Thursday, November 5, 2009

The Vision of Tom Palmer

There is a major street brawl going on between Tom Palmer and some members of the Austrian school of economics.

The brawl started when out of the blue, in a review of a Johan Norberg book about the financial crisis, Palmer threw this in:
...Norberg is a smart guy, a meticulous researcher, and a good writer, but because it’s an exercise in economic analysis and financial journalism, with no religion thrown in. (As an example of the latter, the book Meltdown by Thomas Woods insists, contrary to the evidence, that the artificially induced boom resulted in a lengthening of the capital structure through overinvestment in too many “long-term projects.” [p. 68] In fact, what we saw was a bubble in housing, which is not a “long-term project” that will “bear fruit only in the distant future,” but a speculative investment in a durable consumer good, with an additional twist: the low refinancing rates and the inducements to refinance led many to treat their homes as ATM machines and withdraw cash to finance, not “long-term projects,” but consumption. But Mises and Hayek explained a previous boom-and-bust cycle in terms of a lengthening of the capital structure, so we must believe — we must, a priori! — that all boom-and-bust cycles must — they must! — follow the same process. That’s religion, not analysis. Woods embeds some information on the deliberately induced housing bubble and the policies of Fannie Mae, Freddie Mac, etc. in a populistic treatment of the crisis; setting aside the religion, it’s ok, but it does not compare well with the much more rigorous and financially sophisticated treatment offered by Norberg.)

Let's pull this comment apart step by step.

Palmer writes:
As an example of the latter, the book Meltdown by Thomas Woods insists, contrary to the evidence, that the artificially induced boom resulted in a lengthening of the capital structure through overinvestment in too many “long-term projects.” [p. 68] In fact, what we saw was a bubble in housing, which is not a “long-term project” that will “bear fruit only in the distant future,” but a speculative investment in a durable consumer good,

Palmer may have not noticed, but the stock market collapsed. It was a collapse of the entire capital sector, not just housing. Indeed, the IPO market ground to a complete halt, not just the housing related sector of the IPO market.

And Palmer may have not noticed but, over the last 12 months, non-construction manufacturing durable goods unemployment has climbed from 6.5% to 13.1%. Mining, quarrying, and oil and gas extraction unemployment climbed from 2.8% to 10.7%. In the information sector, unemployment has climbed from 5.0% to 11.2%

If Palmer thinks this was simply a housing crash, then he is really reading much too many headlines and not digging into the facts. I hesitate to say but, by simply reading headlines, he is taking much too much on faith.

As for Palmer claiming the housing market is not a "long term project", but instead a "long term consumer durable", he really fails to make an important distinction that Hayek taught us. Yes, housing is consumed overtime, but because it occurs overtime, part, in fact most, can certainly be called a long term project. In other words, in the construction of a house, immediate consumption is foregone to create something of greater value that will only be consumed at a later time. Instead of men laying on a beach taking in the sun for immediate consumption, they are creating products that have future value. In the case of housing, some part of the home won't be consumed for decades. If something is not consumed for decades, it's a long term project.

Palmer simply fails to understand that, as Hayek taught, it is not the physical attributes of a thing, but the purpose for which an individual assigns to a physical thing that is important. Thus, the same physical thing can have multiple attributes, a completed house can be part immediate consumer good, that which is consumed immediately, and part a product that will not be consumed until decades later, which makes the creation of, at least that part of it, a long term project.

Perhaps, this is understood by most Austrian economists intuitively, as say, they understand that there is a difference between a banana and a banana tree. But for some, because one eats a banana, i.e. part of a banana tree, one is not working on "a long term project" when planting a young banana tree. One is just consuming long term, which of course begs the question, if all one is doing is consuming, why plant the damn tree in the first place? Just consume it long term. One wonders who would plant trees, in a Tom Plamer world, since trees are somehow just consumption.

Palmer then goes on to tell us that:
...an additional twist: the low refinancing rates and the inducements to refinance led many to treat their homes as ATM machines and withdraw cash to finance, not “long-term projects,” but consumption.
This may be an "additional twist" for Palmer, but it has certainly been recognized by Austrian theorists. Murray Rothbard in Man, Economy and State recognized that some bank lending may be made to consumers for consumption, but further recognized this for what it is, a non-distortion of the savings-consumption ratio, since it went to consumption. If you pull money from consumers by printing more money, and then give it back to them through loans for consumption, the savings-consumption ratio doesn't change. And so, while Palmer raises this reality of consumers borrowing, from his tone it appears that he is not aware that it has been brought up and covered, decades ago. For him, it is a new vision, it as if he is driving on the road and suddenly looks up a hill and it is revealed to him in this vision, great words perhaps formed in the shape that clouds suddenly take or, dare we say, on a tablet. But the words, in this vision are big and clear: Yes, consumers borrow money!

Since this "vision" has been so revealing to Palmer, he then writes from the point of view of one who has been blessed, and the rest of us have not been granted such a vision. He sees this vision and nothing else.

He ignores all money going into the capital sector. He taunts those who see such:
Mises and Hayek explained a previous boom-and-bust cycle in terms of a lengthening of the capital structure, so we must believe.— we must, a priori! — that all boom-and-bust cycles must — they must! — follow the same process.
Yes, for those who have not seen his vision, they are now all talking a blasphemous religion. What the Austrians do in recognizing money flow into the capital goods sector is now, "religion, not analysis," because of his vision that consumers borrow. To him, that the capital goods sectors of the economy from the stock market to the mining sector and the durable manufacturing sector have collapsed, is not important. These facts are religion, to the man with the vision. Everything to him is consumption. Even houses are not long term projects, damn it.

Thus, economists have two different roads they can head down at this point, attempt to understand the facts and the money flows, or follow the man with the vision and chant: Consumers borrow! Consumers borrow!!

3 comments:

  1. great explanation

    ReplyDelete
  2. Strictly focusing on housing, a mortgage has two sides. To the borrower it does have a portion in immediate consumption, but to the lender it is all long term project, usually around a 30y one.

    ReplyDelete