used to and it’s more and more about the boom and bust cycles of governments. It is for a fact the title of the “economic rap video” that got me started on this post. All started because my brother, economist by profession, sent me this hilarious rap anthem video of Keynes (the champion of interventionism and the printing machine) versus Hayek, the Austrian economist. I just wanted to share it but it got me going on Austrian economics, and since it’s a subject I enjoy, the post grew… and… spontaneously grew quite more than I initially expected until at the end I dedicated all day to it.

A warning is made that Austrian Economics are unpopular. The best answer I have found as of the reason why is:

Because the Austrian school is the only school which considers economics to be a social science (most approach it as a natural science). Its methodology is one which rejects statistics as having meaning in and of themselves.

Charlie Munger also thinks that economics is a social science. As you may deduce from my favorite books I am a fan of Austrian economics. My view of the world changed after I read Ludwig Von Mises, Friedrich August Hayek and Murray Newton Rothbard. You can find most of their books, and many more, free and legal, at the Ludwig Von Mises Institute. I learned via Phil Carret about the austrians. Carret was a fan of Ludwig Van Mises (and Warren Buffett is a fan of Carret), I therefore suspected that knowing about the Austrian school of thought and its members was important in order to invest good, and I confirmed it after I read about them.

“Investing is not a natural science but rather a social science. So, it’s never purely empirical; what you are trying to do is everything you possibly can to enhance your probabilities of being right more often than being wrong.” – William H. Browne

The Austrian masters have many interesting ideas to share. I’ll try to mention some of them and their sources.

Via M. Newton Rothbard I realized how banks are a part of the government and, like inseparable Siamese twins, tied by vital organs, need one another. The free non central autonomous banking days are over since decades ago. Once upon a time banks could print their gold/silver backed currency and had to back up all they lent because no fractionary reserve existed. Those simple conditions eliminated the risk of bank runs. Due to the lack of fractionary reserve systems they could only lend at most 100% of what they had instead of lending 90% of what they do not have.

Rothbard has great books that several should read, specially in these times : “What has the government done to our money ?” is a must. “The Mystery of Banking” (to the reader who gently sent it to me: I hope you read this post and thanks! because I heard it’s a very expensive book, so I used the savings obtained by not buying it to buy Cisco shares yesterday !) is also an amazing and extremely didactic book. They are both entertaining, enjoyable, memorable and explain very well how those “entities” evolved and operate.

Von Mises, the father of them all, deeply impacted me and made me understand economics for the first time from a completely different angle, a realistic practical angle. For him economics is a sub science based on praxeology, as well anthropology and all social sciences are. Praxeology is the deductive study of human action based on the action axiom, an axiom that embodies a criterion for recommending action, like for example, the maximum expected utility axiom. Decision theory and decision analysis are based on the maximum expected utility axiom, hence the importance of such an economical theory for investors. Praxelogy is the science of “Human Action” (purposeful action). Human action, as Mises‘ book is named is by itself an amazing philosophical book. Why do men act as they do ? What incentivates and motivates them? Those fundamental ideas definitely made me enjoy life more and helped me become a better investor. It makes you fundamentally think about motives and incentives as the source of actions at every level (it brings to memory what Charlie Munger said: “Never, ever, think about something else when you should be thinking about the power of incentives”).

He was very critical on the ever increasing social security system and the power of work unions and syndicates. He was convincing and argued with flawless logic that with minimal social security man would work more and find jobs much faster. His power of conviction was enormous, it is said that he convinced hard core socialists to change their idealogy by exposing crystal clear logical arguments from his other huge treatise “Socialism: An Economic and Sociological Analysis“. It was considered a master piece and the reason why many drastically changed their ideology after reading it. He accomplished that in a time were people killed each other easily for ideological and political ideas.

After reading F. Hayek (no, he is not related to Salma Hayek, believe me I just checked, uhh… finally an entertaining link!) and his famous “Road to Serfdom” I realized how socialism is an inevitable tendency for growing governments. I realized how impossible it becomes for them to plan their society as they grow. Too many planners, too much chaos, augmenting the risk of collapse or dictatorship arising as the only alternative to control (often one has to do what thousands in the government can’t). Of course no one dares to call some of our big governments socialists, but in essence it is what they are, it is what they tend to become as they grow in relation to their society. Socialism can be seen as when the government growingly controls most aspects of purposeful human action, and by doing so they reduce and limit it.

