The Lost Decade

Talk of a Japanese style “lost decade” has abounded ever since the financial crisis took hold in 2008. The Economist has crunched the numbers and on the basis of seven indicators covering economic output, wealth and labor markets, the United States has already gone back ten years.

Its GDP per person, for example, was at a higher level than today back in 2005 and its main stock market index was higher in 1999.

Of the countries considered, Greece has fared the worst. In economic terms, it is just entering the new millennium again. As a whole the rich world has been hardest hit by the financial crisis. Just six of the 34 “advanced” economies categorised by the IMF have GDP per person higher in 2011 than in 2007. Notable among them are Germany and Australia.

The Economist

Keynes vs. Hayek by Brian Doherty

British journalist Nicholas Wapshott’s new book, Keynes Hayek: The Clash That Defined Modern Economics is about a heated debate, eight decades past, between two of the most influential economists in modern history. That debate, which took place in the midst of the Great Depression, concerned the causes and cures of business cycle downturns.

The book comes out at a propitious time. The ongoing economic crisis raises many of the same questions that fueled the intellectual duel between the British-born liberal lion John Maynard Keynes and F.A. Hayek, his free market Austrian friend and opponent. The confluence between subject matter and current events surely helped Wapshott sell his book to a publisher and likely will sell many copies to readers. But potential buyers should be aware that the book says nothing about how the economic dispute between Keynes and Hayek might apply to today’s economic situation. This omission proves fatal.

Wapshott does not ignore the present in favor of the distant past, although the bulk of the book’s narrative is set in the 1930s. But he seems to think his subjects’ contemporary relevance is best reduced to the big-picture conflict between government intervention (Keynes) and free markets (Hayek). Wapshott focuses on the disagreements the two had over political philosophy and practice rather than the technical specifics of their economics. Those political disagreements are important, but they arose from crucial differences in economic theory.

At its root the Keynes/Hayek clash concerned alternate theories about how business cycles work. Wapshott does a workmanlike job walking readers through the lectures, books, articles, reviews, rebuttals, and counter-rebuttals that made up the bulk of their dispute. That is the book’s greatest value, and it’s the most thorough and lengthy such discussion available in the lay literature.

This book is about nothing if not economic theory and history; the personalities simply aren’t that gripping, despite slightly interesting scattered details about Hayek’s marital troubles and the torrid affairs between Keynes’ disciples. Yet Wapshott somehow never spends more than a sentence or two at a time on complicated economic ideas. He devotes far more space to discussing the feuding economists’ intemperate tone than he does to explaining what they meant. Readers who don’t already have a basic understanding of Hayekian and Keynesian economics will get little help here.

But the Keynes/Hayek argument was more complex than just the political question of government vs. markets. It was about complicated notions of price adjustment, especially the vital question of price adjustments for labor. In a 1930s context of very powerful unions, Keynes thought it was politically impossible to achieve the nominal wage reductions necessary to clear the market for labor—that is, to let wages fall so that hiring would be cheaper and unemployment thereby reduced. He instead promoted inflation as a means to trick labor into taking lower real wages.

Keynes’ most famous quip applied to Hayek’s worries about the long-run effects of inflationary attempts to put the consumption cart before the production horse. “In the long run,” Keynes said, “we are all dead.”

Hayek thought the long run might come quicker than Keynesians believed. In his 1941 book Pure Theory of Capital, the Austrian quoted Keynes’ famous line, adding, “I fear that these believers in [that principle] may get what they have bargained for sooner than they wish.” Hayekians would argue that our current economic crisis is an example of living in Keynes’ “long run”—that inflationary credit expansion and high levels of government spending have led to a bust and a debt crisis that we can’t handle. While Keynes himself thought government should spend borrowed money only during recessions, his disciples in government observe no such restriction.

Partly because he shifted from economics to political philosophy in the second half of his career, Hayek is often treated merely as a small-government polemicist. (Wapshott, trying to complicate this view, erroneously reports that Hayek believed in universal government-provided health care.) It’s a shame that a book centered on the years of Hayek’s greatest and most influential work as an economist only cements this incomplete reputation.

