Marx and Predictions of Capitalist Crisis

An interesting passage from Wilhelm Liebknecht’s book Karl Marx: Biographical Memoirs (1901) about Marx’s predictions:

“ … whoever prophesies revolutions is always mistaken in the date.

Well, though Marx was a prophet looking into the future with sharp eyes and perceiving much more than ordinary human beings, he never was a prophesier, and when Messieurs Kinkel, Ledru Rollin and other revolution-makers announced in every appeal to their folks in partibus the typical, ‘To-morrow it will start,’ none was so merciless with his satire as Marx.

Only on the subject of ‘industrial crises’ he fell a victim to the prophesying imp, and in consequence was subjected to our hearty derision which made him grimly mad. However, in the main point he was right none the less. The prophesied industrial crises did come—only not at the fixed time.” (Liebknecht 1901: 59–60).

Actually, even here Liebknecht is being somewhat dishonest about Marx supposedly not making predictions about when the final revolution would come.

In reality, with the failure of 1848 revolutions in Europe, Marx started to rethink the nature of the proletarian revolution, and from 1850 he thought such a workers’ revolution would happen after a cyclical crisis in capitalism (Sperber 2014: 274).

In these years right up until the 1860s, Marx thought that the final revolutionary outbreak that would lead to the proletarian revolution would begin in France (Sperber 2014: 289).

It seems that from the early 1850s Marx was predicting a very bad industrial crisis that would turn into the “final” proletarian revolution. Unfortunately, even the industrial crisis Marx was predicting failed to materialise, and Marx was subject to ridicule even by his own supporters like Liebknecht.

Finally, there was a recession in 1857 (which Liebknecht seems to refer to above), and Marx did indeed think it would be the prelude to the proletarian revolution he was constantly predicting (Sperber 2014: 320–323). He was disappointed again, however, when the revolution failed to materialise – and would suffer disappointment time and again as other recessions did not turn into revolutions.

Of course, Liebknecht – like other Marxists – thought that Marx’s economic theory really did properly explain and predict economic crises. Needless to say, this is false.

It is obvious that modern capitalism is subject to regular and cyclic business cycles, and anyone who claims that there will be a new business downturn at some point in the future will almost certainly be correct, and can then naively claim that they have been proven right.

But neither Marxism nor (to give another relevant example) Austrian economics has the correct economic theory that explains business cycles. Both theories are deeply flawed and have long since morphed into quasi-religious cults.

BIBLIOGRAPHY
Liebknecht, Wilhelm. 1901. Karl Marx: Biographical Memoirs. C. H. Kerr & Co., Chicago.

Sperber, Jonathan. 2014. Karl Marx: A Nineteenth-Century Life. Liveright Publishing Corporation, New York.

How does an Austrian Praxeologist make Predictions?

According to Rothbard, not as a praxeologist qua praxeologist, but as a “forecaster,” a process which is essentially like that “of the historian”:

“How may praxeology be applied to forecasting, to the prediction of future historical events? The process is essentially that of the historian, except that the difficulties are greater. Thus, using the above example the forecaster may see a considerable increase in the money supply take place. He asserts B; C he knows as a praxeological truth. In order to forecast the probable future course of purchasing power, he must make an estimate of the probable course of the demand for money in the period under consideration.

If, on the basis of his judgement, he decides that the relative change in demand will be negligible, he is in a position to predict that the purchasing power of the money unit will decline in that period. With the help of praxeology, his judgement is the best he can offer, but it is still inexact, dependent on the correctness of his estimate—in this case, of the movement in demand for money. If he wishes to make a quantitative estimate of the change in purchasing power, his estimate is still more inexact, for praxeology can be of no help in this attempt. If his prediction proves erroneous, it is not praxeology that has failed, but his judgment of the future behavior of the elements in the praxeological theorem.

Praxeology is indispensable, but it does not provide omniscience. It furnishes laws in the form of: If X, and if Y remains unchanged, then Z. It is up to the historian, and his counterpart, the forecaster, to determine the specific cases in which the law is applicable.” (Rothbard 2011: 116).

So praxeological truths can be used to make contingent predictions by means of conditional statements (e.g., if x, then y) about the future, but the Austrian is not a “praxeologist” when doing this, but a “forecaster.”

This is a rather important datum, because the internet is filled with vulgar Austrians who (bizarrely) assert that Austrian economics cannot be used to make predictions of any kind whatsoever.

A secondary point is this: why a praxeologist cannot make predictions qua praxeologist remains unclear.

Elsewhere we read that the “forecasting” role that any Austrian must assume when predicting the future involves the Austrian being a “thymologist”:

“Austrian economists, as Austrian economists, or praxeologists, do not predict. They can predict not as formal economists, or praxeologists, but, rather, in their role as thymologists, or economic historians. In praxeology, A causes B, other things remaining the same. But, in the real world, other things cannot be relied upon to always remain constant. Therefore, predictions of the ‘A will necessarily lead to B’ type are strictly prohibited. Instead, praxeologists, but not thymologists, must limit themselves to statements of the if-A then-B variety.”
“Austrian Predictions,” Mises Wiki
http://wiki.mises.org/wiki/Austrian_predictions

The word “thymology” or “thymologist” does not even appear in the twenty-volume Oxford English Dictionary (2nd edn.), so you know immediately you are dealing with a highly obscure or archaic word.

It speaks volumes about Austrian methodology that they resort to truly obscure terms, and that the actual praxeological laws are supposed to be universally and necessarily true, but when applied to the real world in prediction suddenly the laws become contingent, as Rothbard says:

“Praxeology is indispensable, but it does not provide omniscience. It furnishes laws in the form of: If X, and if Y remains unchanged, then Z. It is up to the historian, and his counterpart, the forecaster, to determine the specific cases in which the law is applicable.”

