For “new economics,” look to old economists

November 9, 2009

When it comes to managing the business cycle, mainstream economics have failed rather spectacularly, their prescriptions leading to increasingly violent bubbles and busts. For this reason there have been calls for a “new economics.” To get there, perhaps we just need to rediscover forgotten economists like Hyman Minsky and Ludwig von Mises.

I was intrigued by an article by Mark Whitehouse in the Wall Street Journal last week. He described how concepts like “leverage” and “collateral,” crucial to understanding credit and commonly discussed by financial economists, remain foreign to mainstream economics.

These are concepts that Minsky understood as far back as the ’60s. His Financial Instability Hypothesis precisely describes the credit bubble and bust we’ve just been through.

Today Minsky is more frequently discussed in investment circles, but his ideas remain largely ignored by academic economics. And they certainly don’t inform policy.

Then there is Mises, who Mark Spitznagel writes in this weekend’s Wall Street Journal “predicted the depression” yet remains totally ignored by the mainstream: “How curious it is that the guy who wrote the script depicting our never ending story of government-induced credit expansion, inflation and collapse has remained so persistently forgotten. Must we sit through yet another performance of this tragic tale?”

Most likely so, since Mises is generally dismissed as a “sound money” quack.

My favorite forgotten economist is L.M. Holt, who described the debt deflationary theory of depressions in 1897. (For easier reading, I retyped it.)

Irving Fisher, who is credited with that theory thanks to a paper published in 1933, only came to it after being crushed, financially and intellectually, by the Great Crash. (Days before it he declared that stocks had reached “a permanently high plateau.”) Had Fisher read Holt, he might have understood that the market peak was a debt-financed mirage.

Instead of learning from Fisher’s mistake, economists are repeating it, advocating the inflation of a new public debt bubble to replace the private one that just burst.

This is unfortunate. If mainstream economists had the intellectual honesty to admit that their theories don’t properly account for debt, if they gave “fringe” thinkers like Minsky and Mises a fair hearing, we might discover the “new” economics that has been under our noses for a hundred years.

59 comments

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But von Mises is at the root a laissez faire thinker, yes yes? I doubt strongly that if von Mises were alive he would agree that the US has met his idea of laissez faire at any point in the 36 years since his death.Perhaps the distinction is not between the failure of keynesian and “laissez faire” but between keynesian style explicit gov’t *spending* stimulus and “not keynesian” implicit gov’t *sponsored* stimulus? I don’t think the “not keynesian” gov’t behavior ever truly fit the mold imagined by either the Austrian or Chicago school.

Posted by Andrew | Report as abusive

“If mainstream economists had the intellectual honesty to admit that their theories don’t properly account for debt, if they gave “fringe” thinkers like Minsky and Mises a fair hearing, we might discover the “new” economics that has been under our noses for a hundred years.”Kind of reminds me of the Steve Martin routine where he plays an inquisitor, and ponders at great length if there is a better way of determining justice than tying witches up, tossing them into a pond, and if they drown they are innocent…than concludes – Nah.Mainstream economists are enamoured of the multiplier effect – acknowledgement of debt means they would have to take account (he he – little pun) of the DEmultiplier effect – which makes being an apparatcheck so unfulfilling.

Posted by fresno dan | Report as abusive

Andrew…..most certainly I would agree that Mises didn’t get everything right. What I should have made clearer is that we need an honest appraisal of where mainstream economics goes wrong. Perhaps then we can arrive at a synthesis that is a real advance in economic knowledge.I think Mises got some things right and some things probably very wrong. I’m a big fan of free markets, but i think the Austrians take it too far. IF markets were perfectly free, they’d have no integrity and trade would break down….

Posted by Rolfe Winkler | Report as abusive

It is worth mentioning that Irving subsequently (1935 – 100% money) reexamined his core financial and economic beliefs and published a conclusion that eliminating fractional-reserve banking was the only way to remove the possibility of financial crises.

Posted by Conrad | Report as abusive

Which makes sense because if everyone goes back to subsistence farming then no one has to worry about a financial crisis.

Posted by Andrew | Report as abusive

Andrew….no doubt you’ve seen this:http://cafehayek.com/2009/04/gifted -in-nepal.html

Posted by Rolfe Winkler | Report as abusive

Totally on board with your argument for implementing regulation the would allow for the protection of the specialization of labor. Its perhaps the most compelling argument for any regulation I’ve heard, possibly ever.Not on board with the “do away with fractional reserve banking” theory. I’d probably make a terrible farmer.

Posted by Andrew | Report as abusive

The old economist we need to look back at is Henry George. He pointed out that speculation in natural resources– land, minerals, spectrum, etc– inevitably leads to repeated crashes, tho they can be worsened by unwise financial practices. Some newer economists– Mason Gaffney, Fred Foldvary, Nic Tideman– confirm that the remedy he proposed would be effective today.

If you’d like to read an interesting and timely paper about where economic modeling went wrong, take a look atChristophe Schinckus, “Economic uncertainty and econophysics”, Physica A 388 (2009) 4415- 4423.Here’s the abstract:The objective of this paper is to provide a methodological link between econophysics and economics. I will study a key notion of both fields: uncertainty and the ways of thinking about it developed by the two disciplines. After having presented the main economictheories of uncertainty (provided by Knight, Keynes and Hayek), I show how this notion is paradoxically excluded from the economic field. In economics, uncertainty is totally reduced by an a priori Gaussian framework in contrast to econophysics, which does not use a priori models because it works directly on data. Uncertainty is then not shaped by a specific model, and is partially and temporally reduced as models improve. This way of thinking about uncertainty has echoes in the economic literature. By presenting econophysics as a Knightian method, and a complementary approach to a Hayekianframework, this paper shows that econophysics can be methodologically justified from an economic point of view.

