This is an article on behavioral economics, markets, business cycles and Austrian theory. It was written by Doug French, president of the Mises Institute. I am reproducing it in its entirety. Anyone who invests in stocks, bonds, real estate, gold, or whatever, should read this article.
After reading the article I was reminded again of the brilliance of Ludwig von Mises and how perceptive he was about his favorite topic, the study of the behavior of human beings, or what he called “human action” (praxeology). The Austrian School was originally called the Psychological School of economics because of its focus on individual behavior rather than aggregate behavior.
The hot new branch of praxeology is behavioral economics, although many behavioral economists are probably not aware of this fact. In this piece, French summarizes current behavioral research and examines it in light of Austrian theory as it pertains to market behavior. The behavioral examples align well with Nassim Taleb’s Black Swan and his conclusions. Although Taleb doesn’t get into Austrian theory as a framework for economic behavior in his book, he, based on my understanding of reading other articles by Taleb, is Austrian in his outlook and conclusions.
Don’t Go With The Flow
By Doug French
Anyone who follows financial markets has to wonder at times, “What are people thinking? How did they come to make those decisions?”
It’s hard to imagine that John Muth and Robert Lucas came up with what’s known as the “rational-expectations theory,” wherein, as explained in Wikipedia,
it is assumed that outcomes that are being forecast do not differ systematically from the market equilibrium results. That is, it assumes that people do not make systematic errors when predicting the future, and deviations from perfect foresight are only random.
Muth and Lucas should watch daily programs on the financial channels like Jim Cramer’s Mad Money, which is supposedly to help individual investors, or CNBC’s Fast Money, a show clearly geared toward speculators. No viewer can watch these shows and walk away believing, “people do not make systematic errors when predicting the future.”
So while financial markets have been a series of speculative bubbles as the Federal Reserve creates money ad infinitum, rational-expectations economists Robert Flood and Robert Hodrick daringly conclude, “The current empirical tests for bubbles do not successfully establish the case that bubbles exist in asset prices.” [!] … Continue reading Stock Markets, Cycles, and Dopamine
By Jeff Harding
This article on the Great Depression was written in 1969 by Hans Sennholz, an Austrian theory scholar and professor. Ludwig von Mises had escaped the Nazis in Vienna and then in Switzerland to arrive in New York in 1940. Mises arrived with nothing, almost the last surviving scholar of the Austrian School. Sennholz was Mises’s first PhD student in America and was a major force in the rebirth of the Austrian movement.
It’s a brilliant summary of the history of the Great Depression and I urge you to read it at your leisure. It is a long article, but wonderfully written. It will save you from reading lengthier tomes on the subject. You will find the parallels to our present situation remarkable.
The Great Depression
 Caused by government action Although the Great Depression engulfed the world economy many years ago, it lives on as a nightmarefor individuals old enough to remember and as a frightening specter in the textbooks of our youth.
Some 13 million Americans were unemployed, “not wanted” in the production process. One worker out of every four was walking the streets in want and despair. Thousands of banks, hundreds of thousands of businesses, and millions of farmers fell into bankruptcy or ceased operations entirely.
Nearly everyone suffered painful losses of wealth and income.
Many Americans are convinced that the Great Depression reflected the breakdown of an old economic order built on unhampered markets, unbridled competition, speculation, property rights, and the profit motive. According to them, the Great Depression proved the inevitability of a new order built on government intervention, political and bureaucratic control, human rights, and government welfare. Such persons, under the influence of Keynes, blame businessmen for precipitating depressions by their selfish refusal to spend enough money to maintain or improve the people’s purchasing power. This is why they advocate vast governmental expenditures and deficit spending — resulting in an age of money inflation and credit expansion. … Continue reading The Great Depression: A Short History
By Jeff Harding
I am on my high horse right now. Refreshed after a week off I come back to an economic mess. And I’m angry. I like to think that I’m an optimist. That attitude has been difficult to maintain with the news out of Washington. Nouriel Roubini claims he’s not “Dr. Doom,” just a realist, so I would like to claim the same title. But …
 Here is my problem: if one looks at the totality of what is happening on the domestic political front, it amounts to the greatest grab of power by the executive branch in the history of the American republic. Everything the Obama Administration is doing on the domestic side is wrong and getting worse. I believe that is not good for America. And by that, I mean it’s not good for you or me.