From Hayek’s perspective, booms and busts were caused by unnatural credit creation, setting in motion productive processes (say, home building) that end up not paying off in the end, given people’s real desire for future goods vs. present ones. Under normal circumstances, those desires would tend toward equilibrium via adjustments in interest rates. But interest rates are skewed by artificial credit creation. While the additional credit has short-term stimulative effects (booms), in the long run a structure of production that does not match actual saved capital will collapse, leading to damaging busts.

These are precisely the aspects of Hayek’s thought that make him relevant to the current crisis, and these are precisely the aspects that Wapshott avoids when discussing it. That lacuna makes his book a maddening missed opportunity for readers trying to understand how the hoary economic-journal arguments of the 1930s might shed light on today’s problems.

The years leading up to our current crisis saw exactly the sort of artificially low interest rates and monetary expansion that Hayek warned would cause unsustainable booms and busts, in this case manifest in the housing market. In reaction to the 2001 recession, Federal Reserve policy became highly expansionist.

That growth was artificial, and for various reasons having to do with federal housing policy and the practices of the financial industry it led to an economy unhealthily dependent on continually rising housing prices. As Hayek would have predicted, the bust was inevitable. And here we are.


Watches & Western Civilization

“Among other things, this multi-level competition, between states and within states–even within cities–helps to explain the rapid spread and advancing technology of the mechanical clock in Europe.

If Protestant watchmakers were unwelcome in France after 1685, the Swiss gladly took them in. And, as with military technology, competition bred progress as craftsmen tinkered to make small but cumulative improvements to the accuracy and elegance of the product. By the time the Jesuit missionary Matteo Ricci brought European clocks to China in the late sixteenth century, they were so much superior to their Oriental counterparts that they were greeted with dismay.

Because of the greater precision it permitted in measurement and in the co-ordination of action, the rise of the clock and later the portable watch went (it might be said) hand in hand with the rise of Europe and the spread of Western Civilization. With every individual timepiece, a little bit more time ran out for the age of Oriental pre-eminence.”

Niall Ferguson, Civilization: The West and the Rest

Cheap Money Is Not a Victimless Crime By Jeffrey Snider

This is a global problem, conducted under the auspices of modern monetary thought.

The financial world is meant to be directly linked to the real economic world. In the purist, philosophical sense, finance is supposed to not only reflect economic reality, but to foster productivity within the real world by productively allocating what should be scarce capital through price discovery and signaling.

Six years of zero interest rates is not only a mistake, it compounds the destructive nature of low interest rates enacted in previous episodes of economic and financial engineering. Businesses of every type and size make real decisions based on their perceptions of the cost of money, i.e., interest rates, transmitting these interventions well into the real economy.

Easy access to cash can allow business lines and whole businesses to operate unprofitably longer than they really should, meaning the relative importance of innovation and/or productivity is diminished. Efficiency gets lost in the euphoria of asset prices, as stock prices reflect quantities of money rather than true expressions of value.

Since the price effects of ownership changes are instantaneous, whereas productive projects are a net cost up front and often take many years to bear fruit, the systematic skew toward the short-run favors asset manipulation over operational innovation and improvement. True investment is discarded in favor of financial “investment”.

The fundamental processes that create real wealth, the productive exchange of labor and capital within production (or services), are the fundamental foundation of debt service and repayment. As bad as it was that the debt-fueled growth of the bubble periods was really just borrowed prosperity, the systemic and intentional mispricing of risk and the cost of money assured that payment for that borrowed growth would occur during a period where the ability to pay was significantly diminished. The key to keeping this impoverishing cycle going was the artificial alternative to direct/wage economic circulation – asset inflation and debt. Remove those and the high degree of unsustainability became obvious.

I don’t believe it is coincidence that the rate of innovation has fallen off, especially the dramatic and revolutionary innovation that marked previous periods of economic success. The amount of financial resources diverted to financial management was simply immense, growing to unbelievable proportions in the 2000’s, and that represented a huge opportunity cost to the economy as a whole. Our bloated financial industry is a net cost to the economy since there is no foundation of productive, sustainable activities to support it.

