An Austrian Perspective on Economic Crises - An Introduction

8/8/2019 An Austrian Perspective on Economic Crises - An Introduction

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An Austrian Perspective on Economic Crises

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How Central Banks Create MassiveInvestment Traps for Investors,

Time & Again, ... and How to Avoid Them

May 4, 2010

Antwerp

4 MAY 2010


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Warm-up

Geert Noels (chief economist Econopolis, 2010)

From an intellectual point of view, the school of M ises has been the only one announcing the

c red it p roblems tha t wou ld eventua ll y emerge.

Francisco Garci-a Params (Bestinver Asset Management, 2010)

Als grote fan haalt hij zijn inspiratie uit de theorien van de Oostenrijkse economische school. Zij zeggen

dat conjunctuurcycli veroorzaakt worden door kredietexpansie of kredietcontractie. Overdreven kredieten

leiden onvermijdelijk tot overinvesteringen (verkeerde investeringen), zeepbellen en crashes. W at zij

zeggen en verklaren, zien we vandaag in het echt. Daardoor vermeden we de

technologiezeepbel en de recente bankencrash. Het helpt ons niet om te voorspellen wanneer de

Federal Reserve de rente zal verhogen, maar dat hoeft ook niet.

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Agenda

1. The Keynesian Way versus the Austrian Way

2. Austrian Business Cycle Theory The Origins of Money

Good Credit versus Bad Credit

Bad Credit : Fractional Reserve Banking

Boom & Bust

Implications of Policy Measures 07-

3. Perspective4. Investment Implications

The Psychological Advantage

A Focus on Historical Earnings

Risk Management

5. Conclusions / Advice

6. Questions

sl ides @ www .sdeklerck.be

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The Keynesian Way

versus

The Austrian Way


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The Keynesian Way


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The Keynesian Way (1)

Ben Bernanke (FED, Princeton), The Great Moderation, 2004

I have put my case for better monetary pol icy rather forcefully today, because I th ink it l ik ely that

the pol ic y expl anat ion fo r the Grea t Moderat ion deserves more c red it than it has received in

the l iterature.

Ben Bernanke (FED, Princeton), Why are we still listening to this guy?, 2005-2007

It is important to note that fundamentals are also very strong, weve got a growing economy, jobs,

incomes, weve got very low mortgage rates, weve got demographics supporting housing growth, weve

got restricted supply in some places, so its surely understandable that prices should go up some. I don t

know w hether prices are w here they should be but I think m uch of w hats happening is

suppor ted by the s trength o f the economy.

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The Keynesian Way (2)

Olivier Blanchard (IMF, MIT), The State of Macro, August 2008

For a long while after the explosion of macroeconomics in the 1970s, the field looked like a battlefield.

Over time however, largely because facts do not go away, a largely shared vision both of fluctuations and

of methodology has emerged. Not everything is fine. Like all revolutions, this one has come with the

destruction of some knowledge, and suffers from extremism and herding. None of this deadly however.

The st at e of macro is good.

De Tijd, Wie gelooft deze economen nog?, 2009

Waarom hebben economische model len de cr is is n iet voorspeld?

Hoe komt het dat we in igen deze c ris is hebben z ien aankomen?

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!

Central bankers are central planners

Ludwig von Mises, Socialism, 1922

Central bankers are DOOMED to fail !

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The Austrian Way


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Dont be fooled (1)

Waterloo 2.0

Dont be fooled ! (Part I)

Dont be fooled ! (Part II)

dr. Marc FaberGloom, Boom & Doom

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www.sdeklerck.be


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Dont be fooled (2)

Marc Faber, GBD report, 2003

Asset inflation continues unabated in the housing marke t and is revived in the equ it ies marke t and

together superimposes another monstrous bubble on the one we experienced in the equities market in the late

1990s. This, however, would result in an additional immobil isation capital, which, as we discussed above,

means the displacement of the economically most advantageous ratio between fixed capital and circulating

capital in the direction of an excess of the former over the latter. But, unlike in Germanys hyperinflation, theimmobilisation of capital wont lead to an expansion of the productive factors of the US economy, but to

sense le ss specu la ti on in ove rpri ced prope rty and equ it ie s marke ts, and to an expansion of production

facilities overseas, where, under this scenario, costs would remain far lower.

