Austrian Business Cycles and Neutral Money
The proponents of Austrian Business Cycle Theory (ABCT) are often very critical of the diagnosis offered by monetarism: that sharp and substantial contractions in the money supply are the cause of major recessions. Rather, according to ABCT, a recession is a painful medicine curing the disease monetary policy already caused, as Professor Jesús Huerta de Soto, Spain’s leading Austrian economist, explains:
"[Money] is always injected into the economy in a sequential manner and at various specific points…..only certain people will be the first to receive the new monetary units and have the chance to purchase new goods and services at prices not yet affected by monetary growth….which can only lead to changes in society’s entire structure of relative prices." (Money, Bank Credit, and Economic Cycles, p. 533)
The argument here is that money isn’t neutral, that is, changes in it’s quantity affects peoples’ behaviour as price changes aren’t uniform. If money were perfectly neutral; doubling the quantity of money would cause all prices and wages to instantly double and people would go about their lives exactly as they would otherwise. When money isn’t neutral the failure of prices to adjust ubiquitously sends the wrong signals to entrepreneurs, creating mal-investment (capital allocated according to misleading price signals) and a following period of correction/recession. That’s ABCT in a nutshell.
So far, so good. However, Austrians like Soto seem to contradict themselves in their criticism of the aforementioned monetarist diagnosis:
"Attributing crises to a monetary contraction is like attributing measles to the fever and rash which accompany it." (Money, Bank Credit, and Economic Cycles, p. 527)
According to this criticism, monetarists have confused cause and effect; monetary contractions don’t cause recessions, recessions cause monetary contractions. It’s as if Soto is claiming that any sharp contraction in the money supply, even if we accept the premise that it was caused by the recession, had no further effect on the economy - that any sharp monetary contraction is neutral.
If ABCT aims to explain recessions whilst denying monetarism it must state, then, that money isn’t neutral and also neutral. Even more problematic is the apparent claim that money is far from neutral on the way up when growing at a fairly steady rate, but neutral on the way down when declining rapidly. Anyone worried about money supply growth prior to the crisis should also be worried about the fact it tanked in 2008. Soto joins Mises, Rothbard, Schlichter, and perhaps Hayek on the list of popular Austrians who are especially critical of monetarism.
On the other hand, some economists who identify as Austrians, such as Professor Steve Horwitz of St Lawrence University, have accepted some broad form of monetarism. Horwitz goes so far as to suggest that ABCT doesn’t explain every recession, and is only a theory of unsustainable boom. This clearly departs from the classical ABCT which did seek to explain all recessions and is very specific in it’s explanation thereof. And though I mostly agree with Horwitz’s interpretation, it can’t be labelled ABCT, because a theory of unsustainable boom is only a theory for half the cycle. So it leaves the question: can we create a version of ABCT which is consistent in its treatment of money throughout the cycle?
Chart of the week: Target 2 imbalances
Summary: Target 2 imbalances narrow but remain wide
What the chart shows: The chart shows that Target 2 imbalances, while narrower than a year ago, remain wide – and have stopped narrowing
Why is the chart important: Target 2 balances are the net claims and liabilities of banks in the euro area on each other by country. If the monetary union runs smoothly and is believed to be permanent, imbalances will be minimal – as indeed they were until the financial crisis erupted in 2008. If, however, there are concerns about the stability of the banking system in one country or about that country’s continued membership of the single currency, imbalances will widen, with ‘safe havens’ building up claims. Target 2 imbalances peaked when German banks had claims of more than 750 billion euros in August 2012. Although lower, German claims were still close to 600 billion euros in May this year. Whatever politicians and central bankers may claim, markets, companies and households do not believe that the euro area multiple crises are over,The chart shows that Target 2 imbalances, while narrower than a year ago, remain wide – and have stopped narrowing
If only Britain had joined the Euro?
