Austrian Theory of the Business Cycle: A Basic Primer

I’m no expert in the Austrian School of Economics.  But I know enough to like what I see and what I read.  Austrian economics (also see here) views the economic world as fundamentally linked to human behavior.  Thus, equations and rigorous quantitative analysis are not all they’re cracked up to be, as economics operates based on human behavior, which is full of fundamentally irrational aspects.

The result is that to understand economics, certain axioms are asserted about how humans think and act.  The aggregate of these axioms, or their totality, constitutes the Austrian School of Economics.  Many are quite basic and intuitive; for instance, individuals like to economize limited resources.  They like to trade something of lesser value for something of greater value.  They want to minimize expenditures.  And they tend to trade only in instances where they think they will be benefited.  The Austrian theory is really quite fascinating.  Mises.org (named after Ludwig von Mises) has some great basic teachings and texts on the subject.  I highly recommend them.

One aspect of Austrian economics particularly pertinent to our condition is the theory of the business cycle.  For most mainstream economists nowadays, the business cycle is built into the laissez-faire economy.  Thus, intervention is needed to tame the excesses and maladies associated with the laissez-faire business cycle.

For the Austrian theory (which holds up very well to the scrutiny of economic history), the business cycle comes not from laissez-faire economic policies, but from economic interventionism.  The thinking goes something like this:

In a true free market, banks would lend out money at an interest rate based on the cash deposited into the bank.  (How else would banks be profitable?)  The more money is deposited, the more money is available for lending out (i.e. investment).  The less money is deposited, the less money is available for lending.  When money is scarce, then interest rates are high to limit investment.  When money is abundant at the bank, interest rates are low, thus encouraging would-be investors to invest.  But all investments, in a free market, are tied to the savings on hand (or some fractional reserve; but we’ll ignore this aspect for now to keep things basic).

Suppose a bank set the interest rates too low.  Investors would rush in and take out all sorts of loans.  The bank would run out of money.  Depositors wouldn’t be able to get their money back, as the bank has lent out too much money!  The bank would likely go under.

Suppose a bank set the interest rates too high.  Investors would choose to invest in another bank with comparatively lower interest rates.  And so competition tends to set the interest rate at some optimal market rate (which fluctuates, as the market does, with great frequency).  Thus, investments are balanced with deposits, in a free market.

People are encouraged to deposit their money, as investments are based off of savings.  No savings translates to no investments.  So individuals deposit their money, reaping the dividend (interest from the loans being paid back).

Suppose an interest rate is not market-based, nor set based on available savings.  Suppose it is lower than the market rate.  What would happen?

It’s obvious that investors would love to take advantage of this situation: easy loans means easy credit and more money-making opportunities.  (They may even be compelled to take advantage of this just to stay in business.)  So many loans are given out.  Entrepreneurs have a hay-day with the proliferation of money available.  The result is new jobs, new businesses, and high growth.  Very high.  This phase is called the “boom” or the “bubble.” 

It should be noted that investments are riskier and of lower quality than they would be if the interest rate was higher; lenders would be more particular about who they are lending their money to, and for what purpose.  People taking out loans would be more cautious if the required rate of return to pay their loan back was higher.

The result is a bunch of bad investments.  True, there are good ones as well, but there is a disproportionate amount of bad (that is, unsustainable) investments.  When the market tries to liquidate these unsustainable investments, businesses go under.  This is called the “bust” part of the cycle, or when the “bubble” bursts.

Thus, artificially set interest rates with the intent of spurring the economy result in an ill-advised credit spending spree.  When the piper must be paid, businesses start going under.  Lay-offs occur.  Money becomes tighter.  If the boom is big enough, then a recession may result.

Examples of booms are all around us: the “roaring 1920s” is a great example.  We recall this was followed by the Great Depression.  In more recent memory, the dot.com boom of the mid and late 1990s and the huge housing bubble in the early part of this century are examples.  Each is a result of low interest rates, which encourage a huge amount of investment in certain sectors.  In the short-term, many get wealthy and rich.  (How many got involved in sub-prime loans or home equity lines of credit, to name two examples?)  In the long-term, a “bust” or even a “recession” results.

Banks don’t like the roller-coaster ride.  If it were up to them, they would set interest rates at more sustainable levels: just enough to encourage constant economic growth with a minimum of malinvestment.  They don’t benefit from the high highs and the low lows.  They make money when people pay their loans back, not when they default.  They prefer an even keel.

Many well-meaning individuals (like Suze Orman, for instance) talk about how we are a credit-driven society.  She points out that we need to save rather than spend.  That is certainly true.  What she does not acknowledge is that the whole system is set up for easy credit, completely independent of savings.  There is little incentive to save, especially when the rate of return is so low (those artificially low interest rates again) that it’s almost impossible to keep up with inflation.  (Most don’t question this, viewing inflation as a given or a necessary evil.)

