The American Spectator : Bernanke Versus the Austrians

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Bernanke Versus the Austrians

By Jonathan Witt on 12.7.09 @ 6:07AM

Sen. Bernie Sanders has started a useful debate about Ben Bernanke's future.

Vermont Senator Bernie Sanders announced Wednesday that he is stepping into the path of Ben Bernanke's nomination to a second term as Federal Reserve chairman. If Sanders sticks to his guns, Bernanke's supporters will need 60 Senate votes to confirm the nomination.

Good for Sanders. We need a robust Senate debate about Bernanke's policies, since they helped to create the housing bubble and crash we're now experiencing. Bernanke's policies come out of the same Keynesian bag of tricks that turned the 1930 contraction into a decade-long Great Depression, and that gave us the stagflation and malaise of the Carter years.

Two planks in Bernanke's recovery strategy: Expand the money supply like a banana republic dictator and throw sackfuls of cash at failed companies with a proven track record of mismanaging their assets. The justification? According to the late John Maynard Keynes, this is supposed to restore the "animal spirits" of the cowed consumer, the benighted creature who foolishly imagines that after a period of prodigality and mismanagement, maybe a country should rediscover its inner Dave Ramsey -- tighten its belt, get its financial house in order, and with some of the extra savings, invest for future productivity.

Can't have that, now can we?

Bernanke's prescription is designed to get people to borrow and consume more in the short term. But the way an economy gets richer is by producing more goods and services that people value. The Fed can print money. It cannot print cars and groceries and doctors. The math is pretty straightforward: More money chasing the same number of goods doesn't magically generate more goods. Nor do artificially cheap interest rates magically generate more loanable goods and labor for starting, expanding and modernizing businesses.

Bernanke's enthusiasm for bailouts is equally misguided. Bailing out failed companies allows these broken businesses to go right on mismanaging resources, instead of selling off their assets to well-managed companies. And since the failed company can assume the government will bail it out again if need be, its now a mismanaged company that doesn't even have to worry about the consequences of its own stupid decisions -- the spoiled, unproductive rich kid whose daddy owns the town.

We need a Fed Chairman who will let the free market guide interest rates, and who understands that unproductive companies should be allowed to go bankrupt. What's useful in those companies doesn't disappear in a bankruptcy. The valuable assets are purchased and put to better use by more productive companies. And when interest rates are allowed to float upward to reflect the scarcity of current savings, people will be more careful what they borrow for, while others will be enticed to save more, attracted by the higher interest rates paid for bonds. This, in turn, will boost available capital for longer-term business ventures aimed at enhancing productivity.

Consider the short depression of 1920. A decade before the Great Depression, World War I had just ended and a flood of American soldiers returned home in search of work. Meanwhile, the Federal Reserve, having roughly doubled the money supply during the war, now put the brakes on the easy money by moving interest rates closer to where they might sit if simply left to market forces. The government also largely refrained from bailing out failed businesses or trying to juice the economy with big stimulus packages.

All of this is the opposite of what the Keynesians recommend in an economic slowdown. It's the opposite of the Keynesian strategy pursued by both FDR and Hoover during the Great Depression. And it's the opposite of what our government is doing now.

So how did the depression of 1920 play out? The readjustment to a peacetime economy was severe. Production fell by some 20%. Unemployment shot past 11%. But then the depression quickly reversed itself.

Many companies had gone broke, but their useful assets were sold to well-run companies. During the early phase of the contraction, goods and savings were tight, but the higher interest rates signaled to people, "Hey, if you want to borrow money, you'd better have a good, productive use for the money because you're going to have pay a premium for it" -- not because of a bunch of mean old capitalists but because there wasn't a lot of savings to loan out right then. People got the message. Money got loaned to the most productive enterprises, and before long, the economy was humming again. The unemployment rate dropped below 7% in 1922, and below 3% in 1923. The government allowed the free market to readjust itself, and it quickly did.