In almost every manner, the Federal Reserve and global central banks engaged in policies that were the exact opposite of what was needed. You cannot simultaneously borrow from the future while eroding the basis for that future. That is the definition of impoverishment, adding the weight of growing obligations on top of a diminishing ability to repay.

Productive investment is a long-term prospect. Central banks are singularly focused on economic activity today. In order to manage the present, central banks sacrificed the future. They thought creating growth through debt would lead to longer-term prosperity because modern economics makes no distinction about the quality of economic activity. But there is a world of difference that plays out in the drama of sustainability and eventual market discipline. Once the artificial channels of circulation inevitably fell apart, the distinction between quantity and quality produced the astounding magnitude of the Great Recession. Central banks cannot solve the problems because they are the problems. 

We cannot keep sacrificing the future for the present. We cannot borrow any more future prosperity for today–that card is maxed out. Money is not in short supply, productive capacity is. Fiscal authorities have tried to fill the gap, but government is not equipped to run the economy.

Someone in a position of authority has to realize (and have the guts to proclaim) that policy has been backwards for far too long, that short-term sacrifice is needed for long-term success, not the other way around. Cheap money is not a victimless crime.


We’re All State Capitalists Now by Niall Furguson

Today, in the aftermath of the biggest U.S. financial crisis since the Great Depression, the world looks very different.

Not only did the 2008-2009 meltdown of financial markets seem to expose the fundamental fragility of the capitalist system, but China’s apparent ability to withstand the reverberations of Wall Street’s implosion also suggested the possibility of a new “Beijing Consensus” based on central planning and state control of volatile market forces.

In his book The End of the Free Market, the Eurasia Group’s Ian Bremmer argues that authoritarian governments all over the world have “invented something new: state capitalism”:

In this system, governments use various kinds of state-owned companies to manage the exploitation of resources that they consider the state’s crown jewels and to create and maintain large numbers of jobs. They use select privately owned companies to dominate certain economic sectors. They use so-called sovereign wealth funds to invest their extra cash in ways that maximize the state’s profits. In all three cases, the state is using markets to create wealth that can be directed as political officials see fit. And in all three cases, the ultimate motive is not economic (maximizing growth) but political (maximizing the state’s power and the leadership’s chances of survival). This is a form of capitalism but one in which the state acts as the dominant economic player and uses markets primarily for political gain.

For Bremmer, state capitalism poses a grave “threat” not only to the free market model, but also to democracy in the developing world.

Ultimately, it is an unhelpful oversimplification to divide the world into “market capitalist” and “state capitalist” camps. The reality is that most countries are arranged along a spectrum where both the intent and the extent of state intervention in the economy vary. Only extreme libertarians argue that the state has no role whatsoever to play in the economy. As a devotee of Adam Smith, I accept without qualification his argument in The Wealth of Nations that the benefits of free trade and the division of labor will be enjoyed only in countries with rational laws and institutions. I also agree with Silicon Valley visionary Peter Thiel that, under the right circumstances (e.g., in time of war), governments are capable of forcing the direction and pace of technological change: Think the Manhattan Project.

It is an astonishing yet scarcely acknowledged fact that on no fewer than 14 out of 15 issues relating to property rights and governance, the United States now fares markedly worse than Hong Kong. Even mainland China does better in two areas. Indeed, the United States makes the global top 20 in only one: investor protection, where it is tied for fifth. On every other count, its reputation is shockingly bad.

The implications are clear. If we are to understand the changing relationship between the state and the market in the world today, we must eschew crude generalizations about “state capitalism,” a term that is really not much more valuable today than the Marxist-Leninist term “state monopoly capitalism” was back when Rudolf Hilferding coined it a century ago.

No one seriously denies that the state has a role to play in economic life. The question is what that role should be and how it can be performed in ways that simultaneously enhance economic efficiency and minimize the kind of rent-seeking behavior — “corruption” in all its shapes and forms — that tends to arise wherever the public and private sectors meet.

We are all state capitalists now — and we have been for over a century, ever since the modern state began its steady growth in the late 19th century, when Adolph Wagner first formulated his law of rising state expenditures. But there are myriad forms of state capitalism, from the enlightened autocracy of Singapore to the dysfunctional tyranny of Zimbabwe, from the egalitarian nanny state of Denmark to the individualist’s paradise that is Ron Paul’s Texas.