M. Rothbard illustrates how governments gradually took over banks. The answer lies again on praxeology or on the science of human actions and the social/human incentives behind them. Even though many think that banks are still private, they are just government puppets, akin to octopus tentacles, extensions of it. In order to control the money supply governments are akin to a parasitical mafia-operated printing machine. An organism who has the right to bend, abolish or create laws. They can legalize taxes, they can legalize theft. They have the right to get as much money as they want. By printing they can control what percentage of money from society stays with them. By doing that their control is increased, money is diluted, and the common citizen outside of the government gets poorer. Citizens get poorer because of less valuable, diluted, money and more control is exercised upon them, therefore they have less possibilities to exercise their will, less possibilities of purposeful action. Citizens, including government members, become part of a socialistic society, controlled, and limited. Limited by birth, by the borders of the country that the sperm lottery assigned them, and prisoner of a government who controls gradually more and more virtually every aspect of their lives. Where he goes ? How much he works ? For how long and at what rates he pays his debts ? How much he has to give to his government ? How much he can leave to his children ? Where he can live ? What borders he can cross ? Under what conditions can he marry ? At what age is he an adult ? All those basic aspects of life are tried to be controlled and centrally planed by governments. The government grows while the citizen becomes more and more restricted, bounded, controlled, limited, regulated, poor in his limited choices to take actions. But in exchange all become more equal, equal in the socialistic sense and equal in their limits. Therein lies the definition of a socialist government without the socialist name in many cases. That is what governments tend to become as they grow.

An interesting related idea from Murray Newton Rothbard lies in showing how monopolies can flourish with the help of the government, and how monopolies would be limited without its help.

Hayek illustrates in his famous “Road to serfdom” that there is hope (not in the Obama sense of hope), there is hope because socialist goverments collapse by their own weight, by the incapacity of their leaders to plan. They are also easily victims of boom and busts cycles. That’s because they are melted with structurally flawed banks (which bank isn’t anymore?) and because society cannot be planned centrally, specially not by big central planning entities. The answer lies in their inability to plan and control as it grows. And also very importantly in their catallactics inability. Catallactics is the praxeological theory of the way the free market system reaches exchange ratios and prices. Catallactics gave F. Hayek the nobel price, it is a big reason of why central over-controlling fixed planning by big governments (i.e. socialists) collapse, because of their poor catallactics. In other words because of their inability to determine prices and exchange ratios efficiently. Nonetheless, in their socialistic zeal to plan and control everything, they interfere. They do not want to recognize that hey are unable to efficiently control prices or ratios like for example interest rates or actually any price. Prices are not controlled by anyone but by an aggregation of wills, by the aggregate action and desires of humans, and nobody exactly knows how to fix prices and exchange ratios because they emerge as the sum of multiple interactions by multiple participants, uncontrolled by any single entity but influenced by all, by the exercise of their actions. The government is inefficient with regards to any of its fixed pricing activities and is therefore destined to be a sub optimal capital allocator for the society as a whole. By fixing prices, minimum wages and exchange ratios, like most levels of interest rates, or levels of money supply, they interfere with the free market ability to reach optimal prices. It affects the labour market, it causes mal-investments or over-investments which unnaturally deform price ratios even more, spreading to other layers, shifting capital from one sector to another, with extremely complicated, unpredictable, sub-optimal consequences. For example by subsidizing the housing industry, by giving cheap loans to selected companies (Freddie Mac and Fanny Mae), selected by their arbitrary sub-optimal criteria, deciding by themselves which company receives what amount, or by lowering commodity cost prices, they can generate capital over-investments, which could collapse once the subsidies fade out or due to the excess capacity generated which pushes prices down due to over-supply forcing companies who cannot compete out the industry. More harm is done than the good that would have been done if they had not intervened in the first place. They cannot know the aggregate, ever evolving, will of humans, they are taking a risk by interfering with prices and ratios. Nobody can guess and fix a price or an exchange ratio because nobody does know all about the rest, even less about the changing tastes of the rest. Prices are continuously fixed by free markets, as the sum of evolving, ever changing wills, as the sum of momentarily desired actions. If bad things can happen interfering with only one industry, like the housing industry example, imagine what could happen by manipulating the whole system of interest rates, mortgage rates, subsidies, lending rates, etc… It invites the society to reach a worse state than what it would reach if it’s government did not interfere in the process at all with sometimes completely unforeseen and bad consequences, which will tend to be, “fixed” and patched by more interference, compounding the problems. Running the risk of hitting a wall when a limit is reached and total collapse comes on the whole system or vital parts of it. Then you can see problems like; all sorts of government and trading deficits; bank inter-lending freezing; housing collapses; governments collapse; currency busts; money market funds breaking the buck (losing money); banking busts; technology crashes; junk bonds crashes; negative interest rates; extreme unemployment; you name it. Anything can happen, it happens, and it repeats itself cyclically, randomly, as long as interference continues.

