[ExI] Valid economic reasoning should never go out of style

[dan_ust at yahoo.com]

--- On Fri, 5/29/09, BillK <pharos at gmail.com> wrote:
> On 5/28/09, Dan wrote:
>>  We should be looking for valid economic
>> reasoning -- not reasoning that
>> is either old fashioned or new fangled. 
>> Historically, the urge to sluff off valid
>> economic reasoning is very strong.  The "new
>> economy" talk of the railroad
>> era -- yes, they had it back then too! -- led
>> investors, policy-makers, and the
>> general public to believe that bad policies --
>> policies that failed previously
>> and that were theoretically unsound (even given the
>> state of theory in the
>> 19th century) -- would somehow work out.  And the
>> boom-bust cycle resulted.
> 
> No. The boom-bust cycle in inherent in laissez-faire
> capitalism.
> (I know you and some libertarian economic theorists deny
> this).
> But that's the way it works in the real world.
> One of your entrepreneurs starts selling a new widget which
> becomes
> popular. Everybody else and their dog join in, adding
> features to the
> widgets. Some widgets become very rare and expensive.
> People start
> speculating on widget futures. People start investing in
> widgets for
> their pension scheme. Then it all collapses when everybody
> decides
> they don't want any more widgets.
> 
> It's just the herd mentality.

This is a lot like the Schumpeter theory and only makes 
sense if you believe in lots of coincidences working together.  (My guess would be that such coincidences would be so rare that busts -- general downturns -- would be mostly theory talk: few would have been alive to actually see one.:)  The problem with the theory is it doesn't explain why not only widgets go bust, but so does the whole economy.  The key feature of the business cycle -- which even non-Austrians tend to agree on -- is that it impacts the whole economy and not just one industry or one sector.

(Don't you find it extremely unlikely the whole economy would get belly up simply because, say, iPod sales go through a boom and a bust?)

Nor does it explain why everyone goes into widgets.  "Herd mentality" explains nothing as it wouldn't explain why herds form at particular times.  Instead, it seems more like labeling something instead of explaining it.  And, yes, it's true that people will imitate others and that the lure of imitating those who are or seem successful is always there.  But this doesn't explain, in a real world economy, why even non-imitators get burned.  E.g., in an inflation, the people who actually never join in, such as retirees on fixed incomes, experience higher prices for goods and services.  These people weren't herding with the fat cats.

Austrian Business Cycle Theory, on the other hand, explains why there's a "cluster of errors."  This is where many entrepreneurs make mistakes around the same time.  (In any real economy, one would expect entrepreneurial error -- just not systematic error.)  Such entrepreneurs, per se, aren't imititating each other.  In many cases, they're actually pursuing quite innovative projects and even keep them secret.  But it's not the particular innovation, the secrecy, or the lack or presence of imitation that matters here.  Instead, it's the inflation that leads entrepreneurs to misjudge en masse -- specifically, making them think their costs are going to be lower (often because, in the initial stages of the boom, they can borrow money at lower interest rates*) and their final sales higher.
 
>> This is actually a rather old fashioned view of wealth
>> and of production.
>> The valid economic way to look at wealth and
>> production is NOT to concretely
>> look at farms and factories and assume that only
>> specific physical goods are
>> wealth.  Instead, wealth is what people value (if
>> no one wanted oil, e.g., it
>> wouldn't be considered part of wealth or useful to
>> obtaining wealth);
>> production is the process of transforming something
>> into something more
>> desirable (and this can be anything at all from the
>> construction worker laying
>> slabs to produce a building to the singer singing a
>> song to produce music
>> people want to hear).  That is a very wide and
>> all inclusive view of wealth
>> and of production.  It's not limited to who has
>> the most farms or the bigger
>> factories.
> 
> Wealth is power. That's why people want millions of
> dollars.
> The millionaires get the best girls and have a yacht and a
> private jet.

Well, wealth, in a sense, is power.  But, in economic terms, it's merely whatever people value.  In a monastic community, people might value quiet time, a lonely cell, etc.  Granted, this is rare, but, for them, this is wealth.  My point with this rather far-fetched example is not to downplay your current response, but to merely highlight that what's wealth is subjective, i.e., relative to one's values and this can apply to the whole of society if the whole of society starts to value something over something or even completely disvalues something.  (On the last, were we all to adopt the Amish value scales, most technology would seem a waste to us and we would no longer value these things.  You wouldn't be able to sell MP3 players or downloadable music, for instance, and you wouldn't want them for yourself.)

Also, I wouldn't look at this in purely cynical terms.  E.g., people can obtain wealth to have more control over their lives -- not so much to control other people.  For instance, someone saving for retirement is NOT necessarily doing this so she can have servants to boss around or so that she can show up her neighbors.  (This is not to deny people using wealth for status or other reasons.)

