Алтернативен поглед върху финансовия риск

Резюме: Измерването и управлението на финансовия систематичен риск е една от най-противоречивите теми в научните среди. Традиционните използвани методи като волатилност, регресионен анализ и стойност, изложена на риск (Value-at-Risk) не успяват да предвидят неочаквани и негативни за икономиката явления. Причината се корени в допускането, че бъдещите данни ще са сходни на историческите до този момент. Колкото и широк обем от исторически данни да притежаваме, то в бъдещ момент ще настъпи събитие, което е невъзможно да бъде предсказано на база исторически данни. Бидейки наясно с тези недостатъци ние можем да ги използваме в наша полза и да се облагодетелстваме от тях.

Ключови думи: финансов риск, стандартно отклонение, Value-at-Risk, черен лебед

JEL: G32

Едни от най-използваните начини за измерване на риска във финансовата сфера са стандартното отклонение, коефициентът бета и стойността, изложена на риск (Value-at-Risk). Защо точно те са най-широко разпространени и коректно ли е да ги използваме при изчисляването на риска? Идеята зад Value-at-Risk е общоприетата в традиционните финанси, че разпределението на доходностите е нормално и следователно се изчислява каква е стойността, която може да бъде загубена на база исторически данни. Общото между гореизброните три подхода е, че са исторически ориентирани, т.е. данните, които получаваме от тях са изцяло на база минали исторически събития. Ако нещо не се е случило в миналото, то е невъзможно да се случи в бъдещето. Докато при игра с хвърляне на зар резултатът варира от 1 до 6, то в реалния свят, в частност финансовата сфера, той може да е 1-2-3-4-5 и накрая 100. Законът за големите числа е принцип в теорията на вероятностите, по силата на който при дадени общи условия, съвместното действие на случайни фактори води до слабо зависещ от случайността резултат. Казано накратко – при увеличение размера на извадката нито едно случайно настъпило събитие не носи катастрофални последици. Това са причините зад краха на голяма част от икономистите и техните модели при настъпването на Голямата рецесия. Тези техни допускания „скриват” настъпването на т.нар. от Насим Талеб „черен лебед” – събитие, което е много малко вероятно да се осъществи, но последиците от неговото настъпване са с огромен размер.

Известен цитат на канадския философ Маршал Маклуън е „Ние пътуваме към бъдещето, използвайки единствено огледалото за обратно виждане”[1]. Никъде това описание не е по-точно, колкото в областта на управлението на риска.

Въпреки, че използването на волатилността за измервател на риска осигурява статистическа основа за описване движението на капиталовия пазар, нейната слаба прогностична способност означава, че тя е едновременно слаб измервател на риска и същевременно с това ненадежден начин за предсказване на тежка загуба. При изчисляването й се прави допускането, че доходността на активите е с нормално Гаусово разпределение. Поглеждайки към данните за доходността на аквитите за един дълъг период виждаме, че коефициентите на асиметрия и ексцес сочат противоположното[2]. Използвайки исторически данни от портфейли с много на брой активи с цел предсказване на бъдещето увеличава още повече възможността за грешка. При традиционните инструменти за измерването на риска се използват осреднени данни за корелация, докато действителността е точно обратната. Наблюдаваме увеличение в коефициента на корелация във времена на несигурност, което от своя страна намалява ползите от диверсификацията и увеличава загубите отвъд това, което може да се очаква използвайки осреднени данни.

Като следствие от тези недостатъци инвеститорите, които използват волатилността при оценяването на риска са като шофьора от цитата на Маклуън: ограниченията на техния кръгозор за пазара ги възпрепятстват и следователно са податливи на неприятни за тях изненади. Фокусирайки се върху абсолютните нива на волатилност инвеститорите са възпрепятствани да купуват рискови активи когато цените им са ниски, тъй като това обикновено съответства на висока волатилност, и същевременно с това са насърчавани да купуват рискови активи, когато цените им са високи. Тази стратегия тип „купи скъпо, продай евтино” е малко вероятно да е в интерес на когото и да е.

Съществуват и други недостатъци при използването на волатилността – тя е симетрична. Това я прави използваема само за симетрично разпределени данни. Един нагледен пример (таблица №1) от своя страна ще покаже как волатилността може да бъде и подвеждаща.

strategies

Таблица №1: Три различни сценария за инвестиционна стратегия

Изправени сме пред инвестиционно решение измежду три стратегии. Стратегия №3 изглежда най-рисковата, въпреки че има най-висок годишен ръст на CAGR (Compound Annual Growth Rate). От своя страна стратегия №1 се счита за безрискова (волатилността е равна на нула), въпреки че през всяка от трите години бележи загуба от 5%.