Posted by Steve Numero Uno | Report as abusive

“Not on board with the “do away with fractional reserve banking” theory. I’d probably make a terrible farmer.”I’m not sure how you come to that conclusion. Credit would substantially contract from what present day fractional-reserve lending allows for, but lending and investment would continue. Hedge funds, Certficates of Deposit, and other instruments that lock capital-holders into long durations would align to credit demand – at the appropriate interest rate. The counterfactual is indeed a tough nut to crack.

Posted by Conrad | Report as abusive

The author contradicts himself. First he says:When it comes to managing the business cycle, Keynesian and “laissez faire economics have failed rather spectacularly”. [emphasis mine]Then he says we should give Mises a hearing. But Mises is the most consistent advocate of laissez faire!

Posted by lalala | Report as abusive

Conrad,You’re right that credit would substantially contract. Finding a loan for anything would become far more difficult and much more expensive. We’d also revert back to a mostly paper cash society because not only would fewer people have actual credit cards (due to reduced lending), but many fewer would have debit cards either. That’s because retail banking is an expensive business, and since banks wouldn’t be getting nearly as much net interest income from lending out your deposits, they’d either have to pass along the expense to you or the borrower, likely both. Besides, without the ability to originate loans with the funds why would a bank even want your deposits? Your checking account would basically become a safety deposit box: no interest, but monthly fees. Service fees, maintenance fees, teller fees, transaction fees… you think today’s overdraft fees are bad?Hedge funds? You’ve just used the term “hedge funds” in the same sentance as “long duration”?Certificates of deposits? You presume CDs are all long term, and that banks can’t offer weekly, or even daily, maturities. To be fair, the more likely outcome from your suggestion is the death of the common checking account and the creation of new deposit products to circumvent the change.So, yeah, in your version you’d get less credit. You’d also get a much more inefficient economy and a lower standard of living due to those inefficiencies and the related increase in borrowing expenses. I think there are many other changes that could be tried that have less drastic and potentially negative effects.

Posted by Andrew | Report as abusive

Ludwign von Mises and the Austrian school of economics explain not only how the market works but how government interference (described as violent intervention in the voluntary process of the market) always brings about a net loss to society. The Austrian business cycle theory is a natural extension of the Austrian capital theory which is completely ignored by mainstream economics. Mainstream economics have no capital theory and ignore the time structure of production. In other words, they ignore the most important elements of economics.Mainstream economics is NOT economics! At least it has no connection to reality and has nothing to do with the market economy. I don’t know what they’re doing today in those class rooms, but it ain’t economics.

Posted by DD | Report as abusive

Mr. Winkler, what do you mean by “perfectly free markets”? What do you mean by “integrity”?Your answers to these questions will help me in responding to your criticism of the Austrian School. Thanks in advance. :)

Posted by Autolykos | Report as abusive

Mises is a true free market economist. Infact he knew very well the consequences of goverment intrusion in money affairs. So there’s no kid of private bubble: it’s always a public bubble as soon as we have a paper monopoly money managed by the central bank with a fractional reserve system. It’s money and banking socialism which created the current crisis. And Mises predicted the impossibility of socialism too…

Posted by Lorenzo B. | Report as abusive

Don’t forget Roger Garrison and the capital-based macroeconomics theory, building upon Frederik von Heyek.

Posted by Mark | Report as abusive

Andrew,At the start of the change, of course credit would contract. However, this is only because our current monetary system is built on a bunch of fake money. Once people have adjusted to the change by saving up money/capital, then the market would begin lending again as there would be too much in reserves.And who says paying a fee to deposit money in a bank is a bad thing? They would be providing a service like any other business. The only change is a fundamental shift of what a bank is and is not. Currently, a bank doesn’t charge a deposit fee because it literally takes risks with the depositors’ money, needing the government to meddle in its affairs to keep it solvent in case of bank runs. Without the government safety net, banks would have to -gasp- stand on their own feet and participate in the free market instead of privatizing profits and socializing losses.If you think creating and exacerbating business cycles is “efficient” for an economy, then you are free to your own opinion. I trust that you would at least read what Mises and the Austrians have said, and then decide what is efficient (and right) or not.

Posted by Howard | Report as abusive

If you you want to know what Mises “might” have said if he were still alive read this piece and the preceding ones in the series.http://www.freemensch.com/2009/05  /mises-money-gold-and-gibsons-paradox-p art-iv.htmlMises had it right but he did not live in the time of global paper money. I am sure that he would have done a better jobs at explaining how it all works now.Enjoy.Gasman

Rolfe: “IF markets were perfectly free, they’d have no integrity and trade would break down…”Actually, laissez-faire, which Mises always fought for, always includes the rule of law and the protection of life and property. Freedom cannot be achieve in chaos. Mises always pointed out that freedom came from the rule of law as opposed to the arbitrary rule of men, and the chief principles under the rule of law were the protection of property and justice.Hayek wrote “Monetary Theory and the Trade Cycle” in the 1930′s, but it contains a summary of competing theories of business cycles that is amazingly current. It shows how little economics has changed in 80 years. That same decade, mainstream economists decided to exclude the monetary theory from possible consideration as a theory of cycles. Mises suspects that the motivation was to defend Marxism, because Marxism insists that capitalism is inherently unstable and prone to depressions.

