I strongly recommend Vox Day's voxonomics series, an excellent set of interviews and lectures on subjects relating to economics. I especially enjoyed his
a noted scholar of Austrian economics. As the doctor is a bit hard to understand sometimes, I took the liberty of writing up a transcript. At the end they discuss suggested readings. I highly recommend Rothbard's
if you are lucky enough to find a copy. Also Mises'
are excellent books. Mises is definitely the better author, but can be daunting and I tired of the endless references to old German economists I had never heard of or their theories which he spends a great deal of time refuting. Anyways, listen to the interview and enjoy an excellent overview of Austrian economics.
(0:39) Vox: Welcome to the third edition of Voxonomics. Today I'm speaking with Dr. Frank Shostak, Chief Economist of MF Global and an adjunct scholar at the Von Mises institute. He's a regular contributor to the Austrian Journal of Economics and he's doing some very interesting, if oxymoronic, work in developing a theory in applied Austrian economics. If you are interested in learning more about monetary theory, especially from an Austrian perspective, I encourage you to take a look at some of the links to Dr. Shostak's papers provided on the same post as this podcast.
How are you today?
(1:10) Dr: Good.
(1:12) Vox: I have some questions for you specifically relating to the Austrian economic theory. I was wondering if you could tell me what are some of the primary differences between Austrian economics and the Neo-Keynesian economics that dominates the government and media right now.
(1:27) Dr: Well, the most practical aspect of Austrian economics is basically the way that Austrian economics approaches the whole issue of the business cycle. That is the most important, the key actually to the whole framework.
Now for instance in the Austrian economics it pays attention to money supply and such while the mainstream economics today don't really look at money supply at all and if they look at money, they look at it in a misleading way. So for Austrian for instance, the whole issue of business cycle is the result of loose monetary policy of the central bank. In other words when central bank loosens monetary policy, which after a while, follows by monetary injections, this creates the foundation for so called bubble activities, which everybody talks about. Bubble activities in our framework are basically the result of various activities which spring up on the back of monetary printing. Without the monetary printing those activities would not be there.
(2:52) Vox: Right.
(2:53) Dr: Now how they actually emerge: when money is printed, what it does is basically divert the real savings, which is the foundation for real economic growth, from wealth generators to various parasitic activities or bubble activities. When I mention savings here, savings is the most important, the foundation for economic growth in our framework while in mainstream economics savings is completely neglected, or at the best they just will mention it occasionally. But for them savings, in particularly in Keynesian, is bad news because more savings means less spending. For them economic growth originates from consumer expenditure. In our case, economic growth, the heart of it, is the pool of real savings.
(3:52) Vox: So from an Austrian perspective, you're quite concerned about the fact that in the US economy the savings rate has actually been negative for some time.
(4:02) Dr: Well, put it this way, first of all, there is always an issue of whether we can measure savings at all. When we deal with savings we deal in the real terms and its not possible to add up potatoes and tomatoes as you know, so its not really possible to measure it. But in principle we can say qualitatively that there is a hell of a high chance that American savings is such, the pool of savings, its not very good.
(4:31) Vox: That touches on something else I want to get to. Is the relative disfavor in which the Austrian economics is held partly due to its distrust of empirical methodology? Because its a little bit difficult to even discuss economics if you're not framing it within an empirical measure.
(4:54) Dr: Well, I in particular have introduced what we call applied Austrian economics. We do actually measure things, we use for example money supply to assess the possible damage money supply will do to real economy. In other words, there are certain things that the mainstream economics tries to measure, that is actually all fallacy, cause it cannot measure it. But we acknowledge it, and when its due, we will use, so to speak, the real GDP, and we do use consumer price index, but we always acknowledge and say look, guys be careful, because real GDP as such is not really a real GDP, its mostly monetary turn over, it basically comprised of money supply. Consumer price index, beware, that logically speaking its not possible to construct so called total prices as such, because arithmetically it is not possible, but we do use such things also, and communicate also. So we are not against empirical analysis, in fact I am using extensive empirical analysis, but one needs to use it in the correct way, and we argue that the mainstream is abusing this, they are torturing the data, and they try to derive the theory out of the data rather than already having a certain theory, and applying this theory on the data, trying to make sense of the data.