It is difficult to see how such “laws” based on conditional statements are anything but analytic a priori statements.

For the whole epistemological justification of praxeology is that praxeological laws, on the basis of the action axiom, are synthetic a priori truths, and thereby have necessary truth about the real world: yet suddenly when applied to the real world they become contingent.

These statements by Austrians about the nature of prediction must be judged a severe epistemological problem for Austrian economics.

BIBLIOGRAPHY
Mises, Ludwig von. 1978 [1962]. The Ultimate Foundation of Economic Science: An Essay on Method (2nd edn), Sheed Andrews & McMeel, Kansas City.

Mises, Ludwig von. 2007 [1957]. History and Theory. Ludwig von Mises Institute, Auburn, Ala.

Rothbard, M. N. 2011. Economic Controversies. Ludwig von Mises Institute, Auburn, Ala.

What Did Paul Samuelson really say about the Post-WWII US Economy?

Austrians are fond of pointing to various failed predictions of Paul Samuelson about America’s economy after WWII. For background, see my post here.

The relevant predictions by Samuelson can be found in these articles:

Samuelson, Paul A. 1943. “Full Employment after the War,” in Seymour E. Harris (ed.), Postwar Economic Problems, McGraw-Hill, New York and London. 27–53.

Samuelson, Paul A. 1944. “Unemployment Ahead: (I.) A Warning to the Washington Expert,” New Republic, September 11, 297–299.

Samuelson, Paul A. 1944a. “Unemployment Ahead: (II.) The Coming Economic Crisis,” New Republic, September 18, 333–335.

I will focus on Samuelson (1943) in what follows, though I will look at the last two articles in an update.

From the very beginning Samuelson was clear that he did not expect a depression on the scale of the early 1930s:

“... I do not mean to imply that there is a serious prospect that we shall return to national income levels such as characterized the deep depression of 1932-1933. ... The real danger lies in the possibility that we shall lag ever farther behind our true productive potential — that we shall be content with a half loaf instead of insisting upon the whole loaf which can be ours. The thing to fear is an ever-widening gap between our attained levels of output and employment and our true productive potential. It has taken the heavy wartime expenditure to show us how big the gap already is.” (Samuelson 1943: 28).

For Samuelson, then, one of the problems of the post-WWII economy was an output below America’s potential GNP.

Samuelson analyses the nature of consumption and saving when income increases (Samuelson 1943: 29–37), and then the problem of what to do when excessive saving occurs which drains the economy of income and reduces investment.

Samuelson (1943: 37) was also clear that there were fellow economists who were optimistic about a post war boom, on the basis of “private demand alone,” and he listed three types of such economists. The second group of these “optimists” appears to me to be some of his fellow Keynesians:

“[sc. the “optimists” argue that if] ... we add to this the forced saving plans which the future will certainly bring, as well as postwar tax refunds to corporations, it will be seen that the real backlog of deferred demand as a result of wartime depletion of capital will be accompanied by the financial means to make it effective.” (Samuelson 1943: 46).

Certainly this is not dissimilar to what Keynes said about the post-WWII period:

“Keynes harshly rejected the risk of post-war stagnation, holding that because of Social security there would be a large reduction in private saving and so that would be no problem.” (Colander and Landreth 1996: 202).

So here we have evidence from Samuelson that other Keynesians in 1943 were in fact optimists about a boom after WWII.

As an aside, Samuelson also makes some interesting remarks on the post-WWI boom: he notes that the boom of 1919–1920 was also the result of government war spending which continued into 1919 and the surge in demand for American exports in Europe (Samuelson 1943: 48–49), not merely private sector investment and consumption spending.

Now here is the crucial paragraph from Samuelson:

“When this war comes to an end, more than one out of every two workers will depend directly or indirectly upon military orders. We shall have some 10 million service men to throw on the labor market. We shall have to face a difficult reconversion period during which current goods cannot be produced and layoffs may be great. Nor will the technical necessity for reconversion necessarily generate much investment outlay in the critical period under discussion whatever its later potentialities. The final conclusion to be drawn from our experience at the end of the last war is inescapable – were the war to end suddenly within the next 6 months, were we again planning to wind up our war effort in the greatest haste, to demobilize our armed forces, to liquidate price controls, to shift from astronomical deficits to even the large deficits of the thirties – then there would be ushered in the greatest period of unemployment and industrial dislocation which any economy has ever faced. This does not deny that there may be a boom after the war. In this the experts may still be correct. For the release of controls upon demand coupled with plentiful amounts of monetary demand might well give rise to price increase, inventory buying, feverish speculation and all the superficial earmarks of a boom. But it would be the antithesis of a prosperity period, constituting instead a nightmarish combination of the worst features of inflation and deflation. Nor, having spent itself, could it be expected to evolve into healthier channels. Instead, the final outcome would undoubtedly be a cumulative hyperdeflation from which, at best, we should lose a decade of progress and which, at worst, our democracy would not survive.

Of course, this is not intended as a picture of what will in fact happen. For there is every reason to believe that we shall not be lulled into a feeling of false security by the last war’s experience or by the half-truth that the end of the war will witness a boom. No doubt, we shall retain direct controls for a period after the conflict ends. We shall taper off war production gradually. We shall undertake income maintenance in the form of dismissal pay for soldiers, unemployment compensation, direct and work relief expenditure. It is probable, although less certain, that, in addition, the Federal government will initiate employment maintenance measures such as large scale public works, etc. But even these will not be adequate to maintain full employment or any approach to it.” (Samuelson 1943: 51).