The real contest of our time is not between a state-capitalist China and a market-capitalist America, with Europe somewhere in the middle. It is a contest that goes on within all three regions as we all struggle to strike the right balance between the economic institutions that generate wealth and the political institutions that regulate and redistribute it.

The character of this century — whether it is “post-American,” Chinese, or something none of us yet expects — will be determined by which political system gets that balance right.

Foreign Policy

The End of Cash by David Wolman

There are no atheists in the modern economy. You may not have God or Buddha in your life, but you very much have faith—in money. I don’t mean that you worship money in the greed-is-good sense. No, you have faith in its value. Your trust in it depends on everyone else’s, which means that our faith in money’s value is really about trust in each other—a belief in shared purpose, or at least a shared hallucination.

Cash, as in banknotes and coins, helps us to maintain that magical thinking. It’s real in the way that you can hold it, smell it, and want to wash your hands after handling it. Paper notes and metal coins are the treasures of our childhoods, tucked under pillows by tooth fairies, delivered in secret by doting grannies. Despite the dull textbook definition of money—a medium of exchange, unit of account, store of value—it is by way of using it in the form of cash that we first come to understand the civilization-powering technology that is money.

But do we still need cash? In an era when books, movies and music are transmuting from atoms to bits, the greenback and those increasingly costly metal rounds are looking more analog by the minute. Lately it seems like the only people who carry cash are aspiring terrorists, corrupt government officials, drug traffickers, bank robbers, tax evaders, counterfeiters and rich college kids buying little bags of marijuana.

Although predictions about the end of cash are as old as credit cards, a number of developments are ganging up on physical money like never before: mistrust of national currencies, novel payment tools, anxiety about government debt, the triumph of mobile phones, innovative alternative currencies, environmental concerns and growing evidence that cash is most harmful to the billions of people who have so little of it.

The poorer you are, the higher the costs and risks of cash become. Anyone you know can beg you for a few bucks or steal the hard-earned money that you’re trying to save to pay your children’s school fees. A fire or natural disaster can obliterate your meager savings. And you may have to spend days riding buses and walking to the countryside to deliver cash to, or retrieve it from, a relative. Even if a wire service is accessible, that means paying steep service fees.

In wealthy countries, money, for the most part, is already borne in the form of 1s and 0s on some distant computer. If you happen to want or need cash, you stroll to a nearby ATM. Otherwise, you use your credit or debit card, or perhaps a newer technology like Google Wallet or PayPal Mobile.

Having money in electronic form is our ticket to both streamlined commerce and services that help us to achieve stability beyond the next meal or visit to the doctor: mortgages, small-business loans, interest-bearing accounts, health insurance, home insurance, college savings, e-commerce and more. Yet while we can essentially toggle between paper and electronic money as we see fit, the poor are stuck using cash. A primary barrier is the conventional model for banking based on bricks-and-mortar branches. It has never been profitable to put bank branches in the slums and rural villages where poor people live, while balance minimums and the time required to get to and from a branch make old-school banking unrealistic and unattractive.

But phones are everywhere. Mobile technology is now being touted as a solution for getting financial services to the roughly one billion people who already have a phone but who don’t have a bank account. The models vary, but the gist of mobile money is electronically storing or transferring value by way of the phone. For mobile banking, the idea is to make it possible for almost anyone to open and use a no-frills savings account and, through a network of associated merchants, make transactions. Major players like the World Bank and the Gates Foundation are already investing heavily in these new technologies for providing the poor with financial services.

Another innovation that promises to push cash further to the periphery is near field communication, or NFC. A tiny antenna inside a digital device, like a cellphone, can wirelessly transmit payment information with a quick wave toward a reader device or another person’s cellphone. NFC could be a killer for those low-value cash transactions—a pack of chewing gum, a lamp at a garage sale—that constitute the vast majority of today’s cash purchases. (Payment industry geeks call this the “final mile” on the road to cashlessness.) By 2014, transactions conducted via wireless connections from phones world-wide are expected to total $1.13 trillion. Initially, most of these new technologies will only provide alternative ways to make a credit card charge, but that too is changing, as users turn to person-to-person methods that cut out the middlemen, eliminating both fees and friction in our economic lives.

