• federal-reserve-dc

    What Is Austrian Business Cycle Theory?

    Summary

    • The Austrian School is an under-respected economic school which unequivocally embraces free markets in favor of central planning.
    • Austrian Business Cycle Theory attempts to explain the business cycle through the actions of central banks.
    • Austrian Business Cycle Theory offers foresight into the effects of the Federal Reserve’s Quantitative Easing program.

    Austrian Business Cycle Theory

    abct-chartThe six main steps of the business cycle can be seen in my flowchart above.

    1. The first step to understanding an economic bust is knowledge of central bank policy prior to the bust period. The actions that explain the entire cycle are interventions undertaken by the central bank. For this example, we’ll use the fictitious island of Senyek. In the fictitious land of Senyek, central bank policy maker Eknanreb chooses to fix interest rates at near .1% to stimulate economic growth. Eknanreb can hold interest rates near .1% through an incredible inflation of the monetary supply.
    2. Eknanreb’s actions bring us to the second phase of the cycle, actions taken by banks in response to central bank policy. As the monetary supply increases rapidly under Eknanreb’s direction, more funds are able to be lent out. As more funds are able to be lent out, banks incentivize taking on a loan by offering a low interest rate.
    3. Once banks offer credit at low interest rates, businesses respond to the market signal and start to take on debt. Businesses then overinvest in projects with easy credit. The fundamental problem exists in that the credit offered at low interest rates by banks is not a real market signal. Sure, it’s a market signal in that it provokes another action, however, the origination of the market signal is inherently fake. In a free market, low interest rates arrive as a result of decisions made by market participants. For example, interest rates naturally reach low levels if market participants choose to save instead of borrow. As market participants stop borrowing and start saving, banks respond by lowering interest rates to incentivize borrowing. Decisions made by banks to lower interest rates in response to market signals from other market participants create real market signals as the signals represent actions of other market participants. Decisions made by banks to lower interest rates in response to policy directives from a central bank create false market signals, as the signals fail to come from the market.
    4. The next phases of the cycle can be explained by malinvestment. Malinvestment, the misallocation of resources, occurs once businesses have over-invested in projects with easy credit. A great way to explain malinvestment comes from Mises’s Human Action. Mises uses the example of a master builder who planned to build a large house. The builder, unaware that he doesn’t have enough bricks to complete the house, continues to build a house he can’t complete. The building of the house creates a great economic boom, and everyone involved in the project is thrilled. Once the builder reaches the last brick, he realizes what has happened, and the project comes to a grinding halt and an economic bust ensues. This example does a great job explaining what is happening on the island of Senyek. On Senyek, businesses are unaware of the false market signals driving their malinvestment. Likewise, the builder is unaware his great house has too few bricks. The builder has been fooled into allocating resources into building a giant house while Senyek businesses have been fooled into investing in projects derived from an artificial market signal. At last, the unsustainable boom period fueled by easy credit and fake market signals leads to a severe bust period. If only someone told the builder that he had too few bricks earlier, the fallout of the bust would be less severe. Likewise, if the central bank hadn’t created an artificial market signal, the economic bust period would be less severe.

    Applying Austrian Business Cycle Theory

    In the U.S., the Federal Reserve buys $65B worth of bonds every month. In accordance with the Austrian School, this fake stimulation is currently fueling malinvestment and overconsumption. Once the “Fed” completes the “taper” of Quantitative Easing, the current bond buying program, the master builder will realize the market signals he received were false, and his house will crumble. Likewise, the next catastrophe in the U.S. is not too far in the future. Actions taken by the Federal Reserve in response to the Great Recession have fueled a boom period characterized by overconsumption, and a severe bust will follow.

  • Student Loan Debt

    A Vicious Cycle Fuels The Massive Student Loan Bubble

    Summary

    • A vicious cycle of government-backed loans fuels the massive student loan bubble.
    • Student loan debt is a drag on economic growth.
    • Too many young people go to college.
    • The student loan bubble resembles the recent housing market bubble.

    A Vicious Cycle & Its Impact On Growth

    student-loan-cycleThe student loan bubble begins with the government. Loans offered to students are guaranteed by the federal government. Colleges can then charge higher tuition rates if the government intends to back its own loans. The effect of government-backed subsidies and loans is staggering inflation. As seen in the image below, college tuition prices have easily outpaced benchmark inflation.

    tuition-pricesIn fact, college tuition prices have outpaced inflation every year since 1981. Secondly, college tuition increases at an average of 6% greater than benchmark inflation. One method of reducing prices would be to increase the supply of students, thereby lowing tuition costs. However, colleges choose to solve the problem by raising prices and will likely continue to do so. The effects of higher tuition costs are starting to impact the financial stability of students. Two-thirds of college students are in debt and the average graduate owes $25K. In total, student debt exceeds $1T. As a result of mounting debt, the student loan default rate is growing quickly. From 2003-2010, the student loan default rate more than doubled from 4.5% to 9.1%! To compound problems, student loans from the federal government are non-dischargeable. With non-dischargeable loans students cannot declare bankruptcy and rid themselves of student loan debt. Instead, students are only allowed to purchase essential items for survival as the federal government aggressively garnishes the wages of those in debt. An increasing number of consumers that can only purchase essentials serve as a drag on the U.S. economy.