When we read this carefully in context, this passage shows us that Samuelson’s predictions were not as erroneous as Austrians and libertarians make them out to be.

For Samuelson said pointblank: “Of course, this is not intended as a picture of what will in fact happen.”

Samuelson’s dire prediction of the “greatest period of unemployment and industrial dislocation which any economy has ever faced” was all dependent on the assumption of the following:

(1) the war ending suddenly within 6 months after 1943;

(2) very rapid termination of war effort and production;

(3) rapid demobilization and liquidation of price controls, and a sudden shift from astronomical deficits to the large deficits of the thirties, and

(4) absence of any “income maintenance in the form of dismissal pay for soldiers, unemployment compensation, direct and work relief expenditure.”

Samuelson was both right and wrong. He was wrong in that he underestimated that private sector investment and consumption boom after 1945.

But he was right on a number of other points. For example, the US did not suddenly dismantle price controls as soon as the war ended: it was not until 1946 that Truman lifted many of these controls.

Samuelson was right that dismissed soldiers would receive “unemployment compensation” and other support: for the Servicemen’s Readjustment Act (or G.I. Bill of Rights, July 1944) gave extensive unemployment benefits to demobilised soldiers. The act also gave soldiers four free years of college education, which must be counted as a significant measure that prevented unemployment from rising as well, since many returned servicemen took college degrees and did not seek work.

The US government still had massive budgets in 1946 and 1947: it did not suddenly reduce the amount of government spending to, say, 10% of GDP, where it had been in 1934-1935. Samuelson was therefore partly correct in saying such measures would in practice avert the “greatest period of unemployment and industrial dislocation which any economy has ever faced.”

Samuelson was also well aware that pent up demand (or what he called “deferred demand”) would be a source of post-WWII growth (Samuelson 1943: 52), but argued that this would fade out after 18 months to 2 years – not an unreasonable assessment at all.

But, above all, the point that emerges from all this is that other Keynesian economists did not share some of Samuelson’s more pessimistic views (and he cited their opinions as those of his second group of “optimists”). And Keynes certainly did not.


BIBLIOGRAPHY

Colander, D. C. and H. Landreth (eds). 1996. The Coming of Keynesianism to America: Conversations with the Founders of Keynesian Economics, E. Elgar, Cheltenham.

Samuelson, Paul A. 1943. “Full Employment after the War,” in Seymour E. Harris (ed.), Postwar Economic Problems, McGraw-Hill, New York and London. 27-53.

Samuelson, Paul A. 1944. “Unemployment Ahead: (I.) A Warning to the Washington Expert,” New Republic, September 11, 297-299.

Samuelson, Paul A. 1944a. “Unemployment Ahead: (II.) The Coming Economic Crisis,” New Republic, September 18, 333-335.

Hayek and the Stock Market Crash of 1929: So Much for His Predictive Powers

In 1927, the Österreichische Konjunkturforschungsinstitut (Austrian Institute for Business Cycle Research) was opened and Friedrich August von Hayek was appointed as the first director (Hayek 1991: 125, n. 1; Steele 2001: 8–9; for the foundation of the Institute by Mises, see Hülsmann 2007: 575-576). Hayek wrote nearly all the monthly reports (“Monatsberichte” in German) of the institute for four years, and only obtained the assistance of Oskar Morgenstern as his collaborator in 1929 (Hayek 1991: 125, n. 1; Ebenstein 2003: 44; cf. Hülsmann 2007: 576: “Hayek himself wrote the first, very lengthy report [sc. of the “Monatsberichte”] ... Over the years, [sc. Hayek] ... relied more and more on contributions from others”).

You can find PDFs of the Monatsberichte here:

Monatsberichte, Historisches Volltextarchiv ab 1927.

Now it is said that in a report from November 1928 Hayek predicted a great economic crisis (“großen Wirtschaftskrise”) in America. Let’s turn to the relevant passage, with my translation of the German following:

“Harvard Economic Service meint, daß, wenn nicht unerwartete, jetzt nicht erkennbare Faktoren zu einer Liquidation am Effektenmarkt führen sollten, die ersten Monate 1929 eine neue Anspannung am Kapitalsmarkt bringen dürften. Die Kreditsituation sei als heikel und schwierig, nicht aber als gefährlich zu bezeichnen. Doch wenn die Krediterweiterung weiter fortgesetzt wird, wird man in einem Jahr einer noch viel schwierigeren und heikleren Situation gegenüberstehen. Die Position der Federal Reserve-Banken ist allerdings stark genug, um noch längere Zeit Kreditexpansion betreiben zu können und die Zeit der großen Wirtschaftskrise dürfte noch recht weit entfernt sein, wenn dies auch vorübergehende kleinere Liquidationsperioden nicht ausschließt.”

“[The] Harvard Economic Service thinks that factors not now apparent/recognizable, if not unexpected/unforeseen, should lead to a liquidation effect on the market, [and] the first months of 1929 may be expected to bring a new strain in the capital market. The credit situation is to be described as awkward and difficult, but not as dangerous. But, if the credit expansion is continued, we will face in a year an even more difficult and awkward situation. The position of the Federal Reserve banks, however, is strong enough to be able to conduct credit expansion for quite some time, and a time of great economic crisis is likely to be still quite far away, even if this does not exclude periods of temporary smaller liquidation.”
Monatsberichte des österreichischen Institutes für Konjunkturforschung, 2. Jahrgang, Nr. 11. (26 November, 1928). p. 174.

The first thing that sticks out like a sore thumb is the opening clause:

“Harvard Economic Service meint, daß, …” or “[the] Harvard Economic service thinks that … .”