The final blow to old-school scrip may come from currency innovators. Alternative currencies are surprisingly common, and they go well beyond classic examples like Disney Dollars and airline miles. Today there are local versions like Ithaca HOUR (Ithaca, N.Y.) and BerkShare (western Massachusetts), and online ones like Facebook Credits and, most recently, the encrypted digital currency Bitcoin.

It may be tempting to belittle alternative currencies as limited, unrealistic, or maybe a little kooky, but they do work, so long as they don’t run into counterfeiting problems and supply is intelligently controlled to avoid inflation. Nothing but perception—call it religion, even—makes the issuing authority of the U.S. government more legitimate than, say, the Ithaca HOURs Circulation Committee. Both try to supply users with real money, and both do their best to wisely steer monetary policy in a way that promotes growth.

But the hazards are just as real, too. For alternative currencies, the risk of a mismanaged money supply is alive and well, and a misstep, or a crisis in confidence after an outbreak of war in upstate New York, could cause the HOUR’s value to plummet. National currencies run this risk as well, but those who handle the state money supply have more tools at their disposal to maintain stability.

As skepticism, or at least anxiety, about the managers of national or super-national currencies increases (hello, euro zone), supporters of alternative currency schemes will find a wider audience. New ideas about money are uniting people on the right, who worry about deficit spending and the heavy hand of government; libertarians, who see sovereign currencies as interference with market forces; and über-progressives, who seek a monetary system that relies less on frenzied speculation and plundering natural resources. A phantasmagoria of new value possibilities awaits.

Could we completely trash cash tomorrow, or even in five years? No. Too much economic activity and too many livelihoods still depend on it. Cash is useful if your baby sitter doesn’t accept PayPal or if you want to eat at a cash-only Chinese restaurant. And as long as we still use cash and not Facebook Credits to tip waiters and bellhops, we can’t get rid of paper money.

The idea isn’t to make life harder for those whose lives depend on modest transactions; it is to scrutinize cash because it has skated by for ages with barely a whisper of criticism. A closer look at the long history of cash, its present-day costs and the flood of emerging technologies suggests that we may very well be on the brink of a monetary revolution.


Daniel Kahneman on Instinctual Economic Decision Making

Mr Kahneman, an Israeli-American psychologist and Nobel economics laureate, has delivered a full catalogue of the biases, shortcuts and cognitive illusions to which our species regularly succumbs. In doing so he makes it plain that Homo economicus—the rational model of human behaviour beloved of economists—is as fantastical as a unicorn.

This book, his first for a non-specialist audience, is a profound one. As Copernicus removed the Earth from the centre of the universe and Darwin knocked humans off their biological perch, Mr Kahneman has shown that we are not the paragons of reason we assume ourselves to be.

“Most of the time we can trust intuition, and we do. In terms of the distinction I draw between fast thinking and slow thinking, our life is mostly run on fast thinking, which normally does very well. We cross the street safely and make many other decisions safely. However, there are situations where people would do better by slowing down. And there are cases in which people have far more confidence in their intuitions than is justified, as in the case of stock trading.”

“Well, clearly there is a state when we lose our normal grasp on reality, which is mostly defined by what other people do. Under some conditions, people and institutions come to be guided almost exclusively by the worst-case scenario. This can happen at the level of institutions, when banks become afraid of lending to other banks. Understanding these processes is very urgent. We have vague stories but we don’t have good research of the kind we have on individual risk taking.”

— The Economist

The Massive & Lucrative Underground Economy

A $10 trillion underground street economy that will employ two-thirds of the world’s workers by 2020 has been uncovered.

Robert Neuwirth, in his book “Stealth of Nations: The Global Rise of the Informal Economy,” treks through the developing world and finds small, informal — sometimes illegal — enterprises are changing the shape of the global economy.

I believe him because I have seen it myself. And if you have ever traveled about developing nations, you have too. Those kiosks and small stores selling the basics where you can find pretty much everything and anything from cigarettes to pirated DVDs, employ a large chunk of the world’s population — half at the present time, according to Neuwirth — and outsell Wal-Mart. Indeed, big brands know this.

