Epistemological Roots of the Present Crises

0:00I want to thank the Mises Institute in a lot of ways for a number of things before we start. I was asked to write a book by ISI about Austrian economics, and the book will be out. It's called It Didn't Have to Be This Way. The book, we're in the last chapter editing the 40 pages that I did on the trade cycle, which Paul helped me with, and when that's done, the book will be out, so ISI will probably have it out. and I'm not on Amazon right now if you want to read about it, but in any event this is one of the chapters from which I've elucidated. And the strategy in the book is something, an idea I actually got from Joseph Salerno, I have to thank him, because he made a statement here once, it's interesting how you plant a seed, in which he said, Mises said that the Austrian School had now become mainstream.

0:51And so, the strategy of my book was to present Austrian economics and to use mainstream people and every quote I use, I use the mainstream instead of the Austrians and I parallel it with the Austrians. Because I got sick and tired of being in economic circles and being told that I was a minority. And so this paper is part of a strategy that I used, and of course the book, we started in 2007 and I would say doing this book would have been literally impossible without the Mises Institute and the publications that they put out. I mean the work they've done in publications of these classics is phenomenal. has really helped me in class, too, because I can use these as textbooks, too, in the classroom.

1:38So I want to really praise the Mises Institute for that. In doing the book, we started in 2007. Most of us, and the fellow who talked yesterday, whose book is downstairs about using Austrian economics as an investment tool, I gotta tell you, it does work, okay? And we did know that this mess was coming. And so we constantly were putting the book off because we were quoting things that were happening. And one of the things that was happening was all of the literature that came out talking about the problems in the economy. And they focused on two things, okay, or three things really. One was government regulation. The other was the trade cycle, of which Thomas Woods did a magnificent job.

2:25And the other one was epistemological. And this is the one thing I wanted to cover today, rather than talk about the trade cycle, is that the tremendous agreement that's coming out, agreeing with the Austrian economist on epistemology, okay? And prior to this, we had the movement called positivism, which was bringing physics and whatever else, and mathematics and economics. I often refer to what we have now as mathonomics, okay, bringing all that in, and the people The people who fought against positivism were really two groups. There were the Thomists and Fulton J. Sheen in his two books, which I'd recommend to you, The Philosophy of Science and The Philosophy of Religion. They're very difficult to get a hold of. He attacks positivism and the Austrians attack on positivism. In other words, this idea of bringing in the mathematics in.

3:19Almost all of these authors, there are three types of authors that I've gone through and I've read as much as I can of all the books explaining the current meltdown. There are three basic, the authors fall into three categories and if you, when you started reading this, you start seeing that what happened was, is modern economics or whatever mainstream economics, whatever else, couldn't predict it, can't explain it and can't solve it. And who do I quote? George Soros. Okay? George Soros says that. In fact, Soros goes out in his book to say the methodology, and I have the quotes here and I'd be glad to send you the paper if you want with the footnotes. He says the problem with modern economics is it mixed the physical sciences and the social sciences and they should be separate. George Soros. Okay? And there were works coming out. He said that, and you notice that even Paul Paul Krugman said, he says that modern economics, modern macroeconomics, was spectacularly useless

4:25at best and positively harmful at worst, okay? I mean, they're recognizing, the mainstream people are recognizing that the whole thing has been a disaster, okay? So as you go through, and I divided the authors up, and the first group of authors were people People who wrote books, and I've got a list of them here, who agree with the Austrian epistemology, they agree that the mathematical thing led to a disaster, but they don't credit the Austrians. And that's good, because if someone discovers something independently of you, it reinforces your idea of the truth. And it's constant. For example, Richard Lowenstein, When Genius Failed, The Rise and Fall of Long-Term Capital Management, Alan Greenspan, of all people, publishes a critique of mathematical economics in his Age of Turbulence. He obviously didn't follow it, but he published it. Richard Bruchstaber, a demon of our own design. George Soros, the crash of 2008. He emphasizes the mistake of

5:34confusing the social and physical sciences in almost agreement with Mises and Hayek. Charles Charles R. Morris, The Trillion Dollar Meltdown, tremendously large section in that book explaining the failures of mathematical economics and its application to investments, okay? A wonderful book by Pablo Triano, Lecturing Birds on Flying, Can Mathematical Theories Destroy Financial Markets, published in 2009. Now Triano relies heavily on Nassim Taleb, whose famous book The Black Swan, and of course Taleb relies very heavily on the Austrians and has quite a section in there on the Austrians, okay? Gillian Tett writes for the Financial Times, Fool's Gold, published in 2009, critical, directly critical of the positivistic method.