Hayek is quoting from “The Harvard Economic Service,” a publication of the Harvard University Committee on Economic Research: this committee published a quarterly journal on economic statistics, and from 1922 began to provide business forecasting through a weekly newsletter with economic data and analysis.

Apparently, it was a forecast by the American Harvard Economic Service that Hayek is quoting in predicting that some problems would emerge on the US capital market in the first months of 1929. Indeed, Hayek himself on a trip to the US in 1923 had been impressed with empirical business cycle research at Columbia University, and this may have inspired the founding of the Austrian Institute for Business Cycle Research later in 1927 (Overtveldt 2007: 341; Hayek 1994: 6-8, 59; Ebenstein 2003: 43).

So are Hayek’s subsequent statements also derived from information he read in the Harvard Economic Service? If so, Hayek has no great predictive power here: he was relying on American research.

Here is the crucial statement:

“The position of the Federal Reserve banks, however, is strong enough for the credit expansion to be conducted for some time, and a time of great economic crisis is likely to be still quite far away, even if this does not exclude periods of temporary smaller liquidation.”

Was this Hayek’s own prediction? Until we look at the weekly (or perhaps quarterly) issues of the Harvard Economic Service, we can’t know. What is clear is that American forecasters were predicting some kind of crisis in 1929. Hayek picked up on that, and perhaps made this inference. Let’s assume that it was Hayek’s own prediction: in November, 1928 – about a year from the most devastating economic collapse seen in the US and the world – Hayek thought that a “great economic crisis is likely to be still quite far away” (“großen Wirtschaftskrise dürfte noch recht weit entfernt sein”). “Still quite far away” (“noch recht weit entfernt”) sounds like a number of years to me, not one year. This is yet another problem for the view that Hayek was some kind of prescient oracle.

Now Hayek is said to have predicted an economic crisis in the US in a February 1929 report (Steele 2001: 9; Huerta de Soto 2006: 429, n. 28 speaks of a 1929 prediction in the Monatsberichte, but gives no month). However, I cannot as yet find any such prediction. The report is here:

Monatsberichte des österreichischen Institutes für Konjunkturforschung, 3. Jahrgang, Nr. 2. (26 February 1929).

Let’s turn to the second relevant passage. This can be read in the 26 October 1929 issue of the Monatsberichte (my translation follows):

“Jedoch besteht derzeit kein Grund, einen plötzlichen Zusammenbruch der New Yorker Börse zu erwarten. Allerdings ist es nicht ausgeschlossen, daß nunmehr das Ende der geradezu phantastischen Kurssteigerungen gekommen ist und das Niveau langsam abbröckeln dürfte.

Die Kredit Möglichkeiten sind jedenfalls augenblicklich noch sehr große und es erscheint daher die Gewähr gegeben, daß eine ausgesprochen krisenhafte Zerstörung des jetzigen hohen Niveaus nicht befürchtet werden müßte. Zur Zeit werden europäische Gelder bereits in großen Beträgen abgezogen, so daß der Dollarkurs gedrückt ist.”

“However, at present there is no reason to expect a sudden crash of the New York stock exchange. However, it is not impossible that the end of the absolutely amazing price increases has arrived, and [that] the [price] level should slowly crumble. The credit possibilities/conditions are, at any rate, currently very great, and therefore it appears assured that an outright crisis-like destruction of the present high [sc. price] level should not be feared. At the moment, European funds are already being withdrawn in large amounts, so that the value of the [US] dollar is down.” Monatsberichte des österreichischen Institutes für Konjunkturforschung, 3. Jahrgang, Nr. 10 (26 October, 1929), p. 182.

There is a strong likelihood that Hayek wrote this, or possibly as a co-author with Oskar Morgenstern (it is clear from p. 186 of the issue that Hayek is listed as the editor: “Verantwortlicher Schriftleiter: Dr. Friedrich A. Hayek”).

So here a few days before the historic stock market crash of October 28, 1929 (Black Monday) and October 29 (Black Tuesday), a crash that continued until November 13, 1929, we have Hayek predicting

(1) no “sudden crash of the New York stock exchange”;
(2) the possibility of a slow fall in stock market prices, and
(3) an “outright crisis-like destruction of the present high [sc. price] level should not be feared.”

All utterly wrong.

All in all, I don’t see any great miracles of prediction here. There also remains the possibility that Hayek’s November 1928 prediction of a “great economic crisis … likely to be still quite far away” (“großen Wirtschaftskrise dürfte noch recht weit entfernt”) was something he read in the Harvard Economic Service, or that he inferred this from their own prediction of some kind of market liquidation in 1929.


BIBLIOGRAPHY

Ebenstein, A. O. 2003. Friedrich Hayek: A Biography, University of Chicago Press, Chicago and London.

Hayek, F. A. von. 1991. The Collected Works of F. A. Hayek. Volume 3. The Trend of Economic Thinking: Essays on Political Economists and Economic History (ed. W. W. Bartley and S. Kresge), Routledge, London.

Hayek, F. A. von. 1994. Hayek on Hayek: An Autobiographical Dialogue (eds. S. Kresge and L. Wenar), Routledge, London.

Huerta de Soto, J. 2006. Money, Bank Credit and Economic Cycles (trans. M. A. Stroup), Ludwig von Mises Institute, Auburn, Ala.

Hülsmann, J. G. 2007. Mises: The Last Knight of Liberalism, Ludwig von Mises Institute, Auburn, Ala.

Overtveldt, J. van. 2007. The Chicago School: How the University of Chicago Assembled the Thinkers who Revolutionized Economics and Business, Agate, Chicago.

Steele, G. R. 2001. Keynes and Hayek: The Money Economy, Routledge, London and New York.

