Austrian Business Cycle Theory Reaching Mainstream Economists

It is good to know that the Austrian Business Cycle Theory has finally reached mainstream economists. The response varies. Thanks to 2008 global financial crisis. To me this is an indication of the fulfillment of a foresight.

Beginning 2010, I have been encountering in the web that existing economics will undergo transformation. Mainstream economists can no longer afford to ignore the voice of the Austrian school.

A paper written by Jerry H. Tempelman is an example of the influence of such voice. His topic is the “Austrian Business Cycle Theory and the Global Financial Crisis: Confessions of a Mainstream Economist”. He wrote it in 2010.

The paper is structured around three parts: the identity of those who oppose the business cycle theory, the summary of the theory, and the influence of the theory on several mainstream economists. I just want to follow this order in sharing my own understanding of Tempelman’s paper.

Opponents of Austrian Business Cycle Theory

Milton Friedman tops the list of those who oppose the Austrian Business Cycle Theory. For Friedman, the theory does not provide an accurate explanation of economic recession. It lacks verifiable evidence in actual practice.

Unfortunately, Friedman was not able to witness the 2008 global financial crisis. He passed away in 2006. He was no longer there to witness the specific fulfillment of the theory.

Allan Greenspan is another key personality that opposed the Austrian school. He is a Keynesian. Due to his influence, the voice of William R. White, an Austrian influenced economist was ignored.

Prior to 2008 crisis, White predicted an economic crisis that would result from real estate bubble. His warning was not seriously taken. He actually identified central banks as primary responsible for the crisis due to monetary easing policies. The response to White changed when his prediction happened.

Overview of Business Cycle Theory

Tempelman acknowledged that among several schools of economics, the Austrian school is now considered the most reliable source of interpretation of the 2008 global financial crisis with its business cycle theory. He gave an overview of this theory. It is good that he distinguished between two types of economic booms – sustainable and unsustainable. I find it very helpful.

An economic boom is considered sustainable if it is an outcome of escalation in investment funded by growth in saving. On the other hand, it is unsustainable if the resulting escalation in investment is derived from credit expansion by monetary authorities. This kind of economic boom will certainly end in bust.

Ordinary people find it difficult to identify the dynamics that follow after credit expansion. They include lending money at low interest rates, distortion of vital economic information, negative impact on entrepreneurial decision, and unproductive use of capital. The end of the process is economic decline.

The Austrian Business Cycle Theory described above was proven true in the 2008 economic crisis. The credit expansion and mal-investment that characterized the years prior to 2008 was the primary cause for the decline both in financial market and the total global economy.

The Influence of Business Cycle Theory on Mainstream Economists

The names of mainstream economists mentioned in the paper include William Dudley and Paul Krugman. The Economist is also mentioned. Other mainstream economists using different methodology and whose economic researches are classified as “on the cutting edge” are also identified.

Tempelman noted William Dudley’s analysis of the Federal Reserve has many features common in the Austrian school. Paul Krugman also voiced out his criticism of the Fed for its ability to create boom and bust, an idea borrowed from the Austrian school. The Economist even cited the analysis of Ludwig von Mises criticizing the Fed’s monetary stimulation policy. The economic website also recognized that numerous qualities from Austrian business cycle theory characterized the economic decline both in the US and Japan.

Mainstream economists who utilized different methods include Taylor (2007), Jarocinski and Smets (2008), Smithers (2009), and Vogel (2010). All of them, though they used different approach arrived to a conclusion almost similar to the ideas of the Austrian school. Taylor for instance identified the correlation between the Fed’s monetary policy and the boom in the housing industry. Jarocinski and Smets confirmed this findings using “Bayesian vector auto-regression”. Furthermore, Smithers identified the connection between the irresponsible action of central bankers and global financial crisis. Finally, Vogel observed a sequence of events leading to financial crisis. It all started with the Fed’s monetary policy followed by 2001 economic recession leading to house bubble, which collapse finally resulted to the global crisis.