6:26Scott Patterson, a book called Quantz, published 2010, author gives a blow-by-blow description of how the use of mathematical, economic modeling in mathematics played a determining role and The Meltdown, Kevin Dowd and Martin Hutchison. In this book, I can't recommend more highly, The Alchemist of Loss, How Modern Finance and Government Intervention Crashed the Financial System. Enormous amount, and does not refer to the Austrians at all, but tremendous critique on mathematical economics and modeling. Ragem Rajan, Fault Lines, Rajan mentions Hayek with regards to the trade cycle. Now, a lot of them will not mention, in other words, these authors will mention something about the trade cycle, but they will be very critical of the mathematical method.

7:19It's highly critical, the mathematical approach. None of these authors refer to major Austrian economists, yet each was as critical of the approach of positivism as Mises, Hayek, or Rothbard, and they served to affirm the Austrian case. The second group, Krugman and Kraut, are familiar with the Austrians but very opposed to us, but yet they are saying the whole thing has been a disaster. Now, the authors who refer to the Austrians directly, Nassib Taleb and the Black Swan, absolutely refers to the Austrians. Kevin Phillips, Bad Money, Reckless Finance, and Global Crisis of American Capitalism refers In the first two, what? The Austrians were right in rejecting mathematical economics.

8:05Okay, Justin Fox, The Myth of the Rational Market, published in 2009. Talib, Phillips, and Fax explicitly mention Austrian criticism of the use of mathematics. Roubini and Steven, I think it's pronounced Mime, in Crisis Economics, published 2010, praise the Austrian trade cycle theory and are critical of the use of quantitative methods. Emanuel Derman, Models Behaving Badly. Derman specifically mentions Hayek's criticism of mixing the methodologies of the human and physical sciences. Derman, by the way, chief quant for Goldman Sachs, okay? So what we see is this attack now on positivism, which I think gives an opening for us. I'll just read you a little thing for humor.

8:53Where I taught economics at Walsh College before, we had what was called the mad dean, okay, and he was very critical of us, and he said, you have to teach something called financial engineering, which is heavy math and economics, and I asked him, I said, what is it? He said, well, he says, you can take this dodgy debt and through some kind of statistical methods transform it into the triple A bonds, 2005. Even though he claimed to have a doctorate in economics, I knew he had a problem when And he told me that Adam Smith wrote The Theory of Moral Sentiments after he wrote The Wealth of Nations because he felt guilty. Actually, Smith's books on morals came first. When one entered his office, it was like coming into the workshop of a renaissance alchemist where beakers were overflowing with gases and various chemicals were cooking.

9:42He'd be sitting there with his mathematical formulas, somewhat reminiscent of the search for the philosopher's stone. The stone was a substance that was supposed to turn base metals into gold. There he'd be, mothering various incantations as cognitive leadership, mezzanine financing and subordinated debt and he would criticize our economics as not having rigor. When I told him I thought his method would simply cheat a lot of little old ladies out of their money, 2005, he became very incensed, told me he had letters from companies who would not hire our graduates because they were not sufficiently trained in this type of alchemy. This 2005, today Those companies are all bankrupt, leaving a lot of retirement funds holding an empty bag, the ladies have been cheated out of their money, and the entire world economy is suffering from a multi-trillion dollar problem.

10:28The Dean disappeared into the sunset, leaving for parts west was his beakers of smoking chemicals, formulas, PowerPoint presentations, rigor and robustness, seeking the philosopher's stone. Warren Buffett said it best, beware of geeks with formulas. Indeed, a follower of Beckett, an advocate who considered the human element in investing, Robert Heigstrom, warned in 2000, ongoing research has shown that overall our use of mental models is seriously flawed. We construct incomplete presentations of phenomena we are trying to explain. Even when they are accurate, we don't use them properly. We tend to forget details about models, particularly when the time has passed. Finally, we have a distressing and tendency to create mental models based on superstition and unwarranted beliefs.

