"The real threat to capitalism and democracy, however, is depression and unemployment"

From the FT comes some Burkean sense:

"Is your recession really necessary?

Published: January 2 2009 18:53 | Last updated: January 2 2009 18:53

What a bleak midwinter. It is still hard to see where any green shoots of recovery will break through the permafrosted ground. The recession seems especially unnerving given the length and scale of the good times which preceded it – years in which the current malaise was brewed. It is, therefore, tempting to believe that the world deserves and needs recession to pay for those excesses and to rid ourselves of our unnecessary indulgences. This view, however, is wrong( I AGREE ).

In the past few years, the world economy stumbled out of kilter. House prices were unsustainably bloated by cheap money( NO. POOR LENDING PRACTICES. ). Deficit countries, such as the UK and the US, borrowed frantically to sustain their consumption. Surplus countries, such as China and Germany, grew rich by sating their bingeing. ( THIS WAS THE SYSTEM. REPLACING IT WILL BE HARD WITHOUT SOME SOCIAL DISLOCATIONS. )

These imbalances had been allowed to grow to enormous sizes, nourished by dangerous financial magic. Mortgage straw was not respun, but rather packed into bails and relabelled as triple-A gold( NONSENSE. IT WAS FRAUD, NEGLIGENCE, FIDUCIARY MISMANAGEMENT, AND COLLUSION. ). The financial services industry engorged itself, ran up large profits and paid its staff huge bonuses( AND COMMITTED... ). But the pro-cess also contributed handsomely to government budgets( A HYBRID ) and created enormous demand.

Having lived beyond our means( THIS IS SILLY. ), some economists, notably disciples of the Austrian School, would say that we need recession( WE NEED SOCIAL DISLOCATION AS WELL I SUPPOSE. ). The “malinvestment” of the past few years must be liquidated away. The inefficient, along with charlatans and fraudsters, must be exposed. In 1934, during the Great Depression, Ludwig von Mises wrote that policymakers should have been “raising the rate of interest and restricting credit and so giving free play to the purging process( IT'S LIKE A COLONIC. ) of the crisis”.

To von Mises, policy that aimed to “bolster up undertakings that would otherwise have succumbed to the crisis, and on the other hand to give an artificial stimulus to economic life by public works schemes ... eliminated just those forces which in previous times of depression have ... paved the way for recovery( AND REVOLUTION )”.

Such liquidationism makes a fine morality tale: you reap what you sow. It should be little surprise that many prominent members of the Austrian School – and most of its key adherents – are and were socially conservative. But it took the genius of a man whose inhibitions were informed by life in the Bloomsbury Set to fully explain why this is so very wrong.

One of John Maynard Keynes’ great insights was to understand how, in a crisis, demand would not necessarily fall back to the desired sustainable level. If all market actors pull in their horns( A PANIC ), the result is the paradox of thrift: demand will dry up, and economic activity will crack and crumble with it. Crisis will certainly arrive, and it may not leave. Once demand has evaporated, economies can slide into a low-employment, low-growth equilibrium. Governments must respond by supporting demand with loosened monetary and fiscal policy( TRUE ).

These weapons are slow-acting blunderbusses; they do not allow for rapid responses or fine-tuning. But they are preferable to von Mises’ harsh prescription, which could deepen the recession. It is not possible to liquidate the malinvestment without risking allowing unemployment to spiral out of control and demand to fall with it. Such a plan would be less a healthy purgative, and more an acid bath( VERY TRUE ).

Businesses can, and should, still fail( TRUE ). Politicians must not subsidise existing companies( THEY WILL ). Nor should they seek to prevent necessary( ? ) adjustments which must take place. If this is what John Maples, the UK conservative MP meant when he said the “recession has to take its course”, then he is right. But governments must work together, internationally, to sustain demand. They must not sit idly by.

The allure of the Austrian story lies in its devotion to the free market. The real threat to capitalism and democracy, however, is depression and unemployment( AND REVOLUTION AND TOTALITARIANISM ). It is not countercyclical fiscal policy."

"Personally, I think morality play deserves a much larger place in economics than it currently has"

From the always interesting Interfluidity:

"Krugman's "hangover theory", revisited.

I'm trying to write something hard, and failing. I'll keep trying. But this is easy, and I cannot resist. Paul Krugman is once again attacking "hangover theorists", the idea that booms of a certain kind inevitably beget recessions. I do not buy the traditional Austrian story of hangovers — that misallocations and depletions of capital (including human capital) necessarily take time to undo. But I think that now and in his original piece, Krugman is far too quick in his dismissal of the idea that there must be something about some booms that makes subsequent recessions pretty hard to avoid( I AGREE ). Krugmans writes that "[a] recession happens when, for whatever reason, a large part of the private sector tries to increase its cash reserves at the same time( MOVE TO SAFETY. NOT FLIGHT. )." It is rather surprising, isn't it, that "whatever reason" almost always happens subsequent to years of unusual prosperity? Choose your poison — if you don't like the Austrians, go with Hyman Minsky — but if we don't acknowledge the relationship between some kinds of booms and the bad times that follow, we'll have a hard time preventing those bad times( GOOD POINT ).

Krugman is absolutely correct to inveigh against the "morality play" that sometimes seeps into the Austrian rhetoric surrounding recessions. Personally, I think morality play deserves a much larger place in economics than it currently has( I AGREE. IT'S CALLED POLITICAL ECONOMY ), but a fable in which masses of innocents suffer to absolve the sins of the reckless wealthy is hardly moral(GOOD POINT ). The "hangover theory" is best described as an immorality play, which we are watching unfold before our eyes this every moment as financial assets are relentlessly supported while the value of a pair of hands is let to plummet.

However, recessions and depressions do follow booms, and there are reasons for that. Austrians have their vices, but a vice of Keynesians is to underestimate the role of information. Krugman points out that the hangover theory...

doesn’t explain why there isn’t mass unemployment when bubbles are growing as well as shrinking — why didn’t we need high unemployment elsewhere to get those people into the nail-pounding-in-Nevada business?

The obvious answer is that when there is a boom, entrepreneurs know into what sector resources must be reallocated, and pull already employed workers from existing jobs into the new big thing. During a bust, from a God's eye view, the same process must occur: resources must be shifted out of some sectors and into others( RIGHT NOW, OUT OF HOUSING ). But entrepreneurs are only human. They do not know to where resources might be productively employed, only that they cannot be productively employed where they are. This is the asymmetry, I think, that explains mass unemployment during busts.( TRUE. PEOPLE ARE MOVING INTO NEW JOBS )

Krugman also points out that the hangover theory...

doesn’t explain why recessions reduce unemployment across the board, not just in industries that were bloated by a bubble.

I think that this gets to the point about why it is that only certain kinds of booms lead to great and terrible busts. Industries rise and fall all the time, in good times as well as bad. In the 1980s, there was a great boom in the recording industry owing to the advent of compact discs. The boom eventually went bust, but mass unemployment did not ensue. Hangovers result not from booms in and of themselves, but from booms which result in unhealthy concentration of the aggregate investment portfolio( I WOULD SAY RUNS LEAD TO THE REALLY AWFUL DOWNTURNS ). US capital, viewed as a whole, was overly concentrated in housing and construction this decade. China's capital has been overly concentrated in exports and construction( THERE'S NO REAL "OVERLY" ). Traditional portfolio theory views the menu of investments as fixed, and suggests that investors diversify among them. But in the aggregate, there is only one portfolio extant at any point in time. The art of "macro portfolio theory" is to control the evolution of that portfolio so that it remains reasonably efficient. The easy answers don't work: Micro portfolio choices don't necessarily compose into a dynamically sane macro portfolio( TRUE ). We have reason to be skeptical of very heavy-handed industrial policy. So we have work to do.

