Dan Denning on the accuracy of Austrian Economic Theory

Whiskey & Gunpowder
By Dan Denning
May 27, 2010
Melbourne, Australia

There is a place in life for expert opinion. If a doctor tells us our heart is going to quit because we’re drinking too much beer and not exercising enough, we listen to him. If a physicist tells us that jumping from high places without a parachute could be bad for our health, we listen to him. If Tiger Woods tells us how to correctly hit a one iron or send a saucy text message, we listen to him.

But if a group of economists tells us that a government tax delivers a public benefit, we are inclined to guffaw in their collective face.

Most of the economics profession that gets quoted in so-called respectable publications has studied the wrong textbooks over the last 50 years. They are doctors prescribing remedies based on an incorrect understanding of illness.

Most mainstream textbook economists are reading from the playbook of John Maynard Keynes. They believe, and will say on command – not because there’s any evidence that it works but because it’s how you get tenured and earn grant money or get a government job – that when private demand falls because households and business de-leverage, it is the proper role of government to boost consumption and aggregate demand by increasing public spending. Amen.

As a scientific proposition, empirically speaking, there is zero evidence that this policy works. The one example trotted out is FDR’s spending boom in the Great Depression. But the evidence now suggests that it was war-time production that dragged the American economy out of depression, not morally enlightened fiscally policy.

There no evidence to suggest the big deficit spending really is better than doing nothing. But time after time, the interventionist mantra gets trotted out like the Ten Commandments in the Ark of the Covenant to incinerate anyone who doubts its gospel truth. Yet it’s just a bunch of superstition with very little basis in fact.

Economics is simply not a science in the same way that chemistry and physics are sciences. It’s probably not a science at all, to be honest. Or, if it is, it’s a pseudo science, having more in common with psychology than geology.

Complex adaptive systems like the modern marketplace do not behave mechanistically. They cannot be controlled precisely with the rods and levers of monetary and fiscal policy. To believe so is an enormous – and as we’re finding out – costly error. It’s also massively arrogant and conceited.

There’s a reason the great Austrian economist Ludwig von Mises called his great book “Human Action.” Economics is the study of human action. And human action is sometimes rational, sometimes irrational, sometimes predictable...but ultimately...very difficult to model and predict with charts.

As Nassim Taleb points out, all the most important stuff in your life probably happened or will happen in non-predictable ways. Most of the time, today is going to be like yesterday and tomorrow is going to be liked today. But the most life-changing things happen to you at times you’d have no way of predicting or preparing for. But not everyone is comfortable with this kind of un-planned spontaneity.

Please note the Austrian School of Economics was the only school of economic thought that accurately predicted the current crisis. Why? The Austrians correctly identified the influence of credit (free money to change your life) on human action. Altering the price of money alters incentives and changes individual calculations across the breadth and depth of an economy.

The Austrians pointed out that government-controlled interest rates are the real cause of the business cycle inasmuch as they lead to credit booms and inevitable busts. When the price of money is rigged, the market isn’t free. Only if you understand the “root cause” of the business cycle can you learn how to prevent bubbles from blowing up and popping later. The Austrian answer is, by the way, sound money.