This is the strategy recommended by the Austrian school of economics (which incidentally has more adherents in the United States than in Austria). The Austrian school is the polar opposite of the Keynesian school. The Austrian school predicted the Great Depression when others were preaching permanent prosperity. And it predicted our current recession when Bernanke the Keynesian was saying everything was right as rain.

This should give the Senate pause. If reason still has a governing role in that august body (and that's an open question, I realize), they would arrange a substantive public debate between the Keynesians and the Austrians.

As for Senator Sanders, a self-described democratic socialist, he may want to proceed cautiously. If such a debate were to occur, he might look too closely into what economists such as Ludwig von Mises and Nobel Laureate Friedrich Hayek have to teach us about the failed economic policies of Ben Bernanke.

In the work of these economists, Sanders would find proven methods for lifting up the masses, along with tested arguments against Bernanke's brand of centrally managed capitalism, a pseudo-capitalism in which the government is forever partnering with "too-big-to-fail" corporations with million-dollar lobbying budgets. If he's not careful, the senator from Vermont might just find that he's become an Austrian.

topics:
Ben Bernanke, Federal Reserve, Bernie Sanders, Depression of 1920

About the Author

Jonathan Witt is a former English professor and co-author of A Meaningful World (IVP). He also wrote scripts for three documentaries that have appeared on PBS, including The Call of the Entrepreneur and The Birth of Freedom. He is a research fellow with the Acton Institute and lead writer for the PovertyCure initiative.

Letter to the Editor View all comments (49) | Leave a comment

Deborah D| 12.7.09 @ 6:33AM

"Bailing out failed companies allows these broken businesses to go right on mismanaging resources, instead of selling off their assets to well-managed companies. And since the failed company can assume the government will bail it out again if need be, its now a mismanaged company that doesn't even have to worry about the consequences of its own stupid decisions..."

In the psychological world, this is called "enabling." And it works exactly the same way. When a drinker or a druggie doesn't have to face any consequences for his/her bad behavior, they will never stop drinking. It's only when they hit their bottom that addicts might finally see reality. When will our government allow poorly-run businesses to hit their bottom? And, why can't they understand that simple rule?

Oh, I think they understand it...they want to rule these companies, not make them face reality.

Ryan| 12.7.09 @ 8:12AM

Who could have predicted that, at times, polar opposites on the political spectrum would push for the same thing - Bernanke out the door?

Of course, whoever he would want in place of Bernanke may be troubling...

c. j. acworth| 12.7.09 @ 5:22PM

Ryan;
That's my question as well. Mr. Witt says "We need a Fed Chairman who will let the free market guide..." I agree, but do you think the shock-haired socialist from the Granola State has such a thing in mind?

Quartermaster| 12.7.09 @ 9:12AM

Of course, Bernanke was appointed by BusHitler, and we can't have that now, can we?

Seriously, the person who replaces Brenanke is likely to be just as bad. The only difference is he won't have the same baggage. Sanders changing his spots is about as likely as me flying P-47s for the Air Force next year.

Grzmlyk| 12.7.09 @ 9:53AM

One thing I'll say for the Keynesians: Being wrong 100% of the time doesn't dent their confidence one iota.

TrollBob, this is your cue. Tell us again how the economy will right itself in, oh, three weeks (as you predicted last summer).

Tell us again how the GDP statistic upon which you navigate your vessel of misplaced insoucience hasn't been so corrupted as to be virtually meaningless in today's economy. After all, a big slice of that number is now spending by government for government (not "productive" dollars), while actually producing goods (what used to be the "product" in "Gross Domestic Product") accounts for less and less of that statistic.

Tell us again that it's all in our heads, and as long as GDP goes up! up! up! and effective tax rates never change (please ignore those payroll taxes, sales taxes, property taxes, city taxes, energy taxes, etc. etc.), everybody is doing just fine, even though they may not think so. After all, you're the expert! Who do those struggling Americans think they are to allow reality to tarnish your ego?

Tell us again that corporate taxes at 35% don't mean anything and don't drive businesses out of America.