I wish to emphasise that ifthe inflat ion is ts, who are now, under the leadership of the Fed, in control of central

banks around the world, have their way, a very dangerous economic policy course will be followed. This will result

eventually in sharply rising inflation rates and a much lower US exchange rate, and will bring about a

d isas trous g loba l recession , wh ich cou ld threaten the capital is ti c sys tem as we know i t today.

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Dont be fooled (3)

Niall Ferguson (Harvard University), Dead Men Walking, 2009

And the b iggest winners, among economists at least? Step forward the Aust ri ans economists

like Ludw ig von M ises (1881-1973), who always saw credit-propelled asset bubbles as the biggest

threat to the stability of capitalism.

William White (former chief economist BIS), Modern Macroeconomics Is on the

Wrong Track, 2009

In contrast to the Keynesian framework, Austrian theory assigns critical importance to how the creat ion

of m on ey and credit by the financial system can often lead to cumulat ive imbalances over time.

These imbalances, which ultimately come down to investments that do not end up profitable, eventually

implode in the context of an economic crisis of some sort.

Geert Noels (chief economist Econopolis, 2010)

From an intellectual point of view, the school of M ises has been the only one announcing the

c red it p roblems tha t wou ld eventua ll y emerge.

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Dont be fooled (4)

William White (former chief economist BIS), The Origins of the Next Crisis, 2010Whats less comforting about it, and of course, a lot of people dont like to face up to this, this thing

was in it s fundamen tal respect s t he same as all t he pr ev iou s ones, fundamen tally it was t he

same, and you m issed it !

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Dont be fooled (5)

Percy L. Greaves, The Causes of the Economic Crisis, 1977

In foreseeing the interw ar economic breakdow n, Mises w as nearly alone among his

contemporaries - which is particularly interesting because Mises made no claim to possessing

clairvoyant powers. To him, economics is a qualitative discipline. But among those who say that

economics must be quantitative with the goal of accurate prediction, neither the pre-monetarists of the

F isher Schoo l nor the Keynesians foresaw the economic damage that would result from central bankpolicies that manipulate the supply of money and credit. Why is this? Most economists were looking at

the p ric e l evel and g rowth rates as i nd ic ator s o f economic hea lth. Misess theoretical insights led

him to look more deeply, and to elucidate the impac t o f c red it expansion on the en tir e s truc tu re of

the capital ist ic production process.

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Dont be fooled (6)

A delusion about credit

Garet Garrett, 1932

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ABCT


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The Origins of Money (1)

1. Direct exchange

A Bmeat

fish

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2. Indirect exchange

C

A Bwood

fish

wood

meat

A man who finds it hard to obtain indirect barter what he wants to acquirerenders better his chances to acquirewhat he is asking for in later acts of exchange by the procurement of a

more marketab le good. Under thesecircumstances there was no need of government inter fe rence or of acompact between the citizens.

Ludwig von Mises, 1949

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3. The Notion of Marketability

Now just as in nature there is a great variety of skills andresources, so there is a variety in the marketability of goods. Some goods are more widely demanded than others,some are more divis ib le into smaller units without loss of value,some more durab le over long periods of time, some moretransportable over large distances. All of these advantagesmake for greater marketabi li ty.

Murray N. Rothbard, 1963

C

A Bwood

fish

wood

meat

C

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4. The Notion of Marketability

Now just as in nature there is a great variety of skills andresources, so there is a variety in the marketability of goods. Some goods are more widely demanded than others,some are more divis ib le into smaller units without loss of value,some more durab le over long periods of time, some moretransportable over large distances. All of these advantagesmake for greater marketabi li ty.


C

A Bgold/silver

fish

gold/silver

meat

C

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5. Money-based economyIt is clear that in every society, the m ost m ark etablegoods will be gradually selected as the media forexchange. As they are more and more selected as media,the demand for them increases because of this use, and sothey become even more marketable. Eventually, one or twocommodities are used as general media - in almost all

exchanges - and these are called money.


A Bgold/silver

fish

It is the most marketable good which people acceptbecause they want to offer it in later acts of impersonal

exchange.

Ludwig von Mises, 1949

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6. MoneyA good.

The most marketable good.

Outcome of the free-market economy.

The unintentional outcome, theresultant not deliberately designed and

aimed at by specifically individualendeavors of the members of a society.