(6:36) Vox: Well its quite clear considering the way in which the definition of the CPI has mutated in the last 20 years. You can't even compare what the reported rate of inflation was in 1980 to what it is today.
(6:50) Dr: CPI is not a measurement of inflation. If you go back to the 19th century for instance, 19th century economist, when you ask him what his definition of inflation is, he would tell you its changes in money supply, that's what inflation is, and if you go back a little bit more, they would tell you its about debasement of money, debasement of currency. Thats for them what inflation was, counterfeiting if you will. In 20th century things were twisted around. In stead of looking at what inflation is, people started to look at the symptoms of inflation.
(7:34) Vox: Right .
(7:35) Dr: Like in price changes, price of food goes up, and they blame the producers of food, etc. etc. While all this is not inflation, it could be symptoms of inflation.
(7:47) Vox: Lets get back to the cycles because, like you said, it's an important aspect of Austrian economics. Because they play such an important role in the economy, both in Austrian terms, and also in Neo-Keynesian terms, why are they so imperfectly understood? It seems the Neo-Keynesians have problems understanding when the cycles are taking place or what point we are at in the cycle, while Austrians seem to have some trouble gauging the extent of the peeks and troughs of the cycle.
(8:18) Dr: Well, first of all, the mainstream, the Keynesian, Neo-Keynesian, Neo-Classical, all of them, they explain cycles in terms of shocks. For them, business cycles are the result of some shock. So if you have shocks, then those shocks can trigger some kind of a cyclical movement. That's their theory. They don't really have a theory of business cycle as such.
Now as far as Austrians are concerned, at least for Mises, it is very clear what business cycle is. A business cycle is set in motion by the central bank, the existence of the central bank, that's what really sets in motion boom/bust cycles on account of their policies. In fact, prior to the industrial revolution, according to Mises and Rosenberg, there weren't such things as recurrent business cycles. There were famine, there were all sorts of things, but there wasn't a modern recurrent business cycle.
Today, this type of phenomena came about as the result of the introduction of central banking and modern banking as such, the fractional reserve lending and etc etc. So boom/bust cycles are purely monetary pumping, in other words, when the central bank loosens its stance it sets in motion, provides ammunition to, varies artificial forms of life by diverting real stuff, real resources, from wealth generators to false activities, or bubble activities. When the central bank reverses its stance, moves from a loose to tight stance, this sets in motion an economic bust. Obviously there are time lags, so it can happen, that while it's tightening, the effect from the previous loose policy still asserts its dominance on the economy but, after a while, the tighter stance takes over and then it's starting to bite and hit into various activities. And obviously because of the lag there are first activities which get effected, and then secondary, etc. etc.
The current bust we are observing right now, which everybody blames on the sub-prime mortgages, we Austrians say it has nothing to do with sub-prime mortgages. It has something to do with Mr. Greenspan's policies. Between 2001 to June 2004, Mr. Greenspan was pursuing an extremely loose monetary policy. He lowered interest rates from 6 percent in January 2001, to 1 percent by June 2003. As a result there was quite an acceleration of monetary printing by the fed. All this has given rise to various false activities, like sub-prime, like anything you want, there is so plenty of it, and obviously the stock market boom. Now in June 2004, Greenspan reversed his stance, gradually started to raise rates, from one and a quarter until five and a quarter we had by September of last year, when Bernanke was there. The period between June 2004 and September 2007, this is the period of tightening, that tight stance, which now is starting to bite, which hit first the sub-prime, they were just the first, and then you will have the other guys that come, the other sectors, etc. etc.
Now which kind of sectors will be effected is very difficult to say just like that, because it depends on magnitude of the bubble activities. The proportion of bubbles vis-a-vis genuine ones. If the proportion is not very large, then we may not have a serious recession. But if the proportion exceeds 50% lets say, then we could have serious trouble. And if the savings is not there, or not sufficient, then it will be very difficult to fund such a thing. You cannot fund bubble activities, which are not self funded. They cannot fund themselves. They are dependent on the wealth creators all the time. And if they are over 50% then wealth creators are in trouble.