There’s much much more to this picture, but in summary, artificially low interest rates (set by the U.S. Central bank: the Federal Reserve) are responsible for the boom and bust cycles, and for much of the economic turmoil frequently associated with the free market.  There was a time when this was well-understood.  Now, it is all but ignored.

Thoughts on the Revolution

Few may be talking about it, especially in the mainstream media, but Ron Paul came in second in Pennsylvania, with 16% of the vote.  Pretty good for a loon.

Ron Paul is still campaigning.  The Revolution is still going forward. 

What is the nature of the Ron Paul Revolution?  Its aim is to restore the American Republic forged from the Constitutional Convention.  That means a limited government which exists to protect the rights of its citizens.  Instead, we have an ever-expanding (increasingly unlimited in scope) government which infringes upon the rights of its citizens.

Liberty is what the American experiment was based upon: personal, individual, God-given liberty.  Not liberty from poverty or environmental hazard, or any global malady, but liberty from oppressive government influences.  Liberty from warrantless searches and seizures.  Liberty from unjust courts and trials.  Liberty to live as we please, so long as we do not infringe upon the rights of others.  Why else throw off the shackles of a relatively mild (mild by today’s standards, anyway) English monarch?

It just so happens that this pattern of limited government, if followed, would result in the most prosperous nation on the Earth.  How do we know this?  History, especially economic history, informs us that liberty, if implemented, leads to unprecedented prosperity.  We can see this with England’s Constitutional Monarchy, and economic growth in the Industrial Revolution.  We can see this with Japan, Taiwan, Korea, and Singapore in the post WWII era.  We can see this with explosive economic growth in India and China (Ironic, isn’t it, that a government-run, oppressive Communist regime like China has more economic freedom than the good ol’ US of A?)  And we could see this with America, before the welfare-warfare state came into existence.

The good news is that people are starting to wake up.  The Pennsylvania results are just the latest tally in a lasting movement to restore the American Republic to its fit and proper state, that which the Founders set up.

The Ron Paul Revolution is for real, and it is just getting started.

Recommended Book Review

Active LDS author Robert E. Hales (not to be confused with the member of the Quorum of the 12 named Robert D. Hales) wrote Secret Combinations Today: A Voice of Warning in 1996.   It is still in print.  I recently got a copy for Christmas.  I heartily recommend it to the Latter-day conservative crowd.

The book starts out with a doctrinal discussion on secret combinations in days of old. What are they? How did they develop? What scriptural patterns are associated with them? Brother Hales is spot-on (or at least very close) with the doctrinal discussion, in my opinion, where he quotes from various scriptures to support his points.

He then breaks down the rest of the book into a way to examine several different methods the adversary uses to attack, comparing the current with the ancient, using the pattern he cites.

First, he discusses attacks on the individual. Most of this discussion centers around immorality. He questions the legitimacy and wisdom of mass, public sexual education, for instance, as in public schools. He discusses pornography, safe sex, and homosexuality, among other topics, all from an LDS perspective.

The second area focuses on attacks on the family. Here he discusses domestic abuse as well as the conventional views on parenthood, both motherhood and fatherhood, in addition to modern-day obstacles to achieving the ideal situation. One of these obstacles is the financial burden, related to high taxes, on two parents trying to raise their children in an increasingly expensive world.  He goes back to this later.

The third area focuses on the United States as a “choice land,” and a land of liberty, and related threats.  He ties the country’s rejection of the Church in the 1830s and 1840s with many problems in the country (past and present; i.e. war, crime, corruption, etc.) and gives these as evidence of secret combinations among us.  He specifically cites terrorism, organized crime, and gangs, among others.

The fourth area focuses on money and the United States.  Here’s the really good stuff.  He discusses monetary policy, legal tender, and the idea of using commodity-backed currency vs. fiat money.  He also gives a good introductory background into the Federal Reserve, discussing its history and even including the Austrian Theory of the business cycle (albeit not in those explicit terms).

Embedded in this chapter is a discussion on taxation.  It’s a little like what Calvin Coolidge said.  He went to Church one Sunday.  Someone asked him what the subject of the sermon was.  “Sin,” he replied, to which the other asked what the preacher said.  The response: “He was against it.”  That basically sums up this section: Brother Hales is against the philosophy and logistics of a large and growing tax burden, citing Ezra Taft Benson on several instances.

The next area is the attack of communism on the Constitution.  He’s not specifically referring to the Cold War here.  It is more of a reference to the philosophical support of big government (and all of its baggage) domestically.  He discusses federalism and the fundamental role of government, among other topics.

The final chapter of warnings are about the movement towards a one-world government.  He cites banking, environmental concerns, and population control, among others, as evidences of this movement.

The last chapter is essentially a call to arms.  More scripture and doctrine is discussed with the intent of motivating righteous, concerned individuals to band together and oppose the secret combinations, and their attack on all aspects of our society.

