Related: Have you read “What is Austrian Economics?”
When it comes to one’s investments, people in this day and age of economic turmoil and market volatility want to know whether Austrian Economics can help one invest wisely and productively. In one sense, I believe it can. And in another sense, it does not at all.
Let’s start with some observations regarding the latter. Austrian economics does not claim to know where one should put his money in order to make a profit. This is because the good Austrian economist understands that monetary profit and loss is revealed by the market process; that is it is discovered in the course of exchange between seller and buyer. When an entrepreneur wants to make a profit, he will invest in a given capital or consumer good, and seek to exchange that good with a willing buyer. There is nothing a priori (known independent of actual experience) about which goods will be profitable and which will turn out to be rejected by the consumers at large. An entrepreneur might estimate that people in the economy would really like Purple Cups, but he could be wrong. It is only after making these cups and seeking to sell them that he can really know whether his investment was good or bad. The Austrian economist therefore does not know inherently what goods in the economy will be accepted and which will be rejected. Profits are a reward for judging correctly the desires of the consumers; losses are penalties for judging incorrectly. Austrian economists have no more inherent advantage qua Austrian economics than any other businessman, investor, or intellectual when it comes to anticipating consumer demand for a given good.
On another level though, Austrian economics can help in understanding the overall conditions of the “macro” economy; it can point to inflationary trends, deflationary trends, the effects of the Federal Reserve’s monetary policy on the price level of capital and/or consumer goods, bubbles, busts, credit expansion, credit contraction and so on. While these things don’t tell you exactly what investments will be profitable (the consumer is very difficult to predict), and they certainly don’t tell you how long booms can last, what the Fed will do next, and how the markets will respond to these things, it can inform you that, in the case of the expansion of the money supply, one should realize that this will lower interest rates and therefore encourage increased investments by business across the economy; which will lead to short term asset booms (such as the stock bubbles and the housing bubbles). However, Austrian economics also recognizes that these booms, since they were brought about artificially due to monetary expansion and not naturally by savings and deferred consumption, will eventually turn to busts. Austrian economics recognizes that there is healthy and production allocation of scarce goods, and there is also unhealthy and unproductive misallocations of goods. The former is a result of free markets and nature interest rate levels which the latter is a result of economic intervention by the central bank and an artificial interest rate level.
Austrian economics can tell you that a bust will follow a boom; it does not tell you when a bust will follow a boom. Austrian economics can tell you that resources will be misallocated in the event of an expansion of money; it cannot tell you where and to what extent that misallocation will occur. It is also relevant that in a true free market, investors will put their money in shares of stock in order to have a claim on the future cash flows of that company; but in our modern stock market driven by Federal Reserve policy, the very purpose of investing has been lost. For currently, the entire reason most people invest is to watch their stock go up; they want to “flip” stock so that they are buying low and selling high. This is primarily a phenomenon of price level instability encouraged by the Federal Reserve and its fiat money.
Austrian economists don’t have the magic formula for getting you the best return. But they do have the insight to recognize that bubbles are occurring all around us, and that bubbles, by their very nature, cannot last forever. This too has been neglected in our present context of “perma-bulls.” Importantly, this also means that Austrians are not “perma-bears;” that is, we don’t just sit here saying “it’s gonna crash, it’s gonna crash!” We recognize that it could be years and years before the bust comes, that people in the right markets with the right timing can make a lot of money, and that people who time their investments according to the “crash is going to happen tomorrow” mentality will lose in the short run. Rather than having a mindset that stocks will go up forever or that stocks are bound to drop any day now, the Austrian recognizes that timing, investor sentiment, and continued Fed/government policy can change things by the day. Thus, no one knows when the boom will turn to a bust, but we do know that artificial growth is unsustainable.
To conclude, I will add a quick note –to be expanded in the future– on inflation and deflation. Firstly, these terms have been redefined from their older usage. They used to mean and increase in the money supply and a contraction of the money supply, respectively. These days, however, they have come to mean a general rise in prices across the entire economy and a general fall in prices, respectively. There is debate in the Austrian camp about whether “inflation is coming” or not. Ultimately, the answer lies in how the newly expanded money supply enters the economy. If it enters the economy via consumer loans through the fractional reserve lending process, or if the treasury simple prints up new currency and hands it out, this would lead to a rise in consumer prices, other things being equal. However, if as in the present situation, commercial banks are setting records regarding the levels at which they are specifically not lending and instead piling up excess reserves, the new money would stay, in the words of David Stockman, sloshing around in the canyons of Wall Street, leading to rising equity prices and bond prices. In other words, most of the money has never even been out to the “real economy” and to main street where it would circulate and rise prices wherever it went. Thus, when these capital markets experience the painful “popping’ of their bubbles, the impact will be, rather than massive inflation, a time of credit deflation and a liquidation of bad debt. Therefore, the CPI would massively understate the impact that the money expansion has had. Contrary to popular belief, Austrians don’t inherently and always see hyperinflation “just around the corner.” Of course, there are some hyperinflationists who use Austrian economics as a marketing ploy and jump on the bandwagon; but this does not mean they actually understand booms and busts or Austrian claims. Austrians therefore should be careful about going around predicting massive rises in general consumer price levels; it does not have to occur, though it is possible. The bigger concern for Austrians is not price increases, but rather, the boom and bust cycle and the misallocation of resources.
Austrian economics has a very important function in the social sciences; but it does not tell you exactly where to put your money. As such, critics of the Austrian school are simply wrong when they try to discredit the approach to economic theory by way of analyzing Austrian financial advisors poor stock picks, if their stock picks turn out poor. Austrians are on the same level as every other person in regards to anticipating profit and determining consumer demand. Moreover, all persons are led astray equally by Federal Reserve interventions. Under a regime of fiat money, economic calculation becomes enormously difficult.