Through F. Hayek‘s ideas I saw clearly why politics, interventionism and growing parasitical governments tended to destroy human action, limiting freedom and reducing the ability of markets to establish prices.

L. Mises shows how with government intervention money is redistributed inefficiently among the market. Over-taxing, as parasites do, is used to support government salaries. A type of parasite who controls every aspect of the life of its prey. The rest work for the government and are controlled by it. Taxes are used for such purpose. Like that government participants receive money and exercise control. They try to control every aspect of their society including foreign trade and immigration. Taxes are used to subsidize and to inefficiently plan arbitrarily-designed projects, mostly to satisfy selected controlling interest groups. All this shifts money from one group to another, generally from the able to the unable.

Rothbard shows how the government took over the bank roles. Through history, little by little banks lost their money printing power, that was shifted to the government via central entities controlled by them in order to print more money easier. The government, incentivized to create even more money, invented the fractional reserve system and allowed banks to lend multiple times more than what they had, increasing in the process the money supply (and inflation). The fractional reserve system and its unsafe lending created vulnerabilities such as Bank busts with devastating consequences. Since then Banks have to be periodically saved, by who? By governments, while increasing their control yet more in the process. But who saves governments when they need more money ? The people. How ?? By paying more taxes and suffering inflation. in other words by becoming poorer and shifting money to their inefficient, socialistic, governments and Banks. The conclusion is that whatever they do, the ones who pay are always the common citizens. A boom and bust economical system is perpetuated. The citizens’ well being is reduced. It is less than what it could be if the government didn’t become addicted to control and planning in every aspect of life and the economy, fiscal, and monetary.

In spite of inventing the fractional banking system and taking over banks ability to print money, the government is not yet satisfied. To print more money they seek the less resistance possible, so they decided to eliminate the gold and/or silver standard. It is difficult otherwise for them justify more money supply. Once eliminating that barrier money can be easily printed. Money is from then on backed by nothing else than a government promesses. They can now print as fast as they like. Little resistance is left. Money is controlled by central banks, invented by politicians, who are eager to get in the “money counterfeiting” business. Central Banks, controlled by their governments are free to print money, counterfeiting is legalized. Governments are incentivized to control in order to tax and to print, when they like, more money backed by wind. Taxing and printing money are the two ways for the government members to be fed. They need it mostly for political reasons. The logical deductive reasons that they act like that are based on purposeful and logical human actions; to perpetuate and increase their salaries; to avoid charging unpopular high taxes which could risk their political careers; and to inefficiently plan and get more votes in order to secure their jobs. They do it because they can and because it is convenient for them.

Anyways, I think I said enough, hopefully you reached until this point, I started to doubt if I would :). I guess that many interested in reading about economy will find the books mentioned very interesting, or helpful to cure sleeping disorders ! I don’t expect many will read Human Action. I just read that a pocket version is available as of recently, I wonder how they resumed 1500+ pages in a pocket version. Regardless of if you like or not Austrian Economists, what I sure do believe is that this video will make most of you think and laugh a lot, a nice combination !

Cheers!

jrv

PD: For those curious here are the rap video lyrics

Lyrics for Fear The Boom and Bust Video

We’ve been going back and forth for a century

[Keynes] I want to steer markets,

[Hayek] I want them set free

There’s a boom and bust cycle and good reason to fear it

[Hayek] Blame low interest rates.