(12:59) Vox: Is this your explanation for the problem that Japan has had getting out of its bust since 1990?
(13:07) Dr: Well, Japan never has gone out of the bust. Japan was in the so called suppression, mild depression if you want, deflation, since 1990 till recently and it still didn't recover actually. They actually created a massive bubble economy in the 80s as you know.
(13:30) Vox: Right.
(13:31) Dr: They tried to cool it off, they managed to cool it off, and in the mid 90s actually, they were advised by professor Friedman and various experts in America, that they should flood the economy with money on a massive scale and lower interest rates to nil, and thats what they did. They flooded the system with money on a massive scale, and nothing really happened. So they were in a suppressed type of depression if you want. They never showed the data correctly also, they never fired people just like that. They were in a depressed state until now even. They never allowed the liquidation of [zombie?] activities.
(14:26) Vox: Given what you're saying about the focus on the activities of the central banks, how do you distinguish Austrian theory from Friedman's monetary theory?
(14:36) Dr: Friedman got certain good things, we don't say that Friedman is bad actually, completely, we have some disagreement with Friedman of course. For Friedman first of all, he defines inflation as persistent changes in consumer prices.
(15:03) Vox: So he's mistaken a symptom.
(15:04) Dr: Right. So that's already wrong. Then secondly, he doesn't have any business cycle theory, it's more like empiricism, crude empiricism. He says money supply, (although we are more sympathetic to Friedman than other guys) creates shocks, and those shocks create other shocks. He did not have a theory of business cycles as such, but whatever he did have was related to monetary supply, but he never articulated it precisely like Austrians. Friedman was saying printing money could create economic growth. All the Keynesian and mainstream economists are saying you can print money and create economic growth. But after a while, Friedman would say, inflation would take over, and then all the short term economic growth would disappear. Now Austrians say this is all fallacy. Printing money cannot cause any economic growth. It can only reshuffle things. It can take from wealth producers and transfer resources to non-wealth producers. If printing money can create economic growth, then we can solve all the problems of wealth creation in the world today. Every third-world country knows how to print money and everything will be fine.
(16:35) Vox: Doesn't seem to be working so well for Zimbabwe.
(16:49) Dr: That's right. So Friedman was wrong. He saw that in the short term you could create economic growth. Obviously this is nonsense, we say untenable, it's not right. For instance for us, business cycle is when you take resources away from someone who produces wealth and give it to someone who doesn't produce wealth, who is useless, you just feed him. That really weakens the wealth producers. After a while when manifestation of this comes in terms of various symptoms which even the mainstream, central bank doesn't like when its starting to tighten, it hurts the various bubble activities, all the parasitic activities which shouldn't be there. If there is plenty of them of course, then they are a majority, they can dominate everything, and that's the issue.
(17:31) Vox: What is the issue today? I have talked to some people who are concerned about inflation because Bernanke is cutting again, and they are pumping up the money supply again, others are saying that it doesn't matter what he does because we are pushing on a string and heading for deflation. What's your take on the situation from your Austrian perspective?
(17:53) Dr: The key to whether we will move from inflation to deflation is what we call pool of real savings. In other words, imagine a company, a corporation, which has got ten activities. If eight activities are doing well and two are doing badly, two bubble activities, and eight good activities, then we are okay. The eight can carry the two bad ones. But if things are the other way around, lets say we have got only four good activities and six bad activities, then we are in trouble. We don't know at the moment whether we are in the state in which the pool of funding or pool of savings is expanding, or whether it's not. It's very critical, because if the pool of funding is stagnant or declining as we believe this was the case during the 1930s, then the chances for deflation are serious. What will happen then is bank lending will collapse, we are talking about commercial bank lending, and all the credit that was created through fractional reserve lending, the money created out of thin air will evaporate. Then you can have a large decline in money supply which will lead to so called deflation, thats a possibility. But if the pool of money is expanding, then Bernanke may be successful, and revive the struggling economy, to give it a push. At present, the jury is still out, we have to wait and see where we are right now.