Carl Menger, 1871

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Good Credit versus Bad Credit (1)

Good credit

A# fish = 100 consumption = 10 savings = 90

B producer of fish nets

# fishes = 720 = 8 * 90fish net withcapacity = 200

save

invest

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Good credit


B

C

# fishes = 720

# silver = 72

fish net withcapacity = 200

# silver = 72

producer of fish nets

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save

invest


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Good credit


Bank

# silver = 72

C

# fishes = 720

Banks cannot expand good credit assuch. All that they can do in reality is tofacilitate the transfer of a given pool

of savings from savers (lenders) toborrowers.

Frank Shostak, 2008

# silver = 72

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Good credit

save

invest

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Good credit

Despite the apparent complexity that the bankingsystem introduces, the act of credit remains the

transfer of saved real stufffrom lender to borrower.Without the increase in the pool of real

savings, banks cannot create more credit.Atthe heart of the expansion of good credit by thebanking system is an expansion of real savings.

Frank Shostak, 2008

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Good credit

The price level fell to half its initial level in the course of lessthan fifteen years and, at the same time, economic growth

proceeded at a rapid rate. ...Their coincidence casts seriousdoubts on the validity of the now widely held view that secular

price deflation and rapid economic grow th are incompatible.

Milton Friedman and Anna J. Schwartz, A MonetaryHistory of the United States 18671963, 1971

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Bad credit


Bank

C

# fishes = 720

# silver = 72

# silver = 72# receipt = 72

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Bad credit

Bank


A B C Z

receipt

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Bad credit

Bank


A B C Z

# receipt = 100

X

new car

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Bad credit

Bank


A B C Z

# receipt = 3000

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Bad credit

Bank

silver receipt

A B C Z

# receipt = 3000

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Bad credit

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Bad Credit :


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Bad Credit :Fractional Reserve Banking (1)

Good credit

Bank

# silver = 10005%

# silver = 10005,5%

profit = 5

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Bad Credit :


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Bad credit

Bank

# silver = 10005%

# receipts = 10.0005,15%

profit = 465

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!


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!Inflation, as the term was always used everywhere and especially in this country,

means increasing the quantity of money and bank notes in circulation

and the quantity of bank deposits subject to check.

Ludw ig von M ises, Economic Freedom and Intervention, 1951

What many people today call inflation or deflation is no longer the great increase or

decrease in the supply of money, but its inexorable consequences, the general

tendency toward a rise or a fall in commodity prices and wage rates

Ludwig von Mises, Human Action, 1949

CPI

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!


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Good credit higher productivity prices

Monetary policy: CPI = 2%

PRINT, PRINT, PRINT,

!

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0

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Bad Credit :


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Bad credit : 2 consequences

1. Diversion of real wealth

2. Falsification of economic calculation

Distortion of the production structure

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Top 1%43%

Next

4%

27%

Next

5%

11%

Next

10%

12%

Bottom

80%

7%

Bad Credit :


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Bad credit : 2 consequences

1. Diversion of real wealth

2. Falsification of economic calculation

Distortion of the production structure

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Bad Credit :


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Bad credit1. increase in money supply

2. artificial drop in interest rate

3. entrepreuners implement new investment projects: BOOM

4. increase in prices5. increase in inflation component: 5,15% 5,4%

6. investment projects turn NPV negative

7. liquidation of investment projects: BUST

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ABC Th


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ABC Theory

The Origins of Money

Good Credit versus Bad Credit

Bad Credit : Fractional Reserve Banking

Boom & Bust

Policy Implications 2007 -

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Implications of


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Implications ofPolicy M easures 07-...

Ludwig von Mises, The Causes of the Economic Crisis, 1923It is always an inflationist policy, not economic conditions, which brings about the monetary depreciation.

Inflationism, however, is not an isolated phenomenon. It is only one piece in the total framework of politico-

economic and socio-philosophical ideas of our time. Just as the sound money policy of gold standard

advocates went hand in hand with liberalism, free trade, capitalism and peace, so is i nf la ti on ism par t and

parcel of imperial ism, mi li tari sm, protect ionism, stat ism and soc ia li sm.

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Perspective

A Free Market, Ant i-Socialist


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,Oriented Perspective (1)

Dwight W. Morrow, 1927How is the investor to form an intelligent judgment as to the safety of his investment? If he should be

asked this question, I think that he would put in the very forefront of his reasons for making the

investment the fact that he had confidence in the banker who offered him the investment. This throws a

heavy responsibility upon the banker. The banker m ust never be lured, either by the desire for

p rofit or t he desire for r epu tat ion, t o r ecommend an investmen t wh ich he does not believe

t o be good.