11:17And it's interesting, I quote some of the people on the moral problem, and then the paper goes into the allure of science, the allure of this positivism, probably starting with Sputnik. What happened is everything had to be thrown out, all the human sciences had to be thrown out and we had the whole idea of science was launching satellites. Edmond Standen, who writes on the allure of science at the time, talked about science as a sacred cow. Now then I go into the consistent warnings. There have been consistent warnings about this use of this type of methodology starting with Aristotle. You start with the Nicomachean Ethics Criticism, Edmund Burke, English Statesman.

12:07You can't use this stuff in running societies, okay? Jean-Baptiste Say, Alfred Marshall, I've got quotes in my paper from all of them. He said, pardon the mathematics, Gershwisser, one of our guys, is critical. Albert Einstein, he said, we must not forget Einstein's warning that pure mathematical construction can give us no knowledge whatsoever of the world of experience. All knowledge about reality begins with experience and terminates in it. Rabki, of course, was very critical of the mechanistic method. And of all people, guess who said this? The only function of economic forecasting is to make astrology respectable.

12:53John Kenneth Galbraith. Milton Friedman. Of course, I couldn't get the quote from Friedman, but I got it from a good book called Friedman called the Chicago School of Economics and he said, he claims that Friedman never thought much of sophisticated model building, although Friedman, I don't quite agree with his epistemology at all. Now I just want to read you one quote and I'll ask you who said this, one of the saddest days of my life was when my grandson, and he's a particularly brilliant grandson, went to college. He was good at mathematics and after he had been at college for a year or two I asked him what he wanted to do when he grew up. He said, I want to be a financial engineer. My heart sank. Why was he going to waste his time in this profession? A year or so ago, my daughter had seen something in the paper, some disparaging remarks I made about financial engineering.

13:44She sent it to my godson, grandson, who normally didn't communicate with me very much. He sent me an email. Grandpa, don't blame it on us. We're just following orders we're getting from our bosses. The only thing I could do is send them back an email. I will not accept the Nuremberg excuse. There was so much opaqueness and so many complications and misunderstandings involved in very complex financial engineering by people who, in my opinion, did not know financial markets. They knew mathematics. They thought financial markets obeyed mathematical laws. They found out differently. You know, they all said these events could only happen once every hundred years, but we have had once every hundred years now. What's happening every year or two? Who said Paul Volcker. It's astounding that people who are not on our side are coming to our conclusion.

14:34I think it's a tremendous opening for the Austrians. I mean, it's like the line broke. We can ride right through and say, hey, you guys are saying it. Ipse Dixit, he himself said it. Jane Jacobs, her book is very critical of the mathematical method. Her stuff was published in the 1980s. The Economy of Cities and Cities and the Wealth of Nations Very critical of their positivistic approach. And of all people, okay, you can guess who said this, two larger proportion of recent quotes mathematical economics are mere concoctions as imprecise as the initial assumptions they rest on, which allow the author to lose sight of complexities and interdependencies of the real world in a maze of pretentious and unhelpful symbols.

15:21John Maynard Keynes, okay, and you can go through and it's very interesting and then I quote Mises and I sum it up and I said after quoting all these people at the end I said how are these guys different than what Mises said when he wrote the epistemological foundations of economics, the ultimate foundations, it wasn't any different, I mean I'll quote Mises, I know I don't have much time, but it's diluted by the idea that the sciences of human action must ape They shift the technique of the natural sciences. Hosts of authors are intent upon the quantification of economics. They think that economics are to imitate chemistry, which progress from a qualitative to a quantitative state. Their motto is the positivistic maximum sciences measurement.

16:06They try to compute mathematical relations among the various of these data and thus determine what they call by analogy with the natural sciences correlations and functions. They fail to realize that in the field of human action, statistics is always history, and that the alleged correlations and functions do not describe anything else than what happened at a definite instant in time in the definite geographical areas, the outcome of the actions of definite people. As a method of economic analysis, economics is a child's play with figures that do not contribute anything to the elucidation of the problems of economic reality. Ludwig von Mises, and that's in the Ultimate Foundation of Economic Science, okay? I'd like to go on. I'll just say one thing. The rest of my paper is a call for the reconstruction of economics based upon the human action.

16:57And I go back to Aristotle, say Thomas, and build it right up and say, look, we are in the mainstream. They are out to lunch. Thank you very much. Thank you very much.