Will Hutton tells us, in last Thursday's Guardian, that widespread consensus on the UK's staying out of the EU is wrong-headed—joining would have kept our exchange rate low, which in turn would have meant no financial boom and an economy based (more) around producing manufactures. To add to this, our entry would have meant a more activist European Central Bank, which would have been willing to intervene when necessary. There is more wrong with his article than I could possibly tackle in one post, so I will focus on the key elements I've summarised above. None of what I say implies it necessarily would have been bad to have been in the Euro over the past ten years—such an alternative history is almost impossible to conclusively support—just that the arguments Hutton uses are extremely weak.
Pretty much all of his argument is bizarre, utopian and uneconomic. Devaluations work not because they make a country's products cheaper to foreigners, adding to net exports and driving GDP growth. Devaluations work because they boost inflation, which gets around nominal wage stickiness, allowing markets (particularly labour markets) to clear and giving relative prices the space to adjust. They make no difference to the price of a country's goods to foreigners, and in practice often boost imports as much as or more than exports, due to improved conditions. This is even true if we devalue by decree, as Hutton's desired artificially low €-£ exchange rate would be—it's just that the inflation could take slightly longer to come as firms and households bid up prices.
What's more, this is a Good Thing. We don't want to spend energy, time, labour and capital hours, as well as space, producing valuable things only to sell them in exchange for artificially few foreign goods. If countries are happy to send us desirable stuff in exchange for less of our stuff then that's great, and in any case it sows the seeds of its own balance, as consistent deficits (ceteris paribus) will drive down the exchange rate. This may eventually force the UK to run surpluses, but this would not be a Good Thing. Running surpluses means lower social welfare because we are consuming less leisure or goods or services than we would otherwise be able to enjoy. And we may never even have to run one if we keep creating loads of property or financial wealth to pay for our imports.
But let's imagine that Hutton could have subverted economic rules as basic as gravity and magically have kept the exchange rate at his desired low rate without any of the obvious expected balancing effects from wages and prices. And let's imagine that we want to send more goods abroad to get less in return. Would this have supported the manufacturing industries he wants? It's difficult to see how. If the City was providing the best financial services options for the world at £1 = €1.25 then it's not obvious that a cheaper pound, and cheaper financial services, would make them less attractive. The UK's economy contains a relatively large contribution from financial services because the UK is relatively good at financial services—as well as hi-tech manufacturing, advertising, and many service sector areas. These are the UK's comparative and in some cases absolute advantages.
And would the UK be better under the ECB (albeit with some British influence) rather than its own Bank of England? It's hard to see why Hutton thinks this. The BoE let inflation rise to hit 5.2% on the CPI measure, and has consistently allowed inflation to stay above target—the ECB has inflation below its 2% target, despite the obscene jobs crises in Spain, Greece and other crisis-hit countries. It is basically refusing to do any monetary stimulus. There is essentially no debate in Europe over whether the ECB should actually meet its inflation target, or indeed consider other economic variables, or go yet more radical and drop inflation targeting altogether. Would the UK's input really outweigh the massive consensus there, especially when the UK is divided on the issue itself? Again, I am sceptical. Strangely, Hutton seems to think that pointing to the UK's own situation and reminding us we're not living in "a land of milk and honey" is sufficient to gloss over the fact that most of the Eurozone is doing so much worse!
This laughable logical leap is nothing compared to his claim that both sides of the political divide are "united only in their belief, against all the evidence including Britain's export performance, that floating exchange rates are a universal panacea." As might be expected, he doesn't give the tiniest shred of evidence that the consensus view holds that floating exchange rates are not only the best exchange rate policy, but a panacea for all types of economic ills. But really, that's not the point. Even if everyone did—ridiculously—think that floating exchange rates were actually a panacea for economic problems, that wouldn't go any way to implying that they weren't better than fixed exchange rates.
Will Hutton's argument is completely invalid, though perhaps he gets some points for making such an outlandish and unpopular case. If it would have been good for the UK to enter the Euro 10 years ago, then it is not because it would have allowed us to permanently rig all markets to send off more of our stuff for cheaper than it is worth. And it seems completely implausible that the UK could have influenced the ECB enough to see it ditch its destructive hard money policies during the crisis, instead it seems more likely the UK would be just another country suffering under its negligence.