Posted by fundamentalist | Report as abusive

“I’m a big fan of free markets, but i think the Austrians take it too far. IF markets were perfectly free, they’d have no integrity and trade would break down”This is saying, “A case can be made for coercive monopolies.” If you can make a case for any particular market to be taken over by government and controlled at the point of a gun – for the greater good – then why not make all markets coerced? You trust the people in government who hold the power to run markets for the greater good of all participants and not for their own selfish ends. How touching. If you trust them this much then clearly their sterling characters would mean that you can trust them to control every market and you will be better off than otherwise.

Posted by Hoosier Gas | Report as abusive

Rolfe,Incredible. First you put forth the Ricardian-Marxian notion of the Iron Law of Wages on your Option Armageddon blog in response to a comment I made there.Now you reference Mises and suggest everyone should pay more attention to him, while you continue to belittle the very laissez faire economics for which the good Austrian professor was persecuted by the Nazis and driven out of his homeland and into America as a refugee!The irony is astounding. What’s even more astounding is that you’ve remained willfully ignorant on the reality of what Mises and the free market economists have been trying to teach you as evidenced by your treatment of me and my criticisms of your regulatory reform proposals on your blog.Here’s hoping you are starting to come around to a more reasonable, open-minded understanding of free markets. Maybe then you won’t see fit to criticize and disparage something of which you demonstrate little understanding.For more, try here: http://n-k-1.blogspot.com/2009/06/social -armageddon.html

Andrew,Credit might contract in nominal terms, however, there would still be the same amount of real capital to go around. Furthermore, Austrians would argue, the abolition of fractional reserve banking (as well as government spending and monetary finagling) would prevent the mis-allocation of capital. So the costs associated with the warehousing of funds might increase, but these would be more than compensated by avoiding the costs of inflation through monetary policy and the misallocation of funds through fractional reserve banking. So efficiency would actually be improved according to the Austrian theory.In this system if you borrow money you must be more certain that your return would exceed the cost of borrowing, otherwise the owner of the money would not lend it out. That is the whole purpose of the market mechanism — to correctly allocate capital to the parties most likely to produce.In a truly free market I don’t think fractional reserve banking would be abolished, but I do think the market fraction held in reserve would be much higher than is mandated by government today.

Posted by John Deal | Report as abusive

I generally agree with Fundamentalist. But I also want to go back to the beginning and ask how Minsky could be coupled with Mises? Minsky is a complete Keynesian while Mises and his student Hayek are the Anti-Keynes. Minsky described the problem of bubbles well but his explanation of their origin is all wrong precisely because it ignored Mises and Hayek.

Other than claiming that laissez faire has failed spectacularly, this is a damn good piece. Damn good.I would only ask the author to please point to one single instance of laissez faire existing, let alone failing. The housing market is rife with “incentives”, subsidies, and manipulated interest rates. The medical field is even worse (except vitamins and supplements, the only aspect of medicine that nobody seems to have a problem with), the finance industry has the federal reserve and their artificial interest rates and the SEC, American education is almost entirely socialized, the list goes on and on. There are lots of failures in the American economy, but these areas are all accompanied by massive amounts of regulation and intervention.This author would do well to read Mises’ book “Socialism”, or if pressed for time, “A Critique of Interventionism” and “Planning for Freedom”.

Posted by shaneinwy | Report as abusive

What I find amazing is that anyone would try to assert that “laissez faire” has anything what so ever to do with the world economy.Which currency is based in a commodity? None.What country lacks a central bank? None.Is Hong Kong still the only place in the world without import/export duties? Or has that last little bit of laissez faire also bitten the dust?When Andrew Jackson vetoed the Second Bank of the US, he pointed out how having the First Bank had caused massive damage. Exactly the same damage we’re seeing now with the Federal Reserve, and for exactly the same reason.The only negative in terms of investment with a commodity money standard, is that investors will be less likely to throw money into boondoggles and insanities. In other words, just like was seen during the periods where commodity money was the rule, rather than the exception, there wouldn’t be the HUGE boom-bust cycle that has been the rule ever since laissez faire was abandoned with the establishment of the Federal Reserve.This is not just competing economic theories. This is hard historical fact. Just compare what happened in the depressions of 1920 and 1928, compare which one was closer to laissez faire and which was all about “stimulus”, bailout and “saving jobs”, then face the fact that laissez faire works one heck of a lot better than intervention.

Posted by Curt Howland | Report as abusive

One thing is certain: No critic of the Austrian School (outside of a few heretics at GMU) is at all familiar with even the basic concepts of the Austrian Business Cycle Theory. Of course, the Austrian theory and its adherents are ignored: The Austrian School economists long ago eviscerated the entirety of the Keynesian and Chicago schools before the substance of those schools was even first enunciated. The Mises Institute has hundreds of books free online at mises.org. If the Austrians are so wrong, why not read their books and refute them instead of hiding under the bed?Start with “MONEY,BANK CREDIT, AND ECONOMIC CYCLES” by JESÚS HUERTA DE SOTOhttp://mises.org/books/desoto.pdfOr you might start with “The Essential Von Mises” by Murray Rothbardhttp://mises.org/resources/3081T hen there is “Man, Economy and State” by Murray Rothbardhttp://mises.org/rothbard/mes.as pThat’s a good start.

Posted by Bob Roddis | Report as abusive

[...] This time it is Reuters. [...]

