Wednesday, August 1, 2012

A Challenge to Tyler Cowen

With friends like GMU Professor Tyler Cowen, Austrian Business Cycle Theory doesn't need enemies. In the below Koch-funded Institute for Humane Studies clip about ABCT, Cowen provides us with a shaky overview of ABCT. He mentions that some Austrians call for a "monetary rule" to manage monetary policy. However, his definition of Austrian must be very broad since I know of no one from within the mainstream Austrian Mises-Rothbard school calling for a "monetary rule". Such a rule is more associated with Milton Friedman's Chicago school. And I don't know anyone who has been so bold to call Friedman an Austrian. Cowen then comments on the "weaknesses" of ABCT.

He identifies two supposed weaknesses of ABCT.

First, he suggests ABCT fails because entrepreneurs would recognize an ongoing inflation and thus adjust their business activities to counter the inflation and thus suffocate any boom part of the business cycle. This Cowen statement can be decimated on two levels, both empirical and theoretical.

Although empirical studies can not be used to form theories in the science of economics, they can be used to refute theories that do not fit reality. Cowen's charge that entrepreneurs will recognize a boom and thus act in ways to prevent the boom is slapped in the face of the evidence of the current financial and economic crisis. Trillions have been lost by entrepreneurs who failed to anticipate the consequences of the boom-bust cycle. This is evidence alone that Cowen is wrong about entrepreneurs anticipating the business cycle.

But, there is an even greater problem with Cowen's theory of entrepreneurs countering the business cycle. In his theory he is using excessive Keynesian-type aggregation to make his point. He aggregates all entrepreneurs together and talks as if they all hold the same view. This is simply absurd. Some entrepreneurs ( a very few) may understand ABCT. Some entrepreneurs may have lived thorough previous business cycles, not understand the theory, but hold a view that "what goes up must eventually come down."

Finally, there may be entrepreneurs who have no fear of a money-created boom.

In the real world, those who understand ABCT may certainly stay out of the boom borrowing game, but this does not mean all will. Those who understand ABCT and those who hold the "what goes up must eventually come down" theory may also play the debt borrowing game by simply insuring the investment/borrowing structure they use protects them personally once the collapse occurs.

In early 2007, before it was obvious a serious financial crash was starting, I attended the Beverley Hills Michael Milken Conference that year. In panel after panel, which included billionaire after billionaire, almost all the panelists shook their head and said they did not believe how high asset prices (including housing) were going and that the music was likely to stop soon. But they also indicated that they were continuing to raise money while it was still available, because they didn't know when the music would stop. Left unsaid, but certainly understood by all, since they expected an ultimate crash, was that although they were raising money, the structure of the investment vehicles they were using protected them from personal loss once the crash came.

Finally, we have those who do not fear a crash. These are all that are needed for a boom bust cycle to occur. If there is only one person in the world that does not fear a boom, then he can be the person through which all money is funneled to get out into the system to create the boom. In actuality, given the number of businesses that failed and the number of people who lost their houses, it is obvious that from big to small many outlets were available through which banks were able to pump out new money, even if their were very skilled entrepreneurs who feared a crash. Entrepreneurship in not about monolithic thinking, it is about entrepreneurs with very different views. Some may fear money printing, others may not, and still others may be aware of the dangers of money printing, but know how to game the system and protect themselves from the ultimate crash.

In short, aside from a world where ALL entrepreneurs fear the business cycle AND in addition there are no investment vehicle structures allowed that will protect entrepreneurs from personal losses and allow them to play the game until the crash comes, Cowen's contention that because of entrepreneurship the business cycle can not develop is simply nonsense.

Cowen's second claim is that some business cycles are caused by a monetary contraction without a previous expansion.

I know of no historical example where money supply spontaneously collapsed without a previous inflationary expansion. This includes the collapse of  money in the early 1930s, which followed upon a prolonged and large monetary expansion during 1921-1928 (6-7 percent per year)

I hereby challenge Cowen to come up with examples where the nominal quantity of money suddenly contracted during a period of normal (i.e., noninflationary) economic activity, as he states has occurred.

Here's Cowen:


  1. Post - WW1 Great Britain is a classic example of how government mismanagement results in deflationary bad times.

  2. Excellent explanation, Bob. I always thought that all it took was one bad enterpreneur to take the cheap money for the boom to start forming. Not only because he could funnel the cheap money into the system, but also because he would force all his competitors to also start borrowing in order to stay competitive.

  3. Anonymous, it seems to me the main problem was not GB trying to go back to the old parity, but rather the labor legislation and union pressure which made the adjustment far more painful than it needed to be.