Austrians Predicted the Housing Bubble? – But so did Post Keynesians and Marxists

I see certain Austrians citing this LewRockwell.com article by Walter Block listing Austrians who supposedly identified or predicted the 2000s housing bubble:

Walter Block, “Austrian Thymologists Who Predicted the Housing Bubble,” LewRockwell.com, December 22, 2010.

Now the first point that should be made is that the heterodox Keynesian economist Dean Baker (who seems to be associated with Post Keynesianism) clearly identified a housing bubble in August 2002 in a Center for Economic and Policy Research paper:

Dean Baker, “The Run-Up in Home Prices: Is it Real or Is it Another Bubble?,” Center for Economic and Policy Research, Briefing Paper, August 2002.

Since the paper was published in August 2002, and Baker was no doubt coming to the view that a housing bubble was in progress months before by looking at the housing data, it is obvious that some economic observers were coming to this view as early as the first half of 2002. That is to say: a housing bubble was being identified at around this time, and the further asset price inflation in housing predicted by some commentators. In this paper, Baker also predicted a serious economic crisis coming from the collapse of the bubble:

“The collapse of the housing bubble, implying a drop of between 11 and 22 percent in the average of housing prices, will destroy between $1.3 trillion and $2.6 trillion in housing wealth. …. In the late eighties Japan experienced a simultaneous bubble in its stock market and its real estate market. The collapse of these bubbles has derailed its economy for more than a decade. A similar collapse in the United States, coupled with a poor policy response, could have similar consequences here.”
Dean Baker, “The Run-Up in Home Prices: Is it Real or Is it Another Bubble?,” Center for Economic and Policy Research, Briefing Paper, August 2002, pp. 3–4; see also 14–15.

Those are insightful predictions.

Furthermore, by 2004 onwards, we can also find Marxists identifying a housing bubble and coming economic crisis:

Nick Beams, “Greenspan Testimony Points to Deepening US Fiscal Crisis,” World Socialist Web Site, 16 February 2004.

Nick Beams, “Australia at the Forefront of Housing Bubble,” World Socialist Web Site, 27 September 2004.

César Uco, “Is the US housing boom turning toward bust?,” World Socialist Web Site, 6 August 2005

Nick Beams, “US Housing Crisis could Spark Serious Economic Downturn,” World Socialist Web Site, 3 September 2007.

Now does anyone seriously think that these correct identifications of an asset bubble in housing vindicates the Marxist theory? Some Marxists tell us that Marxist theory explains the 2008 financial crisis, but I do not think so at all. And even if some Austrians called an asset bubble in housing, it does not follow at all that their underlying economic theory is right.

Both Austrians and Marxists have economic theories that are fundamentally flawed, even though some of them correctly identified a housing bubble. The doctrinaire Marxists have their absurd historical materialism, the belief that the rate of profit will always fall, the erroneous labour theory of value, and the idea that socialism is inevitable, while many Austrians have a system flawed by a fantasy business cycle theory, an incoherent and logically inconsistent demand for no fractional reserve banking, and insufficient attention to subjective expectations and the role of investment decision-making under uncertainty.

It is obvious that Austrians identifying a housing bubble from 2003–2004 onwards should not regarded as having any special predictive power. They were merely identifying an on-going phenomenon. It is, furthermore, notable that when some Austrians identified a housing bubble in the first half of 2002, so too did the Keynesian economist Dean Baker.

We must remember that any “predictions” after 2002 are not even predictions at all: they represent people identifying an existing asset bubble that was becoming worse.

I. Alleged Austrian Predictions: 1999–2003

Let us review some of these alleged “predictions” below in chronological order from 1999–2003 cited by Walter Block:

(1) Thomas J. DiLorenzo, “Regulatory Sneak Attack,” Mises Daily, September 16, 1999.
There is no prediction of any housing bubble in this article: it is mostly an attack on US government regulation. At one point, DiLorenzo attacks the “Community Reinvestment Act,” complaining that it forces bank “to make bad loans and grants to politically-connected ‘community groups.’” That, however, is not any prediction of a housing bubble in the 2000s.

(2) Ron Paul, “A Republic, If You Can Keep It,” US House of Representatives, January 31 and February 2, 2000.
In this speech, Ron Paul does not predict any housing bubble in the 2000s. The closest Paul comes to any sort of prediction on housing is here:

“If one cares about providing the maximum and best housing for the maximum number of people, one must consider a free-market approach in association with a sound non-depreciating currency. We have been operating a public housing program directly opposite to this, and along with steady inflation and government promotion of housing since the 1960s, the housing market has been grossly distorted. We can soon expect a major downward correction in the housing industry, prompted by rising interest rates.”

Yet it is obvious that Paul is here thinking of a correction of existing 2000 housing prices, not a massive 2000s bubble in real estate and a financial crisis in 2008. The word “soon” strongly suggests Paul was expecting the correction in the next year or two after 2000, as from 1999–2000 the Fed had raised the Federal Funds rate and was widely expected to raise it further in 2000, owing to the dot.com boom. This speech shows no prediction of the 2000s housing bubble.

(3) William L. Anderson, “The Party is Over,” Mises Daily, February 20, 2001.
A careful reading of this article shows clearly that Anderson nowhere predicts the housing bubble of the 2000s. In fact, the words “houses,” “housing,” “homes”, or “bubble” do not even appear in the article at all. Anderson does make this remark about real estate:

“The stock market boom and various real estate booms have either ended or are nearing their end and the next stage of money growth will now affect consumer prices.”

In other words in February 20, 2001, William Anderson thought the stock and real estate booms of the 1990s had ended or were about to end: there is no prediction of a massive continuing housing bubble in the 2000s. We also have this priceless gem from Anderson praising financial deregulation:

“the amount of economic regulation has fallen tremendously in the past three decades. In 1970, all the financial, transportation and telecommunications sectors were highly cartelized industries. All are much more open and competitive today. In fact, one can easily declare that the prosperity of the 1990s would not have been remotely possible without removal of government restrictions that hampered those industries in the 1960s.”

Unfortunately, it was the deregulated financial sector that was the main cause of the 1990s and 2000s bubbles.

(4) Ron Paul, Congressional Record, US House of Representatives, September 5, 2001.
Here Ron Paul identified the emerging housing bubble (quoted in Paul 2008: 220):

“Refinancing especially helped the consumers to continue spending even in a slowing economy. It isn’t surprising for high credit-card debt to be frequently rolled into second mortgages, since interest on mortgage debt has the additional advantage of being tax-deductible. When financial conditions warrant it, leaving financial instruments (such as paper assets), and looking for hard assets (such as houses), is commonplace and is not a new phenomenon. Instead of the newly inflated money being directed toward the stock market, it now finds its way into the rapidly expanding real-estate bubble. This, too, will burst as all bubbles do. The Fed, the Congress, or even foreign investors can’t prevent the collapse of this bubble, any more than the incestuous Japanese banks were able to keep the Japanese ‘miracle’ of the 1980s going forever …. With the current direction of the dollar certainly downward, the day of reckoning is fast approaching. A weak dollar will prompt dumping of GSE securities before treasuries, despite the Treasury’s and the Fed's attempt to equate them with government securities. This will threaten the whole GSE system of finance, because the challenge to the dollar and the GSEs will hit just when the housing market turns down and defaults rise. Also a major accident can occur in the derivatives markets where Fannie Mae and Freddie Mac are deeply involved in hedging their interest-rate bets. Rising interest rates that are inherent with a weak currency will worsen the crisis.”

A video of this speech is here:



This was an identification of the bubble and prediction of a “bust.” Some six months later, Dean Baker said much the same thing. However, Ron Paul predicted that a “weak dollar will prompt dumping of GSE securities before treasuries”: he was wrong. It was the bursting of the real estate bubble and defaulting mortgages that prompted the crisis in mortgage backed securities: the financial crisis then occurred in the investment banking sector and spread to the commercial banking sector. No dumping of US treasuries occurred. These failed predictions have to be borne in mind, with Paul’s prediction of a housing market crash.

(5) James Grant, “Sometimes the Economy Needs a Setback,” New York Times, September 9, 2001.
This article does not predict or identify any housing bubble. Instead it is a discussion of the 1990s tech boom and US business cycle.

(6) Gary North, “How the FED Inflated the Real Estate Bubble by Pushing Down Mortgage Rates: Report As of 2002,” Reality Check, March 4, 2002.
Unfortunately, this is not available online, but as an identification of the housing bubble it was made only a few months before Dean Baker published his own identification of it, and Baker was no doubt also coming to this conclusion in the months before August: so here an Austrian like Gary North simply displayed the same insight as a prominent Keynesian.

(7) Robert Blumen, “Fannie Mae Distorts Markets,” Mises Daily, June 17, 2002.
Robert Blumen refers in passing to the housing bubble here in this 2002 article, but this was also the same time that Dean Baker was calling the bubble: so again an Austrian commentator displayed the same insight as a prominent Keynesian at much the same time. What is particularly interesting about Robert Blumen’s analysis is that he denies that houses are capital goods, the usual absurd trick that Austrians use to try and make the housing bubble fit in with their Austrian business cycle theory:

“A careful parsing of Raines’s and de Soto’s statements is required to arrive at a consistent understanding. A home is an asset, and it is wealth, but it is not capital in the economic sense; i.e., it is not a good that is an intermediate artifact of a time-consuming production process. Housing is a consumption good. True, it is a durable consumption good, and it may rise in value over time for many reasons, but it is not capital.”

Blumen also observes correctly that much of the 2000s mortgages were in fact refinancing and home equity loans, and the debt incurred used to pay credit card debt or fund purchasing of consumer goods: this is the opposite of the process required by the Austrian business cycle theory, which requires credit flows to capital goods investment (I will return to this issue below in section III).

(8) Walter Block lists “undated” predictions or identifications of a housing bubble by Peter Schiff, but such undated predictions are worthless.

Some Austrians claim that Schiff predicted the housing bubble in an interview in May 2002, which you can watch below in these videos.





Peter Schiff does not predict or identify any housing bubble in this interview. The interviewer (not Schiff) refers briefly to “housing prices up” (in part 1), but that is all. Instead, Schiff predicts a bear market in US stocks from 2002 onwards (a false prediction); and a US dollar collapse that would send US interest rates through the roof (another false prediction). At 7.25 onwards (in part 1), Schiff refers to a “bubble” that already exists, but it is clear he is referring to stocks and shares, not housing. So much for Schiff’s predictive power.

(9) Hans F. Sennholz, “The Fed is Culpable,” Mises Daily, November 11, 2002.
In the first part of his article, Hans F. Sennholz merely talks about the 1990s tech boom in stocks and shares. He states that “[e]conomic bubbles have plagued the American economy ever since the First United States Bank opened its doors in Philadelphia in 1791,” but conveniently forgets that the US had no central bank for most of the 19th century, yet asset bubbles also occurred frequently. In a rather surprising analysis, Sennholz seems to think that raising margin requirements could have helped to prevent the 1990s tech bubble, which can only mean that he is suggesting that appropriate financial regulation should have been imposed to prevent it (a strange view for an Austrian).

