Monday, December 21, 2015

Are Capitalists Repeatedly "Fooled" By Business Cycles?: A Note

By Robert Wenzel

Frank Shostak has an essay out today at that discusses the business cycle and the question of whether businessmen can anticipate the business cycle in advance and thus neutralize the cycle.

He quotes Gordon Tullock:
 Hence, it is held, the ABCT is not a serious contender in the explanation of modern business cycle phenomena. According to a prominent critic of the ABCT, Gordon Tullock,
One would think that business people might be misled in the first couple of runs of the Rothbard cycle and not anticipate that the low interest rate will later be raised. That they would continue to be unable to figure this out, however, seems unlikely. Normally, Rothbard and other Austrians argue that entrepreneurs are well informed and make correct judgments. At the very least, one would assume that a well-informed businessperson interested in important matters concerned with the business would read Mises and Rothbard and, hence, anticipate the government action.
I believe Tullock is missing an important point here, He is looking at businessmen in an aggregate and fails to understand that there are many different actors in the economy and that they may respond to the boom phase of the business cycle in many different ways. Further, depending upon their age, they have different experiences with business cycles.

For example, you often see various investments of the Carlyle Group go bad, especially during downturns, but never does Carlyle, itself, go down. That's because the firm structures its investments in a way so that it is protected. Carlyle partners know full-well that  there are boom-bust cycles. They may not know Austrian School Business Cycle Theory but the senior partners have been around long enough and know enough financial history that they know they need to protect themselves from business downturns.

They are, in a way,  performing a kind of arbitrage between smart money and dumb money. They know a bust will eventually come, but they want to ride the boom phase. Thus, they structure investments in a way that the risk will be taken by the dumb money, i.e. those who are not aware of the dangers of the business cycle. Because of the investment structures they create, they will profit from the upside without exposure to the downside. They suck in the dumb money for the downside exposure.

I attended the 2007 Michael Milken conference. Many of the major mortgage securities players were there, including Lewis Ranieri, generally regarded as the "father" of the securitized mortgage market,

The sentiment among these players back then was pretty much "Hey, this is a crazy boom. It won't last, but what can we do but take advantage of it as long as it lasts."

Thus, if there are players who understand a bust is coming, it doesn't mean the boom-bust cycle won't occur. Those, who are aware, are likely to be represent smarter players, who know how to structure investments that limit their exposure but suck in dumb money that they need to ride the boom.

Ranieri, back in 2007 knew full well a crisis was coming. On a panel that also included billionaire Leon Black, founding partner of Apollo Advisors LP and where Milken was the moderator, Raineri said (This was April 2007) that for the first time in history the median home price in the United States was likely to decline.

He also added that there would be many technical problems in working out problem mortgages, He said the vast majority of problem loans were securitized and that, in the past, problem loans were in individual portfolios. This time around, because of securitization, there were many, many holders of the securities with an interest in a mortgage. This will mean, he said, there will be many more parties that will have to agree to everything. In addition, he added, there were more lawyers and accountants in the picture to complicate matters.

He further stated there would be a "political reaction" and he feared that bad legislation could create problems for the entire mortgage sector that are now just limited to the sub-prime area.

Talk about nailing it.

So yeah, there can be many smart people who understand there is a boom-bust cycle (especially older operators who have lived through one) but it doesn't mean most will. And it doesn't mean the smart money won't figure out a way to take advantage of the boom, and operate in it, but protect themselves from the bust!

Further, each boom-bust cycle tends to be a bit different to suck in new players ("It's different this time.") There are sectors that tend to be always involved, such as the stock market, But in 1997-2000, it was the Dot Com bubble that was the epicenter, then it was real estate. You would have to be pretty savvy to understand both were just different representations of the boom-bust cycle.

The only thing you can know for sure is that if a central bank is printing money and it is getting out into the system, there is a boom going on somewhere that will eventually turn into a bust.

For sure, this time around, the stock market is in a boom---which, as I say, is almost a leader in every boom.

So is Silicon Valley, once again.  The bond market is in a super-boom market spanning multiple cycles.

I don't see any of this ending tomorrow, but it will end. And it won't be pretty. The boom-bust cycles have not been learned out of existence.

 Robert Wenzel is Editor & Publisher at and at Target Liberty. He is also author of The Fed Flunks: My Speech at the New York Federal Reserve Bank. Follow him on twitter:@wenzeleconomics


  1. Sheesh! Even as a naive young investor, I had learned that you can "ride the wave" of phony stock bubbles as long as you had a strategy to bail out fast when the correction or bust comes.
    So this Gordon Tullock guy invalidates the entire ABCT because he doesn't get THAT??
    And to think I was once so intimidated by PhD.'s.

  2. Tullock apparently did not understand basic Austrian concepts (which means that the anti-Austrians are still batting 1.000 – none of them understand those concepts). Artificial credit and money creation either produce false and misleading prices or they do not. If they don’t, then Austrian analysis is pointless. If they do, then even a person who understands this phenomenon will not know when a particular set of prices will collapse. If everyone understood that this process produced false and misleading prices, then they would immediately abolish artificial credit and money creation. They do not do so because most everyone does not understand the phenomenon. Or they are evil to the core of their being like the MMTers.

    Isn’t this also Bryan Caplan’s objection to ABCT? It seems to me that this is the ONLY articulated objection to the process I have ever heard other than the usual unfocused name-calling and venom. We win again.

  3. “Anticipate government action”? Tullock should read some Robert Higgs. With all the “regime uncertainty” you would have to be an oracle not to make some big mistakes trying to “anticipate government action”.

    Money manipulation is just part of the uncertainty. We also would have to anticipate all the new regulations, changes to tax laws, price controls (minimum wage laws) forced precipitation such as Obummer Care… Tullock surely knows we are talking about politicians (lying, stinking pieces of !&#%*) and bureaucrats (with no skin in the game). Good luck anticipating what the likes of these caricatures are going to do next.

    Maybe you need to be a lying, stinking pieces of !&#%* to anticipate one. Hence the crony capitalist. Can a crony capitalist be an honest person adhering as best he can to the NAP while working with in the business environment we live in?

    But Tullock is correct. We should abandon the Austrian School of Economics because not all business people who have read Mises and Rothbard have correctly anticipated government action. On the other hand business people that follow the Chicago School have anticipated government actions so much better than those following the Austrian School we should follow the Chicago School with gusto.