An Austrian on the Coming Recession
An Austrian on the Coming Recession
Economists all over the theoretical and policy maps seem to be finally coming to grips with the fact that the upside of the latest business cycle has ended. The only real debate now is how fast, how far and how long. My daily Google search on “economic recession” turned up the last perspective from one Austrian economist, Clifford F. Thies of Shenandoah University in Virginia. I found it interesting. Perhaps others will as well. This is a condensed, excerpted version, with my own comments [EJD] added.
DEALING WITH RECESSION
Before, we would respond to complaints about the global economy taking away jobs by saying a 4 percent unemployment rate means we have roughly full employment. Now, we can say, while 5 or 6 percent unemployment is a low level of unemployment by historical standards, its recent uptick is indicative of a slowing down of an economy and possibly of the start of a recession. [EJD: If a growing percentage of the employed are receiving less income than previously because of downsizing and out-sourcing, should economics change the definition of unemployment?]
Hopefully, the listener will be assuaged by the sympathetic response, and not ask if there is a connection between the global economy and the recession, because we would have to explain that, because of the recent surge in exports, the recessionary pressure that has developed has been ameliorated by the global economy. [EJD: More accurately, by the willingness of foreigners to purchase U.S. government debt even as low rates of interest and the loss of purchasing power of the U.S. dollar result in actual lost purchasing power]
Instead of responding to complaints about the high rate of inflation by saying a 2 percent rate of inflation is pretty close to price stability, we can now say that a rate of inflation of 3 or 4 percent, which has been accelerating recently, is indeed a cause for concern. [EJD: If only economists as a group would demand that government change the definition of inflation to describe reality]
For all the talk by the Federal Reserve about "inflation targeting," we now see that responding to short-run problems is paramount for the Fed. Holding the line on inflation is something the Fed does when it is convenient. Resorting to inflating the money supply when times are tough is predictable, as is a continuing loss of purchasing power of the US dollar. The only uncertainty is how fast the dollar will lose purchasing power. Will it be at a creeping rate, or at a galloping rate, or at a hyperinflationary rate?
You might think that we learned our lesson about inflation during the 1970s, when we moved first from a creeping to a galloping rate, and then risked a further move to hyperinflation. The double-dip recession we then went through starting in 1979 fell in the second tier of economic downturns (below only the Great Depression). There is currently no indication that a severe downturn is on the horizon. But, if we work hard enough at it, with fiscal and monetary policy pumping up the economy and delaying and exacerbating the inevitable, we can make such a severe recession possible in the future. [EJD: Hmmm… Does the fact that the level of household debt as a multiple of annual household income is at record levels, or that servicing the U.S. government debt costs $500 billion annually not provide some indication of a coming downturn?]
This brings me to the Austrian approach to the business cycle and the suddenly revived Keynesian approach embraced by the Federal Reserve, the Bush Administration, the Congress, and the popular media. The Austrian approach would call for the quick and even ruthless liquidation of the malinvestments that were made during the misguided prior boom in the economy. In contrast, the Keynesian approach talks in terms of aggregates without differentiating one type of investment from another, as though the spending of tax rebate checks will have a meaningful impact on the particular sectors of the economy that are in trouble. [EJD: So far, so good, if he defines “mailinvestments”]
In the Austrian view, many business cycles are manifestations of interconnected periods of boom and bust. The boom occurs when the normally prudent risk taking of businesspeople is replaced by overoptimism, and is financed by the creation of credit. A central bank isn't even necessary for this to happen, as private banks are perfectly capable of creating credit on their own, through relaxed standards of creditworthiness. However, now that central banks are around, we can suspect that they aid and abet the process of credit creation, which distorts signals to investors, since the created credit does not reflect decisions by households to save. To revive some antiquated terminology, the created credit is a form of "forced savings," and embeds a disequilibrium into the economy that will eventually reveal itself. [EJD: Is there anyone left who believes bankers have learned anything from past crashes?]
The unwinding of the positions taken during the boom is never very simple, because once capital is invested it loses its initial fungible quality. Initially, capital might be invested in this industry or in that. But, once invested, it usually cannot be easily recovered for reinvestment in a manner better aligned with consumer demands. After the collapse of the dot-com boom, it was not economically possible for companies to recover their investments in hardware and software, and it would have been silly for highly trained programmers to try to become welders or health professionals, honorable as all of these occupations are. Instead, the companies and the people had to make the best of their situations until real growth in the economy, and the normal course of depreciation, obsolescence and retirement restored a balance between supply and demand for the industry.
It is similar today, with the malinvestment in upscale, single family homes in many real estate markets. As long as we don't do anything really stupid, we can expect that over the next few years, our economy will grow enough to absorb the present glut in most of these markets. [EJD: What this means to me is that land prices must fall sufficiently so that housing expenses (what is called PITI – Principal, Interest, plus escrows for taxes and insurance) put less pressure on household income; and, it does not seem likely that the opposite will occur, that household incomes will rise to mitigate land prices]
But, you can never really discard the possibility that we (meaning, the government) will do one or more really bone-headed things. Some really bone-headed things that come immediately to mind are: cracking down on mortgage bankers, raising taxes on the upper middle class, driving interest rates down as low as possible, flooding the markets with funny money, attacking the automobile, and deporting millions of people. Such things as these will further reduce the demand for upscale, middle family homes, depressing their values, and forestalling any recovery in the construction industry. Compared to those inane responses, sending out tax rebate checks sounds benign. [EJD: Too many comments for this small space]
Just as overoptimism and greed come into the booms of the Austrian business cycle, excessive pessimism and fear come into the busts. A free society requires confidence, as well as business entrepreneurship. Fear is antithetical and often comes in the vanguard of some form of authoritarianism. Thus, what is much more important than tax rebate checks is a sound economy that evinces in people confidence that we can and will work through difficult times.
[EJD: OK, that’s it. I just thought it might be a good exercise for us to put our perspectives up against one that is likely to get a bit more attention in cyberspace]