През 1893 г. Карл Пиърсън въвежда термина „стандартно отклонение” за това, което е било известно като „средноквадратична грешка”. Всъщност това са съвсем различни по метод на изчисление стойности. При хипотетичен пример от пет променливи (-23, 7, -3, 20, -1) изчислявайки средноквадратично отклонение получаваме 15.7, докато чрез средното абсолютно отклонение – 10.8. В първия случай взимаме всяко едно число, повдигаме го на втора степен, намираме средната стойност от всички повдигнати на втора степен пет стойности и накрая коренуваме тази осреднена стойност. Във втория случай просто осредняваме петте стойности, премахвайки знаците за минус.

Конвенционалните разбирания за риска ни учат, че това е нещото, от което инвеститорите се страхуват и желаят да се оттърват напълно, или ако това е невъзможно да го сведат до минимум. Наличието на черни лебеди е отвъд нашето влияние и колкото и да се стремим да ги избегнем, те непременно ще настъпват. Затова инвестиционна стратегия, използваща наличието на черни лебеди е това, което инвеститори като Насим Талеб и Марк Шпицнагъл съветват. Brunaker и Nordqvist (2013) я тестват емпирично на шведската фондова борса. Въз основа на допускането за връщане към средната стойност (mean reversion assumption), тяхната стратегия включва инвестиране в акции, които са имали най-голямо процентно изменение след негативно екстремно събитие. Инвестира се в десет на брой акции с равни тегла. Месец след настъпване на негативен черен лебед десет от 30-те акции, чиито цени са спаднали с най-много се добавят към портфейла. Те биват държани до настъпване на нов, този път положителен черен лебед, когато биват заменяни от акции, които поскъпват с най-малко. В случай на два или повече последователни отрицателни или положителни черни лебеди не се предприема нищо. За периода от 01.01.1992 г. до 31.12.2012 г. индексът OMX Stockholm 30 бележи възвръщаемост от 650%, докато портфейлът – 944%.

[1] В оригинал: “We drive into the future using only our rearview mirror.”

[2] Adams, M., Thornton, B. (2013).

ЛИТЕРАТУРА

  1. Adams, M., Thornton, B. (2013). “Black Swans and VaR”. Journal of Finance and Accountancy, Vol. 14.
  2. Brunaker F., Nordqvist A. A Performance Evaluation of Black Swan Investments. Bachelor Thesis, 15 ECTS Spring 2013
  3. Mandelbrot, B., Hudson, R. L. (1967). “The Misbehavior of Markets.” New York. Basic Books.
  4. Spitznagel, M. (2013). “The Dao of Capital: Austrian Investing in a Distorted World”. New York: John Wiley & Sons.
  5. Taleb, Nassim N. (2007). “The Black Swan: The Impact of the Highly Improbable”. Random House.

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Housing: Too Good to Be True – Mark Thornton

Reprinted from Mises InstitutePosted on 06/04/2004 by Mark Thornton.
It’s incredibly important to note the DATE on this article. This was published only a few months into the rise in subprime lending and private label securitization – which means it was written, probably, only a month or two into it. „Subprime“ was barely a thing and Thornton is already warning of a bubble.

Signs of a „new era“ in housing are everywhere. Housing construction is taking place at record rates. New records for real estate prices are being set across the country, especially on the east and west coasts. Booming home prices and record low interest rates are allowing homeowners to refinance their mortgages, „extract equity“ to increase their spending, and lower their monthly payment! As one loan officer explained to me: „It’s almost too good to be true.“

In fact, it is too good to be true. What the prophets of the new housing paradigm don’t discuss is that real estate markets have experienced similar cycles in the past and that periods described as new paradigms are often followed by periods of distress in real estate markets, including foreclosure sales, bankruptcy and bank failures.

The case of Japan’s real estate bubble is instructive. Japan had a stock market bubble in the 1980s that was very similar to the U.S. stock market bubble in the 1990s. As the Japanese stock market started to bust, the real estate market continued to bubble. One general index of Japanese real estate shows that prices rose for almost two years after the stock market crashed with prices staying above pre-crash levels for more than five years. The boom in home construction continued for nearly six years after the stock market crash. Prices for commercial, industrial, and residential real estate in Japan continue to fall and are now below the levels measured in 1985 when these statistics were first collected.