I'll end with an intuition: I think that there's a trade-off between microlevel diversification and macro-efficiency. Barry Bosworth warned that "diversification devalues knowledge". One reason that micro portfolio choices fail to compose is because it is often sensible for investors to "buy the market". Every individual has a unique information set, and ideally we would want all that decentralized knowledge "priced into the market" independently of the judgments of others. However, each individual knows that her own information is profoundly uncertain and incomplete, and that the market represents an aggregation of the judgments of millions of others. So, as passive-investment types have been telling us for more than a decade, it may be optimal for individuals to ignore their own information and defer to the judgement of the market-ex-me. (This is a kind of "information cascade".) But, each person who defers to the market increases the concentration of investment decision making, and decreases the breath of information that is priced into the market( I NEED MORE ABOUT THIS ). If the aggregate portfolio is disproportionately by the decisions of a relatively small group of people, there is no reason to suspect its quality would be better than that decided upon by a bureaucracy of planners( THERE MIGHT BE ). There is reason to suspect, in fact, that it would be worse, because at least the planners know they should at least pretend to serve a broad public interest, while private decisionmakers might quite legitimately think they're just trying to get a piece of next year's bonus pool.( THIS IS TOO GENERAL A STATEMENT )

In sum, I think there is a tension between micro diversification and macro diversification. If we want to maintain a well-diversified aggregate portfolio, it may be necessary to restrict the degree to which the portfolio of firms and individuals can be diversified. This implies forcing individuals to bear more risk than they would otherwise choose, in order to reduce systemic risk( THIS I AGREE WITH ). We might be better off by letting individuals shed risk via some form of social insurance( I AGREE ) while forcing investment choices to be sharp, than by encouraging people to blur the information they present in their portfolio choices in order to diversify and hedge."

The goal is to have a system that stops runs without guaranteeing everything. Bagehot's Principle's do just that.

"let the hedge fund Long-Term Capital Management fail in 1998—preferably in a messy and disorderly fashion—we'd be much better off today"

Justin Fox on the Curious Capitalist:

"Tyler Cowen makes the case in Sunday's New York Times( I POSTED ABOUT THIS ) that if the Federal Reserve had just let the hedge fund Long-Term Capital Management fail in 1998—preferably in a messy and disorderly fashion—we'd be much better off today( MAYBE ):

With the Long-Term Capital bailout as a precedent, creditors came to believe that their loans to unsound financial institutions would be made good by the Fed — as long as the collapse of those institutions would threaten the global credit system. Bolstered by this sense of security, bad loans mushroomed.

Sure, he goes on, a "rapid financial deleveraging" might have followed in the wake of an LTCM failure, probably plunging the economy into recession. But that wouldn't have been all bad:

In 1998, there was no collapsed housing bubble, the government's budget was in surplus rather than deficit, bank leverage was much lower, and derivatives markets were smaller and less far-reaching. A financial crisis related to Long-Term Capital, however painful, probably would have been easier to handle than the perfect storm of recent months.

Cowen is saying that occasional financial crises are healthy, even if they lead to recessions, because they teach market participants to take risk seriously. By averting crises and recessions so successfully over the past quarter century, the Fed thus laid the groundwork for the current megacrisis. ( I DON'T AGREE HERE )

It's an argument that makes a lot of intuitive sense, and appeals to practical students of the market—like Barry Ritholtz, who devoted a long, approving post Sunday to Cowen's article. It also shares much with the no-pain, no-gain Austrian theories of the business cycle that Cowen, while not a true believer, treats with far more respect than most academic economists do( I DON'T BELIEVE THIS ).

More typical is Paul Krugman, who once charmingly described Austrian business cycle theory as being "about as worthy of serious study as the phlogiston theory of fire." Krugman was back on the topic Saturday with a blog post tearing into the idea that a downturn could ever be healthy( I AGREE THAT THEY'RE NOT HEALTHY. I'M JUST NOT SURE THAT WE CAN PREVENT THEM ).

I've written about this debate before, in particular the fact that European economists don't seem so deathly afraid of recessions as their American counterparts. I've never really picked a side, though, and I still can't. It seems clear to me that smallish financial crises and concomitant recessions might actually be healthy, or at least necessary evils( HERE I AGREE ). But it seems even clearer that really big financial crises cause so much collateral damage as to swamp any salutary effects. And it's really hard for Fed policymakers to know ahead of time which sort of crisis they are facing( TRUE ).

For a little while, the late summer and early autumn of 1998 felt like the end of the financial world. In retrospect, it looks like it would have been a much better time for a full-on financial panic than 2007-2008 has turned out to be. That doesn't provide a very useful guidepost, though, for economic decisionmakers who don't possess the gift of clairvoyance."( THAT'S A FAIR POINT ).

I believe that LTCM should have been saved by being taken over by the government and then privatized, after which some form of Bagehot's Principles should have been implemented. In fairness to the Fed, I believe that most investors wanted LTCM saved, and expected it to be saved. That's what the government is there for, in their view.

The only change in the current situation has not been in the government responding, which markets and investors were counting on, but in the magnitude of the crisis and the ineffectiveness of the government's response. I would say that what the markets and investors had was complacency, based upon their belief that the S & L Crisis, LTCM, and other financial problems had eventually been effectively dealt with in recent history. The shattering of that complacency is a major contributor to the fear and aversion to risk and the accompanying flight to safety.

"However, the free market does have a cure: it's called a recession, and it's not fun, easy or quick."

A Doomsayer in the WSJ:

"By PETER SCHIFF

As recession fears cause the nation to embrace greater state control of the economy and unimaginable federal deficits( THIS IS TRUE. THAT'S WHY WE DON'T WANT THEM GENIUS ), one searches in vain for debate worthy of the moment( WE CAN HAVE THE DEBATE LATER, RIGHT NOW WE NEED ACTION. THE TWO AREN'T SYNONYMOUS ). Where there should be an historic clash of ideas, there is only blind resignation and an amorphous queasiness that we are simply sweeping the slouching beast under the rug( DON'T BE DAFT. YOU'RE WRITING IN THE WSJ AND YOU'VE BEEN ALL OVER THE TELLY AND BLOGS. THERE ARE PLENTY OF DISSENTING VIEWS. THEY'RE SIMPLY NOT CONVINCING TO MANY OF US ).

With faith in the free markets now taking a back seat to fear and expediency( SILLY ), nearly the entire political spectrum agrees that the federal government must spend whatever amount is necessary to stabilize the housing market, bail out financial firms, liquefy the credit markets, create jobs and make the recession as shallow and brief as possible( TRUE ). The few who maintain free-market views have been largely marginalized( THEIR VIEWS WON'T WORK. WE DON'T HAVE A FREE MARKET. WE HAVE A HYBRID ).

Taking the theories of economist John Maynard Keynes as gospel( IT'S MORE LIKE A NARRATIVE, BUT YOU OBVIOUSLY FAVOR PEJORATIVES AND OVERSTATEMENTS. YOU'VE BEEN READING MENCKEN, PERHAPS. HE WAS ONE OF A KIND ), our most highly respected contemporary economists imagine a complex world in which economics at the personal, corporate and municipal levels are governed by laws( LAWS? LIKE NEWTONIAN MECHANICS? ) far different from those in effect at the national level.