    Too Many Young People Go To College & Similarities To Th> Housing Market Bubble

    It’s hard to argue with the statistics that indicate too many high school seniors go to college. For one, the U.S. has the highest dropout rate in the industrialized world. If the federal government didn’t guarantee student loans then fewer students would go to college. With fewer students attending traditional higher education, the runaway inflation of college tuition prices would be under control. A second effect of fewer students obtaining traditional higher education degrees would be the decrease of structural unemployment. Too many decent, well-paying vocational jobs go unfilled in the U.S. In other industrialized nations such as Germany, some students choose to attend job training programs offered by companies that are happy to hire dedicated, well-trained high school graduates. It’s healthier to both the individual and the broader economy to be a vocational worker with a $44,000 salary and no college debt than an unemployed humanities major with a frightening amount of student loan debt. In fact, half of humanities students obtain jobs that don’t require a college degree.

    That being said, a simple comparison of salaries indicates that it is unquestionably better to have a college degree than solely a high school degree. The issue is not higher education, it’s too many students pursuing higher education with a huge, government-backed loan. Similarly, too many people became “homeowners” and as household debt soared, the housing market bubble increased. Homeownership is a good thing, but becomes a problem when too many pursue it. Likewise, a college education is a good thing, but not when those who don’t need it pursue it. In both cases, the root cause lies with the federal government and its inflation fueling loans and subsidies. Just as the federal government encouraged home ownership in the years leading up to the housing market bubble, the federal government is actively pushing some students to obtain a potentially unneeded major. Even worse, as college tuitions rise, public pressure increases to increase loans and subsidies to college students! Politicians, responding to the wishes of the people then increase loans and subsidies. And in increasing government loans and subsidies, those in government only add fuel to a rapidly growing bubble that threatens to puncture growth.

  • Capture

    5 Non-Idiotic Economic Reforms Millennials Should Work For

    Rolling Stone, that bastion of intellectual economic policy analysis, has recently produced the article “5 Economic Reforms Millennials Should be Working For.” Libertarians far and wide have already rebutted the nonsense in this article, and I decided to do my part by producing a sane alternative. After all, as philosopher/engineer R. Buckminster Fuller once said: “You never change things by fighting the existing reality. To change something, build a new model that makes the existing model obsolete.” So here is my attempt to make Rolling Stone more obsolete than it already is, which may be difficult, since Rolling Stone is already pretty obsolete.

    1.) No More Slavery

    During the height of chattel slavery, roughly 4 million Americans were imprisoned for a crime against no one. (1) How could such a horror take place? Could you imagine if millions of Americans today were imprisoned for a crime against no one? Well, this is precisely the situation today: In modern America, 7.3 million Americans are imprisoned (2), and 75% of prisoners are in prison for crimes against no one, meaning drug, weapon, public order, and immigration “offenses” (3).

    Offenses against the state are not crimes against a victim: The state is a concept, not a person. Offending the state is a crime against no one unless there is a real victim involved. This means that there are MORE people imprisoned for crimes against no one today than there were in 1860. President Obama, with a stroke of a pen, can pardon/free more slaves than there were at the height of chattel slavery.

    It should be noted that all of Rolling Stone’s “reforms” involve taxation i.e. forced payment under threat of imprisonment. Disobeying a tax law is a crime against the state, i.e. a crime against no one. Rolling Stone’s suggestions, then, are incompatible with the abolition of slavery.

    2.) The Legalization of Summer Jobs

    It’s getting tougher and tougher for teens to find summer jobs. “Less than a third of 16- to 19-year-olds had jobs this summer…” (4) What gives? Are teenagers a bunch of lazy bums who don’t like money? Do greedy capitalists hate teenagers and deny them jobs on purpose? One obvious culprit for the absence of summer jobs is that the vast majority of potential jobs in the US are illegal.

    Think of it this way: If the government imposed a minimum income requirement on small businesses, outlawing any small business that didn’t make the minimum income, would this help the small businesses who are currently making below the minimum income? Will consumers suddenly flock to the less successful small businesses they weren’t patronizing before, in order to help the businesses comply with the law? No, of course not, the least successful small business owners would find themselves unemployed.