The best example of Laissez-Faire’s failure is the OTC derivatives market. Left to its own devices, it blew itself up and would have taken down the world financial system without the bailout.The free marketer in me wants to believe that it’s ok to let that market fail. I’d love nothing more. And regular readers of this blog know how much I hate bailouts and would have preferred to see banks recapitalized properly.But letting the market collapse into another Depression would tank the world economy and probably lead to some pretty nasty wars. This time ’round we’re all nuclear-armed. So I’d prefer to avoid that.Of course, propping up the market with bailouts is no long-term solution.But the market can be made safe with some sensible rules. That means putting OTC derivatives on exchanges, which is to say, regulating them properly.Hobbes had a thing or two to say about perfect free markets, which he called the state of nature. “Regulation” is just another form of “law.” With neither, life tends to be nasty, brutish and short.There’s a reason we “regulate” traffic with stoplights, for instance. If we didn’t our roads would be utter chaos and people would stop using them.Trade goes to zero in markets with no enforceable rules. Exhibit A: Somalia.http://www.forbes.com/2006/09/22  /trust-economy-markets-tech_cx_th_06tru st_0925harford.htmlSo if I’d had more space I would have argued that I don’t think Mises is correct in all respects. My larger point is that Austrians have much to teach the rest of us about the business cycle and the dangers of fractional reserve banking. We ignore them at our peril.

Posted by Rolfe Winkler | Report as abusive

I agree with lalala at 4:07pm GMT on 11/10. I thought the same thing. The quoted sentence evoked cognitive dissonance when I read it in the article.If laissez faire has failed, prove it!

Posted by Anna | Report as abusive

People, these are not examples of Laissez-Faire economics! OTC derivatives failures is a perfect example of what happens when a Laissez-Faire system is *not* in operation. The very existence of these derivative devices is a sham in any sound theory of money, banking, and credit. And if the government was doing their only required duty in the realm of economics, as mandated by the Constitution — which is to ensure that the markets remain free (i.e., genuinely free competition with no artificial (read: regulatory) barriers to entry, protection of private property, and enforceability of contracts — none of the economic problems that exist today would exist. Why? Because there would be no derivatives, no 20x-30x and even 100x leveraging, and there would be sound money. The reason why we have the problem we do is because government Sachs and co. have both created and repealed legislation that serves their own selfish interest. They have effectively usurped the regulatory powers of government and misused them for their own financial gain.This is the prime reason why government should not be involved except in a very limited capacity as previously mentioned. In such a true Laissez-Faire system there would be no compulsion for large and powerful organizations to control and harness the powers of the Great Leviathon through the regulatory framework to control and wreak havoc on the financial markets for their own selfish gain.

Posted by Dalmazio | Report as abusive

Thank you, Mr. Winkler. Although you did not explicitly offer definitions for the terms in question (why not?), I think I can infer them based on your response.Tell me, do you consider there to be no regulation that can possibly *emerge* from markets? That it must all be imposed arbitrarily from “the outside”? Is there, in fact, an “outside” at all?Honestly, I’m not really surprised that you take a Hobbesian approach to human nature. Unfortunately, Hobbes had no understand of the concept of emergent behavior. We have more knowledge these days.Finally, how can you assert that trade in Somalia is at zero? Have all Somalians died? Is the country entirely depopulated now? If not, then how can you claim that there is zero economic exchange going on whatsoever? Or do you mean something different by “trade”?I look forward to your response.

Posted by Autolykos | Report as abusive

Rolfe,The problem: as Austrians will point out, it’s not accurate to say that financial markets are “laissez faire” when we have a central bank playing with interest rates. This is especially true when the central bank has implied that bailouts are to be expected in the case of systemic failure. (In other words, “moral hazard”.) Is it fair to say that the OTC derivatives market was “free” when all the major players expected to be bailed out if things went terribly wrong? I don’t think it is.”Hobbes had a thing or two to say about perfect free markets, which he called the state of nature.”This is an appeal to authority. I can just as easily say “Socrates believed that the sun circled the earth.” Just because Socrates (or Hobbes) was a smart guy doesn’t mean that he was right 100% of the time.”If we didn’t our roads would be utter chaos and people would stop using them.”Actually, no. Check this out: http://www.spiegel.de/international/spie gel/0,1518,448747,00.htmlAlso, for a different view of Somalia, you should look at this:http://www.independent.org/publicat ions/working_papers/article.asp?id=1861

Preventing the mis-allocation of capital?That also means preventing the proper allocation of capital. Mistakes happpen in an open system. You can not prevent mis-allocation while allowing efficient allocation.Return does need to exceed the cost of borrowing. In a non-fractional reserve world borrowing costs would probably be so high as to prohibit many ventures that could have been successfull otherwise.And savings? Who is going to save money in an account that you’d have to pay through the nose to use (a checking account)? They’ll save it in investment deposits instead, which banks can lend without reserve anyway. So what would you have accomplished then?Banks actually seemed to do OK when they were allowed to regulate their own bank run policies (bank panic of 1907). It was only until the gov’t required them to remain open, and insituted the Federal Reserve System that we got the banking collapses on the 30′s, which lead the the FDIC of course.Feel free to reference Friedman’s work on the matter.A fractional reserve system doesn’t need gov’t guarantees to work efficiently. In fact, it would work better because banks would have incentive to take fewer risks yet still have the freedom to distribute capital where it thought prudent.Best case scenario: banks work around the new regulation, chasing off checking deposits as undesirable and funneling money into non-reserved investment deposit products such as daily maturing CDs and sweep accounts. Liquidity is reduced, borrowing expenses increase, and business starts and expansions slow.

Posted by Andrew | Report as abusive

“The best example of Laissez-Faire’s failure is the OTC derivatives market. Left to its own devices, it blew itself up and would have taken down the world financial system without the bailout.”But that’s why free markets work! It’s not an end state, it’s a process! Unproductive economic forms are washed away in their failure. Markets breed variety – and evolution. The companies that made stupid bets would fail, and their assets would be bid away by up-and-coming companies that would have additional knowledge. The economic landscape would have evolved.The objection here is that this would have been hard to take in the short term – the entire “financial system” would have come crashing down. Which is important information to have! What does it say about our government created financial system if it isn’t resilient to the failure of a couple companies?It means that the government has built a pyramid scheme on a shaky fractional-reserve, federal reserve system. And the quicker that collapses, the quicker a new organic system can be built from the group up, conceived in liberty and competing currencies.Rolfe, buddy, we don’t have free markets. So stop pretending we do!