Individuals, companies or cities with heavy debt and shrinking revenues instinctively( THEN WHY HAVEN'T THEY BEEN DOING THAT UNTIL NOW? ) know that they must reduce spending, tighten their belts, pay down debt and live within their means. But it is axiomatic in Keynesianism that national governments can create and sustain economic activity by injecting printed money into the financial system( IT CAN. AN ECONOMY ISN'T A HOUSEHOLD. BY THE WAY SCIENTIST, THE LAWS OF NATURE ALSO APPLY DIFFERENTLY AT DIFFERENT LEVELS OF EXPLANATION, OTHERWISE WE'D HAVE KEYNE'S CAT OR SOME SUCH MONSTROSITY ). In their view, absent the stimuli of the New Deal and World War II, the Depression would never have ended( MORE LIKE TOTALITARIANISM MIGHT HAVE WON ).

On a gut level( IS THAT A DIFFERENT LEVEL THAN THE NATIONAL? WHAT ARE ITS LAWS? ), we have a hard time with this concept( WHAT IS IT AGAIN? ). There is a vague sense( QUITE SPECIFIC AREN'T YOU GALILEO ) of smoke and mirrors, of something being magically created out of nothing( LIKE THE BIG BANG? ). But economics, we are told, is complicated( MORE LIKE OF LIMITED USE ).

It would be irresponsible in the extreme for an individual to forestall a personal recession by taking out newer, bigger loans when the old loans can't be repaid( ACTUALLY, MANY PEOPLE HAVE MAXED OUT THERE CREDIT CARDS, GONE BUST, AND THEN STARTED OVER AGAIN. PRESUMABLY, ON THIS MODEL, COUNTRIES COULD THIS AS WELL. IT DOES APPLY TO CITIES. ). However, this is precisely what we are planning on a national level.( IT'S A SILLY ARGUMENT )

I believe these ideas hold sway largely because they promise happy, pain-free solutions( ARE THOSE NOT TO BE DESIRED? ). They are the economic equivalent of miracle weight-loss programs that require no dieting or exercise( ENOUGH OF THE ANALOGIES ). The theories permit economists to claim mystic wisdom, governments to pretend that they have the power to dispel hardship with the whir of a printing press, and voters to believe that they can have recovery without sacrifice( MAYBE THEY'D LIKE MUTUAL SACRIFICE ).

As a follower of the Austrian School of economics I believe that market forces apply equally to people and nations( I'VE POSTED ON THE PHILOSOPHY OF THE AUSTRIAN SCHOOL. IT HAS SOME VERY USEFUL INSIGHTS, BUT THIS ISN'T ONE OF THEM. ). The problems we face collectively are no different from those we face individually( OF COURSE THEY ARE ). Belt tightening is required by all, including government( FOR A SCIENTIST, YOU THROW AROUND A LOT OF CLICHES ).

Governments cannot create but merely redirect( IS THIS LIKE THE DEBATE ABOUT WHETHER GOD CREATED THE WORLD FROM NOTHING, OR JUST REARRANGED MATTER? ). When the government spends, the money has to come from somewhere( SAME THING WHEN I SPEND ). If the government doesn't have a surplus, then it must come from taxes( THE GOVERNMENT CAN INVEST. YOU'VE JUST GIVEN A WHOLE TREATISE TELLING US THAT THE NATION AND PEOPLE ARE THE SAME ). If taxes don't go up, then it must come from increased borrowing. If lenders won't lend, then it must come from the printing press, which is where all these bailouts are headed( I SHOULD HOPE SO ). But each additional dollar printed diminishes the value those already in circulation ( AND? ). Something cannot be effortlessly( HOW MUCH EFFORT DOES IT TAKE? ) created from nothing.

Similarly, any jobs or other economic activity created by public-sector expansion merely comes at the expense of jobs lost in the private sector( MORE OR LESS ). And if the government chooses to save inefficient jobs in select private industries, more efficient jobs will be lost in others( THERE'S NO WAY TO KNOW THAT A PRIORI. IT'S CONCEIVABLE THAT THE PRIVATE ECONOMY COULD CREATE EVEN LESS EFFICIENT JOBS ). As more factors of production come under government control, the more inefficient our entire economy becomes( OVER THE LONG RUN THAT IS TRUE ). Inefficiency lowers productivity, stifles competitiveness and lowers living standards( TRUE ).

If we look at government market interventions through this pragmatic lens( WHAT'S PRAGMATIC ABOUT WHAT YOU JUST SAID? IT'S ALL THEORY ), what can we expect from the coming avalanche of federal activism( TELL ME )?

By borrowing more than it can ever pay back( HOW'S THAT ? ), the government will guarantee higher inflation for years to come, thereby diminishing the value( NOT REALLY. PRICES WILL VARY BASED ON MANY FACTORS ) of all that Americans have saved and acquired. For now the inflationary tide is being held back by the countervailing pressures of bursting asset bubbles in real estate and stocks, forced liquidations in commodities, and troubled retailers slashing prices to unload excess inventory. But when the dust settles, trillions of new dollars will remain, chasing a diminished supply of goods. We will be left with 1970s-style stagflation, only with a much sharper contraction and significantly higher inflation( NOT ).

The good news is that economics is not all that complicated( USEFUL ). The bad news is that our economy is broken( IT'S NOT A MACHINE. GOD SPARE US MECHANISTIC THINKERS ) and there is nothing the government can do to fix it. However, the free market does have a cure( THAT MAKES THE UNEMPLOYED WHAT ? ): it's called a recession( AREN'T WE GOING THROUGH IT? ), and it's not fun, easy or quick. But if we put our faith( TRY ARGUMENTS, WHICH YOU HAVEN'T EVEN BOTHERED TO ARGUE AGAINST ) in the power of government to make the pain go away, we will live with the consequences for generations( DON'T BE SILLY. IF WE LISTEN TO YOU, WE WILL LIKELY END UP WITH SERIOUS SOCIAL DISLOCATIONS, WHICH, BELIEVE ME, YOU AREN'T PREPARED TO DEAL WITH. )"

I guess if you're rich, you're supposed to be smart. I don't believe that.

Let's go over this once again. The context determines the range of possible actions. Since he likes analogies, the same is true for human communication. The context determines the meaning of a sentence or word. Because our investor class believes in government bailouts and was preparing for them, they were entirely unprepared to handle this crisis on their own. That is the true context of this crisis. The free market does not exist here. We have a Welfare State. Most people accept its terms of operation.

Wittgenstein had a sentence about meaning that applies here:

"If a lion could talk, we could not understand him."

Let's try this:

"If a free market proposal were offered, we could not implement it. "

Let me add a postscript from Thoreau:

"That government is best which governs not at all"; and when men are prepared for it, that will be the kind of government which they will have. "

Men are not prepared for it, including libertarians. It's our job to get them there, but, as a good Burkean, I believe that it will take time and compromise, and nothing is written.

"The present distress stems from both a lack of regulation and too much regulation."

David Merkel with an interesting take on an article that I read in Bloomberg:

"Waiting for the Death of the Chicago School, and the Keynesian School also December 24th, 2008

Bloomberg wrote a piece over the puzzlement that many in the Chicago School of Economics feel at the present time with all of the distress in the markets. After all, don’t markets self-correct? Sadly, no, not all the time, or, at least not with high speed during credit crunches. (All of the econometric studies I have done note a weak tendency to mean reversion in financial markets, even excluding periods where there are credit difficulties.)

For markets to self-correct, it requires that economic agents have enough access to capital( TRUE ) in order to make the investments necessary to arbitrage the differences between the markets that are in disarray( TRUE ). It should be no surprise that during a time where credit is hard to come by, that there are potentially profitable arbitrages that are going begging( I THINK THAT THIS IS IMPORTANT ).

Barry did a post today off of the Bloomberg piece, suggesting the death of the Chicago School. I think that prediction is too early.