Tempelman mentioned three among cutting edge mainstream economic research. The first type of research focused on financial leverage and liquidity. Someone mentioned in the paper that a growing body of literature has been focused on this important subject. The works of Tobias Adrian and Hyun Song Shin (2009) is just one example of this type of research. Again the works of these scholars appear to be an echo of the message of Austrian business cycle theory.

Another type of research resonates the voice of the Austrian school is simply focused on liquidity. Brunnermeier (2009) argues that the face of macroeconomics will certainly change and a new economics will emerge considering the contribution coming from the macro, the micro, and financial economics.

The third type of cutting edge research concentrates on behavioral interpretations of business cycle. This one is considered complementary to Austrian Business Cycle Theory.

Conclusion

Tempelman wrote that since 2008 crisis, Federal Reserve officials have shown some “positive signs” acknowledging the mistake of their monetary policy. They admitted that low interest rates for too long does not really help, but has made the crisis more severe.

Some ideas for monetary reform are now considered. Unfortunately, in spite of the accuracy of the Austrian school, its proposal is still considered too radical and therefore rejected. The proposal includes closure of central banks, return to gold standard, free banking, and monetary competition.   

Personal Response

Immediately after the crisis, central banks escaped public blame. All fingers are pointing to free market capitalism. That’s the power of mainstream media. Statist interventionism is doing its best to find a scapegoat.

Thanks to alternative media and bloggers. Thanks also to the influence of Ron Paul. Central banks now are exposed. In time, the role of statist interventionism on the global crisis will also become part of mainstream consciousness.

Regarding the paper, I observe that despite the fact that core features of Austrian Business Cycle Theory were fulfilled in 2008 crisis, mainstream economists are still hesitant to acknowledge the direct influence of the Austrian school in their economic interpretation. This is my personal impression after reading the paper. I think this observation also applies to Templeman’s position. Even though he was in favor of the Austrian school, somehow he remains reserve in the way he presented his material.

As a whole, I appreciate the fact that the Austrian Business Cycle Theory is making an impact among mainstream economists. How I wish that such impact would lead to a thorough study of the Austrian school of economics and the abandonment of the Keynesian economic framework. I also wish to see the fulfillment of George Reisman’s vision in our generation: the spread of Austrian economics literature into the library of universities worldwide. I believe that such education would enable economists to see the real colors of dominant ideologies behind our present political and economic turmoil around the world. I am hopeful that the exposure of the schemes of socialism and statist interventionism would lead to a new appreciation of genuine free market capitalism. And this would mean a better future for global economy based on personal liberty, honest money, and private property.

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Is Warren Buffett a Communist?

Many would laugh at the idea implied by the above question. How could a person in his right mind ask such a question referring to the most successful capitalist investor of our time? But such a question was asked by an informed economics professor to the great billionaire. His name is George Reisman.

George Reisman

In November 26, 2006, Ben Stein of the New York Times reported his interview with Warren Buffet. The billionaire admitted the reality of on-going class warfare initiated by the rich class and claimed that they are winning. George Reisman was worried about the social implications of the billionaire’s statement that prompted him to write an open letter after six years. In the middle of the letter, Reisman asked Warren Buffet, “You’re not a communist, are you?” And in the concluding advice, Reisman stated referring to Warren Buffet and his capitalist friends:

“And, of course, even you and most capitalists are not in fact advocates of capitalism, because you and they have accepted the essentials of Marxism along with almost everyone else.”

Our goal in this article is to introduce the real character of capitalism by presenting the main ideas in the open letter. We hope that this summary would provide an overview of capitalism and clarify common misconception about capitalism as exemplified by Scott Stephens.

The open letter is very educational. The major obstacle reading it is its length. It has 20 pages with 9,206 words. So I doubt if anyone would spend time reading such a long open letter.