Do technological advances destroy jobs without creating new ones?
In a very readable article in the New York Times Paul Krugman expresses sympathy for the Luddites, suggesting that the benefits of future technological developments may not accrue very equally across society. This being the case, he suggests that policies such as a universal basic income may be one way of compensating the unlucky who have spent lots of resources on, say, a university education which has now devalued, something they couldn't possibly have predicted. Since I share Krugman's basic luck egalitarian intuitions, I am very sympathetic to his case.
The beef I have is with a response written by Gavin Mueller in Jacobin magazine. Up until now almost everything I've seen from Jacobin has been well researched, even handed and thoughtful, if coming from a very different set of basic premises to those I hold, but this is an exception. He makes much stronger claims than Krugman, calling technology "a weapon used against us" and arguing that a long-term goal of "abundance and leisure for all" (one I share!) may require "smashing the relations of production" in the short-term. Perhaps the line which most annoys me is "the belief that technology doesn't destroy jobs, but merely creates new and better ones, is, like so much else about bourgeois economics, a baseless assumption."
Does Mueller really believe that claim? Unemployment is 7.8%. Employment is touching 30m, its highest level ever. Since the 1750s there has been a tide of vastly transformative technological improvement and yet somehow a much larger population is employed. At the same time, this larger workforce is working much fewer hours and enjoys much greater abundance. Surely these widely available facts are enough to suggest that the assumption technology creates—as well as destroys—jobs is more than just a "baseless assumption"?
By no means is it certain that the trends of the past, which have seen mobile phones, more hygienic toilets and tasty soft drinks spread to even the poorest areas of the world, will continue. But certainly some evidence (e.g. the graph above) seems to suggest that technologies are spreading throughout society—and benefiting the general populace, not just the wealthy—faster than ever before. This is great, and implies that we can hope for greater abundance and leisure without smashing new technologies. If it turns out that not all benefit, then what we need is something like Krugman's universal basic income, not drastic societal upheaval.
Video of George Selgin's talk "Could deflation be salvation?"
George Selgin spoke the tuesday before last, 28th May, on the possibility some deflation—that coming from improvements in the supply side—is not harmful to the economy, but good. He made an extremely convincing case, pointing out that the so-called Long Depression of 1873-1896 was actually the site of a vast improvements in living standards and social welfare. And he pointed out that the problems attendant with deflation, that economists are fond of pointing out, only obtain when that deflation comes from a demand shock, not a change in supply.
Chart of the week: US household debt still above sustainable area
Summary: US household debt relative to disposable income rose slightly in Q1
What the chart shows: The chart shows US households gross debt, relative to personal disposable income. This debt/income ratio edged up in Q1 2013 for the first time since Q1 2009.
Why is the chart important: The financial crisis that erupted in 2007 was very much an excess debt crisis. Historically, US households have shown themselves able to carry a debt burden that puts their interest and amortisation payments around 15% of disposable income. By 2007, interest and amortisation took 18% of disposable income and debt was close to 130% of income. The implication was that debt was 1/6 too high at normal interest rate levels. This means that debt had to come down from 130% to below 110% of income. But, unsurprisingly, households continued to deleverage. The Q1 2013 figure (if not revised away) shows that households now feel confident at taking up some debt again. This strengthens the case for a sustained US recovery. US household debt relative to disposable income rose slightly in Q1.
Destroying jobs is the entire point of this invention stuff
The ONS has a nice set of statistics about how the world of work has changed over the past 170 years. Changes which underlie my insistence that the whole point of this advance and invention stuff is to destroy as many jobs as possible.
In 1841, over one in five workers (22%) were in the Agriculture and fishing industry.
This has now fallen to under 1%. But we produce an awful lot more food than we did back then.
In 1841, a third of the working population (36%) worked in manufacturing and in 1901 this was at a similar rate of 38%.
This has now fallen to 9%. And we do indeed still manufacture an awful lot more by value than we did back then.
