Best of the Week
Most Popular
1. Stock Markets and the History Chart of the End of the World (With Presidential Cycles) - 28th Aug 20
2.Google, Apple, Amazon, Facebook... AI Tech Stocks Buying Levels and Valuations Q3 2020 - 31st Aug 20
3.The Inflation Mega-trend is Going Hyper! - 11th Sep 20
4.Is this the End of Capitalism? - 13th Sep 20
5.What's Driving Gold, Silver and What's Next? - 3rd Sep 20
6.QE4EVER! - 9th Sep 20
7.Gold Price Trend Forecast Analysis - Part1 - 7th Sep 20
8.The Fed May “Cause” The Next Stock Market Crash - 3rd Sep 20
9.Bitcoin Price Crash - You Will be Suprised What Happens Next - 7th Sep 20
10.NVIDIA Stock Price Soars on RTX 3000 Cornering the GPU Market for next 2 years! - 3rd Sep 20
Last 7 days
A Look at the Perilous Psychology of Financial Market Bubbles - 25th Sep 20
Corona Strikes Back In Europe. Will It Boost Gold? - 25th Sep 20
How to Boost the Value of Your Home - 25th Sep 20
Key Time For Stock Markets: Bears Step Up or V-Shaped Bounce - 24th Sep 20
Five ways to recover the day after a good workout - 24th Sep 20
Global Stock Markets Break Hard To The Downside – Watch Support Levels - 23rd Sep 20
Beware of These Faulty “Inflation Protected” Investments - 23rd Sep 20
What’s Behind Dollar USDX Breakout? - 23rd Sep 20
Still More Room To Stock Market Downside In The Coming Weeks - 23rd Sep 20
Platinum And Palladium Set To Surge As Gold Breaks Higher - 23rd Sep 20
Key Gold Ratios to Other Markets - 23rd Sep 20
Watch Before Upgrading / Buying RTX 3000, RDNA2 - CPU vs GPU Bottlenecks - 23rd Sep 20
Online Elliott Wave Markets Trading Course Worth $129 for FREE! - 22nd Sep 20
Gold Price Overboughtness Risk - 22nd Sep 20
Central Banking Cartel Promises ZIRP Until at Least 2023 - 22nd Sep 20
Stock Market Correction Approaching Initial Objective - 22nd Sep 20
Silver Bulls Will Be Handsomely Rewarded - 21st Sep 20
Fed Will Not Hike Rates For Years. Gold Should Like It - 21st Sep 20
US Financial Market Forecasts and Elliott Wave Analysis Resources - 21st Sep 20
How to Avoid Currency Exchange Risk during COVID - 21st Sep 20
Crude Oil – A Slight Move Higher Has Not Reversed The Bearish Trend - 20th Sep 20
Do This Instead Of Trying To Find The “Next Amazon” - 20th Sep 20
5 Significant Benefits of the MT4 Trading Platform for Forex Traders - 20th Sep 20
A Warning of Economic Collapse - 20th Sep 20
The Connection Between Stocks and the Economy is not What Most Investors Think - 19th Sep 20
A Virus So Deadly, The Government Has to Test You to See If You Have It - 19th Sep 20
Will Lagarde and Mnuchin Push Gold Higher? - 19th Sep 20
RTX 3080 Mania, Ebay Scalpers Crazy Prices £62,000 Trollers Insane Bids for a £649 GPU! - 19th Sep 20
A Greater Economic Depression For The 21st Century - 19th Sep 20
The United Floor in Stocks - 19th Sep 20
Mobile Gaming Market Trends And The Expected Future Developments - 19th Sep 20
The S&P 500 appears ready to correct, and that is a good thing - 18th Sep 20
It’s Go Time for Gold Price! Next Stop $2,250 - 18th Sep 20
Forget AMD RDNA2 and Buy Nvidia RTX 3080 FE GPU's NOW Before Price - 18th Sep 20
Best Back to School / University Black Face Masks Quick and Easy from Amazon - 18th Sep 20
3 Types of Loans to Buy an Existing Business - 18th Sep 20
How to tell Budgie Gender, Male or Female Sex for Young and Mature Parakeets - 18th Sep 20
Fasten Your Seatbelts Stock Market Make Or Break – Big Trends Ahead - 17th Sep 20
Peak Financialism And Post-Capitalist Economics - 17th Sep 20
Challenges of Working from Home - 17th Sep 20
Sheffield Heading for Coronavirus Lockdown as Covid Deaths Pass 432 - 17th Sep 20
What Does this Valuable Gold Miners Indicator Say Now? - 16th Sep 20
President Trump and Crimes Against Humanity - 16th Sep 20
Slow Economic Recovery from CoronaVirus Unlikely to Impede Strong Demand for Metals - 16th Sep 20
Why the Knives Are Out for Trump’s Fed Critic Judy Shelton - 16th Sep 20
Operation Moonshot: Get Ready for Millions of New COVAIDS Positives in the UK! - 16th Sep 20
Stock Market Approaching Correction Objective - 15th Sep 20
Look at This Big Reminder of Dot.com Stock Market Mania - 15th Sep 20
Three Key Principles for Successful Disruption Investors - 15th Sep 20
Billionaire Hedge Fund Manager Warns of 10% Inflation - 15th Sep 20
Gold Price Reaches $2,000 Amid Dollar Depreciation - 15th Sep 20
GLD, IAU Big Gold ETF Buying MIA - 14th Sep 20
Why Bill Gates Is Betting Millions on Synthetic Biology - 14th Sep 20
Stock Market SPY Expectations For The Rest Of September - 14th Sep 20
Gold Price Gann Angle Update - 14th Sep 20
Stock Market Recovery from the Sharp Correction Goes On - 14th Sep 20
Is this the End of Capitalism? - 13th Sep 20
The Silver Big Prize - 13th Sep 20
U.S. Shares Plunged. Is Gold Next? - 13th Sep 20
Why Are 7,500 Oil Barrels Floating on this London Lake? - 13th Sep 20
Sheffield 432 Covid-19 Deaths, Last City Centre Shop Before Next Lockdown - 13th Sep 20
Biden or Trump Will Keep The Money Spigots Open - 13th Sep 20
Gold And Silver Up, Down, Sideways, Up - 13th Sep 20