I am not a Chicago School economist. I don’t like the neoclassical synthesis. It posits human rationality in ways that make us robots, both individually and collectively( I CALL IT MECHANISTIC ). I have been a critic of their methods through both behavioral economics and nonlinear dynamics, a la the Santa Fe Institute. We need a new paradigm to replace the neoclassical synthesis. It does not adequately describe how mankind behaves( VERY TRUE. WE NEED A HUMAN AGENCY EXPLANATION ) (and we have known that for 25 years — the models don’t predict well, either in micro or macro).

But the answer is not Keynesian policy, in my opinion. Just because markets are unstable, that doesn’t mean that government action can stabilize them over the long run( I AGREE ). In the short-run, while credit is still easily available, yes, government action can work, whether through the Fed, subsidies, or tax incentives( I APPROVE OF THEM ). But Keynesian remedies don’t work when the government can’t easily tax or borrow in order to provide the stimulus. We will face borrowing problems soon enough( TRUE. INFLATION ).

The answers are not to be found by asking the Chicago School or the Keynesians( THEY PROVIDE SOME HELP ). We need an economic theory that accepts the neccessity of moderate booms and busts, where the government does little to try to correct the imbalances( I AGREE ). Moderate imbalances are normal, and if we try to eliminate the moderate busts, wew get a series of small busts, followed by one humongous one. We experienced easy money( I DON'T SEE THIS AS THE CAUSE ) in the 20s, and in the 1990-2000s. Easy money cured the moderate busts, but at a price.

A quick excursus: I agree that tight regulation of financial institutions is necessary if there is fiat money. Controlling the money supply means controlling credit. I don’t like fiat money, and would rather have a gold standard( IT WON'T WORK ), but if we must have fiat money, then make life tough for the banks. Restrict what they can invest in. Regulate lending practices.( I AGREE IF THEY WANT GOVERNMENT GUARANTEES )

The present distress stems from both a lack of regulation and too much regulation( I AGREE ).

Lack of regulation:

• Lack of enforcement on bad lending( THE MOST IMPORTANT CAUSE HERE )
  
• Leverage limits on commercial and investment banks were too loose. ( TRUE ABOUT GUARANTEED BUSINESSES )
  
• Modest limits on the banks dealings with the non-regulated financials. ( MAY BE STRICTER )
  
• Regulatory arbitrage allowed depositary financial to choose weak regulators. ( I CALL IT SHOPPING )
  
• Failure to disallow investment in areas the regulators did not fully understand( I CONSIDER THIS THE REGULATOR'S FAULT ).

Too much regulation:

• Lack of limits on Fed stimulus action (our “independent” central bank was/is compromised) ( DON'T AGREE:SPIGOT THEORY:MECHANISTIC )
  
• Tax deductions for residential real estate, including the home sale capital gains exclusion( THERE SHOULD BE ANY INCENTIVES OR DISINCENTIVES ON HOME BUYING AT ALL ).
• Limiting the number of rating agencies( HUGE PROBLEM: CONFLICT OF INTEREST ON A MASSIVE SCALE ).

My view is that we eventually have to give our currency some backing and get the government out of the money business( THERE WILL ALWAYS BE A LOLR ). Until we get there the ride will be bumpy. We need to transist back to an economy where credit is not easy, but not non-existent, and where total leverage declines( TRUE ). Saving has to become a virtue again( TRUE ), which our present monetary policies will not encourage( SAVING IS A VIRTUE ).

It is too early to declare the demise of the Chicago School, much as it should disappear( DON'T AGREE ). But now we will get the test of the Keynesian School and I predict failure there( TRUE ); they will not solve our crisis. The crisis will end when enough bad debts have been liquidated, and the financial system can begin lending normally again( TRUE ). Call it unrealistic; call it the Austrian School if you like( IT'S USEFUL ) (I have not read and von Mises or Hayek), but it is what restores the financial sector, which cannot live with too much leverage once assets are deflating.

PS — The Bible says that the borrower is servant to the lender. True enough, but if the lender is himself a borrower, like most of our banks, the proverb does not hold. The only lenders that are truly soverign are those that control their own destinies, because they have no debt."

I quote Dr. Johnson again:


"Those who made the laws have apparently supposed, that every deficiency of payment is the crime of the debtor. But the truth is, that the creditor always shares the act, and often more than shares the guilt, of improper trust. It seldom happens that any man imprisons another but for debts which he suffered to be contracted in hope of advantage to himself, and for bargains in which proportioned his own profit to his own opinion of the hazard; and there is no reason, why one should punish the other for a contract in which both concurred."
Johnson: Idler #22 (September 16, 1758)"

For me, Theories are merely more or less useful, not true or false. The Context and Presuppositions of the time cannot be separated from theories dealing with Human Agency. All Three Schools mentioned might supply us with useful suggestions at any point in time. The cannot, however, supply us with the truth. As Yeats says:

"Man can embody truth but he cannot know it. W.B. Yeats"

"As was the case in the 1930s, we also have a choice"

Martin Wolf on Keynes on the FT:

"We are all Keynesians now. When Barack Obama takes office he will propose a gigantic fiscal stimulus package. Such packages are being offered by many other governments. Even Germany is being dragged, kicking and screaming, into this race.

The ghost of John Maynard Keynes, the father of macroeconomics, has returned to haunt us. With it has come that of his most interesting disciple, Hyman Minsky. We all now know of the “Minsky moment” – the point at which a financial mania turns into panic.

Like all prophets, Keynes offered ambiguous lessons to his followers. Few still believe in the fiscal fine-tuning that his disciples propounded in the decades after the second world war ( TRUE ). But nobody believes in the monetary targeting proposed by his celebrated intellectual adversary, Milton Friedman, either( TRUE ). Now, 62 years after Keynes’ death, in another era of financial crisis and threatened economic slump, it is easier for us to understand what remains relevant( I SAY USEFUL ) in his teaching.

I see three broad lessons.

The first, which was taken forward by Minsky, is that we should not take the pretensions of financiers seriously. “A sound banker, alas, is not one who foresees danger and avoids it, but one who, when he is ruined, is ruined in a conventional way along with his fellows, so that no one can really blame him.” Not for him, then, was the notion of “efficient markets”( I AGREE ).

The second lesson is that the economy cannot be analysed in the same way as an individual business. For an individual company, it makes sense to cut costs. If the world tries to do so, it will merely shrink demand( AS A WHOLE, I CAN UNDERSTAND THIS ). An individual may not spend all his income. But the world must do so( TRY TO ).

The third and most important lesson is that one should not treat the economy( ECONOMICS IS FINE HERE ) as a morality tale( HERE I DISAGREE COMPLETELY. MORALITY IS PART OF POLITICAL ECONOMY ). In the 1930s, two opposing ideological visions( THERE WERE OTHERS, THANKFULLY DEFEATED ) were on offer: the Austrian; and the socialist. The Austrians – Ludwig von Mises and Friedrich von Hayek – argued that a purging of the excesses of the 1920s was required. Socialists argued that socialism needed to replace failed capitalism, outright. These views were grounded in alternative secular religions: the former in the view that individual self-seeking behaviour guaranteed a stable economic order(I DON'T AGREE WITH HIM HERE. VON MISES CRITIQUE OF SOCIALISM WAS MORE THAN A MORALITY TALE, AND SO WERE HAYEK'S VIEWS ABOUT THE MARKET AND THE DANGERS OF TOO MUCH STATE CONTROL); the latter in the idea that the identical motivation could lead only( IT WAS THIS MECHANISTIC APPROACH TO POLITICS AND POLITICAL ECONOMY THAT MADE MARXISM, FOR EXAMPLE, NOT SUITABLE FOR HUMAN CONSUMPTION ) to exploitation, instability and crisis.