The answer to how we did both is that we invented machines that did a lot of the work of those people. Yes, this did indeed mean that these people thus became unemployed: which was the very point of making the invention. The point of the mechanical hay baler is to make manual hay balers unemployed. The point of the robot riveter is to make human riveters unemployed.
And thus those made unemployued by the technological change can go off and work in services. Which is how we all become richer: we've now got the machines doing the food and the manufacturing, the humans doing the services and we get all three: food, manufactured goods and services.
Think about it for a moment, if we still had 22% in farming and 36% in manufacturing then that's 58% of the people. Currently 81% of the population work in services (there's a bit in construction, water etc as well). If we've 58% who cannot be in services because they're in food or manufacturing then we'd, just as in 1841, only be able to have 33% working in services. So, which half to two thirds of the services we currently do get would you like to give up simply because we don't have the people available to do them? OK, we all agree the diversity advisers can go but beyond that?
Quite. By mechanising agriculture and manufacturing we've been able to get the production of both of those that we desire and also have a vast expansion of services that we also get to enjoy. We have more thus we're richer. And that of course is the point of doing such mechanisation: to make us all richer and long may it continue.
23 Things We're Telling You About Capitalism XXIII
Chang's twenty third thing is that we really don't need to have lots of bright economists around in order to be able to run a decent economy. This is most certainly true provided that the economy is still run along the right basic lines: which might be the bit that we and Chang disagree about.
It's certainly true that all the time markets, nothing but markets, doesn't quite work. There are a number of imperfections that mean that we cannot just leave everything to voluntary action. We might point to natural monopolies as an example: someone, somewhere, has to stop them rooking everyone. We do like the rule of law which means we've got to have government (sorry anarchists) and the taxes to pay for it (sorry everyone). And there are more subtle problems out there: take externalities for example. By definition these are things that are not included in market prices and therefore are not considered in market transactions. We really cannot therefore conclude that markets will deal with externalities when hte whole point is that markets ignore externalities.
So we're all fine with the idea that we cannot have an entirely and wholly pure market system. Nor would we want one that is entirely capitalist: I'm extremely happy about the idea that the Army is a State run organisation. We tried private capitalism in this field and the Wars of the Roses just don't have that good a reputation. Not from the peon and churl end of the telescope at least and I know darn well that's where I would have been.
However, that doesn't mean that because we cannot be purist about these things that therefore any old intervention into the economy is just fine. Which is what Chang is partly doing. Having shown that some intervention is demonstrably desirable he then goes on to conclude that the sort of intervention he desires has been demonstrated: which the past 22 little notes might have dissuaded you of.
But I will agree that he's right: we don't need vaslty intelligent and highly educated economists running the place for us all to get gloriously rich. As Adam Smith himself said:
Little else is requisite to carry a state to the highest degree of opulence from the lowest barbarism, but peace, easy taxes, and a tolerable administration of justice.
You'll note there's nothing there about managing the exchange rate, regulating the bendiness of bananas nor even one word about the employment of economists.
So of what use actually is economics. If we don't need economists to run the country then what point in the entire intellectual exercise? As Ben Bernanke has observed:
Having taken a stab at sociology and political science, let me wrap up economics while I'm at it. Economics is a highly sophisticated field of thought that is superb at explaining to policymakers precisely why the choices they made in the past were wrong. About the future, not so much. However, careful economic analysis does have one important benefit, which is that it can help kill ideas that are completely logically inconsistent or wildly at variance with the data. This insight covers at least 90 percent of proposed economic policies.
If I am to be fair about economics there's very little in the corpus of knowledge that makes up the field that is really about making the world a better place. Plenty of attempts at such of course, and many more from people who wouldn't know an econ if it came and micced them. What there is a great deal of is warnings about don't do this because you'll make the world worse. As PJ O'Rourke put it about the Soviet Union, shooting all the smart people and then killing off anyone trying to get rich does not great societal wealth make. We've got lots and lots of knowledge about things like that that we shouldn't be doing. There are some areas where things have to be done: those natural monopolies, externalities and so on. But they're few and far between when you think of the vast possibilities of human behaviour.