Market Oracle FREE Newsletter

How to Get Rich Investing in Stocks by Riding the Electron Wave

Never Mind Their Distrust of Economic Data and Forecasts; Austrians Can Help You Predict the Economy

Economics / Austrian Economics Jul 16, 2014 - 02:26 PM GMT

By: F_F_Wiley

Economics

[O]f all the economic bubbles that have been pricked, few have burst more spectacularly than the reputation of economics itself. – From The Economist, July 16, 2009.

It’s been five years since the The Economist magazine published the critical commentary  excerpted above. In hindsight, the noted reputational damage was neither lasting nor spectacular. As of today, we’d say it’s almost non-existent.


Mainstream economists continue to dominate their profession and wield huge influence on public policies. They merely needed to close ranks after the financial crisis and wait for people to forget that their key theories and models were wholly discredited.

Meanwhile, heterodox economists who stress credit market risks and financial fragilities – the Austrians, the Minskyites – remain stuck on the fringes of the field. It doesn’t much matter that the crisis validated their thinking.

There may be no better example of mainstream economists’ Machiavellian preservation of position than in the cadre of left-wing, Keynesian bloggers led by Paul Krugman. We say “led by Krugman” because he seems to set the tone and tactics that many of his cohorts mimic. If you happen to read a blog post that attacks ideological foes through a combination of ridicule, name-calling and false narratives – such as the absurd claim that all conservatives (alternatively, all Austrians) predicted rising inflation in recent years – it was probably inspired by Krugman.

Readers of this blog know that we would welcome a genuine shake-up in the field. Wouldn’t it be nice to have a Colonel Jessup moment – when the code of silence breaks and everyone finally knows the truth?

Lt. Kaffee: “Did you order the Code Red?” Col. Jessup: “I did the job I…” Lt. Kaffee:DID YOU ORDER THE CODE RED?Col. Jessup:YOU’RE GODDAMN RIGHT I DID!”

In other words: we want the impossible. Hollywood endings only happen in Hollywood studios. The real life Jessup would have denied the Code Red, smirked through his acquittal and caught the first flight back to Gitmo. He may have even felt the need to send a message to his troops by ordering another Code Red at the first opportunity. That’s pretty much what we’ve witnessed in the economics profession.