He cites numerous examples of brands from Procter & Gamble, Colgate-Palmolive, Unilever, among mobile providers and others that distribute their products via this network — sometimes knowingly and sometimes not. Neuwirth calls this network of small enterprises System D (taken and shortened from a French term).

“System D is growing faster than any other part of the economy, and it is an increasing force in world trade. What’s more, after the financial crisis of 2008/2009, System D was revealed to be an important financial coping mechanism.

A study by Deutsche Bank, the huge German commercial lender, suggested that people in the European countries with the largest portions of their economies that were unlicensed and unregulated — in other words, citizens of the countries with the most robust System D — fared better in the economic meltdown of 2008 than folks living in centrally planned and tightly regulated nations,” Neuwirth writes.

Moreover, given that the population of the developing world is growing right along with their economies, it makes sense that the sales outlets people are used to shopping in would grow too. And smart brands, such as those mentioned, should benefit. It’s easy enough to spot big brands even in remote places. U.S. soda producers, snack makers and bathroom product distributors are seemingly omnipresent the world over.

This should give investors pause as to which companies to invest in for the future. Small, growth companies don’t have the distribution systems that big, old-school consumer brands do. To be sure, big brands often don’t want the association with street stalls and the like, especially if these outlets are selling illegal items, which many do. Neuwirth points this out as well and explains that third-party distributors are often involved.

In any event, the power of the street economy should be taken seriously.

The market itself is what Neuwirth describes in “Stealth of Nations.” Alien perhaps to us with items strewn along tables, on the ground, and bartered over, but common enough to the majority of the people in the world. Such commerce is the future. From microloans that support these street vendors to big brands that stock the shelves, such as they are, there are many ways for investors to play System D for profit.

It’s well worth reading about and investigating these shadow markets. They will add up to what Neuwirth alludes to with his title: the wealth of nations to come.


Dollar Vs. Euro

The dollar has looked good against the stumbling euro in the past year. But it’s a different story compared to the yen and other global currencies

The euro and dollar are more currency chumps than champs lately. Sure, the dollar has strengthened against the euro in recent weeks as Europe’s debt crisis continues to fester. But there are many reasons to dislike both currencies.

The Federal Reserve has already said that it is likely to keep its key overnight lending rate near zero until mid-2013. Low interest rates are an enemy of a currency as exchange rates tend to rise and fall with them. And it would not be a major surprise if the Fed, which just disclosed Tuesday in minutes from its latest meeting that it intends to start publishing interest rate projections with quarterly economic forecasts, extends the zero rate pledge until 2014 sometime soon.

For one, the U.S. economy remains in a low and slow “recovery”. What’s more, several of the more hawkish (i.e. inflation fighters generally in favor of less stimulus) members of the Fed’s policy committee are out this year and will be replaced by Fed regional presidents with more dovish leanings.

That adds up to a weaker dollar, especially if the Fed announces a third round of bond purchases, or quantitative easing, to keep long-term rates low. QE3 is far from certain since some market experts and politicians have warned about an eventual inflation spike if the Fed keeps printing money to buy debt.

While the U.S. has a looming debt problem, Europe is already in a full-blown crisis. And it may be impossible for the different nations in the eurozone to come up with a quick and neat solution. That’s why the euro, which Wednesday morning slipped back toward the 17-month low of $1.28 that it just hit last week, may continue to fall in the next few months.

“Europe is a mess. They still don’t know what they want to be. A political union? A monetary union? They need to make a decision,” said Michael Woolfolk, senior currency strategist with Bank of New York Mellon.

Nonetheless, investors should not mistake any more gains that the greenback may make on the euro as a sign that the dollar is almighty once again.


Heterodox Economics & Marginal Revolutionaries

The “Austrian” school of economics, which traces its roots to 19th-century Vienna, is sternly pre-Freudian: more inhibition, not less, is its prescription. Its adherents believe that part of the economy’s suffering is necessary, an inevitable consequence of past excesses. They do not think the Federal Reserve can rescue the economy. They seek instead to rescue the economy from the Fed.