Posted by Jack | Report as abusive

Rolfe, you have got to be kidding. Somalia has actually shown an incredible amount of economic growth, even in the midst of government collapse and a war with Ethiopia. It’s anarchy is far from the kind libertarians desire, and there is the appearance that there is no rule of law; but on closer inspection, there is a structure of law and property, with enforcement methods…and these are actually functioning better outside the urban areas, where tribal anarchy is the norm, rather than rival states competing for power.As far as regulation, there is a severe difference between voluntary submission into a rules-based process (red lights), and a monolithic group that threatens to use violence against whatever they consider prohibited behavior. There is no inherent vice or problem with capitalism, only the state interventions that claim to “correct” it. You will notice throughout economic history, all major downturns can trace their roots to government interventions or natural disasters. The largest economic meltdowns occur around price fixing, particularly with the price of interest (due to credit expansion policies like central banking and fiat currencies).When anyone is free to produce and trade what they want, consumers find ever-better systems of rules that they choose to abide by. When the state uses coercion to “regulate” the economy, special interests pour big money into DC, using the regulatory power to stifle their competition, or otherwise funnel unearned wealth into their pockets. This timeless mercantalist tale continues to be repeated simply because regulation has NEVER produced its intended results (that SEC sure can’t seem to prevent financial bubbles, eh?). Thus, the illogical conclusion of statists is that the monopoly regulatory agency is too weak. No, it just has no incentives to work as the public desires it to.

Posted by Bob | Report as abusive

I should add that this whole notion of systemic risk is WAY, WAY over-hyped. This “we had to save the system from itself” talk is nonsense. Look at the Asian financial crisis. They said the same thing. But the actual risks were very, very small.The OTC derivatives market did not fail. Most of the credit fault swaps worked as advertised. It was the mortgage-backed securities that failed, as well as the CDO’s built on them.If you want to talk failure, start with Fannie Mae and Freddie Mac, the Federal Reserve, and all the big name economists that completely failed to see the collapse approaching. Then move on to the SEC (Madoff?), HUD, and whoever has been giving federal funds to Acorn.

Posted by Bob | Report as abusive

Andrew says: “You’re right that credit would substantially contract. Finding a loan for anything would become far more difficult and much more expensive.”Nonsense. If anything, credit would be cheaper (long term; there’d obviously be a spike in the short term) — interest rates in the days before fractional reserve banking were low and constantly falling; what makes you think that would change now?

Posted by Peter | Report as abusive

The use of the term “laissez faire” applied to our recent economic situation is preposterous. Perhaps we have a failure to communicate. We certainly have a failure to agree upon the use of terminology. Austrian School advocates like Ron Paul eschew economic “regulation”. However, here is an interview with Andrew Ross Sorkin by Tavis Smiley wherein Sorkin calls for higher bank capital requirements as a form of “regulation”.http://www.pbs.org/kcet  /tavissmiley/archive/200911/20091109.ht ml#At the same time, Ron Paul, in Chapter Two of “End the Fed”, holds that fractional reserve banking is inherently fraudulent suggesting that when a bank holds anything less than 100% of its deposits, it is acting fraudulently.http://mises.org/story/3687 Somehow, Sorkin’s view becomes identified as “pro-regulation” while Paul’s much more restrictive proposal is deemed “laissez faire”.

Posted by Bob Roddis | Report as abusive

No, lazy fair economics couldn’t have failed because there hasn’t been anything approximating a lazy fair since 1913. It’s been a playground for bureaucratic busybodies. And the Austrians advocate the total free market, the laziest of fairs. You should have just said, “Keynesian economics have failed rather spectacularly” and it would have been well spoken.The writer of this article doesn’t understand the most rudimentary issues.This is typical of Reuters. Reuters needs to blacklist the Ivy League. Just stop hiring anyone who went to an Ivy League school.Those schools have just been assumed to be good for too long, their graduates dominate journalism, and the results are manifest.

Posted by Ryan Faulk | Report as abusive

For anyone who might be confused by the comments, the original first line read thusly:”When it comes to managing the business cycle, Keynesian and laissez faire economics have failed rather spectacularly, their prescriptions leading to increasingly violent bubbles and busts.”

I am sick of hearing about “free” markets. There is no such thing. Actually a “laissez faire” market is a market where the rules were established by custom rather than by decree.Every market will have customary behaviors or regulation: rules said or unsaid. And any market can be co-opted by the most powerful (those with market, political, or criminal power) and turned into a quasi-monopoly or an oligopoly. It can be better to have self regulation (bottom up emergent behavior) than top down regulation: this is the insight of late twentieth century math, but this is not always true.Rather than argue for regulation or against regulation, invoking mystical beliefs that free markets will automatically fix everything or that a magic commissar will bring about a dictatorship of the proletariat, economists must get with the 21st century: examine the system AS a system, treating both regulation and informal custom as properties to be examined and planned. We should figure out how to design an economy that is both profitable for all and fun to be in.

Posted by Gil | Report as abusive

Mises is one of the most articulate and lucid individuals ever to practice economics. His works on praxeology, credit, inflation, and banking were and still are revolutionary. The only fault that I can find in either Mises or Hayek is they agreed that a state was necessary to facilitate the market. The very existence of the state necessarily sets into motion the eventuality of totalitarianism. Public goods are excessively, and inefficiently delivered and only help to stagnate progress [and drive prices upward] in whatever sector they monopolize.