Keynes’s genius – a very English one – was to insist we should approach an economic system not as a morality play but as a technical challenge( WRONG ). He wished to preserve as much liberty as possible( I AGREE. AS DO I. ), while recognising that the minimum state( HERE I DISAGREE ) was unacceptable to a democratic society with an urbanised economy( I CAN FORESEE A TIME OF LESS GOVERNMENT INVOLVEMENT, BUT THIS IS CURRENTLY TRUE ). He wished to preserve a market economy, without believing that laisser faire makes everything for the best in the best of all possible worlds( I WOULD SEEM TO AGREE WITH HIM ).

This same moralistic debate is with us, once again. Contemporary “liquidationists” insist that a collapse would lead to rebirth of a purified economy( COMPLETELY UNBURKEAN ). Their leftwing opponents argue that the era of markets is over. And even I wish to see the punishment of financial alchemists who claimed that ever more debt turns economic lead into gold( I WOULD LIKE TO SEE THE PUNISHMENT OF CRIMINALS ).

Yet Keynes would have insisted that such approaches are foolish. Markets are neither infallible nor dispensable( TRUE. THEY ARE USEFUL. ). They are indeed the underpinnings of a productive economy and individual freedom( TRUE ). But they can also go seriously awry and so must be managed with care( TRUE ). The election of Mr Obama surely reflects a desire for just such pragmatism( TRUE ). Neither Ron Paul, the libertarian, nor Ralph Nader, on the left, got anywhere( TRUE ). So the task for this new administration is to lead the US and the world towards a pragmatic resolution of the global economic crisis we all now confront.( I AGREE )

The urgent task is to return the world economy to health.

The shorter-term challenge is to sustain aggregate demand( YES ), as Keynes would have recommended. Also important will be direct central-bank finance of borrowers( YES ). It is evident that much of the load will fall on the US, largely because the Europeans, Japanese and even the Chinese are too inert, too complacent, or too weak( TOO MUCH BEGGARING ON THEIR PART ALREADY ). Given the correction of household spending under way in the deficit countries( SPENDER COUNTRIES ), this period of high government spending is, alas, likely to last for years( BTREATHE DEEPLY MATE ). At the same time, a big effort must be made to purge the balance sheets of households and the financial system. A debt-for-equity swap is surely going to be necessary( IT WON'T NEARLY BE AS LARGE AS HE THINKS. TOO MANY PEOPLE WANT THE OLD SYSYEM BACK. IT SUITS US. ).

The longer-term challenge is to force a rebalancing of global demand. Deficit( SPENDER ) countries cannot be expected to spend their way into bankruptcy( TRUE ), while surplus ( SAVER )countries condemn as profligacy the spending from which their exporters benefit so much( THAT'S WHY THEY'RE STRUGGLING TO KEEP THIS SYSTEM ). In the necessary attempt to reconstruct the global economic order, on which the new administration must focus, this will be a central issue. It is one Keynes himself had in mind when he put forward his ideas for the postwar monetary system at the Bretton Woods conference in 1944.

No less pragmatic must be the attempt to construct a new system of global financial regulation and an approach to monetary policy that curbs credit booms and asset bubbles( WE'LL TRY ). As Minsky made clear, no permanent answer exists( TRUE ). But recognition of the systemic frailty of a complex financial system would be a good start( OK ).

As was the case in the 1930s, we also have a choice: it is to deal with these challenges co-operatively and pragmatically or let ideological blinkers and selfishness obstruct us ( I AGREE ). The objective is also clear: to preserve an open and at least reasonably stable world economy that offers opportunity to as much of humanity as possible( I AGREE ). We have done a disturbingly poor job of this in recent years. We must do better. We can do so, provided we approach the task in a spirit of humility and pragmatism, shorn of ideological blinker. ( WE GET THE POINT )

As Oscar Wilde might have said, in economics, the truth is rarely pure and never simple. That is, for me, the biggest lesson of this crisis. It is also the one Keynes himself still teaches( I AGREE )."

He gets a bit simplistic, but I generally agree with what he's saying, except for the fact that, long term, I believe that less government with a growing and balanced economy is possible. Keynes view is still too rooted in the 30s to be of major use to us undigested, and is much too pessimistic and mechanistic, as that era tended to be. Again, Political Economy and Politics are underpinned by the context and presuppositions of the time.

What Keynes offers us is a little useful wisdom and a narrative of perceived success at helping the world out of a crisis, which goes a long in times like these.

"investigating how human psychological limits lead to bad private-sector contract design that then magnifies psychological biases."

Brad DeLong at Cato:

"Think of it this way: two years ago we lived in a world in which the wealth of global owners of capital was some $80 trillion — that was the market value of all of their property rights to dividends and contract rights to interest, rent, royalties, options, and bonuses. Now over time the wealth of global capital fluctuates, and it fluctuates for five reasons:

1. Savings and Investment: Savings that are transformed into investment add to the productive physical — and organizational, and technological, and intellectual — capital stock of the world. This is the first and in the long run the most important source of fluctuations — in this case, growth — in global capital wealth. ( WHAT ABOUT INVESTMENTS IN HOUSING? )
2. News: Good and bad news about resource constraints, technological opportunities, and political arrangements raise or lower expectations of the cash that is going to flow to those with property and contract rights to the fruits of capital in the future. Such news drives changes in expectations that are a second source of fluctuations in global capital wealth. ( WHAT ABOUT OIL CONCERNS? )
3. Default Discount: Not all the deeds and contracts will turn out to be worth what they promise or indeed even the paper that they are written on. Fluctuations in the degree to which future payments will fall short of present commitments are a third source of fluctuations in global capital wealth.
4. Liquidity Discount: The cash flowing to capital arrives in the present rather than the future, and people prefer — to varying degrees at different times — the bird in the hand to the one in the bush that will arrive in hand next year. Fluctuations in this liquidity discount are yet a fourth source of fluctuations in global capital wealth.
5. Risk Discount: Even holding constant the expected value and the date at which the cash will arrive, people prefer certainty to uncertainty. A risky cash flow with both upside and downside is worth less than a certain cash flow by an amount that depends on global risk tolerance. Fluctuations in global risk tolerance are the fifth and final source of fluctuations in global capital wealth.

In the past two years the wealth that is the global capital stock has fallen in value from $80 trillion to $60 trillion. Savings has not fallen through the floor. We have had little or no bad news about resource constraints, technological opportunities, or political arrangements. Thus (1) and (2) have not been operating. The action has all been in (3), (4), and (5).

As far as (3) is concerned, the recognition that a lot of people are not going to pay their mortgages and thus that a lot of holders of CDOs, MBSs, and counterparties, creditors, and shareholders of financial institutions with mortgage-related assets has increased the default discount by $2 trillion. And the fact that the financial crisis has brought on a recession has further increased the default discount — bond coupons that won’t be paid and stock dividends that won’t live up to firm promises — by a further $4 trillion. So we have a $6 trillion increase in the magnitude of (3) the default discount. The problem is that we have a $20 trillion decline in market values."

That leaves $14 trillion. Where are these figures from?

"The problem is made bigger by the fact that for (4), the Federal Reserve, the European Central Bank, and the Bank of England have flooded the market with massive amounts of high-quality liquid claims on governments’ treasuries, and so have reduced the liquidity discount — not increased it — by an amount that I estimate to be roughly $3 trillion. Thus (3) and (4) together can only account for a $3 trillion decrease in market value. The rest of that decline in the value of global capital — all $17 trillion of it — thus comes by arithmetic from (5): a rise in the risk discount. There has been a massive crash in the risk tolerance of the globe’s investors."

Okay. $17 trillion from 5.