Forget the massive spending. Forget the greatest expansion of the money supply by the Fed. Forget the new regulations that will stifle initiative in an attempt to impose “stability” on us. Forget the caving in to special interests such as unions. Forget the bailout of companies that should go bankrupt. Forget the nationalization of the health care industry.
There is something worse. That something is the ascendancy of the technocrat, whom I shall call “Mr. Fixit.”
I don’t mean to diminish the importance of the above “forgets” because they are very significant issues that will have long-term negative impacts on all of us. But the triumph of the technocrat is the “something” that has allowed the “forgets” to happen, and there is a reason for it. It has to do with philosophy, or, if you will, ideas.
Mr. Fixit is the modern version of the New Deal idealist socialist technocrat and we are giving him greater power than ever.
Mr. Fixit is not a leftist fringe idealist: he is the mainstream.
Until we can defeat the current philosophy, we will continue to lose our freedom and prosperity.
I hear all the time that I should confine my commentary to facts and current events because readers don’t want all the philosophy crap. But how do you know if the stuff I’m feeding is not crap? (Assuming you don’t already believe that it is crap.) There has to be a way to spot, if not the truth, then at least the crap. It isn’t just plain common sense. … Continue reading Mr. Fixit
By Jeff Harding
Fed Chairman Ben Bernanke gave a startling commencement address for the Boston College School of Law Class of 2009 this week. He admitted an apparent turnabout of his fundamental views of economics. No news media picked up the significance of what he was saying.
After the introductory and self-humbling remarks usually made by great men at these events, he made the following revelatory comment:
Instead, I’d like to offer a few thoughts today about the inherent unpredictability of our individual lives and how one might go about dealing with that reality. As an economist and policymaker, I have plenty of experience in trying to foretell the future, because policy decisions inevitably involve projections of how alternative policy choices will influence the future course of the economy.
The Federal Reserve, therefore, devotes substantial resources to economic forecasting. Likewise, individual investors and businesses have strong financial incentives to try to anticipate how the economy will evolve. With so much at stake, you will not be surprised to know that, over the years, many very smart people have applied the most sophisticated statistical and modeling tools available to try to better divine the economic future. But the results, unfortunately, have more often than not been underwhelming.
Like weather forecasters, economic forecasters must deal with a system that is extraordinarily complex, that is subject to random shocks, and about which our data and understanding will always be imperfect. In some ways, predicting the economy is even more difficult than forecasting the weather, because an economy is not made up of molecules whose behavior is subject to the laws of physics, but rather of human beings who are themselves thinking about the future and whose behavior may be influenced by the forecasts that they or others make. To be sure, historical relationships and regularities can help economists, as well as weather forecasters, gain some insight into the future, but these must be used with considerable caution and healthy skepticism.
[Emphasis added]
Let me translate this for you on two levels. On one level he is talking about his personal belief in the failure of economic prediction, and at another level, is the realization by him of the failure of the science of econometrics. No small thing.
Here’s what he says in a nutshell:
- He has spent his life trying to predict economic behavior.
- The tools used to predict the future have not been very successful.
- The science of economic prediction cannot be based on mechanistic models suitable to measuring physical matter.
- Our knowledge of human behavior will always be imperfect.
- Therefore, human behavior is very, very difficult to predict.
This is a humble and revealing statement from a man who believed the Fed could prevent a depression by carefully applying the monetary tools of the Fed. … Continue reading Bernanke: A Stunning Revelation
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