The real point of economics is to struggle manfully with those very few things which must be done, shoot down in flames at least 90% of the things that are suggested we should do and then leave the rest of it, the vast majority of life, to people to do as they wish as long as they're not harming others or their right to do the same. You know, the liberal idea of free people interacting voluntarily in a free market. Capitalism's just an offshoot of the rights to private property: and one of the lessons of the experiment that was the 20th century is that we do have the data about what happens when you try to do that.
So, capitalism and free markets for all it is then. Which, given that the last 30 years, as the two have spread through globalisation, has seen the largest reduction in absolute poverty in the history of our entire species, is very probably a damn good idea. After all, even if we don't need many economists or much economics to do it, the poor getting rich is what we all want, isn't it?
23 Things We're Telling You About Capitalism XXII
Our twenty second thing is the rather alarming suggestion that finance must be made deliberately less efficient. This is a very odd indeed thing for an economist to say for our first assumption, right at the very start of the subject, is that the needs and desires of human beings are larger than the ability to assuage them. Thus increased efficiency is always desirable as it means we can assuage more desires with our limited stock of resources. Indeed, we usually go on to say that something that is in infinite, as compared to demand or desire for it, supply is not actually an economic good. So deliberately calling for less efficiency, no, not as a side effect of something else but as an aim in itself, is almost a form of anti-economics.
The claim is that finance now moves more swiftly than the "real" economy. Thus we must slow it down otherwise finance will be, erm, moving too quickly for said real economy. There's no evidence proffered for this assertion: it is simply asserted. People can buy and sell shares quickly which means that the money to build factories, something that takes some time, isn't around seems to be one lunge at a back up. Which is a very strange argument indeed as we don't seem to have any shortage of factories. Nor of investment to build them if someone comes up with a good idea. Indeed, the world seems to be awash with VC funds, with FDI, with bond funds looking for a good home for their cash. Far from finance not funding that "real" economy it's amazingly easy to get cash to follow an idea through, easier than it has ever been I would wager. And there are plenty of people, Nobel Laureates among them, who insist that the recent troubles were all about a global savings glut.
There is one shortage, this is true. Banks (especially UK ones) being unwilling to lend into companies. But this complaint is really just a disguised misunderstanding. Banks simply aren't the appropriate place to get risk capital from: public markets or private investors are. And as I say, there's no shortage of that sort of funding at all. SMEs aren't all that fond of it, true, because gaining such finance means giving up equity. Which is as it should be of course: you want risk capital you've got to share the upside as well as the downside.
Other than that there simply isn't a shortage of capital for companies: so the basic complaint seems invalid. Maybe finance is running faster than the real economy. Finance has certainly screwed up memorably in recent years as well. But if that real economy does still get funded, as well as all the froth that's being complained about, then we can't use the real economy not being funded as an excuse to do anything. And it should be noted too that a lot of the froth is actually the sharing of risk from those real world investments. The wheat futures market spreads the risks the farmer and the baker are taking: meaning that more funding can be offered as risk has indeed been spread. This continues out to even the most exotic markets. Sterling interest rate futures, as one example, mean that both borrowers and lenders can shift the risks of interest rate changes to speculators. Thus meaning that for the same amount of risk carried by lenders and borrowers there can be more lending done. The froth doesn't detract from that real economy funding: it adds to the ability to increase the volume of it in reality.
And I must say that I was most amused by one piece of evidence called in by Chang. He notes that the profitability of the finance sector has risen in recent decades. He uses this as the basis of a claim that obviously it should be pruned back. But profit, excess profit, as Adam Smith pointed out in not quite these words, is proof that you are adding value. So if profitability of finance has risen then that must mean that finance is adding more value. And the idea that we want to stop people doing that is again almost anti-economics.
I suspect that the real basis of Chang's complaints about finance is that his attitude towards it is akin to a Victoiran dowager's about "trade". We know that it goes on, is even necessary, but we most certainly wouldn't want anyone we know to be associated with it.