Austrian Economics versus Mainstream Economics

0:00It's a pleasure to be here with you today. I want to welcome you to the Mises Institute, which is really the worldwide hub of Austrian economics. And my purpose, my goal here is to explain to you what Austrian economics is and distinguish that from the mainstream of economic thought. Your typical average economist out there that you might see on on television, might be working for the Federal Reserve or the Treasury Department, things of that nature. Austrian economics is the oldest continuous school of economic thought. It was essentially founded in 1870, but we date our roots back to 1730. So we're the oldest school of economic So we're the oldest school of economic thought. We're actually also the smallest school of economic thought. There's probably a hundred or maybe a thousand mainstream economists for every Austrian economist today. And oddly, we are also the fastest growing school of economic thought. So we're the oldest, the smallest, and yet we're the fastest growing.

1:12And that growth has intensified in the last few years, largely due to the economic crisis. Mainstream economics, generally Keynesian economics, but there are other schools of thought out there as well, they use very complicated methods. They use elaborate mathematical modeling, supercomputers, laboratory rats, all sorts of things to try to predict the future of the economy. That's their goal is prediction and they're willing to use anything and go to any expense to come up with accurate predictions even using unrealistic models about human behavior. The Austrians Economics on the other hand have a very simple approach to economics of using logic and reasoning to try to understand human economic behavior and various economic processes.

2:19And while that's simple, it's not necessarily easy, we've spent several hundred years now trying to develop economics as a realistic approach to human behavior. And so what I'm going to do is look at about a half a dozen different aspects of our approaches to economics, our various views on economics, to try to distinguish the Austrians from mainstream economists. And this is very important for me in particular because economists in public opinion polls actually rank lower than the US Congress. Okay, so we've got a reputation to build here.

3:04Let's look at the basic differences between success and failure in terms of economics and economies. The US, the United States, was a very successful economy built from virtually nothing to what it is today, which is the world's largest economy. You can look at other countries as well, like Hong Kong, very, very successful. And then you can look at other areas which were not successful. Various African economies have fared very poorly. Many of the former communist countries fared very poorly, where the economies actually shrank over time. And then you can look in more recent times, and you look at China and India, which have gone from very low levels of economic development to the fastest growing economies in the world.

3:56Okay, so what explains that? Austrians, on our view, is that free markets in the economy lead to success. That private property rights, where individuals have clear title to their houses, their factories, their warehouses, their goods and services, that's also very important. People want to feel secure in their property rights, and if they do feel secure, they're willing to increase the amount of property. They're willing to save. They're willing to invest. We also feel that sound money is very important for an economy so that the measuring rod in all exchanges stays stable over time.

4:43And so, Austrians advocate a gold standard where gold coins and silver coins are the the medium of exchange and that medium is essentially stable over long periods of time so that when we're measuring things, just like with the yardstick, we don't want the length of that yardstick changing very much. Now, mainstream economists have a different view. They are very heavily into regulation. Government regulation of the economy is essential to create a growing economy. They find market failures all over the place. They believe in a government safety net is important for economic growth, and they view things like the Federal Reserve or central banking, which controls the money supply as well as the banking system is the key to economic success. So we disagree wholeheartedly with that approach, but that's That's the difference. The issue of prediction is very important for the mainstream economists.

5:51That's their goal. And it's a worthy one. Everybody wants to know the future. Austrians believe that you can't know the future with certainty. However, Austrian economists have successfully predicted all of the major economic crises over the last century. Ludwig von Mises, For example, the namesake of this institute correctly predicted the Great Depression in a book that he published in 1928. F. A. Hayek also predicted it, who was Mises' student. Mainstream economists at the time thought we were in a new era of prosperity that would never turn back. The same was true for the stagflation of the 1970s. Murray Rothbard, who was the first academic vice president of this institute successfully predicted the oncoming stagflation of the 1970s where mainstream economists thought we were, again, in a new era.

6:52When we came to the tech stock bubble of the late 1990s, Austrian economists, by the dozens, were warning about the bubble and the crisis to come while mainstream economists were predicting Once again, a new era, because of technology, the only thing that they were worrying about was that the technology was going to put people, we wouldn't have anything left to do in terms of work. And then of course with the housing bubble, in the current economic crisis, Austrian economists were writing about that in 2003, 2004, 2005, while mainstream economists were predicting a new era. You could never lose money in housing, they were telling us. Real estate prices never go down. So that's the story in terms of prediction. How about the cause of this economic crisis? Well, it's already been mentioned that Austrians view The Federal Reserve policy of setting interest rates at 1% in 2002, 3, 4 was the cause of this crisis, that low interest rates led to increased demand for housing, more homes,

8:10bigger homes and a lot more debt. Mainstream economists say it was a lack of regulation of the economy, that we had bad had regulations, and the consumers and investors were, for whatever reason, exhibiting highly speculative behavior. So they were blaming the consumer, people, for the crisis. We find that it was the Federal Reserve. Well, how about the cure to this crisis? Well, Austrians believe that easy credit and low interest rates led to too much debt and too little saving, Keeping households and businesses at risk for lower housing prices. Therefore, the key to curing this crisis is less debt and more savings.

9:02Mainstream economists view that we need more regulation and that government must provide a stimulus in the form of increased government spending and even more debt. So the mainstream wants us to take on even more debt while the Austrians view that debt is key to the problem. So what should the Fed do? What should the federal government do and the Federal Reserve do at this point? Well, Austrians believe that interest rates, as been previously shown, should be determined by the marketplace, Bailouts by the free interchange of borrowers and lenders, savers and investors.