The Austrians see the bogeyman as inflationary bubbles, and for good reason. Indeed, the Austrian school has thrived on the back of massive disillusion with mainstream economics, which held that the economy would grow steadily if central banks kept inflation low and stable, and that there were no great gains in the offing from fiscal expansion, nor any great cause for concern over financial instability. And they have benefited hugely from blogging.

Economics, perhaps more than any other discipline, has taken to blogs with gusto. Mainstream figures such as Paul Krugman and Tyler Cowen have commanded large online audiences for years, audiences which include many of their peers. But the crisis has made the academic establishment fractious and vulnerable. Highly credentialed economists now publicly mock each other’s ignorance and foolishness. That has created an opening for the less decorated members of the guild, and the truly peripheral. In the blogosphere anywhere can be “The Center of the Universe”. And that center now pivots on Tyler Cowen, a professor at George Mason University whose “Marginal Revolution” blog has drawn wide acclaim.

Tyler Cowen is a proponent of Austrian economics—a resurgent school of thought that, unlike market monetarism, has not been doing much to change the minds of most mainstream economists but, unlike neo-chartalism, has built up a broad constituency on and through the web. Its adherents differ a lot in their preoccupations and prescriptions. But they agree that interest rates should reflect the fundamental forces of thrift rather than the whims of central bankers.

The Austrian school’s thinking centres on the way “malinvestment” orchestrated by central banks distorts the business cycle. By keeping interest rates artificially low, central banks trick entrepreneurs into believing that society is more abstemious than it really is. The entrepreneurs then embark on ambitious, long-gestation investment projects, only to discover that the men and materials they require are otherwise engaged in the production of more immediate gratifications. Once this realisation dawns, the entrepreneurs abandon their follies, firing their workers. If wages are flexible and workers mobile, this bust need not be too bad. But misguided attempts by the government or the Fed to prevent unemployment will delay the necessary reshuffling of labour from industries too tied up in the future to those catering to the needs of the present.

Scholars such as Lawrence White of George Mason University see in this the grounds for replacing central banks with “free banking” in which private institutions take deposits and issue their own banknotes without government permission or protection. To make these liabilities credible, free banks would probably have to make them redeemable into something else, such as gold. As a consequence, banks will hesitate before expanding too quickly, lest their gold reserves come under threat. This, Mr White argues, would impose a natural check on overexpansions of credit.

The resurgence of Austrian analysis is not merely a web-based phenomenon. In 1981 Margit von Mises approved the establishment of an institute in the name of her late husband, Ludwig von Mises, one of the giants of the Austrian tradition of economic thinking. The Mises Institute set up shop at Auburn University in Alabama, attracted by a couple of “Austrian-friendly” faculty members and a timber owner willing to donate money to the cause. From early days in the shadow of the football stands, the institute now boasts its own amphitheatre, conservatory, recording studio and library. At one of the institute’s soirées, accompanied by a recital on its Bösendorfer piano, Vienna may not seem so very far away. Yet the institute’s impressive web presence, with ever more signing up for its online classes, makes its ideas, if not its ambience, available to all.

Austrians still struggle, however, to get published in the principal economics journals. Most economists do not share their admiration for the gold standard, and their theory of the business cycle has won few mainstream converts. According to Leland Yeager, a fellow-traveller of the Austrian school who once held the Mises chair at Auburn, it is “an embarrassing excrescence” that detracts from the Austrians’ other ideas. While it provides insights into booms and their ending, it fails to explain why things must end quite so badly, or how to escape when they do. Low interest rates no doubt helped to inflate America’s housing bubble. But this malinvestment cannot explain everything.

As for the Austrians, Brad DeLong, a Keynesian Berkeley professor who also blogs, has called an acquaintance with their ideas a useful part of a diversified intellectual portfolio. But his frequent comrade in arms, Mr Krugman, does not seem to have revised his view that their business-cycle theory is “as worthy of serious study as the phlogiston theory of fire”.

His analogy implies that economics, like chemistry and physics, makes enough intellectual progress to allow economists to ignore some old thinkers. But is economics that kind of science? Its practitioners cannot run controlled experiments on whole economies, contrary to Krugman’s pseudo-scientific claims.

The Economist