Posted by dewind | Report as abusive

Regarding the first line—which originally read “When it comes to managing the business cycle, Keynesian and laissez faire economics have failed rather spectacularly….”—I thought Lucas Englehart’s comment was the best one. Austrians make a fantastic point that it’s hard to consider parts of the financial market “free” when the whole structure is based on a price-fixing scheme (the central bank’s fixing the price of money).I stand corrected on that line. It wasn’t germane to my argument anyway.I also agree with comments that more creative destruction is desperately needed. The sooner the better.I maintain, however, that allegiance to perfectly free markets is misguided. I rest my case on the fact that a number have said Somalia is a model of governance to emulate. I invite those of you who believe that to move to Somalia.

Posted by Rolfe Winkler | Report as abusive

@Gil”Every market will have customary behaviors or regulation: rules said or unsaid”You miss the point of “free market” economics and anarchist, for that matter. The issue has never been about having markets without any rules, since surely we are all subjects to the rules of nature; the issue is government rules, rules which are non-voluntary and are coercively enforced.In a “free market”, if you do not like the rules as they are, you can always go somewhere else, and either start your own market, making whatever rules you see fit; or go participate in another already existing market that is run in accordance with your liking. However, when governments make rules, we are all stuck with them, no matter how bad, arbitrary, unfair, or harmful they are.If you think the US banking system is mismanaged and Wall Street is crooked, and you would like to go elsewhere to protect yourself and your assets; tough luck. In this “free country”, you can go to any bank and stock market in the country you wish, as long as it is run and regulated by the federal government.

Posted by George P. Burdell | Report as abusive

Peter,A) I’d be interested to know who you think would be making loans without fractional reserve?B) With what money?C) When is this “pre fractional reserve” time to which you refer? Seing as how fractional reserve has been the standard since, oh, about 1800 or so. Dr. Gregory Clark notes that interest rates for land in the medieval ages were typically 10-12 percent. Of course, money was also usually pegged to, or actually was, a mostly fixed suuply of metal, so (as long as the gov’t wasn’t debasing the coinage) deflation was generally more of an issue than inflation, which would tend to call for lower interest rates anyway.Further, for all those who seem to think I’m attacking the Austrian thought, I’d point out that in 1933 Hayek himself argued that the positives of fractional reserve banking outweighed the negatives in the long run.Also, those who consider themselves Austrians (actual economist, not arm chair postulators) are hardly unified in their opinion on fractional reserve banking.Fractional reserve banking is not the problem. The government manipulation and socialization of risk is the problem.

Posted by Andrew | Report as abusive

@Rolfe WinklerIF markets were perfectly free, they’d have no integrity and trade would break down….How do you figure, what immutable law of nature precludes markets from working without government supervision? What logic brought you to this conclusion? How do governments add integrity to a market? Why are governments the only way to add integrity to markets, especially since governments are instituted largely to lie, keep secrets, and to do nefarious things for the “greater good” (since doing none evil things for the greater good tends to happen naturally, without incentives)?More practically, “black markets” are about the freest markets in the world, since they operate extra-government by definition. When was the last “black market” to fail? Why do government run markets, the classic example being the Soviet Union, fail and become over run by the “black market,” even while the Soviet Union was prosecuting “black market” participants as fast as they could throw them in jail? Why do “black markets” not experience “boom and bust” cycles like government run markets? Why do they, “black markets”, not have crashes? Are “black markets” not subject to same laws of economics as every other market?Now, I am in no way proposing that we have “black markets.” However, I think it is a fair question to ask why they thrive without the help, support, and supervision of the government.

Posted by George P. Burdell | Report as abusive

@Andrew”Fractional reserve banking is not the problem”Wrong, while it might not be THE problem, it is A problem. Fractional reserve banking allows banks to loan out money they do not have, which is, itself, inflation, since it increases the amount of money in circulation. Inflation in turn causes economic instability, booms, and crashes.If fractional lending is such a lawful and accepted practice, why can you not loan one of your friends $20 dollars, when you only have $10 to your name? Andrew, you should try it some time, because unless you are the government or a bank, you will go to jail for wire fraud and/or counterfeiting.

Posted by George P. Burdell | Report as abusive

@ Rolfe Winkler”I maintain, however, that allegiance to perfectly free markets is misguided. I rest my case on the fact that a number have said Somalia is a model of governance to emulate. I invite those of you who believe that to move to Somalia.”How very grown up of you!I guess the same could be said of you, if you want government controlled markets, maybe you should move back to Europe! I hear Europe’s markets are well controlled, unlike our lawless Yankee markets. The added irony is that your ancestors probably came to America looking for free markets.

Posted by George P. Burdell | Report as abusive

“I maintain, however, that allegiance to perfectly free markets is misguided. I rest my case on the fact that a number have said Somalia is a model of governance to emulate. I invite those of you who believe that to move to Somalia.”No – you intentionally misunderstand.It’s not a question about the US vs. Somalia. It’s a question of Somalia 1990 vs. Somalia now. And Somalia has improved to some extent.Government rules affect how a society progresses – they don’t instantaneously change that society.