9:51So the Fed should do, in our view, nothing that it should allow interest rates to find their own level. Bailouts by the Fed only lead investors to even worse behavior, knowing that the Fed will bail them out. is a moral hazard. If you see people getting bailed out, then why not undertake risky behavior yourself? It should be noted that the chairman of the Federal Reserve is a Ph.D., mainstream economist. He got his doctorate in economics. He wrote his dissertation on the Great Depression where he found that the Great Depression was caused by the failure of the Federal Reserve, their failure to bail out the banks. So in terms of bailing out banks, Mr. Bernanke literally wrote the book. So in retrospect, I guess it shouldn't be too surprising that he moved his way up the ladder to become the nation's chief inflationist.

11:15Deflation is an interesting topic. You might have heard that occasionally in the news and in the newspaper and the financial news. Deflation for mainstream economists is literally the and the black hole of economics. In other words, if you see prices falling in the economy, for them that can lead to bankruptcies and foreclosures with assets having to be sold off at auctions and that's causing lower prices which is causing bankruptcies, foreclosures and failures and layoffs leading to even still lower prices and the economy literally swirls goes down the black hole like water down a toilet. So they're fearful of this and they're willing to do anything to prevent it. Going to extreme measures such as putting out hundreds of billions of dollars out there to try to keep prices up. Austrians have a completely different view. We view deflation as a perfectly normal part of the economy where we expect In a free market economy on sound money, for prices of things to go down, like the price

12:33of computers going down, the price of television sets going down, the price of cell phones going down, we would expect in a free market economy that the prices of everything would be going down slowly over time. So we're not afraid of it. We, just like everybody who shops at Wal-Mart, enjoy lower prices, where the mainstream economists fear them. They have a phobia of lower prices. In a crisis, deflation actually plays a critical role that the mainstream economists don't see. So let's think about a crisis and think about falling prices.

13:20What's actually happening? Well, the first thing in a crisis is that stock prices go down dramatically. The price of capital goods falls dramatically. The price of raw materials and commodities falls dramatically. There's also large decreases in real estate prices. There's a notable decrease in wages. As people get laid off, the wage pressures go downward. There's widespread bankruptcies, foreclosures, and layoffs. Resources are being dislocated, right? That's what's happening. Capital labor and real estate is being dislocated from where it was. And there are small decreases in consumer goods. Luxury goods might fall dramatically, but necessities fall very little because of consumers' inelastic demand.

14:19You're going to buy toilet paper. You're going to buy bread and milk, or rice or whatever. You're going to buy the necessities. And this seems awful and fair on the surface of it, doesn't it? Where the basic necessities are falling very little. However, what the mainstream economists miss here is that this changing of prices and this dislocating of resources is opening up profit opportunities. The price of consumer goods is staying firm, but capital is falling, land prices are falling, real estate prices are falling, raw material prices are falling, labor prices are falling, and so the gap between all the resources you need to make consumer goods and the price of those consumer goods is widening.

15:14And that widening between those prices is profit opportunities. As a result, people become more entrepreneurial because of these widening opportunities. They think, you know, I can get the land, I can buy that store or rent that store and hire a few kids and get some raw materials and sell at a profit. People also become more entrepreneurial because of lack of jobs. I've got to do something. I've got to make some money. That's what people are doing all over our economy and all over the world right now. So entrepreneurs put these resources back together. They reallocate those dislocated resources into new firms and new functions.

16:02This puts the brake on falling prices. Instead of being a black hole that the mainstream economists see, we see deflation as a shock absorber. There's a shock to the economy, the deflationary process starts, but it's actually a shock absorber that reallocates those misallocated resources back to productive areas that consumers want. So again, entirely different vision of the world. And of course, our vision of stimulus and bailouts and other programs is also quite different. We view stimulus spending, we associate that with higher taxes, higher inflation, and if the money is borrowed, that just means our future taxes are going to go up.

17:01None of that is good, either for the people paying higher taxes today or investors looking at the future. It makes the outlook worse for entrepreneurs. It reduces our incentive to invest. And more importantly, it doesn't work. And if we're borrowing the money, it just adds to the national debt. Bailouts are also something we disapprove of. You're giving money to bad companies, the poorest run companies, sometimes it's just a matter of bad luck, but that's the capitalist system. You give bad incentives to both good companies and In terms of the Federal Reserve's policy, of course we disapprove of that. It discourages savings. Looking at those low interest rates that Doug was talking about, everybody I know, if I go to a party or something like that and they find out I'm an economist, they want to know what they can do, how can they make money on their savings.

18:19You know, what if I say, oh well just find the riskiest possible thing you can do and put your money in that. You might earn a few percentage points of interest over inflation. There's really nothing you can do. So it discourages savings, it discourages lending to households and businesses, and it devalues the dollar at the same time. Finally, cash for clunkers and the first-time homebuyer credit. Well, as Doug said, you know, those policies distort markets, they waste resources. I mean, they're kind of silly, in a way. But they are also a good illustration of what I was talking about with deflation.

19:11The first time homebuyer credit basically said, if you buy a house and this is your first house, you're going to get a $7,000 deduction off of your taxes so that in effect the house, the price you're paying for that house is actually being reduced by $7,000. If you buy a car, we're going to give you this cash for clunkers rebate. So you're in effect reducing the price of those cars, the new car purchases. So what this illustrates is not that we want to follow these policies indefinitely, but what it illustrates is that lower prices cause people to buy things.

19:59That's really the solution. We shouldn't fear deflation. We shouldn't fear allowing the marketplace to work even if it involves a lot of pain in the short run. It's my feeling and my conclusion that if we had allowed the crisis to take its natural course, we would already be viewing it as a historical phenomenon, not a current phenomenon, that it essentially would be over and we would be on to progress and the future. So in conclusion, there is a great deal of difference between Austrian economics and mainstream economics. We've had a lot of success in predicting these crisis events and understanding the events as they unfold and how do we go about curing such events.

20:58Thank you very much.