Sunday, 12 August 2012

What is Austrian Economics?

Based on my own experience of discovering Austrian Economics a bit later than ideal, I thought others might be in the same shoes. Therefore, below follows a short introduction to what it is with some links to further information if you want to dig into the material should you not already be familiar with it (or maybe even never heard about it). The material below are from the Ludwig Von Mises Institute, the best source of material on the matter based on my personal experience.

The Austrian School of Economics, or simply Austrian Economics, is a school of economic thought that derives its name from its founders and early supporters that were economists from Austria. These economists include Carl Menger, Eugen von Böhm-Bawerk and Ludwig von Mises. Other notable Austrian economists are Friedrich Hayek (Nobel Laureate) and Murray Rothbard.

The Ludwig Von Mises Institute, which desribes itself as the "...the world center of the Austrian School of economics and libertarian political and social theory", and which provides a rich source of research, videos and materials on the subject, summarises Austrian Economics as follows,

The school emphasizes the spontaneous organizing power of the price mechanism and holds that the complexity of subjective human choices makes mathematical modeling of the evolving market practically impossible and therefore its scholars eschew what they consider "naïve" and pointless mathematical modeling of the economy, considering much of mainstream economics a form of economic charlatanism. Its proponents tend to advocate the strong protection of private property rights and the strict enforcement of voluntary contractual agreements between economic agents, but otherwise advocate a laissez-faire approach to the economy and hold that the smallest imposition of coercive force (especially government-imposed force) on commercial transactions is the most effective way to secure long-run economic stability and well-being.
In particular, they voice serious concerns about the distorting and damaging effects of government involvement in commerce, arguing that few government regulations in this area are necessary or desirable and often trigger a "ratchet effect" as problems associated with existing regulations are often blamed on the free market, thereby justifying further damaging, coercive incursions into the market. They are particularly critical of long-standing governmental incursions into the area of private money production, advocating instead the immediate abolition of all coercive legal tender laws and the return to full reserve - or free - banking, where the financial system is decentralized and not dominated or controlled by coercive monopoly government or a monopoly central bank.
An important part of Austrian Economics is its view on the business cycle, detailed in the Austrian Business Cycle Theory.  In summary, again from the Ludwig Von Mises Institute,

The business cycle describes regularly occurring booms and busts observed in the economy and the Austrian Business Cycle Theory (sometimes called the "hangover theory" or simply ABCT) is an explanation of this phenomenon from the Austrian School. Originally developed by Ludwig von Mises in the 1912 Theory of Money and Credit it was elaborated on by Hayek and others. In one classical rendition:
Banks expand credit well beyond their own assets and by the funds of their clients, often supported or encouraged by the setting of low interest rates by a central bank. This additional credit flow into the economy from increased borrowing for capital projects stimulates economic activity. Projects which would not have been started before, seem now profitable, creating malinvestment. They increase demand for production materials and for labor and their prices rise, which, in turn, leads to an increase in prices of consumption goods. If the banks would stop the extension of credit, the boom would be rapidly over. To prevent the sudden halt of this boom (and the resulting collapse of prices), the banks must create more and more credit, and the prices will rise even more.
But this expansion of credit cannot continue forever. There is no additional capital or labor; there is only more money (and debt). The means of production and labor which have been diverted to the new enterprises have to be taken away from others. Society is not sufficiently rich to permit the creation of new enterprises without taking away from others. As long as the expansion of credit is continued this will not be noticed, but it can't be pushed indefinitely. The inflation and the boom can last only as long as the public thinks that the prices will stop rising in the near future. When the public becomes aware, that there the inflation will not end, and that prices will continue to rise, panic sets in. Eventually, people may give up the currency and rush to exchange money for goods, buying things they have no use for, just in order to get rid of the money (the so-called "flight into real values.")
In these days of ever increasing central bank intervention and governments manipulating the markets, especially in the U.S. and Europe, which certainly seems likely to continue for a while longer, the message of the Austrian School of Economics is arguable even more relevant and important than ever before. Even if you should not agree with the Austrian school of thought generally, you are very likely indeed to find some powerful explanations and philosophies you can apply to for example the investment decision making progress (for example, read this if you are an investor or economists, or a CFO for that matter and this if you work in equity research or is a fundamental equity investor).

If you want to learn more, I suggest you start right here with a history lesson on the subject. Happy readings!