Wednesday, June 26, 2013

The Extremely Dangerous Defense of Austrian Economics Being Made By Bob Murphy

Over at Bob Murphy's web site, Bob is spinning and doing handstands because interest rates have been climbing since Fed chairman Ben Bernanke hinted that "tapering" maybe in the Fed's cards down the road.

Here's Bob in one cartwheel:
 In that context, the following chart from Justin Wolfers is a bit problematic for my confident blogging friends [Note: Murphy means Paul Krugman and Scott Summers are his confident blogging friends-RW]

OK, that looks sorta consistent with the perspective coming from my blog and other Austrian-friendly sources, right? Doesn’t mean we have a monopoly on truth, but it sure means that Krugman and Sumner need to either (a) ignore this completely or (b) when commenting on it, do so with some humility and explain why it totally contradicts what they’ve been telling people for years.

Bob says on the above chart that there has been a "freaking huge rise in long-run interest rates" and he seems to be  implying that it is because of Bernanke's statement. He is then taking a victory lap for "Austrian-friendly sources."

I say, "not so fast."

As Mises, Hayek and Rothbard taught, the science of economics is a deductive science, not an empirical science. Let's consider this possible scenario.What happens if Bernanke retracts his statement in the next few days, as he well might do through leaks to favored journalists, and interest rates continue to climb? This could happen.

 Would it not be fair for Krugman and Summers to then argue that Murphy doesn't know what the hell he is talking about, since he argued that Bernanke's statement caused the run-up in interest rates but now that  Bernanke is hinting that there will not be any "tapering" soon and interest rates are still climbing that Murphy must have the causal factor wrong?

We live in an extremely complex world and arguing that a massive change in interest rates is being caused simply by the comments of the Fed chairman is particularly dangerous. In my EPJ Daily Alert, I advise regularly that what must be watched is often not the news but the reaction to the news. Indeed, in the Alert of June 11th this is exactly what I wrote:
 It is often more instructive to watch the reaction to news, rather than the news itself.
By this I mean that there may be underlying factors that are driving the market in a given direction and that  the headline news is something that may catch the attention of an analyst with a tin ear, but deeper processes may be going on.

Currently, money supply growth (as I measure it in the Alert) has slowed dramatically. I believe that this is the underlying cause of weakness in the US stock market and bond markets and that the Bernanke statement was just  an opportunistic factor that caused markets to go in a direction that tight money supply forces were pushing them in anyway.

On June 14 in the Alert, I wrote as much, just 5 days before Bernanke's statement:
As for the very short-term, all eyes are on the Fed's taper. But the
key is that commercial banks are tapering money growth by sticking
funds in excess reserves. In other words, the crack in the markets is
coming, regardless of when the taper comes.

Former Goldman Sachs economist Jim O’Neill writes

The past few weeks have given us a hint of what might happen when the
Federal Reserve starts to reverse its super-easy monetary policy.
Expect turbulence in financial markets, especially for assets that
have moved far above normal or reasonable valuations.

In a separate Bloomberg Television interview he added that investors
should expect “quite ugly days” in the process.

He is correct in the sense that news of Fed tapering will intensify
the change in sentiment that is occurring and we may have major down
days for equities and bonds after such news, but the news will only be
a catalyst. The Fed has already lost control of money growth because
of banks using the Fed as a parking place for reserves. The Fed is in
other words pushing on a string.

This is a time to continue to increase cash reserves and on a
long-term basis to continue to accumulate gold and silver, as with all
major market moves there will be increasing volatility both on the
upside and the downside, but when the dust settles, stocks and bonds
will be much lower.
Indeed, I would argue that if money supply growth were exploding at the same time Bernanke made his "down the road" tapering statement that the interest rate spike would have been much smaller and short lived, or there might not have been any spike at all.

It's one thing to beat Krugman up when he warns about a price deflation that never occurs. That is something that can be proven wrong by facts. If someone says X will occur and it doesn't, then that person is wrong.

However to argue that Krugman and Summers are wrong because of a Fed statement, while ignoring that markets are complex and ,especially ignoring changes in money supply growth, is a very sloppy way to approach things. It opens Murphy up for attack by Krugman and Summers every time Bernanke opens his mouth and says something that results in markets moving in a way different from the way Murphy expects.  Krugman and Summers can then pounce. How is Murphy going to dig himself out of that?

1 comment:

  1. Great post, Bob. I've added another scenario that in my view could also derail this causal factor to the movement of UST yields.