“Mythbusting” the theories of mainstream economists

Nonetheless, we’ll continue to explain why we think a shake-up is overdue. In prior posts, we demonstrated the risks of Keynesian fiscal policies using 200 years of government budget balances and 63 high debt episodes, and by working through the implausible arithmetic in Krugman’s debt reduction formula. More recently, we argued the Austrian/Minskyite position that bank lending is riskier than lending funded by prior savings, and also discussed many economists’ ignorance of the way that bank lending works.

We’ll tie the last two points together here, by taking a closer look at what happens when credit growth disconnects from naturally occurring (not through bank money creation) or “prior” savings.

This time, though, we look further back than the inception dates of the BEA’s National Income and Product Accounts (NIPA) and the Fed’s “flow of funds.” For debt, we include older Census Bureau data recorded in the Historical Statistics of the United States. With adjustments, we can show that the Census Bureau series tracks a similar “flow of funds” series fairly closely during the overlap:

We also look at pre-NIPA savings rates, calculated from data on disposable personal income and consumption:

The earlier savings rates don’t match NIPA exactly because: 1) they’re calculated from different surveys, and 2) they ignore personal interest and transfer payments, skewing the figures higher than they should be. In any case, true savings rates were surely low during the late 1920s – when both consumer credit and durable goods purchases were in bubble mode – and quite possibly even lower than the data in the chart.

Which brings us back to our reason for looking at history – to consider what happens when savings and credit run in opposite directions.  Here’s our answer:

Although there are only two episodes combining low savings with rapid credit growth, the outcomes couldn’t be clearer.

What’s more, quarterly data available from 1952 tells a similar story. With this more complete data set, we can cleanly separate total credit growth into two components:

  1. “Risky lending” financed by bank money creation or foreigners (as discussed in “3 Underappreciated Indicators to Guide You through a Debt-Saturated Economy.”)
  2. Lending from domestic, “non-money” savings (essentially prior savings).

Here’s the chart:

Risky lending tends to peak before lending from domestic, non-money savings, and also before recessions. In other words, once risky lending maxes out, the ensuing weakness feeds into the broader economy.

Moreover, the earlier chart running from the Great Depression to the global financial crisis adds a giant exclamation point to the post-WW2 results. It seems clear that risky lending is a key driver of the business cycle, while extreme differences between lending and savings lead to fully-fledged busts.

Needless to say, our conclusions aren’t exactly mainstream when it comes to economic theory. There’s no place in mainstream models for the idea that money-creating bank lending is any different to lending from prior savings. Nor is there a place for other fundamental features of credit booms, such as the malinvestment that deepens recessions or balance sheets that are unsustainably swollen with debt. Mainstream models don’t include balance sheets, after effects of malinvestment or even the very existence of banks!

To take the most basic steps towards understanding booms and busts, you need to venture outside the mainstream. The Austrian school, in particular, stresses key differences between money creation and lending from prior savings, matching the real world results in the charts above.

About the title

If you happen to show this post to your favorite Austrian economist, we wouldn’t be surprised if you’re told it’s too empirical. The Austrian school’s distrust of empirical research is well-defended by our friend Detlev Schlichter here, and we don’t completely disagree with him. But we do believe that many ideas in economics are reasonably refuted by observing real world happenings, while others are reasonably validated (though never proven). At least that’s how we see it, as you may have guessed from our content.

Think of the show Mythbusters, where all kinds of theories, rumors, adages, movie scenes and more are tested through experiments. While the experiments are often inconclusive, they’re informative enough for the presenters to make a judgment call – is the myth “busted” or not? We take essentially the same approach. Our experiments can’t be controlled, for obvious reasons, and this is the greatest limitation to empirical research in economics. Nonetheless, it shouldn’t prevent us from gleaning whatever information we can from history, and then considering what it tells us about the accuracy of economic theory.

Even Murray Rothbard, we might add in closing, made the occasional empirical argument.

Data sources and Q&A

See “Technical Notes for ‘Never Mind Their Distrust of Data and Forecasts…’.”

F.F. Wiley

http://www.cyniconomics.com

F.F. Wiley is a professional name for an experienced asset manager whose work has been included in the CFA program and featured in academic journals and other industry publications.  He has advised and managed money for large institutions, sovereigns, wealthy individuals and financial advisors.

© 2014 Copyright F.F. Wiley - All Rights Reserved

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules