Reader Bashkim Rrahmoni notified me of a Megan McArdle attack on Austrian business cycle theory. I was going to cut her some slack, but the more I thought about it, the more ridiculous her post struck me. In “The evil man theory of failure,” she tries to play it above the fray, transcending the foolishness of left and right:
Both right wing Austrians and many liberals have a common theory of how all this happened: Alan Greenspan dunnit. The mechanisms by which he accomplished his foul task are different in the two cases, of course. Austrians, and many other free-market types, believe that by lowering short-term interest rates after 9/11, Alan Greenspan made the housing bubble, and its eventual bust, inevitable. The liberals think that by failing to regulate . . . er, something (usually either mortgage originations or CDS’s) more closely, he made the crisis inevitable….
Here’s the problem: if markets are so great, how come the entire system can be brought low by a smallish injection of short-term capital? The alternative question for the liberals: if regulation is so great, how come one guy, or one fairly minor bill, can apparently single-handedly destroy the most heavily regulated industry in America that doesn’t actively involve radioactive material? If your preferred system is really that fragile, then maybe we should be looking into alternatives.
OK, we all get her point, and maybe it’s a good one with regard to the leftists. (Will Wilkinson takes this tack too, and I think he and McArdle are on to something. But that’s probably my bias talking; maybe a leftist could blow them up the way I’m about to do to McArdle.)
OK, first we’ll show the specific details of how silly McArdle’s post is (vis-a-vis the Austrians), and then we’ll pull back and do a “McArdle is a Moron” from 50,000 feet.
This “smallish injection of short-term capital” corresponded to the lowest that the Fed had set inflation-adjusted rates since 1979. I explain the matter in this piece, but here’s the relevant graph:
And note too in the above chart, it’s not like Greenspan had cheap credit for three weeks or something. He held the (nominal) fed funds rate at a ridiculous 1% for an entire year. And the year in question was June 2003 to June 2004. Did that coincide at all with the housing boom? Surely a coincidence.
OK sure, Greenspan made credit really cheap. But maybe that was partly a result of the infusion of foreign investment, the bogeyman that Tyler Cowen and Alan Greenspan are blaming. (“And my scheme would’ve worked, too, if it hadn’t been for those meddling savers in China!”) So let’s just look at something that Greenspan directly controlled, namely the monetary base. The below chart shows the absolute change in the monetary base from the prior year; so be careful, this is in dollars, not percentages:
As you can see, Greenspan let the base grow far more than at any time in prior US history. (The big spike up and down is because of the Y2K scare; they flooded the system with liquidity so people wouldn’t pull out their money. Also, in % terms Greenspan’s actions were not unprecedented, but still significant.) From January 2001 to June 2004, the monetary base grew by $154 billion–and remember, this is the base of the money-and-credit pyramid. I know Ms. McArdle gets a lot more readers than I do, but still, if she considers $154 billion in base money just a “smallish injection”–te salute, Ms. McArdle!
Finally, the big picture: Suppose I blamed the economic disaster in interwar Germany on the guy(s) running the printing press. Would McArdle ridicule that as an evil Kraut theory?
I hope this post doesn’t disillusion some of our younger readers, but we don’t hold back here at Free Advice: Ever since the financial crisis became obvious to all, many other free marketeers and I have been consciously trying to make sure government gets the blame for this, not “laissez-faire capitalism.” Obviously we are doing this because we think it is true, but I do want to acknowledge the strategic aspect of it. In particular, I have been trying to drive home the Austrian business cycle theory now that there is a brief window in which many academics, as well as a bunch of nerdy investors, would be far more receptive than ever before.
But alas, with Greenspan’s recent testimony, we lost. He conceded defeat. It doesn’t matter how many impassioned pleas or delectable analogies I write. The single person on earth who bears the most responsibility for the housing bubble is taking responsibility–by saying it was his faulty faith in deregulated markets. Here’s the smoking gun:
Waxman: Dr. Greenspan, I’m going to interrupt you. The question I have for you is… You had an ideology … You had the authority to prevent the lending practices that led to the subprime mortgage crisis, you were advised to do so by many others, and now our whole economy is paying the price. Do you feel that your ideology pushed you to make decisions that you wished you had not made.
Greenspan: Well, remember what an ideology is. It’s a conceptual framwork for the way people deal with reality. Everyone has one. To exist, you need an ideology. The question is whether it is accurate or not. And what I’m saying to you is that I found a flaw – I don’t know how significant or permanent it is – but I’ve been very distressed by that fact. But if I may, can I just answer the previous question?
Waxman: You found a flaw in the reality…
Greenspan: I found a flaw in the model that I perceived is the critical functioning structure that defines how the world works.
Waxman: In other words you found that your view of the world, your ideology, was not right. It was not working.
Greenspan: That’s precisely the reason I was shocked because I was going for forty years or more with very considerable evidence that it was working exceptionally well.
Checkmate. Weisberg 1, Liberty 0.
Sure, we will keep writing, just for posterity. People 50 years from now can read our reports to understand precise details that would otherwise be forgotten. But let’s not kid ourselves that we can still spin the narrative to exonerate markets.
Nope, this is about as damning a concession as if Don Rumsfeld testified, “Yeah, I am quite frankly shocked at how badly things turned out in Iraq. I mean, the use of overwhelming firepower worked so well in World War II and the first Gulf War. I have to rethink my views on diplomacy.”
Can you imagine Bill Kristol trying to spin that? So now you feel my pain.*
Oh, at this point it probably goes without saying that Tyler Cowen disagrees with me; he doesn’t think Greenspan conceded much at all.
* Don’t get mixed up, folks. I was against the Iraq invasion. And so I’m saying, it would be hilarious to me to watch an intellectual try to justify militarism in light of the chief architect admitting it didn’t work. So by the same token, how can I possibly be taken seriously by leftists who distrust the market, after its leading “proponent” and architect of the housing bubble admitted that the Invisible Hand doesn’t work after all?
In response, I pointed out that we don’t need to do that yet, because so far (except for gasoline) the government hasn’t imposed price controls. And on the gas situation, I’m referring to the “anti-gouging” measures in some states that kept stations from raising their prices after the hurricanes. In Nashville, we really did have maybe 40 – 50% of the gas stations closed for a few days, and then long lines–spilling out onto the roads–at the remaining, open stations.
Anyway, it would not surprise me in the least if, a few years from now, there is a black market in bottled water. Check this out (HT2 Dan Simmons):
BTW, it occurs to me that because Google is inexplicably flashing pro-Obama ads all over my blog, I should clarify for newcomers that I do NOT endorse the views in this trailer. My point is, there is a growing campaign to demonize bottled water. Even a relatively free market guy like David Zetland has blog posts calling bottled water “evil.” (In fairness to David, I should mention that he opposes government restrictions on bottled water.) So my fairly alarmist views on the Paulson heist etc. don’t imply a rush to stockpile canned goods (contrary to Leeson’s caricature), but some of this other garbage might, a few years down the road. Specifically, what could happen is that the recent shenanigans will lead to massive price hikes, and then a solidly liberal Democrat federal government will “protect the poor” with various measures. Then you might want to stockpile on water and tuna while they’re still on the shelves.
* “Pedant” is a word with negative connotations, which I didn’t really intend. I couldn’t think of a better word that started with “p” though.
When I was much younger, I was shocked to read that mobsters might favor gambling and drug prohibition, since they were involved in those areas. I.e. I still clung to the naive view that actual businesspeople longed to be left alone by the government.
In that spirit, it occurred to me the other day–after watching No Country for Old Men–that Hollywood might be behind the Drug War. After all, think of how many cool movies would be totally boring if drugs were legalized! You’ve got obvious ones like Traffic and Serpico, but also The Godfather and, most recently, No Country for Old Men. And as cool as Russell Crowe and Denzel Washington are, American Gangster would have been rather lame if drugs were legal. “Frank Lucas is the most intimidating importer in the country! He’s pulling in, like, ten grand a month! Let’s make sure he’s not violating OSHA rules!”
This guy might be crankier than me! He quotes from a widely circulated Blanchard paper that summarized the state of macro and concluded it was “good.” Kling merely paraphrases Blanchard’s observations (fairly, too–i.e. Kling isn’t putting words into Blanchard’s mouth), and then points out that one might easily have concluded that mainstream macro is in the toilet. Here’s Kling:
So, the state of macro is this:
1. We have a workhorse model, with no capital or financial markets.
2. We have some work on asymmetric information and financial markets that is not really integrated into the workhorse model, but which suggests that when “shocks” occur, their effects may be amplified relative to the workhorse model.
3. Real-world data have interesting patterns that either are unexplained by or contradict the most widely-used models.
4. Papers follow a “haiku-like” ritual in order to be published.
And this is “good.” I agree with all four propositions, but I disagree with the conclusion.
Then in another angry post, Kling says:
I am shocked at the behavior of my fellow economists during this crisis. They are claiming to know much more than they do about causes and solutions. Rather than trying to understand and explain what is going on, they are engaged in a fierce battle over narrative.
Later on he has this quotable quote:
I have always thought that the issue of the relationship between financial markets and the “real economy” was really deep. I thought that it was a critical part of macroeconomic theory that was poorly developed. But the economics profession for the past thirty years instead focused on producing stochastic calculus porn to satisfy young men’s urge for mathematical masturbation.
I didn’t know Kling was so feisty! He’s bald so I bet he worries about everything like I do, too! As Little Big Man’s grandfather said (in reference to General Custer): “I’d like to meet this man, and smoke with him.”
For those who have long suspected that economics is not a science, I am ashamed to report that several of us PhDs can’t even agree on whether there was a “credit crunch” during the first half of the year.
For my part, I side with Alex. Below I reproduce just two of the charts Thoma shows, but the others all show a similar pattern. During the dark days of the credit crunch, when we were warned the entire financial system would collapse if we didn’t cough up $700 billion, the supply of “industrial and commercial loans at all commercial banks” was at an all-time high, and in fact its year/year rate of growth at its lowest point was “only” 12% or so. If you exclude the last few years–which everyone agrees was an insane period with perhaps criminally lax lending standards–then the year/year rate of growth in these loans was higher than at any point going back to the early 1980s. Really, this is amazing, given all the fear-mongering we’ve been hearing. Just study the picture below for a few moments and let it sink it. (Remember, this is is year/year growth; look at the units on the left axis.)
But here’s my favorite. Even if we look at “real estate loans at all commercial banks,” we see that the year/year growth rate was always positive, and in fact stayed above 4% the entire time (I’m just eyeballing the chart, it’s probably close to 5%).
That’s right folks, during the “credit crunch” fueled by the subprime crash etc., the volume of real estate loans made by commercial banks only experienced a significant slowdown in its rate of growth. Sounds like something worthy of bank nationalization to me.
Good job on all this, Alex. Fight the power.
One closing caveat: If you dabble with these series at the Fed site (and it’s very convenient to do so–you might as well get something for the depreciating dollar), you will see that in some cases, there was a drop in the level starting in 2008. But still, the charts above show that there was still year/year growth. I.e. even though some credit items fell from, say, December 2007 to March 2008, those items were still higher than they had been in March 2007. If one wants to argue that the economy was slipping off of a cliff, and Paulson needed to save us, OK that’s consistent with the charts. But it is NOT true that we were already in a crisis (vis-a-vis the entire scope of the various credit markets) when Paulson and Bernanke had no choice but to go for the Fidel Castro option.
This post will be critical of John Stossel, so I just want to make clear that he is awesome and is doing a lot to spread free market ideas. Now then…
In a recent WSJ op ed, Stossel compares society to an ice skating rink, and explains that he filmed an attempt to “centrally plan” 100 skaters using a bullhorn. (This was Daniel Klein’s idea.) Then they even got Brian Boitano to try it as well, and even here the outcome was obviously inferior to a “deregulated” skating environment.
Well, in today’s WSJ, there were a bunch of cynics pointing out that if you slightly changed the analogy to make it closer to the financial bailout, then Stossel would obviously want a “referee.” (E.g. if there were so many skaters that if they piled onto one area of the rink, the whole building would collapse and kill the spectators.) And then someone else sarcastically agreed with Stossel, and said he also thought we should get rid of stoplights. Somebody else said you need referees in professional ice hockey.
Now, I’m sure Stossel’s TV show was worth doing; it sounds like they did it pretty cleverly, and bringing the “expert planner” Boitano in was a great twist. (I must confess that I can’t hear that guy’s name without thinking of South Park.)
This exchange of views illustrates the difficulties of minarchism. A Rothbardian anarchist can quite consistently say, “Yes, it’s not whether there are ‘rules’ or not, it’s that owners should set the rules on their property. So darn tootin you get rid of government streetlights and stop signs, and you sell the roads to the private sector. Let them decide how to provide the best service to their customers.”
If you are a consistent champion of the free market, then all these nagging problems fall away. You’re not in the awkward position of having to say that the financial bailout is wicked and stupid, but the Pentagon and Supreme Court are virtuous and brilliant.
A surprisingly libertarian analysis. (She’s actually pretty good on other issues too since her Bush-bashing matches up with most of my views. I’m sure I will hate her comedy routines during an Obama administration, though.) HT2 Mitche.