[Keynes] No… it’s the animal spirits

[Keynes Sings:]

John Maynard Keynes, wrote the book on modern macro

The man you need when the economy’s off track, [whoa]

Depression, recession now your question’s in session

Have a seat and I’ll school you in one simple lesson

BOOM, 1929 the big crash

We didn’t bounce back—economy’s in the trash

Persistent unemployment, the result of sticky wages

Waiting for recovery? Seriously? That’s outrageous!

I had a real plan any fool can understand

The advice, real simple—boost aggregate demand!

C, I, G, all together gets to Y

Make sure the total’s growing, watch the economy fly

We’ve been going back and forth for a century

[Keynes] I want to steer markets,

[Hayek] I want them set free

There’s a boom and bust cycle and good reason to fear it

[Hayek] Blame low interest rates.

[Keynes] No… it’s the animal spirits

You see it’s all about spending, hear the register cha-ching

Circular flow, the dough is everything

So if that flow is getting low, doesn’t matter the reason

We need more government spending, now it’s stimulus season

So forget about saving, get it straight out of your head

Like I said, in the long run—we’re all dead

Savings is destruction, that’s the paradox of thrift

Don’t keep money in your pocket, or that growth will never lift…

because…

Business is driven by the animal spirits

The bull and the bear, and there’s reason to fear its

Effects on capital investment, income and growth

That’s why the state should fill the gap with stimulus both…

The monetary and the fiscal, they’re equally correct

Public works, digging ditches, war has the same effect

Even a broken window helps the glass man have some wealth

The multiplier driving higher the economy’s health

And if the Central Bank’s interest rate policy tanks

A liquidity trap, that new money’s stuck in the banks!

Deficits could be the cure, you been looking for

Let the spending soar, now that you know the score

My General Theory’s made quite an impression

[a revolution] I transformed the econ profession

You know me, modesty, still I’m taking a bow

Say it loud, say it proud, we’re all Keynesians now

We’ve been goin’ back n forth for a century

[Keynes] I want to steer markets,

[Hayek] I want them set free

There’s a boom and bust cycle and good reason to fear it

[Keynes] I made my case, Freddie H

Listen up , Can you hear it?

Hayek sings:

I’ll begin in broad strokes, just like my friend Keynes

His theory conceals the mechanics of change,

That simple equation, too much aggregation

Ignores human action and motivation

And yet it continues as a justification

For bailouts and payoffs by pols with machinations

You provide them with cover to sell us a free lunch

Then all that we’re left with is debt, and a bunch

If you’re living high on that cheap credit hog

Don’t look for cure from the hair of the dog

Real savings come first if you want to invest

The market coordinates time with interest

Your focus on spending is pushing on thread

In the long run, my friend, it’s your theory that’s dead

So sorry there, buddy, if that sounds like invective

Prepare to get schooled in my Austrian perspective

We’ve been going back and forth for a century

[Keynes] I want to steer markets,

[Hayek] I want them set free

There’s a boom and bust cycle and good reason to fear it

[Hayek] Blame low interest rates.

[Keynes] No… it’s the animal spirits

The place you should study isn’t the bust

It’s the boom that should make you feel leery, that’s the thrust

Of my theory, the capital structure is key.

Malinvestments wreck the economy

The boom gets started with an expansion of credit

The Fed sets rates low, are you starting to get it?

That new money is confused for real loanable funds

But it’s just inflation that’s driving the ones

Who invest in new projects like housing construction

The boom plants the seeds for its future destruction

The savings aren’t real, consumption’s up too

And the grasping for resources reveals there’s too few

So the boom turns to bust as the interest rates rise

With the costs of production, price signals were lies

The boom was a binge that’s a matter of fact

Now its devalued capital that makes up the slack.

Whether it’s the late twenties or two thousand and five

Booming bad investments, seems like they’d thrive

You must save to invest, don’t use the printing press

Or a bust will surely follow, an economy depressed

Your so-called “stimulus” will make things even worse

It’s just more of the same, more incentives perversed

And that credit crunch ain’t a liquidity trap

Just a broke banking system, I’m done, that’s a wrap.

We’ve been goin’ back n forth for a century

[Keynes] I want to steer markets,

[Hayek] I want them set free

There’s a boom and bust cycle and good reason to fear it

[Hayek] Blame low interest rates.

[Keynes] No it’s the animal spirits