It has now been three years since the U.S. stock market crash. Greenspan has indicated that interest rates could soon reverse their course, while longer-term interest rates have already moved higher. Higher interest rates should trigger a reversal in the housing market and expose the fallacies of the new paradigm, including how the housing boom has helped cover up increases in price inflation. Unfortunately, this exposure will hurt homeowners and the larger problem could hit the American taxpayer, who could be forced to bailout the banks and government-sponsored mortgage guarantors who have encouraged irresponsible lending practices.

More Greenspam

Once again, Fed Chairman Alan Greenspan has created a new-age economic panacea, and earlier this year he applauded his contribution to the economic recovery: „very low interest rates and reduced taxes, have permitted relatively robust advances in residential construction and household expenditures. Indeed, residential construction activity moved up steadily over the year.“

The key to this panacea is the process of „equity extraction“ that occurs when people refinance their homes; they take equity out and spend it to increase their standard of living. However, because variable rate mortgages are so low, their payments actually go down so they have more of their income to spend, or they can upgrade to a more expensive house.  As Greenspan explained:

Other consumer outlays, financed partly by the large extraction of built-up equity in homes, have continued to trend up. Most equity extraction—reflecting the realized capital gains on home sales—usually occurs as a consequence of house turnover. But during the past year, an almost equal amount reflected the debt-financed cash-outs associated with an unprecedented surge in mortgage refinancings.

As is the norm, Greenspan hedges his statements. He also considers some of the potential drawbacks and pitfalls on the horizon for the new paradigm in housing, but in the end he concludes that we really have nothing to worry about. Low interest rates, rising home prices, and lower financing costs mean that we actually can have our cake (homes) and eat it too (equity extraction).

To be sure, the mortgage debt of homeowners relative to their income is high by historical norms. But as a consequence of low interest rates, the servicing requirement for the mortgage debt of homeowners relative to the corresponding disposable income of that group is well below the high levels of the early 1990s. Moreover, owing to continued large gains in residential real estate values, equity in homes has continued to rise despite sizable debt-financed extractions. Adding in the fixed costs associated with other financial obligations, such as rental payments of tenants, consumer installment credit, and auto leases, the total servicing costs faced by households relative to their incomes are below previous peaks and do not appear to be a significant cause for concern at this time.

The Housing Bubble

I first reported on the housing bubble in the U.S. at the beginning of this year when the bubble was already well under way, if not in full bloom. As the chart below indicates, real residential investment has jumped far above both its historical trend and even above its cyclical channel. This indicates to me that there is a bubble in residential real estate. The data for this chart stop at the beginning of 2003. We now know that investment in housing increased by 8.8% last year. This is a historically high rate of construction, but far from a record rate increase. However, 2003 marks the ninth year in a row that housing investment was positive, the first time that has ever occurred since the statistic has been collected. Frank Shostak and Christopher Mayer have also written very informative articles on the Housing bubble.

Recently I came across a piece of anecdotal evidence of a housing bubble. Last Sunday afternoon, a friend of mine put a „For Sale by Owner“ sign in the front lawn of a small house he owned on a side street. It wasn’t listed with a real estate agent or in the newspaper, but he nonetheless had a couple of calls that afternoon, with many more to follow, and within a couple of days he had multiple offers before finally accepting a bid that was over his original asking price.

Mainstream economists who discount the possibility of a housing bubble would dismiss such evidence. But they also ignore all the macro evidence of the current housing boom and see it as a positive development. For example, the number of new homes being constructed is at an all-time high, despite a „soft“ labor market. In the graph below, the annualized rate of new home construction is shown to have surpassed the two surges of the 1970s when inflation was out of control.

The prices of houses are also up, but mainstream economists have generally ignored this development as well; and as noted above, Greenspan sees this as a positive development. Some economists can even point to the Consumer Price Index which shows that the housing component in the CPI is steady or falling. And yet reports are coming out nearly every day saying that housing prices are up dramatically and setting records all across the country. Record prices have been recently reported in the San Francisco Bay Area, Denver, Boston, Las Vegas, the state of Washington, and even Buffalo, New York.

Nationally, the price of a median family home was up 15% between 2001 and 2003, with regional increases of 30% in the Northeast, 8.5% in the Midwest, 14.4% in the Southeast, and 20.4% in the West. Over the last year, increases have been reported as 18.7% in the Northeast, 1.9% in the Midwest, 3.8% in the Southeast, and 10.7% in the West, or 6.5% for the nation as a whole. Interestingly, the median price has actually dropped 7.2% in the Midwest and 7.3% in the South since peaking in the 3rd quarter of 2003, while prices have been generally flat in the West. Statistics from the last couple of quarters might therefore suggest that the housing bubble may have topped out, or at least temporarily cooled down, in most of the country.