(19:47) Vox: Isn't the fact that Bernanke is kicking around the idea of nationalizing the banking system an indication that he's not real confident about his ability to kick start it?
(19:59) Dr: That's absolutely right, what you're saying. But to me, Bernanke is also paranoid, because he is supposedly a great student of the great depression, like he studied a lot of it and has written a lot on the great depression, but he is a Friedmanite guy. He also has got a particular weird model called the financial accelerator model. This model that Bernanke uses, every small shock in the financial economy can create a massive shock in the real economy, so that's why he is so concerned about the various balances in the financial economy, that's why he was acting so aggressively so to speak.
But I basically believe that he is of the view that we might be heading for a great depression, that's the impression he gives me all the time at least. He believes, but doesn't say it loudly, that we may be heading for a great depression.
(21:03) Vox: Now Ludwig Von Mises makes for some heavy going for those who are interested in economics but may be new to it. Who's work would you recommend for an introduction into Austrian economics?
(21:14) Dr: Well, you're right, it's a very valid comment that Mises' writings are not always simple. It requires you to apply yourself. Incidentally it may be much easier than the mainstream economics because if you take mainstream economics it's all cluttered with algebraic formulas and geometrical type stuff, which makes it completely inaccessible to the layman. So the real difficulty is, I'm not sure if Mises is much harder than anybody else. But if somebody wants a good introductory book, unfortunately there are not many, I would still recommend some easy books by Mises, and of course Rothbard, Rothbard is the right man.
(22:14) Vox: What do you think about Taylor's introduction into Austrian economics?
(22:18) Dr: I think its good, its very good, but still its got a particular deep type of philosophical aspect, etc. and to say it gives you practical things, because most people want practical things, like most business men want something actionable, practical. So I believe the action stuff, in particular business cycle, money supply, such things, Rothbard is the right man. His booklet What Government Has Done to Our Money (http://www.mises.org/Money.asp) is really the best type of book that is available, a small book actually.
(23:00) Vox: Yeah, his book on the history of paper money is really good too.
(23:06) Dr: Yeah, yeah. Man, Economy, and State (http://www.mises.org/rothbard/mes.asp) if somebody has the care to read it, cause thats a great pretext to read it. And of course a very great book, the Mystery of Banking by Rothbard, is also a great book.
(23:27) Vox: One last question: what would you do if you were in Bernanke's situation now?
(23:32) Dr: If we have to accept the fact that the central bank exists and we have to operate it, I would say that Bernanke right now is in a very difficult situation. Most people are not aware, that he tries to inflate the economy now since September, inflate the market. Now if you noticed the interest rate spread has hardly budged, they are still widening, still very wide. The reason being because he didn't succeed in trying to raise money supply. That sounds very strange, paradoxical. The reason being because of the way the central bank really operates in terms of targeting interest rates. The Fed does not pump money just like that. First of all they have to adhere to a target. So Bernanke at present has a serious problem. He does understand that he would like to have more monetary liquidity, but he cannot pump, because the moment he will pump, it will upset the interest rate target. So the only way he would be able to freely pump is if the interest rate where to fall to zero, which is quite possible. Then he will have all the freedom to use the helicopter money. At the moment, the only damage he did is by manipulating interest rates, but he hasn't really caused massive damage from monetary pumping yet.
(24:09) Vox: So if you were in charge of the Fed, you would just lay everybody off and go home.
(25:14) Dr: Well, I wouldn't be doing like Mises said and say "I am resigning" or whatever, but put it this way: existence of the central bank is a useless institution. It causes only damage, let's accept it. But if we have to have it, then one thing that Murray Rothbard suggested in his writings, the congress must pass legislation that the Fed must not be allowed to buy assets. Because the way that the central bank is allowed to pump money is to buy assets. By buying treasury bonds in open market operations. This should be forbidden, and thats about it. Then you prevent the boom/bust cycle policies.
(26:01) Vox: Well thank you so much for your time Dr. Shostak, its been very enlightening.
(26:06) Dr: No, that's great.