    Every wage laborer is a small business owner, a capitalist in charge of his own human capital, who must convince customers/employers to buy the wage laborer’s labor. If the government makes the product too expensive through price fixing, the supply and demand won’t match: There will be a shortage, and a shortage of jobs is called unemployment. Economists nowadays are generally in agreement that price fixing for goods like gasoline and laptops would result in shortages. But for some reason many turn a blind eye to the most important price of all: Labor.

    Minimum wage laws don’t just hurt teens: They also hurt young adults and many other sets of workers trying to make their way up the career ladder. Many businesses would offer training and valuable work experience to low-skill workers as apprentices/interns, but unless the worker is producing an amount of goods/services worth at least the minimum wage, it is not economically feasible to hire them. Businesses have found a loophole whereby they can pay workers nothing and call them volunteers. Obviously making nothing is not an improvement over making a buck less than the minimum wage, and so workers are worse off due to the minimum wage law.

    But even this is becoming illegal: California and several other states have passed a law mandating college credit be attached to unpaid internships. (5) So now, anyone who isn’t in college will be shut off from opportunities to climb the first rung in the career ladder. Everyone who does get to work has to pay thousands of dollars for college credit to do so. Paying thousands of dollars to work, of course, is not an economic improvement from being paid a buck less than the minimum wage.

    Among poorer populations, minimum wage laws can be so destructive that workers threatened with unemployment will riot: South Africa workers, for instance, revolt whenever the minimum wage laws are raised. (6)

    3.) An End to the College Bubble

    This one won’t require much work from millennials, since all bubbles pop, but millennials should be demanding that it pop as soon as possible. Like the Housing Bubble, the College Bubble is the result of easy-money subprime loans, guaranteed by the federal government, that created an asset bubble. “Federal aid for students has increased 164% over the past decade, adjusted for inflation… After adjusting for differences among schools, the authors find that Title IV-eligible schools charge tuition that is 75% higher than the others. That’s roughly equal to the amount of the aid received by students at these schools.” (7)

    The Housing Bubble was very painful when it popped, but all bubbles must pop eventually. The sooner the bubble pops, the less damage it causes. The cost of an asset bubble is what that money otherwise could have been spent on: Instead of loans going for overpriced houses, loans could have gone to machinery, job training, research and development, or any number of other investments that increase real wealth in the economy. And, indeed, during the peak of the Great Recession, as housing prices were plunging, money started being used for productive uses. GDP was falling due to the housing market, but manufacturing hit an all-time high in 2009. (8)

    The money that students currently spend paying off their overpriced college loans could be invested, used to produce real goods and services instead of bloated college bureaucrat salaries. $200,000 could be lent more productively to start-up companies instead of 18-year-olds majoring in art history. If the government stopped incentivizing college loans by insuring them, you would see the price of college plummet (along with the endowments of many colleges, which will not make college administrators happy, so expect them to lobby for a bailout).

    4.) Cut Off Our Welfare-Queen Parents

    If the government neatly separated the population into two tax groups, one with an average net worth 49 times higher than the other, and then took a chunk out of the poorer group’s paycheck every week and sent it to the richer group, this would be a travesty! And it is! “Older Americans are 47 times richer than young” (9), but a hefty chunk of the young people’s salaries are stolen from the poor and given to the rich, so to speak.

    In The Simpsons, a homeless man asks Grandpa Simpson if he has any change, to which he replies, “Yeah! And you ain’t gettin’ it! Everybody wants something for nothing!” He then promptly walks into the Social Security Office and says, “I’m old, gimme gimme gimme!”

    Social Security in the US is not invested in an account that grows like the Chilean Social Security System or a 401k (10). Social Security is a direct transfer from the young to the old, and since the population demographics are getting older, young people have to pay in more than they get back. Congress set aside a Social Security Trust Fund account to ostensibly make things slightly fairer for millennials, but this Trust Fund is filled with US Treasuries (11), which are promises by the federal government to tax the young even more! And even if young people were getting back everything they put into Social Security adjusted for inflation, this would be a raw deal, since they would be losing money when they need it most (economically, you can say that the marginal utility of money for young people is higher).

    Adjusted for inflation: “A single earner couple turning 65 in 2010 and earning the average wage would have paid in about $294,000 in Social Security taxes over a lifetime — but would get about $447,000 back” (12). Again, there is no interest being earned on Social Security “investments”, they are a zero sum game: Any “capital gains” on them means increased theft from the young. And Social Security is not the only form of indentured servitude for millennials: “If you add up all the promises that have been made for spending obligations, including defense expenditures, and you subtract all the taxes that we expect to collect, the difference is $211 trillion.” (13) That’s over $700,000 in debt per American; in other words, young people are born with a mortgage and no house.