"Thus we have an impulse — a $2 trillion increase in the default discount from the problems in the mortgage market — but the thing deserving attention is the extraordinary financial accelerator that amplified $2 trillion in actual on-the-ground losses in terms of mortgage payments that will not be made into an extra $17 trillion of lost value because global investors now want to hold less risky portfolios than they wanted two years ago."

This makes sense to me given the magnitude of the fear and aversion to risk, and accompanying flight to safety. It must be enormous.

"From my standpoint, the puzzle is multiplied by the fact that we economists have what we regard as pretty good theories about (4) and (5), and yet those theories do not seem to work at all. As far as the liquidity discount (4) is concerned as long as we love our children as ourselves (and most of us do) and as long as we have access to and can credibly pledge collateral for financial transactions (and we can) the magnitude of the liquidity discount should be roughly equal to the technologically and organizationally driven rate of labor productivity growth divided by the intertemporal elasticity of substitution. The technologically and organizationally driven rate of labor productivity growth is a fairly steady 2 percent per year. The intertemporal elasticity of substitution is in the range from 1/2 to 1. The liquidity premium should be in the range of 2% to 4% per year in real terms — and no central bank should be able to drop it to 2% per year by a few open-market operations: big moves in the liquidity premium should require big moves in expected future growth rates of consumption. Perhaps in the old days — back when banknotes and demand deposits backed fractionally by gold or central-bank reserves were the only liquid stores of value, the only means of payment, the only mediums of exchange, or the even older days when the king’s picture on a disc of gold was it, and when the torturers of the Mint and the Tower were standing by — things were different and credit expansion via the use of the seigniorage power could have greater effects. But today the ability of central banks to swing the liquidity discount as they have in the past year and a half is a mystery."

I think that this is possible:

"big moves in the liquidity premium should require big moves in expected future growth rates of consumption."

"Things are even worse as far as the risk discount is concerned. Our models predict that in normal times, with the ability to diversify portfolios that exists today, the risk discount on assets like corporate equities should be around 1% per year. It is more like 5% per year in normal times — and more like 10% per year today. And our models for why the risk discount has taken such a huge upward leap in the past year and a half are little better than simple handwaving and just-so stories. Our current financial crisis remains largely a mystery: a $2 trillion impulse in lost value of securitized mortgages has set in motion a financial accelerator that we do not understand at any deep level but that has led to ten times the total losses in financial wealth of the impulse."

I think that it's understandable, but doesn't make sense. That's what a Human Agency Explanation can afford you.

"Thus my dissatisfaction with Larry White’s piece: he talks only about the impulse, while it is the propagation mechanism — the financial accelerator — that is the important part of the story. $2 trillion shocks to global wealth do, after all, happen every several years, every time there is a recession or a big rise in the prices of natural resources. But financial distress of the magnitude we see today happens once a century. Since the Bank of England developed its lender of last resort doctrine in the 1830s, we have only had two episodes this bad: the Great Depression and today."

This is a fair point. It's weird, by any standard.

"Moreover, I do not think that Larry White has gotten the part of the story that he does cover right. I am not convinced of his account of the origins of the trouble in the housing finance market. Larry White blames government subsidies: the implicit government guarantee offered to FNMA and FHLMC, the explicit guarantee to the FHA, the requirements of the CRA, and the subsidy to borrowers provided by the Federal Reserve’s credit expansion — i.e., its open-market operations that bought Treasury bills for cash."

I think that it is the guarantees, but not for the reasons White does. However, DeLong is correct, these subsidies are a small part of the problem.

"From the start of 2002 to the start of 2006 the Federal Reserve bought $200 billion in Treasury bills for cash. This $200 billion reduction in outstanding bonds and increase in cash surely did lead to an increase in demand for private bonds. But recall the magnitudes here. We have $2 trillion of losses on $8 trillion in face value of mortgages that ex post should not have been made. Are we supposed to believe that $200 billion of open-market purchases by the Fed drives private agents into making $8 trillion of privately unprofitable loans? Not likely. I can see how monetary contraction can make previously profitable loans unprofitable. But I see no way that this amount of monetary expansion can force private agents to make that amount of unprofitable loans. The magnitudes just do not match."

I agree. It's a Mechanistic Explanation. It won't add up.

"The requirements of the CRA also appear to me to be a red herring. Larry White writes that those who blame the crisis on greed are wrong because “greed… is always around” and you cannot explain a variable result by a constant cause “just as one can’t explain a cluster of airplane crashes by citing gravity.” I say that the same is true of the CRA. It has been around in more-or-less its current form for a generation."

I agree.

"FHA, FNMA, and FHLMC make up the last of the actors to whom Larry White attributes the impulse — the $8 trillion in unwise mortgage loans made over the past five years. Once again the problem is that they have been around for a while. White tried to deal with this by saying that the GSEs changed their policies by cutting severely on down payment requirements — and that the private-sector mortgage lenders had no choice but to match them."

I don't accept this explanation. These incentives are just that. They cannot excuse stupid and fraudulent lending. That sort of explanation is Mechanistic as well. They do not explain the magnitude of what happened.

"This claim provokes two immediate reactions. First, as your mother says: “If Freddie jumps off a cliff is that a good reason for you to follow him?” The answer to your mother’s question is: “No.” Just because GSEs are leading the market in making stupid money-losing loans did not force private financial companies to follow them and so lose their money too."

I completely agree.

"Second, Freddie and Fannie and FHA were not the first to jump off the cliff. They lost huge amounts of market share in the mid 2000s. We don’t have a crisis which started when private mortgage lenders losing market share cut back on the quality of the loans they were willing to make. We have a crisis which started when private mortgage lenders cut back on the quality of the loans they were willing to make and so gained market share. The sequence is the opposite of what would have happened if White were correct."

It's not the Freddie/Fannie problem that is the main culprit.

"Moreover, if ill-judged loans by the GSEs were the problem, we would expect to see a crisis in which FNMA and FHLMC failed first — which they did not, their troubles coming back in the line well after the Countrywides and the Bear Sternses. And we would expect the failure of FNMA and FHLMC to take the form of them leaking cash as the number of mortgage payments they received crashed with defaults and consequent foreclosures. Instead Fannie and Freddie are still cash-flow positive — as long as they can borrow at nearly the Treasury rate. Fannie and Freddie crashed not because their revenues collapsed but because their borrowing costs ballooned. At it looks right now as though government ownership of 80 percent of Fannie and Freddie will bring money into the Treasury over the next five years."

There was a problem with the implicit, actually explicit guarantees, that did cause problems for this particular program. But it's a small part of our crisis. Let's move on from this issue.

"So why does Larry White’s diagnosis of what is going on differ so much from mine? I think that what is going on is a characteristic weakness of the Austrian tradition: the baseline assumption that all evils must have their origin in some form of government misregulation. If government could be drowned in the bathtub, then an Eden in which people indulged in their natural propensity to truck, barter, and exchange would emerge. And this automatically rules out what I regard as the most likely and fruitful road to walk down to understand this financial crisis: the road that starts from investigating how human psychological limits lead to bad private-sector contract design that then magnifies psychological biases."

This is what I call a Human Agency Explanation. Excellent.

"I am not happy with the state of such explanations — they seem to involve, at the moment, a great deal of handwaving. But in my judgment it is less handwaving than required to make the case that our current financial crisis is the result of our abandonment of a proper gold standard and our embrace of fractional-reserve banking and government-sponsored mortgage lending enterprises."

Those explanations are Mechanistic, and will get you into a pickle, not out of one. This was an excellent post from DeLong. I listed a few questions I'd like answered, but, otherwise, a great job.