>> I don't think this has to do with being
>> moralistic.  One can completely take
>> values out of the theory: malinvestments are
>> malinvestments not because
>> Lee or I don't like them, but because they lead to a
>> production structure that
>> doesn't sustain in the long run -- one that eventually
>> must be corrected -- not
>> because people are all moralistic but because
>> eventually projects invested
>> in fail and fail much more frequently than can be
>> accounted for by simple,
>> unsystematic entrepreneurial error.*  That's an
>> objective truth -- not
>> dependent on our values or morality or misdiagnoses.
> 
> Boom-bust entrepreneurs *always* fail. The whole point is
> to enable a
> boom in widgets and suck money from the population (while
> it is
> fashionable for everybody to have a widget). Then, cash in
> the huge
> salaries, sell the company for millions, and watch the bust
> from your
> island mansion. It has very little to do with creating
> 'value'.

See above.  This sort of thing might work on a small scale, but it wouldn't happen economy-wide unless there were a means of transmitting that to the whole economy.  ABCT far better explains this: inflation is the means to transmit what would be isolated problems to the whole economy.
 
> <http://www.huffingtonpost.com/arianna-huffington/laissez-faire-capitalism_b_152900.html>
> December 22, 2008.  Quote:
> It's time to drive the final nail into the coffin of
> laissez-faire
> capitalism by treating it like the discredited ideology it
> inarguably
> is. If not, the Dr. Frankensteins of the right will surely
> try to
> revive the monster and send it marauding through our
> economy once
> again.

This is just the usual rant against free markets.  Ho-hum.  It's not going to prove anything and is merely preaching to the choir.  The author, too, doesn't see the difference between being pro-free market and pro-business -- nor the difference between rhetoric and reality.  Granted, on the latter, Republicans tend to talk the free market talk, but their actual policies are pro-business -- meaning interventionist.  (Historically, too, Republicans have been for interventionism: Lincoln's party was one of high tariffs, central banking, and corporate welfare.) 
 
> We've only just begun to bury the financially dead, and the
> free
> market fundamentalists are already looking to deflect the
> blame.

Actually, this sounds like bizarro world.  The firms that should be "financially dead" are exactly those being bailed out.  Do you see the current round of bailouts and the preceding interventions -- from artificially low interest rates to previous bailouts to special privileges and other regulations -- as the free market in action?

> <http://www.nytimes.com/2008/12/21/business/21admin.html?_r=1&pagewanted=all>
> 
> December 20, 2008.  Quote:
> There are plenty of culprits, like lenders who peddled easy
> credit,
> consumers who took on mortgages they could not afford and
> Wall Street
> chieftains who loaded up on mortgage-backed securities
> without regard
> to the risk.
> 
> But the story of how we got here is partly one of Mr.
> Bush’s own
> making, according to a review of his tenure that included
> interviews
> with dozens of current and former administration
> officials.
> 
> From his earliest days in office, Mr. Bush paired his
> belief that
> Americans do best when they own their own home with his
> conviction
> that markets do best when let alone.
> 
> He pushed hard to expand homeownership, especially among
> minorities,
> an initiative that dovetailed with his ambition to expand
> the
> Republican tent — and with the business interests of some
> of his
> biggest donors. But his housing policies and hands-off
> approach to
> regulation encouraged lax lending standards.

While the Bush Administration and the Fed deserve some blame for the housing boom -- the Fed perhaps more so because it controlled interest rates and kept them at historical lows during the boom -- the CRA is also to blame and pre-Bush (heck, it started in 1977!) as are the long time federal policy of intervening in housing markets, including the use of Freddie Mac and Fannie Mae.  The lesson here is not market failure, but the failure of interventionism.  Specifically, the federal government over decades has decided it knows what's best for people and intervened in the direction of increasing home ownership.  Yes, this really took off with the very low interest rates under Greenspan and pushing the "ownership society" under Bush, but these, too, were both interventions in the economy -- unless you believe it's not intervention when Fed sets interest rates and when the federal government promotes certain financial decisions over others.  (To be extremely
 clear: in a free market, there would be no government intervention -- either to set interest rates or to make it easier or harder for people to buy (or sell or suck the wallpaper off) homes.)

Regards,

Dan

*  This leads them to bid up the prices of factors of production.  Wherever the new money -- e.g., the newly created loans -- goes first, this will be the first place to experience a shortage.  This will draw in more resources -- e.g., people will start shifting labor and supplies to those entreprenuers who are now paying more for those factors.  Other savvy entrepreneurs may notice this and forecast, rightly or not, future price increases, thereby entering these markets as supplies to the initial set.  It's not a herd mentality per se, but entrepreneurs doing what they should do under normal conditions -- attempt to forecast prices to make a profit -- but the conditions are not normal -- that is, there is actual inflation, which entrepreneurs are either unaware of or don't forecast correctly (during the initial stages of a boom, inflation expectation tend to be very low; in the latter stages, inflation expectations are often very high).