Why have home prices been increasing? David Lereah, chief economist with the National Association of Realtors, explained: „It’s a simple matter of supply and demand…We continue to have more home buyers than sellers in most of the country, which results in tight housing inventories and higher rates of home price appreciation.“ Of course the cause of higher home prices is that the Federal Reserve has kept interest rates, and thus mortgage rates, at historically low rates so that people find it easier to finance homes. In fact, despite an 18% increase in home prices since 2001, the median monthly payment remained the same at $789/month and the „median payment as a percentage of income“ has actually fallen. This is the magic of monetary inflation, courtesy of Alan Greenspan.

Price inflation follows monetary inflation

The price of just about everything I buy is going up these days. Gasoline is higher, dairy products are higher, paper products and just about everything else—higher. Mainstream economists have sounded surprised by the recent upturn in price inflation and they have offered us every excuse to ignore signs of inflation: Ignore rising oil prices. Ignore rising food prices. Ignore rising health care costs. Ignore higher taxes and government fees. And then there is their dirty little secret about housing prices.

Higher price inflation should not have been a surprise given that the Fed has increased the money supply by 25% during the period 2001–2003. In addition, the price of basic commodities has been rising for many months and these higher commodity prices eventually turn up in the price of goods and services. One leading indicator of higher commodity prices is the Dow Jones Commodity Index (stock prices of major commodity producers). It has been rising since the fourth quarter of 2001 and has doubled in value since that time. This stock index is now higher than it has ever been, outside of the blip that occurred in mid-2002.

Only recently have commodity prices begun influencing government price indexes like the Producer Price Index and the Consumer Price Index. For the first four months of 2004 CPI-inflation increased at an annual rate of 4%, which is a higher rate than we have „experienced“ in the last few years. The Producer Price Index actually decreased in 2001, but has increased in 2002 and 2003. Over the last year, prices for finished producer goods increased 3.7% while at earlier stages of production the prices for intermediate goods increased by 5.1% and the prices of crude materials index surged 20.4%. This would suggest that there is plenty of price inflation still in the pipeline. The experience of the 1970s would suggest that price inflation adds fuel to housing bubbles because tangible assets like homes serve as a hedge against inflation.

The Dirty Secret

While this price inflation did not surprise me, the delay in its arrival did. That is, until I came across the dirty little secret in the CPI. With prices increasing all around us, there is one thing in Auburn, Alabama that seems to be in abundance with stable, if not declining prices. This „good“ is now being advertised on most streets throughout the town, whereas in the past it did not require much, if any, advertising over the twenty-plus years I have lived in this college town. This abundant good is apartments and rental houses.

It is a truly odd market when houses and apartments move in opposite directions. After all, houses and apartments are just different products in the same „market for housing.“ In Auburn, it is nearly impossible to find the kind of house you want to buy despite frantic building by construction companies, and yet rental properties (which include many smaller houses) seem to be readily available in all shapes and sizes. Has the population changed? Have people become anti-rent? Or are we just in a „new housing paradigm“? Is this a „new era“ of homes?

Greenspan’s low interest rates have driven renters to become homeowners and knocked the market out of equilibrium. Underneath this Fed-inspired distortion rests the dirty little secret of how the cost of housing has served to limit increases in measured inflation. The Consumer Price Index has underreported price inflation because the government uses the rental value of housing, rather the actual price of houses, in their index.

In the basket of goods used to calculate CPI, the goods that have increased slower than housing include food and beverages, recreation, and education, which total to about a 30% weighting of the CPI basket of goods. Housing accounts for 42% of the basket, with housing „prices“ representing almost 25% of the entire basket. However, housing prices are calculated with „Owner’s equivalent rent“ which is an estimate of the rent that people would have to pay for their houses. With home prices rising and rental rates stagnant, CPI underestimates the real rate of price inflation over the last year by about 50%.

Do Housing Bubbles Burst?

Housing prices never, or rarely, go down. That is the conventional wisdom and the conventional wisdom is correct. Housing is always a good investment, isn’t it? It’s an inflation hedge and it’s an investment that you get to use everyday, plus you get a great tax break. And the home, after all, is a big part of the American dream.