Posted by Jack | Report as abusive

@Andrew”A) I’d be interested to know who you think would be making loans without fractional reserve?B) With what money?”Simple, banks would make loans with money that depositors have left with the bank, for that specific purpose. This is not much different than something like money market accounts or CDs, since your money is tied up for a certain amount of time and is not immediately redeemable. So, if you deposited $100 with the bank, then the bank would have $100 to loan out as it sees fit, for the window of time that your money is not redeemable. But, since your money is not redeemable, there is no inflation; which is the point. Also, banks would be able to take any profits, including profits from fees and from loan interest, and use that money to finance other loans (which would presumable make the bank more money, thus more profits and more new loans).Andrew, why would this not work? Why do we need inflation (even if only a little) to be prosperous? If inflation makes for prosperity, why are Zimbabwe and Wiemar Germany not the most prosperous countries in the world, with the most vibrant and thriving economies, especially since their stock markets constantly out preform(ed) even the most bullish periods in our market.Obviously, our economy would not have such boom-ing growth periods in a full reserve system, but I though that was the point, since the boom periods necessitate and cause the crashes. But, I am not sure why full reserve banking would necessitate us all resorting to sustenance farming….

Posted by George P. Burdell | Report as abusive

[...] Happily, the mainstream media is rediscovering other writers too. Last week the WSJ ran a nice piece on Mises, “The Man Who Predicted the Depression,” focusing on Mises’s 1912 Theory of Money and Credit (the book dismissed by Keynes as unoriginal, with Keynes admitting, a few years later, that he understood German well enough to comprehend things he already knew, but not to grasp anything new). “With interest rates at zero, monetary engines humming as never before, and a self-proclaimed Keynesian government, we are back again embracing the brave new era of government-sponsored prosperity and debt,” writes Mark Spitznagel. “And, more than ever, the system is piling uncertainties on top of uncertainties, turning an otherwise resilient economy into a brittle one. . . . How curious it is that the guy who wrote the script depicting our never ending story of government-induced credit expansion, inflation and collapse has remained so persistently forgotten.” Then yesterday Reuters ran a piece by Rolfe Winkler urging readers to study Mises and  Hyman Minsky. [...]

[...] Happily, the mainstream media is rediscovering other writers too. Last week the WSJ ran a nice piece on Mises, “The Man Who Predicted the Depression,” focusing on Mises’s 1912 Theory of Money and Credit (the book dismissed by Keynes as unoriginal, with Keynes admitting, a few years later, that he understood German well enough to comprehend things he already knew, but not to grasp anything new). “With interest rates at zero, monetary engines humming as never before, and a self-proclaimed Keynesian government, we are back again embracing the brave new era of government-sponsored prosperity and debt,” writes Mark Spitznagel. “And, more than ever, the system is piling uncertainties on top of uncertainties, turning an otherwise resilient economy into a brittle one. . . . How curious it is that the guy who wrote the script depicting our never ending story of government-induced credit expansion, inflation and collapse has remained so persistently forgotten.” Then yesterday Reuters ran a piece by Rolfe Winkler urging readers to study Mises and Hyman Minsky. [...]

Yes, both have failed but, in the same time and in a very strange way, both are correct!!. We are living in a bubble economy every day, and from the time to time, this bubble bursts in a bigger one, and a bigger one, like in the Plato allegory of the cave. The only problem now is that this bubble is the biggest one ever imagined. The biggest one possible on “this Earth” and on this system, with the actual resources. We have hit the sky. We are ONE! (like Obama or Merkel say these days).I called it “Sphere Economics Theory”. All the rules are applied on a sphere rather than on a plane, and that’s why all the projections are very different. You could have for instance a triangle with 3 x 90 degrees angles. It is like Pitagora could draw his hypotenuse not only in sand but on a global scale, using the Ecuador as hypotenuse and 2 meridians like the two other sides. They could meet at North Pole in a 90 dgr angle (because they are the projection of the initial triangle) but they are also parallels (because they are meridians) “in the same time”.He have hit the limits, again. “Exponential growth vs limited resources” has only one solution “infinite/renewable energy with.. limited/constant consumption”. It’s the same as in 1790 with Malthus. It’s the same as in 1930, when Hayek experienced for the first time the power of globalisation (but we, the humans, were not prepared to make the jump)…. Read MoreThis is why all the current projections are distorted and sometimes “Logic” does not make any sense at all.This new approach (*using hyperbolic geometry) could be one starting point of view that could unify both “free market” and Keynes, for good.

[...] Mises, and Holt understood what the current crop of economists don’t, says Rolfe Winkler, that debt drives economic cycles. The problem is, they’re all dead. Category: Investing, Reading [...]

“I maintain, however, that allegiance to perfectly free markets is misguided. I rest my case on the fact that a number have said Somalia is a model of governance to emulate. I invite those of you who believe that to move to Somalia.”At the very least, I didn’t say that. I just referred to a paper that suggests that Somalia has been doing better without a central government than it did with one. The facts that Powell documents in that paper suggest that: (1) the Somali anarchic system works well for the Somalis, and (2) the system doesn’t work well for non-Somalis. Ultimately, when justice is administered by tribes and relationships between tribes, being without a tribe would likely lead to a lack of justice. So, it would be unwise for me – or anyone else who thinks Somalia’s system is doing a decent job – to move to Somalia. It may be a country that works for Somalis, but it’s not one that expands to include immigrants very well.The only point that I was trying to make is that Somalia gets an unfair “bad rap”, and as such is not a good argument for why unfettered markets are a bad idea.So far, your argument against unfettered markets has relied on:OTC derivatives – which you now agree isn’t actually free because of the Fed’s interest rate interventions.People not using roads without stoplights – which is false because there are European cities that have actually gotten rid of their traffic laws, and have ended up better.An appeal to authority – from Hobbes, a man who believed that your dreams were largely a function of how warm you were when you slept.Somalia – which has improved since it got rid of its government, even if it doesn’t incorporate new members into society very well.I’m sure you don’t mind if I find myself unconvinced.