  4. I am going to take a wild guess and guess that this guy has never actually been a businessman or much less run a business. Why do they allow someone to earn a Phd in business, finance or economics without any real world experience? To get my CPA license I had to have two years of practice before I could use the title, why not the same for academic professionals? These people are dangerous!

    Anyhow, I can tell you as someone that has founded and run several businesses, two NASDAQ listed, that he is full of crap. I lived through the dot com to dot bomb boom while owning my own a dot com tech related company during that time. The one thing I found during that time, no matter who I spoke to, was that everyone believed in the *new economy* (a term from the same idiots in academia) crapola and thus thought that the boom would go on for a long, long time to come. Was Cowen asleep during this period in time?

    Lastly, I would certainly welcome another money created boom right now. I would tell myself I would know when to get out, but of course I'd be wrong. LOL Great job refuting this modern day alchemist Bob!

  5. Best way to kill a movement? Co-opt it and distort it.

    We've seen this over and over in history in political movements.

    The question is: Who's Cowen's patron?

    1. I would like to know too.

    2. I was hoping to glean something easily from wiki on such luck but I did find some interesting tidbits:

      "Cowen argued that libertarians "should embrace a world with growing wealth, growing positive liberty, and yes, growing government. out of touch is this guy? Growing wealth? Growing positive liberty? LMAO! I guess 1 out of 3 isn't bad if we use baseball batting averages as the metric.

      "We don’t have to favor the growth in government per se, but we do need to recognize that sometimes it is a package deal." and later it goes on to say he was a supporter of the Iraq War.

      Seriously, how many people outside of the "libertarians" in Cato think to themselves, yea...the guy described above is a libertarian? (which he claims to be)

  6. Here's my Austrian monetary rule:

    The central bank should, at all times going forward, focus on taking vacation, no matter what the statistics indicate. Optimal monetary policy will be obtained by having all central bank empoyees not show up to work.

    Seriously, I would be willing to pay a lot of money to have a completely inert Fed. Maybe that would be a good compromise solution: we pay them for doing nothing, and they stop inducing business cycles and distortions throughout our economy. Win/Win.

  7. Bryan Caplan is the only Keynesian who even comes close to grasping Austrian concepts and it turns out his major complaint is rejection of a-priori analysis as being the most important foundation of economic science. It's a very unconvincing argument indeed.

    1. Lol, bryan caplan is not keynesian. Keynesian =/= smear term for non-Austrian. He's an AnCap for petes sake.

  8. "Those who understand ABCT and those who hold the "what goes up must eventually come down" theory may also play the debt borrowing game by simply insuring the investment/borrowing structure they use protects them personally once the collapse occurs."

    That was me, and I wasn't even conceptually aware of ABCT at the time. I leveraged up housing assets to buy a business in 2003 because I knew it was all bullshit...sold some assets off at the peak...when the crash came in 07' my structure saved my business and the banks got hosed on my leveraged/overvalued assets.

    lol, they deserved every bit of it. I'd only have been better off if I'd have dumped a bit more than I did into gold too at the time...but I still made out ok.

  9. Bob, thanks for this.

    When I saw this video it made me a little ill. I'm a novice when it comes to econ, but even I could spot the flaws in his comments on ABCT. I saw the video on YouTube under the banner. This is a tragedy because now some folks are going to go away thinking they know a little more, when actually they know less than when they started.

    A couple of other comments based on my recollection (I saw it a few days back now):

    (1) I think he might have been saying that there has been _price_ deflation without prior _monetary_ inflation. If so, I think he's right... but so what. As far as I can tell Austrians expect a certain amount of price deflation, as it reflects changes in supply or demand, and/or improvements in productivity. I think the Austrian argument is that price deflation is not necessarily a bad thing -- particularly when it's not induced by artificial monetary inflation.

    (2) I think he asserts that Austrians believe FED (or perhaps it was central banking in general) is the only culprit, and therefore ABCT can't address bubbles that have occurred without a central bank in place. But of course there are any number of legislative interferences in the past that have resulted in monetary inflation and associated bubbles. The point isn't central banking, but any form of interference in the money supply that makes it difficult for entrepreneurs to accurately assess its value in relation to the goods it purchases.

    I'm not sure what Cowen's deal is, but it seems like it has to be one of the following: (a) He's in someone's pocket; (b) He's not nearly as smart as he thinks he is (there may be some sort of degenerative disease involved); (c) He's simply a cynic who is trying to make a name for himself.