Reisman started the letter with direct questions addressed to the billionaire implying that the latter was not really aware about the implication of his statement on class warfare. He then explained class warfare coming from Marx’s exploitation theory where capitalists are perceived as enemies of majority of humanity.

After giving that brief “lecture,” Reisman clearly identified that Warren Buffet’s understanding of capitalism has nothing to do with the real nature of true capitalism. He blatantly said that the billionaire was in fact ignorant about the actual character of capitalism and in terms of understanding “the most fundamental matters of economic theory and economic policy” the economics professor described Warren Buffett as much an “ignoramus” as he is “a ‘genius’ in the field of securities trading.” The professor then admonished the billionaire to correct his misconceptions and to withdraw his statement on class warfare.Warren Buffett

After stating his admonition, George Reisman mentioned that despite of the billionaire’s misunderstanding of capitalism, the latter has actually blessed humanity with better standard of living due to his capitalistic endeavors. Seeing from this perspective, capitalists therefore are not exploiters and enemies of humanity as Marx’s exploitation theory emphasized, but innovators and benefactors. Self-inflicted guilt therefore among Warren Buffett and his friends is unnecessary. If Marx’s theory is correct, no amount of philanthropist acts could atone for the alleged crimes of the capitalists.

By “philanthropist acts,” I refer to the giving pledge signed by Buffet and his fellow billionaires and to his idea of raising taxes for highest earners and heaviest investors. According to the professor, these acts would finally result into the reduction of general standard of living due to its impact on production capital. In short, instead of helping society, such measures would actually lead into further economic destruction.

George Reisman then proceeded to explain the role of inflation (increase in money supply) in connection to capital gains. He believes that capital gains should not be taxed for they are not real gains. He then claimed: “The combination of inflation and capital gains taxation is a racket that puts money into the government’s hands at the expense of its citizens.”

The professor believes that the right way “to reduce the burden of taxation in the economic system is to start with the reduction of the taxes that land most heavily on saving and investment.” He further affirms that this type of tax reduction if complemented with similar reduction in government spending and regulations would result to better economy and higher standard of living.

George Reisman is against Warren Buffett’s idea of raising taxes for investors for the funds that would be collected could be utilized to finance more regulations hampering free market. Instead of increasing taxes, the professor advised Mr. Buffett to invest all the more in business capital for that would provide employment and the necessary products and services for the people.

The economics professor sees that socialism is the greatest threat to economic freedom. He mourned that the US Supreme Court has already abandoned its duty to protect people’s economic freedom for the last 75 years. Congressmen have passed laws under the influence of Marxist ideology. The real culprit for the economic woes of our time is the government’s growing intervention to prevent people from exercising their freedom to act concerning their basic economic rights and property. If this growing intervention of the government over the economic freedom of individuals would not be corrected, the future of humanity would be slavery and genocide as history clearly demonstrated to us in the experiences of Nazi Germany, Soviet Russia, and Communist China.

Capitalism

The only way to reverse the widespread influence of Marxism in the academe, the increasing restriction of people’s liberty, and the worsening economic tide is through an intellectual movement. The professor is calling Warren Buffett and his fellow billionaires to educate themselves in the economic theory and political philosophy of capitalism. He then introduced a list of free market thinkers and their books with specific emphasis on Ludwig von Mises and his works. He summoned Warren Buffett to finance this intellectual movement by helping spread those books in colleges and universities. He dreams to see of intellectuals to have deeper exposure in the ideas of best defenders of capitalism. He believes that the success of this intellectual movement would serve as the basis “for a peaceful and ever more prosperous world.” He describes that future dream as follows:

“…a world of respect for property rights and all other actual individual rights. This would mean a world of free trade, freedom of investment, and ultimately the free movement of people from everywhere to everywhere. Such a world would be a world in which no motive would exist for territorial aggrandizement on the part of any country, since its citizens would already be able to gain everything they might wish from the territory of any other country simply by buying its products, investing in it, or living in it.”