Towards the end of his analysis, Sennholz identifies the housing bubble and predicts a bust:

“The most ominous of all cycles, which touches millions of people, is the boom-and-bust sequence in real estate. Just as in equity markets, these bubbles are clearly visible in their price-earnings ratios or price-rental ratios that greatly exceed those of healthy markets. Abundant credit at bargain rates of interest causes housing prices to soar, especially in growing communities, which fosters not only feverish construction activity but also enlarges the mountains of debt, even consumer debt. Fannie Mae, the publicly owned and government-sponsored Federal National Mortgage Association, reports that soaring housing prices and falling mortgage rates are allowing homeowners to refinance $1.4 trillion of mortgages in 2002, up from $1.1 trillion last year. In both years homeowners are estimated to take out some $100 billion in equity. The real estate bubble is bound to burst as soon as the distortions become visible to ever greater numbers of participants.”

However, Dean Baker had already done this months before Sennholz in August 2002. Moreover, Sennholz makes an inaccurate prediction: he calls a “U.S. Treasury bubble,” and predicts that “the bubble will burst and the market value of all notes and bonds will drop drastically.”

(10) William L. Anderson, “Recovery or Boomlet?,” Mises Daily, July 7, 2003.
In this Mises.org article, Anderson talks of a “mini-boom,” but it is clear he is thinking of the stock market and general economic conditions, not an asset price bubble in housing:

“In recent weeks, the stock market has staged a mild rally. Though the most recent unemployment numbers are well over six percent, Republicans, as well as a few market analysts, are claiming that the long overdue economic recovery has arrived. While I wish that were the case, the facts demonstrate otherwise; this is not a recovery, but simply an unsustainable mini-boom that makes the long-term economic picture even worse. .... Thus, any upturn whether in economic statistics or in the stock market is almost certain to follow the patterns not of economic recovery but rather a mini-boom. I say ‘mini’ because there is no way that this particular boom, as pathetic as it is, can be sustained for a long time, unlike the boom of the late 1990s. In fact, the Fed's recent actions can only force more malinvestments which themselves will have to be liquidated in the future.”
William L. Anderson, “Recovery or Boomlet?,” Mises Daily, July 7, 2003.

In short, there is no identification of an asset bubble in housing here.

(11) Ron Paul’s Address to the House Financial Services Committee, September 10, 2003.
This speech was delivered on September 10, 2003 (you can read it in Paul 2008: 380–381), and Ron Paul correctly identifies (not predicts) an on-going housing bubble and predicts troubles for indebted homeowners:

“Despite the long-term damage to the economy inflicted by the government’s interference in the housing market, the government's policy of diverting capital to other uses creates a short-term boom in housing. Like all artificially created bubbles, the boom in housing prices cannot last forever. When housing prices fall, homeowners will experience difficulty as their equity is wiped out. Furthermore, the holders of the mortgage debt will also have a loss. These losses will be greater than they would have otherwise been had government policy not actively encouraged overinvestment in housing.”

You can also watch this speech quoted here:



However, this was over a year after Dean Baker had correctly identified the bubble too, and predicted a serious downturn when the bubble collapsed. Ron Paul displayed no great predictive power here.

So what are our conclusions from this analysis?

When we review the various alleged Austrian “predictions” of the 2000s housing bubble most of them collapse. Of the eleven claims made, six (54%) do not even identify the housing boom, and certainly do not predict any such thing. Two (18%) identify the bubble, but after Dean Baker did (in August, 2002).

The 2002 identification of the bubble by Gary North (March 4, 2002) and Robert Blumen (June 17, 2002) was only a few months before Dean Baker’s paper published in August 2002, and Baker himself must have been coming to the same conclusion in these months. So these Austrians just displayed much the same insight as a progressive Keynesian economist.

The only early identification of the housing bubble that does stand out is that of Ron Paul in a speech to the US House of Representatives on September 5, 2001. However, even here Ron Paul made a number of failed predictions, so his predictive power was hardly spectacular.

II. What about After 2003?
The Austrians showed no great predictive power in 2003 or afterwards in identifying the bubble and the economic effects of a crash. There were heterodox and Post Keynesian economists who predicted a financial crisis caused by a housing bubble and excessive debt. The most obvious example is the Post Keynesian Steve Keen of the University of Western Sydney (Australia), who from 2006 was predicting a major financial crisis (see Steve Keen, “‘No-one saw this coming’ Balderdash!” July 15th, 2009, Debtwatch.com).

Moreover, Dirk Bezemer, Professor of Economics at the University of Groningen (Netherlands), has also done a survey of economists and economic commentators trying to establish who predicted the crisis by looking at those with (1) a serious economic model that was used in analysis, (2) predictions that went beyond identifying the property bubble to the implications for the real economy, (3) predictions on the public record, and (4) correct estimates of the timing of the crisis (see Dirk Bezemer, “‘No One Saw This Coming’: Understanding Financial Crisis Through Accounting Models,” Groningen University, 16 June 2009). Here is Bezemer’s list, with my additions in italics:

Forecast date: 2002
Dean Baker, US, Co-director, Center for Economic and Policy Research;

Forecast date: 2005
Fred Harrison, UK, Economic commentator

Forecast date: 2006
Dean Baker, US, Co-director, Center for Economic and Policy Research;

Michael Hudson, US, Professor, University of Missouri;

Steve Keen, Australia, Associate professor, University of Western Sydney;

Jakob Brøchner Madsen, Denmark, Professor, Copenhagen University;

Robert Shiller, US, Professor, Yale University;

Nouriel Roubini, US, Professor, New York University;

Kurt Richebächer, US, Private consultant and investment newsletter writer;

Forecast date: 2007
Wynne Godley, US, Distinguished scholar, Levy Economics Institute of Bard College;

Eric Janszen, US, Investor and iTulip commentator;

Peter Schiff, US, Stock broker, investment adviser and commentator.