"the main propositions about economics that so-called Austrians believe."

Via Positive Liberty, I came upon this credo of Austrian Economics put up by Peter Boettke :

"Proposition 1: Only individuals choose.

Man, with his purposes and plans, is the beginning of all economic analysis. Only individuals make choices; collective entities do not choose. The primary task of economic analysis is to make economic phenomena intelligible by basing it on individual purposes and plans; the secondary task of economic analysis is to trace out the unintended consequences of individual choices."

I'm not sure that I understand this. Can't a Union, say, the UAW, choose to ratify a contract? Also, I don't understand what it means to say "make economic phenomena intelligible", if all there is to describe are individual actions. In order to describe a person's choice, say, why he chose an apple instead of a pear, you simply ask him. His intentions make his decision intelligible. All economic choices are is really a subset of human choices and actions that have to do with things like buying and selling. In the same way, one can only have an unintended consequence of an action where one has an intention to be fulfilled by the action that goes sideways, or that one didn't foresee. However, an unintended consequence can't simply mean anything that flows from a particular action, otherwise it encompasses consequences that can't be humanly predicted, and, therefore, can't even be intended.

When you limit or delimit a range of human action as economic, you are already abstracting out a quality that rises over and above individual actions. It's the difference between the members of the set, and the set. To the extent that you attempt to standardize, regularize, or categorize, particular human actions, you are describing something over and above the individual, unless saying that individuals make choices and collective entities do not, simply means that collective entities are not physical. Yet, even that seems false, since a club can be a group of particular individuals. This seems a lot like Russell trying to define numbers with sets, and getting into a bit of jam by doing so, as I remember.

A point about methodology. It's no good telling me that something I can say meaningfully doesn't really mean anything. If I say, "The Chess Club is meeting on Tuesday", you can't reply that I really mean to say that " The members of the Chess Club are going to meet on Tuesday". Suppose I say, "The Chess Club is 100 years old". Do I mean to say that the members of the club are all 100 years old?

"Proposition 2: The study of the market order is fundamentally about exchange behavior and the institutions within which exchanges take place.

The price system and the market economy are best understood as a “catallaxy,” and thus the science that studies the market order falls under the domain of “catallactics.” These terms derive from the original Greek meanings of the word “katallaxy”—exchange and bringing a stranger into friendship through exchange. Catallactics focuses analytical attention on the exchange relationships that emerge in the market, the bargaining that characterizes the exchange process, and the institutions within which exchange takes place."

This sounds like barter. Here's Liddell:

katallagê ¹

I.exchange, esp. of money: the profits of the money-changer, Dem.

II.a change from enmity to friendship, reconciliation, Aesch., etc.

2.reconciliation of sinners with God, NTest.

I like number three. None of them fit. Anyway, from Wikipedia, this is funny:

"According to Mises (Human Action, page 3) it was Richard Whately who coined the term "catallactics". In effect, in Whately's book Introductory Lectures on Political Economy, published in 1831, it can be read:

"It is with a view to put you on your guard against prejudices thus created, (and you will meet probably with many instances of persons influenced by them,) that I have stated my objections to the name of Political-Economy. It is now, I conceive, too late to think of changing it. A. Smith, indeed, has designated his work a treatise on the "Wealth of Nations;" but this supplies a name only for the subject-matter, not for the science itself. The name I should have preferred as the most descriptive, and on the whole least objectionable, is that of CATALLACTICS, or the "Science of Exchanges.""

Also, in a footnote to these sentences, he continues:

"It is perhaps hardly necessary to observe, that I do not pretend to have classical authority for this use of the word Catallactics; nor do I deem it necessary to make any apology for using it without such authority. It would be thought, I conceive, an absurd pedantry to find fault with such words as "thermometer," "telescope," "pneumatics," "hydraulics," "geology," &c. on the ground that classical Greek writers have not employed them, or have taken them in a different sense. In the present instance, however, I am not sure that, if Aristotle had had occasion to express my meaning, he would not have used the very same word. In fact I may say he has used another part of the same verb in the sense of "exchanging;" (for the Verbals in are, to all practical purposes, to be regarded as parts of the verbs they are formed from) in the third book of the Nicom. Ethics he speaks of men who hold their lives so cheap, that they risked them in exchange for the most trifling gain []. The employment of this and kindred words in the sense of "reconcilement," is evidently secondary, reconciliation being commonly effected by a compensation; something accepted as an equivalent for loss or injury."

It has also been cited that Whately first coined the term in commentary during his Oxford lectures. ^[3]

I love when he says," nor do I deem it necessary to make any apology for using it without such authority". No. But you need to spend a paragraph justifying it.

I think I said buying and selling earlier, without have to search through Liddell. What about the institutions? Fine. But this kind of defining the limits of a subject is messy.

"Proposition 3: The “facts” of the social sciences are what people believe and think.

Unlike the physical sciences, the human sciences begin with the purposes and plans of individuals. Where the purging of purposes and plans in the physical sciences led to advances by overcoming the problem of anthropomorphism, in the human sciences, the elimination of purposes and plans results in purging the science of human action of its subject matter. In the human sciences, the “facts” of the world are what the actors think and believe.

I would say that Human Agency has Intentionality.

"The meaning that individuals place on things, practices, places, and people determines how they will orient themselves in making decisions. The goal of the sciences of human action is intelligibility, not prediction. The human sciences can achieve this goal because we are what we study, or because we possess knowledge from within, whereas the natural sciences cannot pursue a goal of intelligibility because they rely on knowledge from without. We can understand purposes and plans of other human actors because we ourselves are human actors."

I agree.

"But unless the Martian comes to understand the purposes and plans (the commuting to and from work), his “scientific” understanding of the data from Grand Central Station would be limited. The sciences of human action are different from the natural sciences, and we impoverish the human sciences when we try to force them into the philosophical/scientific mold of the natural sciences."

The Martian would use the Martian version of the Principle of Charity. Read Quine.

"Proposition 4: Utility and costs are subjective.

All economic phenomena are filtered through the human mind. Since the 1870s, economists have agreed that value is subjective, but, following alfred marshall, many argued that the cost side of the equation is determined by objective conditions. Marshall insisted that just as both blades of a scissors cut a piece of paper, so subjective value and objective costs determine price (see microeconomics). But Marshall failed to appreciate that costs are also subjective because they are themselves determined by the value of alternative uses of scarce resources. Both blades of the scissors do indeed cut the paper, but the blade of supply is determined by individuals’ subjective valuations."

Marshall is philosophically correct. Cost is not Subjective. Cost can be no more subjective than the meaning of a word. We can't have a Private Language, and we can't have a Private Cost.

As Wittgenstein says:

94. But I did not get my picture of the world by satisfying myself of its correctness; nor do I have it because I am satisfied of its correctness. No: it is the inherited background against which I distinguish between true and false.

Institutions and the meanings of words and the cost of a pear are objective, not subjective. What is subjective is my decision to buy the pear or not.

"In deciding courses of action, one must choose; that is, one must pursue one path and not others. The focus on alternatives in choices leads to one of the defining concepts of the economic way of thinking: opportunity costs. The cost of any action is the value of the highest-valued alternative forgone in taking that action. Since the forgone action is, by definition, never taken, when one decides, one weighs the expected benefits of an activity against the expected benefits of alternative activities."

This is not how human beings act. This picture is an abstraction, an attempt to organize disparate intentions and actions. Nothing more. It might be useful, but it is not true.

As Yeats says:

"Man can embody truth but he cannot know it. W.B. Yeats"

"Proposition 5: The price system economizes on the information that people need to process in making their decisions.

