Thursday, June 25, 2009

The Austrian Economics Newsletter's 1996 Interview with James Grant

AEN: Your argument about business cycles in The Trouble with Prosperity rests heavily on the work of the Austrian economist Wilhelm Röpke instead of the more well-known Austrians.

GRANT: I am an observer of the contemporary scene, a journalist, rather than a theorist. I picked up Austrian economics almost everywhere except in school. It came to me, and I to it, in the way that the Austrians say that so many good things happen, that is, by accident, rather than by design.

Over the years I read Mises, Hayek, Rothbard, and others on interest rates, capital, and the business cycle. I've long been inspired by Henry Hazlitt's career, someone who wrote as well as he did, and as long. To think that this man professed the ideas he did in the pages of the mainstream press is certainly startling and revelatory.

I chose to feature Röpke because of his book Crises and Cycles, which appeared in English during the Great Depression. He offers a clear and forceful exposition of the mechanics of the Austrian interest-rate and business-cycle model, and the very difficult but rewarding structure of the theory itself. Vera Smith must have done a great job in translating the work. By the way, I recommend Vera Smiths book The Rationale of Central Banking as a further elucidation on Röpke's already clear theory. I know there are all sorts of holes in my bibliography; there might be better and more faithful explanations than Röpke offers. But I really do recommend this to people for its simplicity.

AEN: How do you sort out short-term glitches from structural distortions?

GRANT: What we do is look for extremes in markets: very undervalued or very overvalued. Austrian theory has certainly given us an edge. When you have a theory to work from, you avoid the problem that comes with stumbling around in the dark over chairs and night stands. At least you can begin to visualize in the dark, which is where we all work.

The future is always unlit. But with a body of theory, you can anticipate where the structures might lie. It allows you to step out of the way every once in a while. So I'd like to put in a plug, not just for the theory itself--as elegant as it is--but for the application of the theory for calling the turn of cycles in the workaday world.

AEN: Will the newly-created indexed bond improve our discernment abilities?

GRANT: The theory is that it will reveal future inflation to policymakers. But they will be severely disappointed. There are a number of different inflations. Whichever one they focus on will be the wrong one. And will not improve the information available to the Fed to run monetary policy. Moreover, it doesn't excite me at all as a speculative or investment vehicle. Any securities innovation coming from the government leaves me cold as a first principle. You can have my share of any and all future indexed bond issuance.

AEN: Is it another example of the attempt at monetary central planning?

GRANT: It is worse. It is a symptom of Greenspan's fundamental failing that will prove to be his undoing. Before this is all over, there will be a big speculative upset, a loss of faith in financial assets, and a loss of faith in the steward of financial markets: Greenspan himself. His tragic flaw is that he thinks--contrary to the teachings of the Austrian masters--that there is some piece of data that will allow him to see the future clearly and head it off at the pass. He really believes that, notwithstanding what he knows about Mises.

There is no worse error. Somebody once told me that when Greenspan went to Washington, he felt that at last he would have the information he needed to make him a great economic forecaster. He evidently thought that in the upper-left-hand drawer of his desk, there was going to be a chart book that would show him everything.

AEN: Do you think the consumer credit market is itself a creation of loose credit?

GRANT: It has been subsidized and encouraged by the central bank, and the rise of debt that has come with it, but it has a life of its own--by and large a successful life, I might add. Wilhelm Röpke criticized all consumer credit as being a product of the inflationary age. He couldn't have anticipated how fully developed the market would end up.

In Germany today, consumer credit is only a minor fixture in the financial markets; the main use of credit cards is to debit ones bank account, not to run up balances. Americans think Germans have it all backwards; the purpose of credit cards is to get yourself in debt and go to Aruba.

AEN: Does the American practice have advantages?

GRANT: America has shown that a bank can stay open 24 hours a day. It has shown that you can conduct business without a teller discovering the details of your personal financial life. That's great. The technique of consumer finance in America is wonderful. Has it opened the way to abuses? Certainly. Has it changed the nature of the economy? Certainly, for better and worse.

AEN: Yet under the gold standard, the availability of credit was severely restricted.

GRANT: Correct, and only by degree did bankers come to trust ordinary working men and women. There is nothing incompatible between the gold standard and a democratic regime of credit. Nineteenth-century bankers miscalculated and overlooked a great business opportunity when they overlooked the average American worker. Had World War I not happened, the markets would have discovered, through trial and error, that consumer credit is a legitimate and lucrative business. As it turns out, consumers collectively have presented a much better credit risk than corporations individually. That's not likely to remain true indefinitely.

The purpose of markets is to test the limits of ideas, and sometimes take them to absurd extremes. Markets tested the absurd extremes of financial leverage in the 1980s. They've tested the absurd extremes of the equity market in the 1990s. They've tested various structures of corporate finance during various cycles. Markets will test the extreme limits of consumer credit too.


Related books:

Mr. Market Miscalculates

The Trouble with Prosperity

Related link: The Mises Online Store