Saturday, February 26, 2011

The Curious Task

"The curious task of economics is to demonstrate to men how little they really know about they imagine they can design." -- F.A. Hayek

As a college student studying business in this day and age, I realize how little my fellow students really understand about economics.  Any introduction class to economics should cover Frederich Hayek in some way.  Instead, John Maynard Keynes is covered (glowingly depending on the professor.)  Mine never did.  I found out about Hayek due to a friend who mentioned him and a really good economic rap battle music video on YouTube.  Business classes seem to focus almost exclusively on the nuts and bolts without any time spent on the larger picture.  It is best to demonstrate this by example.

In one finance class I was in, my professor brought up the graph showing the required returns on Treasury notes.  She asked what the recent rise in required returns meant.  I knew the answer immediately.  The rest of the class was flabbergasted.  They brought up mathematical concepts without any grip on the market implications.  I said that a rise in required returns means that the market sees the Treasury notes as riskier investments than they were in the past.  This means that more people think the chance of default has increased.  This is most likely due to the constant and exponential increase in government spending, which has exploded the debt and the deficit in recent years.  In conclusion, current government spending levels are unsustainable.  The professor seemed pissed at my long response but no one else realized it.  One student even said, "That makes sense."  Our Treasury notes have a AAA (or Aaa) bond rating from the two major investment rating agencies, S&P and Moody's.  If that rating were downgraded, there would be chaos in the streets.

Hayek's views accurately predicted nearly every economic downturn since he's been around.  The only one I could say he wouldn't have predicted based on his models was the dot com bubble burst.  That was based on overvaluation of dot com start-ups based on a faulty valuation model (website hits.)  Some recessions can be caused by technology expanding further than financial techniques.  That was one of them.  People just didn't know which websites would succeed.  I cannot fault Hayek for that.  He died before the Internet was even common in households let alone the necessity it is today.  I personally wonder what works he would publish today on the Internet's influence on available information and the influence such information aggregation has on prices if he were alive today.

Modern Keynesians focus way too much on macroeconomics.  They look over their "perfect" models, looking down on the common people from their ivory towers.  These same people, from Greenspan to Bernanke, did not see the housing bubble burst coming.  How is that possible?  George W. Bush saw it coming in the early 2000s and tried to get Congress to rein in Fannie Mae and Freddie Mac all the way back in 2003.  These Keynesians don't realize their ivory towers are ablaze.

"The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood.  Indeed, the world is ruled by little else.  Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist." -- John Maynard Keynes

That quote from Keynes above is probably one of his best.  The thing modern Keynesians don't understand is that the "defunct economist" is Keynes.  He was dismissed in the '70s when rampant stagflation happened.  Why has his influence returned while few college students even know who Hayek is?

Hayek claimed that booms go bust due to an expansion of credit, usually done by the Federal Reserve keeping interest rates artificially low.  Personally, end the Fed.  Seriously.  Let the market decide interest rates.  It makes no sense to centrally plan that.  That's what Hayek called the Fatal Conceit, the idea that "man is able to shape the world around him according to his wishes."  In other words, it is impossible for anything to be centrally planned because it is impossible to know everything.  In short, no one can act, like buying a car, knowing fully every result of his action.  It's the same idea that Leonard Read advanced in his essay "I, Pencil."  In short, a pencil seems to be such a simple item, yet no one person knows how to make one.  It takes thousands of people and a near infinite set of transactions to make one.

Not to say I agree with Hayek on everything.  His view on intellectual property laws makes me a little leery.

That's enough for now.  That's a taste of my economic ideology.