The strongest critique of the Austrian theory of business cycles has always been that it makes businessmen out to be a bit foolish. Why are they always getting tricked by the low interest rates of central banks into making unsustainable investments? Wouldn’t a smart businessman take advantage of low rates to make investments that could withstand inevitable rate raises?
There are lots of possible responses to this. The Austrian economists have offered plenty, including the fact that low interest rates create a kind of calculational chaos that makes if very hard to figure out which projects are sustainable and which are too risky.
One of the favored responses, however, has just been that businessmen did not understand the business cycle very well. After all, Austrian economics has long been regarded as outside the realm of mainstream economics. Many MBA’s probably have nothing but a vague sense of the Austrian business cycle theory. So the reason businesses didn’t anticipate and respond to the boom-bust cycle is that they didn’t know much about it. Their errors were based in ignorance.
A conspiracy theorist might point out that this ignorance served the purposes of central bankers very well. It made it possible for central bankers to use interest rates to manipulate the economy. They could lower interest rates and count on businessmen to respond as they expected—by starting and expanding business lines.
This brings me around to my point today. I think that we may have entered a new era.
We may all be Austrians now.
Here's the problem with applying a strictly Austrian theory to the last decade: the Austrian theory assumes business leaders are foolish and don't understand the boom-bust cycle, absolutely. It assumes then that boom-bust are caused by overexpansion, mergers and acquisitions that end up going sour, and new products that don't pan out ("malinvestment") triggered by the boom part of the cycle that eventually leads to the bust part.
Why the Austrian theory doesn't apply is that on the contrary, the folks who made out like bandits hedging their bets towards a Greenspan housing bubble collapse knew exactly what they were doing anticipating the chaos. The banks certainly were counting on it, and they were counting on the collapse being so large and systemic that the government would save their asses. They hedged their bets, and literally bet on the house of cards falling apart in the derivatives and counter-insurance markets. It wasn't ignorance at all, but purposeful chaos brought on by the increasingly leveraged derivatives roulette wheel.
The other big component of Austrian theory is that anything central banker related is automatically bad. But again, it was the big banks playing the counter-insurance Big Casino games with AIG and Fannie and Freddie that caused the problem. They bet on bust, and bust is what happened. We've seen just how hollow a lot of these outfits are in the integrity department with the Foreclosuregate scandal. They literally never expected to get caught playing on the dark side of the shadow economy.
Austrian economics breaks down when the corporate actors behave in a manner that causes the bust on purpose in order to force central banker intervention, enriching the businesses in spite of their malinvestment...malinvestment designed to lose badly enough to force the Fed's hand.
Now, to be fair, straight Keynesian economics again assumes rational actors in the business community as well, but the central bank in this case is more the economic cop and not the bad guy here. So it's a bit more applicable, but not by much. The Fed is still the cop, but there's nothing it can really do. Interest rates are already nil. What else can the Fed do? The buyer of last resort is buying whatever it can, creating fiat money to do it with. That's a economics solution to a legal problem. Shooting money at the banks won't make them invest.
We're out into a whole new ballgame here that's neither Austrian nor Keynesian, but just plain old fraud. So what's the answer? Well, if the corporate actors are no longer rational, then Austrian theory goes out the window. At the same time, Keynesian applications (what we're seeing now) seem to be working, but we're seeing a huge glut of cash at the top, especially with businesses raking in record profits. The Keynsian money we're throwing into the system is not being translated into additional jobs or investment at all. It's not malinvestment, it's no investment.
That leaves us pushing on a couple billion feet of string. It's not an economics issue, it's a malfeasance issue. And until we make the people responsible pay for it, classic macroeconomics won't apply. The game is simply too rigged now.
What we need is a national holistic solution. And with the 112th Congress...well, good luck with that.
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