However, government can screw up just about everything. Given enough power and time it will screw up everything. Housing and real estate in America is just the latest example. The Federal Reserve and the Mac-May family (Freddie, Fannie, Sallie, etc.) have conspired to create a housing bubble in the U.S. and as the old saying goes, „what goes up must come down.“ It’s only a matter of time.

Housing bubbles typically do not pop like a balloon; they don’t even crash like stock markets. Rather, the air in housing bubbles tends to leak out slowly—painfully slowly—while in commercial real estate markets there is a more noticeable hiss. We really don’t know the current value of our homes until we sell them. They are not traded on a daily basis, like shares of stock in Wal-Mart. Some never get exchanged in the market, but are passed on within a family from generation to generation. The market value of a home may drop 20% and the owner might never realize it.

Worse yet, when the market for real estate collapses, prices are less likely to collapse because when buyers fail to make offers houses simply don’t sell. Sellers often resist cutting their prices in favor of just leaving the house on the market or taking it off the market. Traditionally the market adjustment to a collapse in real estate markets has come from the quantity side, not the price side—fewer houses are sold—while price reductions tend to come gradually. This doesn’t mean that housing bubbles can’t exist or that the bust is any less painful, only that it doesn’t make as much noise.

It is difficult to predict how long bubbles will last and when they will go bust. The best indicator is interest rates, because when the Fed forces rates down it tends to create bubbles, and when rates are forced upward bubbles tend to pop. My guess is that Greenspan will raise rates after the election. The rates of interest on long-term bonds have already „spiked“ up from their historical lows. The chart below shows the recent increase in the interest rate on 10-Year Treasury bonds to the highest levels in almost two years.

Prior to this spike up, interest rates had been falling since the early 1980s. As mentioned above, lower rates have coaxed people into refinancing their homes and drawing equity out of their homes to spend on other purchases, like cars, boats, renovations, vacations, or even investments in the stock market. As a result, owner equity as a percentage of real estate value is now at an all-time low.

Here is the unmentioned problem with Greenspan’s panacea. What happens to all these „equity poor“ homeowners if the return of monetary inflation establishes a new trend of higher prices and higher interest rates over the coming years?

An ever-increasing proportion of mortgage financing has come in the form of variable-rate mortgages, where the payment increases as interest rates increase. In my experience, variable-rate mortgages come with a „cap“ that only allows the variable rate to increase by a certain amount. Even with the cap, however, your mortgage payment could increase by around 50%. I have recently learned that many variable-rate loans are now offered without a cap. If rates were to explode upward, mortgage payments for these folks could double or triple. And if this did happen, the housing market would collapse with sellers swamping buyers.

Given the government’s encouragement of lax lending practices, home prices could crash, bankruptcies would increase, and financial companies, including the government-sponsored mortgage companies, might require another taxpayer bailout.

Of course inflation might not materialize. Interest rates could stay low. In a recent column, I reported on a new book that even predicts that deflation will reign in our financial future. Greenspan has suggested that his economic panacea has given American homeowners greater economic „flexibility.“ I would suggest that it is not flexibility he offers, but the shackles to an economic nightmare. Stick with the fixed-rate mortgages, keep the equity in your homes, or go get one of those cheap apartments.

Are the Austrians Too Harsh? – John P. Cochran

Reprinted from Mises Institute

Randall W. Forsyth, writing for Barron’s early spring 2009, wrote about Austrian economists, „Their ideas warned us of the bubble; their prescription for the bust is too harsh, however.“1 Now that the NBER has announced that the current „Great Recession“ ended in June 2009, after 18 months, let’s reexamine this claim. First, the end date clearly indicates that the 2009 stimulus had no discernable impact on either the timing or the depth of the trough. Subsequent economic activity clearly should cause one to question whether the $800 billion package sped recovery at all.

In fact a better question is the one raised by the Wall Street Journal, in „A Tale of Two Recoveries“: Did Keynesian policies do more harm than good? The Journal, sounding much like Robert Higgs, answers in the affirmative. „Our view is that hyperkinetic government policies have done more harm than good, leading to uncertainty and higher costs that have undermined business and consumer confidence and slowed the economy’s otherwise natural recuperative powers.“2

The Journal, then, granting NBER’s chronology, contrasts the current recession and „recovery“ with the almost equally long (16 months) and severe (unemployment peaked above 11 percent) recession of July 1981–November 1982 and subsequent recovery. Their conclusion is that the different policy circumstances significantly explain the drastically different recovery paths: following the trough in late 1982, the economy rapidly surpassed the prerecession levels of output. But currently, nearly 15 months past the trough, our economy is still significantly below prerecession levels.3

