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Monday, October 13, 2008

Gold Crushes Marxian Business Cycles.

The Novel Crashmaker by Gold Bug, Dr. Edwin Vieira tells a story where Russia implements the Gold Standard after a worldwide economic crash. Today, Putin is moving his Gold Reserves to back the Russian Stock Market. There is also talk of converting the Ruble to Gold. The novel also tells the story where a Libertarian wins the U.S. Presidential election. Does Ron Paul still have a chance? Life sometimes is stranger than fiction.
As pointed out by Professor Kirzner (2001, pp. 137, 140), Mises did not start out with the intent to develop a theory of the trade cycle. The trade cycle argument first appeared in the last few pages of The Theory of Money and Credit (1912). This early development of Austrian business cycle theory was a direct manifestation of Mises's rejection of the concept of neutral money and "emerged as an almost incidental by-product of his exploration of the theory of banking …" (Kirzner 2001, p. 140). This development was an incomplete sketch of the theory, particularly for those not well versed in the capital theoretical foundations of the argument.

In fact, Hayek's (1999, pp. 105–6 fn.) first exposition of his version of the theory appears in a long footnote in his 1925 paper "Monetary Policy in the United States after the Recovery From the Crisis of 1920." The note was added following a suggestion from Gottfried Haberler. Hayek later explained that since "no sufficient exposition of the theory I had used was to be found in Mises's published works and if I was to expect to be understood, I must give a fuller account of the theory underlying my reports of the events described."

The Austrian theory of the business or trade cycle is an intricate blend of monetary theory and capital theory. Mises's (and Hayek's) monetary and capital theory differs in both significant and subtle ways from the mainstream neoclassical approach. Economists working in the Misesean tradition are still plagued by problems of communication with mainstream economists. While the terminology used is similar in both theories; definition of keys terms, the understanding of the nature of the economic problem, and the role of prices, especially prices for the means of production, differ considerably.

Hayek did much of the work developing the 'real aspects' of the business cycle theory, but, as has been pointed out by others, Hayek had one foot in the Austrian camp and one foot in the Walrasian general equilibrium camp.[1] For this reason, Hayek can be an important bridge between mainstream and Austrian economics. Hayek can be read (or perhaps more easily read—reading Hayek is never easy) by a neoclassically trained economist with a limited background in Austrian economics. In many cases his insights can be assimilated and/or at least partially incorporated into neoclassical analysis.

Austrian business cycle theory and the calculation argument are dependant on Austrian capital theory and the Austrian understanding of the role of time in the economic process for many of its subtleties. Those relying on Hayek, often interpret Hayekian arguments in terms of neoclassical capital theory and can be misled to believe that Austrian business cycle theory "was by no means so intellectually satisfying as it appeared at first. There were admitted gaps here and there in the first published account which was intended as merely rudimentary, and which when one attempted to fill these gaps they became larger instead of smaller, and new unsuspected gaps appeared" (Kaldor, [1942] 1980, p. 148).

While there is much that is useful in Hayek's numerous attempts to answers his critics, one must go back to his mentor Mises and to what Lewin (1999, pp. 115–33) calls modern Mengerian capital theory to build a more complete and convincing response to Kaldor and like critics. The response depends on the development of a theory of the market process of a monetary economy.

As Lewin (1999, p. 71) explains, while Neoclassical and Ricardian capital theorist interpret Bohm-Bawerkian within an equilibrium framework and focus on his empirical insights regarding the greater productivity of capital using process, "modern Austrian (market process) theorists, following Mises, Hayek, Lachmann, Kirzner and Rothbard (and also Frank Fetter) focus on some of Bohm-Bawerk's less formal pronouncements and draw some crucial insights from them. In particular these involve the role of time and the nature of profit and interest."

This market process theory leads to an understanding that monetary calculation and capital provide the only basis for rational economic planning. Rational economic planning is the foundation for the development and continuation of civilization based on social cooperation and the division of labor.

Cycle Theory and the Development of the Monetary Calculation Argument

Peter Boettke (2001, p. 44) has argued, "The centrality of monetary calculation to Mises and Hayek is the unique contribution of the Austrian school of economics. Combined with the additional Austrian assumptions and theoretical propositions—irreversibility of time, uncertainty, time structure of production, heterogeneity and multiple specificity of capital goods, non-neutrality of money, and so on—monetary calculation emerges as not just an aspect of the market process, but the crucial element which allows for the social cooperation under the division of labor" (Boettke, 2001, p. 44).

The arguments concerning the importance of monetary calculation for rational economic planning came to the forefront during the socialist calculation debate. The rational economic calculation argument was an extension of Mises's earlier work in monetary theory and its extension to the trade cycle. For Mises and Hayek, the trade cycle theory was an attempt to integrate an understanding of a complex capital structure into a monetary exchange economy (Boettke 2001, p. 34).

Austrian business cycle theory is based on intertemporal misallocation of resources. The real intertemporal pricing problem is the relationship between the prices of inputs applied at an earlier date to the prices of outputs available at a later date—the natural rate of interest in an Austrian model—and the market rate of interest in the loan market as influenced by credit creation. Kirzner (2001, p. 141) highlights this point as a key element in Mises's theory. Mises "relies on the reader's understanding the Böhm-Bawerkian insight that the money rate of interest simply corresponds, in a smoothly running economy at a given level of production, to the excess value of consumer goods at a given date, over the value—the spot prices—of the inputs invested at an earlier date in their production."

It is in the development of the trade cycle theory that Mises and later, Hayek recognize that rational economic planning involves, not only monetary calculation―"in the absence of money, there are no economic quantities and no economic calculation" (Salerno, 1998 [2002], p. 2)―but more importantly the appraisal of the value of resources available in earlier periods relative to the expected prices of the relevant output available at later dates. This is the entrepreneurial function and it cannot be duplicated in the absence of a market process where prices reflect the preferences and judgments of valuing, acting individuals. As pointed out by Salerno (1993, p. 123), "The real market process is driven by an identifiable, though ever changing, class of individuals whose productive activities are guided by monetary calculation based upon perpetual forecasting of an uncertain and changing future."

The market environment necessary to allow this entrepreneurial planning process to function most efficiently is the connection between the monetary, capital, and interest rate theory that is the foundation of the Austrian business cycle theory and the development and refinement of the arguments advanced by Mises and Hayek in the socialist calculation debate. The key elements in this enabling environment are private ownership of the means of production, monetary calculation, capital, and sound money.


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