Mr. Burdell;I invite you to learn more about fractional reserve banking. It seems you have fallen prey to a common, yet very basic, misunderstanding about how it works.A bank cannot lend more money than it has. If you deposit $20, the bank can only lend $18, which is something I could also do without violating any laws.In the end, I agree that full reserve abnking would work. The subsistence farming comment is a bit of hyperbole (and really only applies to those who believe that CDs should be fully reserved as well).However, my contention that the system would still work is based on a confidence that banks would merely work around the restrictions and that effectively nothing would change. Sure, the lower classes and small businesses would probably lose access to low fee deposit accounts, but banks would simply drive all but the most stubborn or ignorant depositors to investment deposits thus evading the reserve requirement.In fact, just during my morning bike ride I created a workable structure that a bank could implement using daily maturity CDs to replace demand accounts. It’d be more expensive for the bank, and therefore more expensive for the depositor and borrower, but it would work.So sure, it would work, but in spite of your attempts to hobble the system.You are also rediculous for attempting to imply that I think hyper inflation is good. As long as the change in currency (inflation or deflation) is moderate and predictable I’m not sure that it matters which way things go. It’s when the movement of money is extreme and/or unpredictable that damage occurs.

Posted by Andrew | Report as abusive

Andrew:You forgot that in lending the $18 the bank still owes me $20 and only has $2 in reserve to give me. To make good on its contract with me, if I decide to withdraw my $20 before the loan is due, it must, in effect, counterfeit $18, which it does via the Federal Reserve Bank. The contracts I refer to are checking and savings accounts which I can withdraw from at anytime vs. instruments like CDs which stipulate a specific time in the future when I’m able to access that money.

Posted by Art Thomas | Report as abusive

Art:And yet fractional reserve banking worked across the globe for well over a century without a federal reserve.That’s because every bank has a hundred thousand people depositing money and they don’t all want their money out at once. Taking advantage of this goes back well before formalized fractional reserve banking.

Posted by Andrew | Report as abusive

I think the concept of perfection has made a lot of danger and this because of the current mainstream math-economics models which draw and calculate this supposed perfect state of the world. There’s no perfection in every human activity, so there’s no such a thing like an ideal of perfect market (and the need of the government to act when the market fails to reach this perfect state).And there’s no such a thing like a perfect free market. There’s only the market: the whole of voluntary exchanges. It’s free in his own definition. And what Mises theory shows us is that a free market is better if we want to avoid the business cycle.Don’t you like bailouts? So you shouldn’t like the central bank and the current global financial system: central banks are only there to help banks when they have problems and they can do it because of their monopolistic status. And if only the central bank can produce money, well that’s not really “free” like it should be. End of story.

Posted by Lorenzo B. | Report as abusive

@Andrew”I invite you to learn more about fractional reserve banking.”I am always trying to learn more, including about banking. I absolutely muddled up my whole analogy. You are right that banks can not loan out more money than is originally deposited with them. The point I was trying to get at; however, and I am sure you would agree, is that, if only for a short time, banks are creating money (in the form of credited deposits) by, per the example, loaning out $18 of my deposit, while still telling my that they have $20 sitting in my account (when in reality there are only $2 “sitting” there). Art points this out in his post. Now, if you repeated this behavior, you would be committing fraud, since you really do not have my $20 sitting safely away in your vault or wherever.

Posted by George P. Burdell | Report as abusive

Ok, so we have a difference on what your account represents and what the bank has promised you.You think your account should be like a safety deposit box, representing money present, so that the bank’s only job is to pay guards to stand watch.It actually represents how much money you have a right to demand from the bank.Claiming that the bank is undertaking a fraud because they don’t have all $20 of “your” dollars on hand is like saying you are being fraudulent if you tell someone you have $20 after you deposited the money.You DO have a right to $20, so you do “have” $20. Of course, what you really have is a cash equivalent receivable of $20. In fact, its so close to being like cash in your pocket (especially with debit cards) that there is nearly no distinction these days.So long as the bank can meet its obligation to pay you the amount you have a claim to at the time of your demand it has met the promises it made. Any other promises you imagined were made to you are not binding on the other party.I would like to see you, or anyone, put together a business plan for a full reserve bank. For the sake of discussion, let’s say its a not-for-profit bank. Put pencil to paper and figure out the fee revenue that your bank would have to generate from the depositor’s accounts just to break even while still providing the transaction services that a banking customer expects today.If you do that, I believe you’ll realize why there are no full reserve banks in business. No one would be willing to pay the fees that would be required.

Posted by Andrew | Report as abusive

[...] This time it is Reuters. [...]

It seems obvious to me now, Mr. Winkler, that you\’re not actually interested in rational discussion. As far as I can tell, no commenter claimed that \”Somalia is a model of governance to emulate\”. For you to claim that multiple commenters have done so is a first-rate example of the straw-man fallacy. Something tells me that this was, in fact, deliberate on your part; hence you seem to be only interested in spreading propaganda.Perhaps your goals would be better served by disabling the comment feature on your blog, if that is allowed by the parent website.

Posted by Autolykos | Report as abusive

Andrew,It all depends on the contract between the bank and the depositor. If the bank says it will pay you upon demand (and they make the same claim to all other depositors) then they are committing fraud because they obviously cannot pay all depositors on demand (and during a bank run they would actually default). Banks should be honest in their contract language, otherwise depositors will not have the correct information to make the best decision with their property (and mis-allocate it).Of course if people wished to put their property at greater risk (short or long term deposits or whatever else) they will be compensated for the risk (lower fees and greater returns).All I believe the Austrians are trying to say is that the warehousing contracts banks enter should be separated from any investment aspect.

Posted by John Deal | Report as abusive