    5.) Cheaper Weed

    I was expecting to at least agree with Rolling Stone about drug legalization, but it was conspicuously absent from their “reforms”. I already covered the truly sadistic aspects of drug laws when discussing slavery, but there is another economic side to drug laws that destroys human happiness and productivity.

    Drug laws make drugs more expensive: In Canada, legal THC-free cannabis costs 45 cents a pound (14). An anonymous, confidential source I cannot possibly disclose tells me that illegal cannabis costs thousands of times more (and is sometimes awful). The two goods are not equivalent, but legal hemp does give us a window into how far economies of scale, capital investment, and a fairly deregulated market could drive cannabis prices down. If alcoholic beer were illegal and cost $20 per bottle on the black market, and legal non-alcoholic beer cost 50 cents per bottle, it would give us some cause to believe that legalization would make beer cheaper.

    If drugs were far cheaper, what would the money gained by drug consumers be spent on? This, in the words of 19th-century French economist Frédéric Bastiat, is the unseen cost of prohibition. Some consumers may currently be doing cheap, deadly drugs such as methamphetamines or krokodil (15). Were drugs legalized and prices driven down, these consumers could switch to safer drugs like cannabis. This is one hypothetical reason why, when Portugal ended its drug war, drug abuse rates fell by 50%. (16)

    But what of the new, legal markets for THC-containing cannabis in Colorado and Washington? State legislators have seen the light, told the US Supreme Court to shove it (17), and created legal “taxed and regulated” cannabis markets. The only problem: If you tax and regulate a market too much, you interfere with that market’s ability to match supply and demand. The result is that there are widespread cannabis shortages in Colorado’s legal market, legal cannabis prices have been driven sky high, and the situation is so bad most cannabis consumers have chosen to risk jail and continue using the black market. (18) Millennials should be striving for a true, free market for cannabis, not a highly regulated, state-planned faux market.

    *                                         *                                      *

    Millennials should shake off their Stockholm Syndrome and stop demanding small welfare bribes in lieu of real, meaningful reform. End slavery, don’t reform it. Legalize jobs. Fire the academic establishment’s pampered bureaucrats. Stop stealing from the poor and giving to the rich. And let us have the cheap, quality weed that only a deregulated market can provide.

     

    (1) http://economics.ucr.edu/papers/papers03/03-12.pdf
    (2) http://www.nytimes.com/2009/03/03/us/03prison.html?_r=0
    (3) Data from 2009: This statistic is actually higher than 75%, because some misdemeanors are victimless crimes, and the study doesn’t separate misdemeanors into categories, so I didn’t count them. http://www.bjs.gov/content/pub/pdf/fjs09.pdf
    (4) http://online.wsj.com/news/articles/SB10001424127887323423804579025192355931448
    (5) http://www.policymic.com/articles/50069/unpaid-internships-aren-t-the-problem-working-for-credit-is
    (6) http://www.nytimes.com/2010/09/27/world/africa/27safrica.html?pagewanted=all
    (7) http://www.marketwatch.com/story/why-college-aid-makes-college-more-expensive-1330033152060
    (8) http://www.industryweek.com/global-economy/manufacturing-index-hits-all-time-high
    (9) http://money.cnn.com/2011/11/07/news/economy/wealth_gap_age/
    (10) http://news.investors.com/ibd-editorials/092613-672776-score-another-one-for-the-chilean-model-of-private-pensions.htm
    (11) http://www.ssa.gov/pressoffice/factsheets/WhatAreTheTrust.htm
    (12) http://www.urban.org/UploadedPDF/social-security-medicare-benefits-over-lifetime.pdf
    (13) http://www.npr.org/2011/08/06/139027615/a-national-debt-of-14-trillion-try-211-trillion
    (14) http://www.omafra.gov.on.ca/english/crops/facts/00-067.htm
    (15) http://sacramento.cbslocal.com/2013/09/27/cheap-heroin-alternative-krokodil-eats-users-flesh-from-the-inside-out/
    (16) http://www.forbes.com/sites/erikkain/2011/07/05/ten-years-after-decriminalization-drug-abuse-down-by-half-in-portugal/
    (17) The US Supreme Court even told the states that they couldn’t have medical cannabis:
    http://abcnews.go.com/WNT/story?id=131034
    Luckily, 20 states and even the District of Columbia have disobeyed them on that:
    http://www.usatoday.com/story/news/nation-now/2014/01/06/marijuana-legal-states-medical-recreational/4343199/
    (18) http://business.time.com/2014/01/04/colorados-pot-shops-say-theyll-be-sold-out-any-day-now/