Benjamin Graham, The Intelligent Investor, 1949

... whose chief value to their clients is in shielding them from costly mistakes ...

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A Free Market, Ant i-Socialist


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,Oriented Perspective (2)

Joseph Schumpeter, Capitalism, Socialism, and Democracy, 1942It is the absence of d irect responsibi li ty for pract ica l a ffai rs and the consequent absence of first hand knowledge of

them which distinguishes the typical intellectual from other people who also wield the power of the spoken and written

word.

Friedrich A. Hayek, The Intellectuals and Socialism, 1949

The layman, perhaps, is not fully aware to what extent even the popular reputations of scient is ts and scholars aremade by that class and are inevitably affected by its views on subjects which have little t o do w ith the m erits of the

real achievements. And it is specially significant for our problem that every scholar can probably name several instances

from his field of men who have undeservedly achieved a popular reputation as great scientists solely because they hold

what the intellectuals regard as "progressive" political views; but I have yet to come across a single instance where such a

scientific pseudo-reputation has been bestowed for political reason on a scholar of more conservative leanings.


What is needed to stop the trend towards socialism and despotism is common sense and moral courage.


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Investment Implications



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The Psychological Advantage


Risk Management

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A Focus on Historical Earnings (1)


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DE FAVORIETE AANDELEN VOOR2008Met twee rechtstreekse vermeldingen en een onrechtstreekse, via de moederholding KBC Ancora, verdient de

Vlaamse bank-verzekeraar de vijfde plaats. 'KBC is een superkoopje: zeer solvabel, een hoge

winstgroei en een lage waardering ', vat SG Private Banking samen. 'KBC moet de komende jaren in staat

zijn een dubbelcijferige klim van de winst per aandeel te realiseren dankzij de groei in Centraal-Europa, de

inkoop van eigen aandelen en kostenbesparingen in private banking', vervolgt Delta Lloyd Bank. Bank Degroof

raadt aan KBC via KBC Ancora in portefeuille te nemen. 'Met die holding koop je KBC met een korting van 19

procent.'

Koers KBC 31/12/ 2007: 96

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2

3

4

5

6

7

8

9

10

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

KBC KBCA


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Benjamin Graham, Security Analysis, 1934:The concept of earnings power has a definite and impor tan t p lace in in vestmen t t heory. It

combines a statement of actual earnings, shown over a period of years, with a reasonable expectation

that these will be approximated in the future, unless extraordinary conditions supervene. The record must

cover a number of years, first because a continued or repeated performance is always more impressive

than a single occurrence and secondly because the average of a fairly long period will tend to absorb

and equa li ze the d is tort ing inf luence of the bus iness cyc le.

Warren Buffet, 2009

What I pay attention to is earning power. Coca-Cola has no tangible common equity. But they've got

huge earning power.

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Risk Management


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Risk Management

A Profound Understanding of Austrian Economics

A Profound Understanding of Financial History


A Ban on Complexity

A Ban on Leverage

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!


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!

Liquidity is a coward; when you need her

most she runs away and hides!

Jeff Saut, 2007

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Conclusions

!


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!

Central bankers are central planners


Central bankers are DOOMED to fail !

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!


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!

Worldly wisdom teaches that it is better for

reputation to fail conventionally than to

succeed unconventionally.J.M. Keynes, The General Theory, 1936

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!


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!Inflation, as the term was always used everywhere and especially in this country,

means increasing the quantity of money and bank notes in circulation

and the quantity of bank deposits subject to check.

Ludw ig von M ises, Economic Freedom and Intervention, 1951

What many people today call inflation or deflation is no longer the great increase or

decrease in the supply of money, but its inexorable consequences, the general

tendency toward a rise or a fall in commodity prices and wage rates

Ludwig von Mises, Human Action, 1949

CPI

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!


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Good credit higher productivity prices

Monetary policy: CPI = 2%

PRINT, PRINT, PRINT,

!

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0

0,2

0,4

0,6

0,8

1

-15 35 85

!


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!

Liquidity is a coward; when you need her

most she runs away and hides!

Jeff Saut, 2007

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Questions

An Austrian Perspective on Economic Crises - An Introduction

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