Most telling is the numbers on Gross Private Domestic Investment (GPDI). Approximately one year past the November 1982 trough, GPDI was up over 8 percent from the prerecession peak. In contrast, in April 2010, nearly 11 months past the June 2009 trough, GPDI was down 21 percent from the prerecession peak. The policy differences are falling marginal tax rates and reductions of regulatory burdens across the economy in the early ’80s compared to the current expansion of government, the increasing likelihood of significantly rising tax burdens, increasing burdens of regulation from Obamacare, and recent finance-reform legislation that increases the burden on firms (both financial and nonfinancial) while also adding great uncertainty. Current regime uncertainty is only increased by card check and cap and trade, which are possibilities — if not through legislation then through regulatory sleight of hand.

While what the Austrians have said about the cause of the boom and bust is, per Forsyth, gaining increasing recognition and acceptance, what the Austrians have said about recession and recovery is either ignored or grossly distorted. The distortions are based both on misunderstandings of theory and misinterpretations of the historical record. The Austrian understanding of recession and recovery is firmly rooted in the best microeconomics and tied to a capital-structure-based approach to macroeconomics.4

The Austrian understanding also has significant support in properly interpreted historical events.5  Booms are created when money and credit creation misdirect resources and production — the boom is the result of a central-bank-driven mini–calculation failure. The transition from boom to bust begins as the inconsistencies in business plans become apparent. Because of this distortion of the capital structure, „the recession periods of the business cycle then become inevitable, for the recession is the necessary corrective process by which the market liquidates the unsound investments of the boom and redirects resources.“6

Recessions are the discovery-of-error phase of the cycle. Unemployment results, not from deficient aggregate demand, but, per Hayek, from „a discrepancy between the distribution of labor (and other factors of production) among industries (and localities) and the distribution of demand among products.“7 During a recession, errors are discovered and resources are released and made available for use in potentially higher-value production processes.

Recovery is the phase of the cycle where misallocated resources are redirected to uses more consistent with consumer preferences. The process of reabsorbing an economy’s various unemployed resources into new or expanding enterprises (i.e., economic recovery) potentially begins in the same moment that the discovery of and adjustment to previous errors and resource misallocations takes place (i.e., recession). If all resources were perfectly homogenous and all prices, wages, and interest rates perfectly flexible, then the recession and recovery phases would indeed be a single process. But declines in economic activity are coupled with factors like nonhomogenous, often task-specific capital goods, price rigidities, and time lags in adjustment processes. This means that the recession phase precedes the recovery, which is a second and lagging phase. As will be discussed later, recession is even further prolonged (and recovery further delayed) by interventions, especially by policies or reforms that create an environment of „regime uncertainty.“

Recovery, like growth and development, requires forward-looking planning. Here, perhaps the best guide to policy comes from the developing literature examining the institutions that best support economic growth and development.8 What best makes societies rich is also what is most likely to bring about recovery and to return the economy to sustainable growth. Austrian capital theory implies that a significant portion of current economic activity is directed not to current, but to future consumption.9 Planning and calculation include decisions on reinvestment to maintain current levels of production into the future as well as new investment for expansion and new enterprises, all of which are future oriented.

Recovery, like sustained growth, requires an environment that facilitates the planning and development of projects (which will create current jobs), most of which will be directed toward future consumption. Austrians have historically emphasized impediments to adjustment caused by the by the nonhomogenous nature and varying specificity of many capital goods and some „human capital“ misdirected during the previous boom. These are a given aspect of any restructuring of an economy and they are unique to each crisis.

These malinvestments do have the potential to create losses and impede reallocation, but there is no necessary connection between the length of the boom, the degree of misallocations, and the actual severity of the recession and the length of the recovery process. One also has to take into consideration whether markets are being allowed to work, whether the „regime“ is certain — stable, predictable, and consistent with stated policy — and whether the policy is conducive to entrepreneurship and prudent risk taking. Policies that impede competition and impose excessive tax burdens — or that in any way simply add to costs, reduce expected returns, or increase the uncertainty of the results and returns from business activity — are seen as the most important factors in forestalling recovery and turning economic corrections into stagnation, stagflation, or depression.10

Historically, policies and actions that threaten property rights create „regime uncertainty“ or „regime worsening.“ Such policies have a two-pronged negative impact on the economy: they prolong the recession phases and they delay recovery.