While I may not agree with all the points provided, I nevertheless find this a very interesting and worthwhile book.  If you are like me and are scared away by super long books with tiny print, be of good cheer: this is under 200 pages long.  Brother Hales has done his research: he quotes extensively from sources spiritual and secular throughout.  It’s a very interesting and inspirational discussion of a topic near and dear to Latter-day conservatives, and important to us all.

Seven (Religious) Principles for Surviving Economic Turbulence

Elder Hafen visited our stake recently, and shared seven tips or principles Elders Ballard and Scott (of the Quorum of the 12) recently shared with the brethren to deal with economic turbulence. I imagine none are too surprising considering the past and current teachings of the Church on temporal welfare. I thought I would share them here:

1. Pay your tithing and fast offerings. No question that the spiritual blessings from tithing and fast offerings outweigh any physical inconvenience. This is especially true in times of difficulty. This is number one as an expression of faith to open the windows of heaven.

2. Education and literacy.  This is done with a long-term perspective in mind, a preparation for life.  For me, I think it doesn’t just mean one discrete period of training, (i.e. college, vocational school, etc.) but more like a continuous, lifelong quest for learning, where one constantly strives to better one’s self.

3. Employment with a focus on career development.  One factor to consider when finding a job is how it will contribute to one’s personal and professional development, both short and long-term.

4. Financial management.  Elder Hafen explained this means avoiding consumer debt and having a savings for a time of need.  He was befuddled by our overspending culture, bankruptcies, floating credit, etc.  As a libertarian, I had no problem plugging in the easy money and easy credit policies of the Federal Reserve right into this one as a cause.  And then I thought: is the cause (and a good comprehension thereof) really important theologically?  I decided it is not nearly as important as understanding how to get through the difficult circumstance.  To sum up, stay out of debt and save for the future.

5. Family home storage.  This includes a financial reserve (see number 5) as well as some food storage.  Elder Hafen referenced President Hinckley’s practical approach to food storage: better to have something than nothing.  One must start somewhere.

6. Physical health.  Elder Hafen mentioned eating right and exercising to stay in good physical health.  This one was curious to me.  But there are at least two relatively obvious reasons why this would be important: first, bad health can be very costly.  In a time of need, it can be that much more of a financial burden to pay for medical care.  Another reason is that good physical health makes one much more marketable in the labor force.  This means a greater likelihood of finding a well-paying job in a tough labor market.  And of course there are other benefits, like being better able to accomplish one’s job, feel good about one’s self, and receive spiritual blessings from good health.

7. Welfare.  This was a little open-ended and vague.  Elder Hafen asked “Why aren’t we (as a Church) doing better in welfare?”  I was a little hazy at what was specifically meant, but suppose that this means that members of the Church should watch out for each other’s welfare, spiritually, physically, emotionally, socially, etc., and for some reason, we don’t (at least not as well as we should).  Elder Hafen largely left this question for us to think about.

Of course, none of these points are surprising or unusual when compared to traditional Church teachings and doctrine.  Education, good health, continual progression, food storage, and watching out for each other’s welfare, for instance, all have strong scriptural and historical precedent.

These are all somewhat comforting to me.  I have been thinking of this for some time.  How do I prepare for economic calamity?  These simple principles were somewhat of an answer to that query.

I would add that it behooves each member of the Church to strive for guidance and direction from the Holy Ghost, in addition to the seven recommendations.

A More Excellent Way

There are many not of our faith who share our distaste and disgust with our leviathan government. They share our concerns about a loss of liberty as a result of unconstitutional domestic infringements. They share our concerns about bankruptcy as a result of blatantly irresponsible fiscal practices. They share our concerns about pending danger and attacks as a result of an untenable, immoral foreign policy position. There is much we have in common with our brothers and sisters outside of the faith who share our concerns about such things.

As Latter-day Saints, however, our charge is different. We are to support the cause of liberty, yes, but in the context of preparing the world for the Second Coming of the Messiah. Our means must be different. Salvation and exaltation is at stake, both for us and for others. Our way must be different, for what we do, and how we do it, molds our character; we will be accountable for such on the Day of Judgment. What doth it profit us, if we gain a small and restrained government, but lose our own souls?

Frustration and anger is commonplace among many small government advocates. But the Lord directs us to “Love your enemies, bless them that curse you, do good to them that hate you, and pray for them which despitefully use you, and persecute you” (Matthew 5:44).

What shall we do? Faith, hope, and charity are musts. We need faith in salvation through Jesus Christ. We need hope in a better world. We need charity for all.

How do we show charity while not compromising our positions? There are plenty of examples of what not to do. The vitriol of Paul Craig Roberts, for instance, seems anything but charitable to me.

Instead, we should strive to remember what it was like before we had small government beliefs. Or, if we have had such our entire lives, then we should try to put ourselves in someone else’s shoes. We must strive to understand the perspective of others, empathizing when possible, and sympathizing when empathy is not possible.

In summary, as Latter-day Saint advocates of small governments, we must transcend the ways of the world and strive for a more excellent way, that others may choose to believe what we do by their own choice, and not be bullied or manipulated or pushed into it.