Crisis In Economics?

Ayn Rand summarized the attitude of present day intellectuals in these words: “Forgive me, Father, for I know not what I am doing-and please don’t tell me.” She continued: “Observe how noisily the modern intellectuals are seeking solutions for problems-and how swiftly they blank out the existence of any theory or idea, past or present, that offers the lead to a solution. Observe that they profess to be moved by compassion for human suffering –and close their eyes indignantly to any suggestion that man does not have to suffer.” Such an attitude was evident in Sumati Mehta’s article on George Soros’ “Institute for New Economic Thinking” in Business Standard. George Soros, who pushed for a world central bank in his book “The Crisis of Global Capitalism”, founded the institute “to provide fresh insights and thinking, with a view to promoting changes in economic theory and practice”.

“Economics is in a crisis”, writes Sumati Mehta. What exactly is the crisis? She tells us explicitly: “The crisis in economics has come about because of the failure of economists as a body of professionals, and economics as a field of knowledge, to provide advance warning regarding the economic and financial crisis which the global and national economies witnessed in 2008.” This is factually wrong. Hundreds of economists of the Austrian school of economics predicted the crisis. This was true of the great depression of the 30’s too. This is well documented.  Ron Paul, Jim Rogers, Peter Schiff & James Grant were a few among them who had a public voice. Anyone can access YouTube videos of Peter Schiff predicting the crisis in 2006, when mainstream economists were laughing at him.(The attitude of mainstream economists to the crisis was well expressed by Mike Shedlock : They were “people who did not see what was coming, denied what was happening, and then failed to see the implications of what was indeed happening.”) Peter Schiff had even published a book on the then-coming crisis, titled “Crash-Proof”.

Even more wrong is the statement that economics and economists could not explain how economic agents interact and how economies work. Our knowledge of economics is far from perfect, just like there is no such thing as perfection in knowledge in any other science. However, business cycle theory has a long history, which can’t be wiped out by mainstream theorists. Ludwig Von Mises, drawing ideas from Economists of the past, came up with the only valid explanation for boom-bust cycles in his classic “The Theory of Money and Credit” as early as 1912.

Why did this happen? Sumati Mehta, here, as expected, doesn’t part way with the conventional wisdom. The reasons are self interest, blind faith in Ayn Rand philosophy, emphasis on individual self and personal freedom, greed, and selfishness. How would we get out of this mess? The answer is obvious: “It only requires a conscious promotion of the values of selflessness and sacrifice.” After arguing for years that the warning against government interference in the housing market come from heartless people, collectivists are undeterred even by their dismal failure. They are calling for more forced “sacrifice” and “selflessness”. It might not be altruism which is behind the crisis, as people who gamble with other people’s money and those who promote it, are not motivated by altruism. But, altruism serves as a cover for Government meddling. As it is said, people did exactly what the Government and planners wanted them to do.

Sumati Mehta rightly points out that there is something wrong in the rational expectations hypothesis and efficient market hypothesis. But, there is nothing new in it. Both were long before refuted by competent economists. Nowhere in the article does the author clearly explain how all this happened, other than Capitalism somehow caused it. If there is anything more dangerous than the suffering we are going through, it is the belief held universally, both by economists and laymen alike, that this crisis was born out of the excesses of freebooting capitalism, or “greed”. Nothing could be farther from the truth. Economic depressions are caused, not by anything inherent in the free markets, but due to government intervention in the economy-specifically, government manipulation of money and credit.

There is one thing in common between the intellectuals who blame the crisis on “laissez faire” capitalism. It is a complete lack of understanding of economics and the nature of capitalism. Capitalism is a politico-economic system in which all property is privately owned, and the economy is left uncontrolled and unregulated by the government. As many have pointed out, It is ridiculous to blame the present mess on capitalism, when capitalism never existed anywhere in the first place.

It has also become customary to point out that we got here due to the deregulation that happened in the past three decades. But, this was no genuine deregulation. As Thomas Woods writes: “Any “deregulation” of the banking system that permits the banks to take greater risks while maintaining government (that is, taxpayer) insurance of their deposits is not genuine deregulation from a free market point of view.” Moreover, Fifty-one thousand new regulations were added in the past twelve years. The federal register has seventy-three thousand pages of government regulations, of which, ten thousand pages were added in the past three decades. The financial and housing system is highly controlled by the Government. There was never a free market in finance and housing. Fannie Mae and Freddie Mac are government-sponsored, government regulated mortgage giants. Banks are chartered, defined and regulated by the Government. Government promoted increased home ownership through loose monetary policy. Artificially low interest rates wouldn’t have been possible in the absence of the Fed. The existence of the Federal Reserve is totally incompatible with Capitalism. So is the existence of the Securities and Exchange Commission.

To make sense of the crisis, one should first have a strong causal theory. This phenomenon of boom-bust cycles is clearly explained by the Austrian theory of Business Cycles. At any point in time, a particular amount of money would be spent in investment and savings and the rest in consumption. This investment-consumption pattern would be decided by the collective time preference of the people. If time preference is low, the investment consumption proportion would be high and if time preference is high, it would be low. The boom starts when banks print money and lend it at lower interest rates to businessmen and the general public. The increased money supply lowers the rate of interest below the market level artificially. This artificial lowering of the interest rates makes several projects seem profitable to businessmen which wouldn’t have appeared so otherwise. If the interest rates had fallen due to lower time preference of people, and was backed by real savings, boom-bust cycles wouldn’t have taken place. But, the artificial lowering of the interest rates sends wrong signals to businessmen about the savings-consumption pattern of individuals. Businessmen are misled to think that there are more savings, when there isn’t. This low interest rate sends a signal to the entrepreneurs that consumers are asking for more goods and services in the future. In order to fulfill those future demands at a future date entrepreneurs starts new long term capital projects in present time which will enable them to produce more in future and thus meet the future demand of consumers. This leads to mal-investments. The recession is the necessary part of liquidating these mal-investments.

It is important to realize that the recession is the markets readjustment process, and is to be embraced. Business failures and bankruptcies are to be celebrated, as the market is correcting its own errors. There is no reason for the recession to last for a long time, if the government doesn’t intervene with the markets correction process. The intervention of the Government with the markets adjustment process aggravates the very problem it is supposed to cure. Bailouts are neither necessary, nor just. Usually governments prevent or delay the liquidation process, which prolongs the depression period. They inflate and create more malinvestment, and this keeps down the interest rate. They keep wage rates up and hence aggravate the unemployment problem. They keep prices up creating unsaleable surpluses. They subsidize unemployment and hence prolong it. They stimulate consumption and discourage savings. All the above are the courses resorted to be the governments during a depression and each one of them is a bad course to take. It might seem disturbing for some when I say that the Government should do nothing during a depression. Yet, “laissez-faire” is the ideal policy to take during a depression.

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