Prices summarize the terms of exchange on the market. The price system signals to market participants the relevant information, helping them realize mutual gains from exchange. In Hayek’s famous example, when people notice that the price of tin has risen, they do not need to know whether the cause was an increase in demand for tin or a decrease in supply. Either way, the increase in the price of tin leads them to economize on its use. Market prices change quickly when underlying conditions change, which leads people to adjust quickly."

The price system is useful to us. Nothing more. If something was or becomes more useful, we will use that. It has no special magic.

"Proposition 6: Private property in the means of production is a necessary condition for rational economic calculation.

Economists and social thinkers had long recognized that private ownership provides powerful incentives for the efficient allocation of scarce resources. But those sympathetic to socialism believed that socialism could transcend these incentive problems by changing human nature. Ludwig von Mises demonstrated that even if the assumed change in human nature took place, socialism would fail because of economic planners’ inability to rationally calculate the alternative use of resources. Without private ownership in the means of production, Mises reasoned, there would be no market for the means of production, and therefore no money prices for the means of production. And without money prices reflecting the relative scarcities of the means of production, economic planners would be unable to rationally calculate the alternative use of the means of production."

The only book by Von Mises that I really liked was "Socialism". It is the best book on the subject. I haven't read it for many years, but as I remember it, Von Mises said that if Socialism could do what is says it can, we would all be socialists. However, it cannot. That's my opinion, but my opinion is provisional. I don't like the human nature argument at all. It could be that the reason private property works has nothing to do with what we tell ourselves. What has come about has done so because it works, not because it was preordained. We merely perceive what works as preordained.

"Proposition 7: The competitive market is a process of entrepreneurial discovery.

Many economists see competition as a state of affairs. But the term “competition” invokes an activity. If competition were a state of affairs, the entrepreneur would have no role. But because competition is an activity, the entrepreneur has a huge role as the agent of change who prods and pulls markets in new directions.

The entrepreneur is alert to unrecognized opportunities for mutual gain. By recognizing opportunities, the entrepreneur earns a profit. The mutual learning from the discovery of gains from exchange moves the market system to a more efficient allocation of resources. Entrepreneurial discovery ensures that a free market moves toward the most efficient use of resources. In addition, the lure of profit continually prods entrepreneurs to seek innovations that increase productive capacity. For the entrepreneur who recognizes the opportunity, today’s imperfections represent tomorrow’s profit.1 The price system and the market economy are learning devices that guide individuals to discover mutual gains and use scarce resources efficiently."

The most efficient uses of resources for what? I actually helped start a business. It was formed really out of dissatisfaction by the two other people who started the business with me with the business we were working at. I simply went along for the ride. People starts businesses for many different reasons. They do it. That's what we need to know. Some incentives might work once, and not work later. That's life.

"Proposition 8: Money is nonneutral.

Money is defined as the commonly accepted medium of exchange. If government policy distorts the monetary unit, exchange is distorted as well. The goal of monetary policy should be to minimize these distortions. Any increase in the money supply not offset by an increase in money demand will lead to an increase in prices. But prices do not adjust instantaneously throughout the economy. Some price adjustments occur faster than others, which means that relative prices change. Each of these changes exerts its influence on the pattern of exchange and production. Money, by its nature, thus cannot be neutral...

But inflation is socially destructive on several levels. First, even anticipated inflation breaches a basic trust between the government and its citizens because government is using inflation to confiscate people’s wealth. Second, unanticipated inflation is redistributive as debtors gain at the expense of creditors. Third, because people cannot perfectly anticipate inflation and because the money is added somewhere in the system—say, through government purchase of bonds—some prices (the price of bonds, for example) adjust before other prices, which means that inflation distorts the pattern of exchange and production."

I generally agree with this, but it strikes me as exaggerated. A little inflation might well work for reasons that are hard to define. Major discontinuities are generally destructive.

"Since money is the link for almost all transactions in a modern economy, monetary distortions affect those transactions. The goal of monetary policy, therefore, should be to minimize these monetary distortions, precisely because money is nonneutral.2"

I don't know what's being distorted. It's like saying that if a planet does something different than expected, and varies from our models, it's a distortion. Rather, it's simply that our models are of limited use.

"Proposition 9: The capital structure consists of heterogeneous goods that have multispecific uses that must be aligned.

Right now, people in Detroit, Stuttgart, and Tokyo City are designing cars that will not be purchased for a decade. How do they know how to allocate resources to meet that goal? Production is always for an uncertain future demand, and the production process requires different stages of investment ranging from the most remote (mining iron ore) to the most immediate (the car dealership). The values of all producer goods at every stage of production derive from the value consumers place on the product being produced. The production plan aligns various goods into a capital structure that produces the final goods in, ideally, the most efficient manner. If capital goods were homogeneous, they could be used in producing all the final products consumers desired. If mistakes were made, the resources would be reallocated quickly, and with minimal cost, toward producing the more desired final product. But capital goods are heterogeneous and multispecific; an auto plant can make cars, but not computer chips. The intricate alignment of capital to produce various consumer goods is governed by price signals and the careful economic calculations of investors. If the price system is distorted, investors will make mistakes in aligning their capital goods. Once the error is revealed, economic actors will reshuffle their investments, but in the meantime resources will be lost"

I don't understand the use of "distorted". People use the information available as best they can. If they make too many cars, why is that a "distortion"? If I throw a pitch and it's called a ball, is that a distortion?

"Proposition 10: Social institutions often are the result of human action, but not of human design.

Many of the most important institutions and practices are not the result of direct design but are the by-product of actions taken to achieve other goals. A student in the Midwest in January trying to get to class quickly while avoiding the cold may cut across the quad rather than walk the long way around. Cutting across the quad in the snow leaves footprints; as other students follow these, they make the path bigger. Although their goal is merely to get to class quickly and avoid the cold weather, in the process they create a path in the snow that actually helps students who come later to achieve this goal more easily. The “path in the snow” story is a simple example of a “product of human action, but not of human design” (Hayek 1948, p. 7).

The market economy and its price system are examples of a similar process. People do not intend to create the complex array of exchanges and price signals that constitute a market economy. Their intention is simply to improve their own lot in life, but their behavior results in the market system. Money, law, language, science, and so on are all social phenomena that can trace their origins not to human design, but rather to people striving to achieve their own betterment, and in the process producing an outcome that benefits the public.4

This seems true. As Austin says:

"...our common stock of words embodies all the distinctions men have found worth drawing, and the connections they have found worth marking, in the lifetime of many generations: these surely are likely to be more numerous, more sound, since they have stood up to the long test of survival of the fittest, and more subtle, at least in all ordinary and reasonable practical matters, than any that you or I are likely to think up in our armchair of an afternoon – the most favorite alternative method"

"The implications of these ten propositions are rather radical. If they hold true, economic theory would be grounded in verbal logic and empirical work focused on historical narratives. With regard to public policy, severe doubt would be raised about the ability of government officials to intervene optimally within the economic system, let alone to rationally manage the economy.

Perhaps economists should adopt the doctors’ creed: “First do no harm.” The market economy develops out of people’s natural inclination to better their situation and, in so doing, to discover the mutually beneficial exchanges that will accomplish that goal. Adam Smith first systematized this message in The Wealth of Nations. In the twentieth century, economists of the Austrian school of economics were the most uncompromising proponents of this message, not because of a prior ideological commitment, but because of the logic of their arguments."

I don't see these propositions as that radical, and they seem true, by and large, as does this final statement. I also don't like the phrase "logic of their arguments". All this says is that the proposition follow from each other, not that they are true. Logic needs premises.

Am I an adherent of Austrian Economics? No. It seems to be a misnomer, for one thing. But do the economists mentioned in this group have a lot of important things to tell us? Yes.