Now of these eleven commentators and economists:

(1) Five (45%) are Heterodox/Progressive Keynesians or Post Keynesians (Baker, Godley, Hudson, Keen, Sorenson);

(2) Two (18%) are basically maverick neoclassicals (Roubini and Shiller);

(3) Two (18%) are in the Austrian tradition (Richebächer and Schiff).

(4) One (Fred Harrison) calls himself as a Georgist (a follower of Henry George)

(5) One is a combination of Austrian and Post Keynesian (Janszen).
(on the classifications, see Barkley Rosser, J. “Did Heterodox Economists Do Better At "Calling It" Than Mainstream Ones? August 28, 2009).

So in other words eight (72%) of the eleven made accurate predictions about the bubble and crisis and were non-Austrians. The largest group (45%) were actually Heterodox Keynesians.

The idea that Austrian economists were the only ones to predict the actual crisis of 2008 is utterly false. Moreover, just because some Austrians correctly called the housing bubble, it simply does not follow that the Austrian Business Cycle Theory (their explanation of the crisis) has been vindicated. Many other economists from different schools also called the housing bubble and a financial crisis. Are we, for example, to say that because Fred Harrison correctly predicted a housing bubble that his actual Georgist economics is therefore proven right? This simply does not follow, nor does it follow that Austrian economics is correct, merely because some Austrians identified the housing bubble as Harrison did.

III. The Austrian Business Cycle Theory (ABCT) does not Explain the Crisis

The Austrian Business Cycle Theory (ABCT) holds that central bank fiat money or fractional reserve banking-induced increases in credit (unbacked by commodity money) drives down the monetary rate of interest, causing it to go below the Wicksellian natural rate of interest. This causes malinvestment in capital goods sectors. However, the unique Wicksellian natural rate of interest does not exist, and is a pure fantasy (see here and here). The ABCT does not explain or deal with reckless lending by banks to people for mortgages or consumer goods, and nothing about financial or real asset bubbles, and nothing about financial crises. The irrelevance of ABCT to the real estate bubble of the 2000s and financial crisis of 2008 can be seen in a passage in Rothbard’s Man, Economy, and State (2004 [1962]: 994–1008):

“What happens, however, when the increase in investment is not due to a change in time preference and saving, but to credit expansion by the commercial banks? …. What are the consequences? The new money is loaned to businesses.¹¹⁰ These businesses, now able to acquire the money at a lower rate of interest, enter the capital goods’ and original factors’ market to bid resources away from the other firms. At any given time, the stock of goods is fixed, and the [new money is] … therefore employed in raising the prices of producers’ goods. The rise in prices of capital goods will be imputed to rises in original factors. The credit expansion reduces the market rate of interest. This means that price differentials are lowered, and … lower price differentials raise prices in the highest stages of production, shifting resources to these stages and also increasing the number of stages. As a result, the production structure is lengthened. The borrowing firms are led to believe that enough funds are available to permit them to embark on projects formerly unprofitable.

[footnote]
¹¹⁰ To the extent that the new money is loaned to consumers rather than businesses, the cycle effects discussed in this section do not occur. (Rothbard 2004 [1962]: 995–996).

After this, Rothbard (2004 [1962]: 996–1004) expounds ABCT in its usual form. But his footnote has profound significance: “[to] the extent that the new money is loaned to consumers rather than businesses, the cycle effects discussed in this section do not occur.” In other words, the mechanisms causing recession or depression as postulated by both Rothbard’s theory and the earlier Hayekian versions of ABCT do not occur if the money is mainly loaned to consumers! ABCT assumes that newly created credit money is mainly loaned out to businesses (causing malinvestments in capital goods), and not to consumers to a significant degree. In this case, we can already see that Rothbard’s version of ABCT cannot be a serious explanation of the housing bubble in the 2000s and the financial crisis of 2008, because credit flowed to housing, a consumption good.

Moreover, many of these mortgages loans were refinancing and home equity loans, and the money obtained from the debt not used for new housing construction at all, but to pay credit card debt down or purchase more consumer goods. In fact, the Austrian Robert Blumen’s (June 17, 2002) admission that houses are not capital goods severely contradicts the Austrian Business Cycle Theory explanation of the 2000s crisis.

Conclusion

The best the Austrians have is a Ron Paul identification (not prediction) of the emerging housing bubble in late 2001, with a number of other false predictions, such as his idea that a “weak dollar will prompt dumping of GSE securities before treasuries.” Other Austrians were also wrong in predicting a collapse in the value of US Treasury notes and bonds. In particular, Peter Schiff’s failed predictions in May 2002 also stand out. Above all, Ron Paul was followed only six months later by the Keynesian Dean Baker also calling a housing bubble and a serious crisis when that asset bubble collapsed.

Furthermore, many economists from 2002–2004 – Marxists, maverick neoclassicals, New Keynesians, Post Keynesians, and even a Georgist – also called the housing bubble and predicted a severe economic crisis.

Addendum

A graph of US housing prices in constant dollars can be seen here:

USA CPI-Deflated House Price Index.
http://www.debtdeflation.com/blogs/wp-content/uploads/2008/03/IMG0005_739046.PNG

It is obvious that astute observers could have see an explosion in housing prices by 2000-2002. The idiocy of the Austrian business cycle theory was not necessary to see the astonishing upward trend, or to call a bubble.


BIBLIOGRAPHY

Paul, R., 2008. Pillars of Prosperity: Free Markets, Honest Money, Private Property, Mises Institute.

Rothbard, M. N. 2004 [1962]. Man, Economy, and State: A Treatise on Economic Principles, Ludwig von Mises Institute, Auburn, Ala.