Economic history and institutional analysis give us good insights into what impedes recovery and/or retards growth. Theory supported by that history indicates that an institutional framework of sound money, easy and predictable taxes, a stable legal environment built on rule of law and contract enforcement, regime certainty,11and broadly competitive markets encourage successful long-run planning and development.

What then would be the Austrian policy recommendations for today’s problems? First, according to Hayek and Rothbard, stop the credit creation and inflation.12 Then, per Hayek, prevent a secondary deflation. Further, remove all government impediments to effective entrepreneurial planning by avoiding protectionist measures and allowing prices and wages to adjust as needed to restore market equilibrium. Cut tax rates, as was done in the incomplete reforms of the 1980s and during the crisis of 2001–2003, and drastically reduce the government budget.13 To prevent future boom-bust episodes, reform the monetary system from the current government monopoly to a market-determined medium of exchange.14

What is actually being done to mitigate the recession and promote recovery? Is it consistent with a framework that promotes entrepreneurial planning and job creation? Or is it more closely aligned with failed policies of the past that have retarded recovery and promoted stagnation? The Fed balance sheet is at $2 trillion and growing. The crucial question is, does the current monetary-policy response create significant problems moving forward? Does it set up significant future price-inflation problems, a possible collapse of the dollar, stagflation, and/or another boom-bust sequence?

Complicating the picture of moving forward and „unwinding“ the Fed’s current position is pressure from some to target not price stability but a 5–6 percent inflation rate in the CPI. Some economists believe that the correct target for the federal-funds rate should now be significantly negative and with an actual effective limit of zero, pushing the Fed to undertake operations over and beyond the traditional targeting of the federal-funds rate.15

Instead of fiscal constraint and tax decreases, there is a massive expansion of government spending both actual and proposed, a guaranteed massive tax increase when the 2001–2003 tax cuts expire automatically at the end of 2010, targeted tax increases on the rich (those making over $250,000), and a proposed cap and-trade-policy to fight global warming (which policy is in fact a massive tax increase on productive and consumption activity that uses fossil fuel energy).

Instead of privatization, government is organizing takeovers and bailouts of private business in the automotive, health, and financial sectors. Many of these actions have been conducted in ways that violate contracts and the rule of law. There are proposed wasteful government misdirections of production through subsidies and directives, such as an energy policy that promises „green jobs.“ Even more significant is a concerted verbal assault on economic freedom and therefore the threat of „regime worsening“ on a large scale.16 Combined, these factors have predictable long-run negative impacts on the economy.

In the absence of real reform, Rothbard saw the alternatives for the American economy in the 1980s as a choice between a 1929-type depression and an inflationary depression of massive proportions.17 Among possible alternatives, the most likely outcome today is a return of a 1970s-style decade-long period of high unemployment and inflation. Also possible are a decade-long Japanese-style stagnation and a permanent Eurosclerosis. There is, however, still time to turn course and follow the Austrian path to sustainable prosperity. End government intervention in the economy and return to a sound money policy. Such a policy has been dubbed as harsh or too draconian; but the pain of a short, severe recession followed by renewed, sustainable growth and prosperity may actually be „comfortable and moderate compared to the economic hell of permanent inflation, stagnation, high unemployment, and inflationary depression“ that is the likely outcome of a continuation of our current policy.18

  • 1.Forsyth, Randall W. „Ignoring the Austrians Got Us in this Mess,“ Barron’s, March 12, 2009.
  • 2.„Review and Outlook: A Tale of Two Recoveries,“ The Wall Street Journal. Tuesday, September 21, 2010, p. A20. For samples of Robert Higgs’s excellent running commentary on the current economic climate, see “Credit Shortage or Regime Uncertainty.”
  • 3.See the following figures for GDP, private sector jobs, and retail sales.
  • 4.An Austrian interpretation of recession and recovery is discussed more fully in my upcoming 2010 paper: Cochran, John P. „Capital in Disequilibrium: Understanding the „Great Recession’ and Potential for Recovery.“ The Quarterly Journal of Austrian Economics. Much of what follows draws heavily on parts of that paper, which was drafted in the spring and early summer of 2009.
  • 5.How inappropriate policy of the type discussed in this article created depressions, prolonged recessions, and delayed recovery is well documented in work by Rothbard, Higgs, Ohanian, Gallaway and Vedder, Smiley, and Murphy. This includes the great depression and the depression within a depression, the 1936–37. The „forgotten depression“ of 1920–21 (Woods) and the depression that was not — 1946 (Gallaway and Vedder and Higgs) provide strong evidence of the effectiveness of Austrian medicine as does the „German miracle“ (White). See the list of additional readings.
  • 6.Rothbard, Murray N. America’s Great Depression. Auburn, AL: Ludwig von Mises Institute, 2000 [1963], p. xxvii.
  • 7.Hayek, Friedrich A. Unemployment and Monetary Policy: Government as Generator of the „Business Cycle.“ San Francisco, CA: Cato Institute, 1979, p. 8.
  • 8.The period from 1980 to 2005 illustrates how well markets can perform when freed even marginally from some of the collectivists’ constraints of the past. Shleifer characterizes this period as the „Age of Milton Friedman.“ Shleifer, Andrei. „The Age of Milton Friedman.“ Journal of Economic Literature, 47:1, 2009, pp. 123–135. Per Shleifer „Between 1980 and 2005, as the world embraced free market policies, living standards rose sharply, while life expectancy, educational attainment, and democracy improved and absolute poverty declined“ (p. 123). He then asks, „Is this a coincidence?“ After reviewing competing claims he concludes, „On strategy, economics got the right answer: free market policies, supported but not encumbered by the government, deliver growth and prosperity“ (p. 135). I thank Steve Hanke for this reference. Capital structure as a key component of economic development is explored in detail and in a historical context in Shenoy, Sudha R. „Investment Chains Through History; or, An Historian’s Outline of Development: ‘Using Goods of Ever Higher Orders.'“ Indian Journal of Economics and Business, Special Issue. 2007, pp. 185–215.
  • 9.See Skousen Skousen, Mark. The Structure of Production; with a New Introduction. New York and London: New York University Press, 2007 [1990], pp. xi–xxxix) for an excellent summary. Skousen recommends moving toward a measure of Gross Domestic Expenditures to get a more realistic picture of the importance of business spending (future oriented) in total current economic activity. Whereas consumption appears to be approximately 70 percent of the economy based on GDP, measures of economic activity more in line with a capital-structure view of the economy drop this number closer to 30 (p. xvi).
  • 10.For a similar argument see Becker, Gary S., Davis, Steven J, and Murphy, Kevin M. „Uncertainty and the Slow Recovery.“ Wall Street Journal, January 4, 2010, p. A 17.
  • 11.Higgs, Robert. „Regime Uncertainty: Why the Great Depression Lasted so Long and Why Prosperity Resumed After the War,“ The Independent Review. 1 (4), 1997, pp. 561–90; Shleifer, Andrei. „The Age of Milton Friedman.“ Journal of Economic Literature, 47:1, 2009, pp. 123–135
  • 12.Rothbard, Murray N. America’s Great Depression, pp. 185–86; Hayek, Unemployment and Monetary Policy, pp. 15-19.
  • 13.Rothbard, America’s Great Depression, pp. 185–86.
  • 14.„I do not believe that we would have major industrial fluctuations if it were not for the present banking system, which in turn depends on the government monopoly of the supply of money. I have been driven into proposing the denationalization of money. “ Hayek continues, „Anyhow, depressions are not the result of the operation of the market. They are the result of government controls, particularly in the sphere of monetary policy.“ Hayek quoted in Pizano, Diego. Conversations with Great Economists. Jorge Pinto Books, 2009, p. 10. See also the concluding section in Garrison, Roger W. „Interest-Rate Targeting During the Great Moderation.“ Cato Journal, vol. 29, no. 1 (Winter) 2009, pp. 187–200.
  • 15.See Ducca, DiMartino, and Reneir. „Fed Confronts Crisis by Expanding Role as Lender of Last Resort,“ Economic Letter: Insights from the Federal Reserve Bank of Dallas, vol. 4, no. 2, February/March 2009 for a well-presented overview of the extraordinary recent activities of the Fed. See also Ceccheti, Stephen G. „Crisis and Responses: The Federal Reserve in the Early Stages of the Financial Crisis.“ Journal of Economic Perspectives. Vol. 23, Number 1 (Winter) 2009, pp. 51–75; Garrison, „Interest-Rate Targeting“; and Taylor, John B. „The Financial Crisis and the Policy Response: An Empirical Analysis of What Went Wrong.“ Unpublished 2008.
  • 16.Powell, Benjamin. „U. S. Recession Policies: Nothing New Under the (Rising) Sun.“ The Intercollegiate Review, (Fall) 2009, pp. 13–21.
  • 17.Rothbard, America’s Great Depression. p. xxiii.
  • 18.Rothbard, America’s Great Depression. p. xxvii.