Tell us again how Ben Bernanke's promiscuous policy of flooding this country with dollars is actually producing anything (besides inflation and debt).

Tell us again how all we have to do is resume the credit feeding frenzy and all will be well.

I could use a good fairy tale right about now, and they're always more entertaining when relayed to me by a talking horse's ass.

Ken(Old Texican)| 12.7.09 @ 10:02AM

Seems to me that if Obama keeps Bernanke...then he can keep blaming Bush. Heh!

...Some of W's appointees were terrible, tis true, but primarily stupid or wrongheaded.

Obama's on the other hand...are pure (pardon the shorthand), communists that want ALL the power over us the governed.
I will choose stupid any day.

Pete2| 12.8.09 @ 1:21PM

It's really funny that a commie is questioning another one about fiscal policy. Sanders should be a great supporter of Bernake since they belong to the same school. I would question his motives. BTW, he's the senator from my state and I know what a blustering phony he really is.

Pete2| 12.8.09 @ 2:45PM

Just read an article today about Bernanke on NRO and it supports Bernanke. It sattes Bernanke was handed an impossible job by Bush and he handled it alright given the circumstances. it also sheds some light on Sander's motive for opposing the man. It also states that Bernanke will be confirmed no matter what.

JP| 12.7.09 @ 10:36AM

Its alot more complicated than this, see Milton Friedman and his take on Gold, the Great Depression(which Gold helped to cause) and Keynes.

"Golden Fetters" is a good book

aware| 12.7.09 @ 5:22PM

Friedman and the supplysiders are monetarists, as such they only half support a freemarket. They accept government dominance of the market, especially the Federal reserve and its fiat money. Changing engineers does not change the nature of a train or where its headed.

The Fed is the rottenest kernel of corruption in a thoroughly rotten system. No paper money regime has ever lasted and this one is fast approaching its endgame. Every minute it exists your money is losing value INTENTIONALLY. The dollar only buys a nickel's worth of what it did when they started "managing" the money supply. When it buys a penny's worth will that be a clue? ZERO??
If the Federal Reserve is the cure, I'd rather take my chances with the disease.

Houston Rao| 12.7.09 @ 10:39AM

The Fed (a banking cartel) and the government are working together to wage war on the American people to confiscate the wealth of the people.

In a free market economy, banks would compete to raise funds from the savers and private parties by offering interest rates in line with their capital and lending needs. This would truly reflect the 'cost of money' in prevailing economic and financial conditions. The Fed (public option?) distorts this mechanism by printing and providing money to the banks at 0% interest - thus transferring interest incomes from savers and fixed income seniors to the banks. Why would banks borrow expensively from private savers when the Fed will provide them money at no cost?

Second, the value of the dollar depends on a 'limited' supply of money that acts as a proxy for value and facilitates/greases trade by removing the need for barter. The printing of money is akin to counterfeiting - surreptitiously generating more bank notes to enable the counterfeiters to purchase real assets without earning the money. And the benefits of such counterfeiting goes primarily to the ones who engage in it - notably the Fed and the banks. This dilution of the store of value erodes the value earned and stored by the workers and investors and amounts to a plunder of their wealth by the banks.

Spiral Architect| 12.7.09 @ 6:09PM

Well said.

There is a very good reason that this (once) great nation has three times had a national bank.

The current version should join the previous two in the history books, where it belongs.

This link briefly depicts a time line of the national bank, in it's glory:

http://www.civil-liberties.com/cases/bank.html

Note how ever since (and every time thereafter) the nation is taken off 'hard currency' the economy implodes and, of course, the nation suffers.

DatsunMark| 12.7.09 @ 1:11PM

Mr. Witt,
I agree and like your acticle however I disagree that the Agricultural Depression of 1920-21 was the result of good policy. Rather it was a contrived means of the Fed to acquire banking assets from profitable farmers who sold their products during the WW1 years. The farmers were profitable and placed their assets in non-fed member regional banks during this time. The fed extended easy credit to these banks which in turn the farmers were encouraged to purchase new lands and use these loans. The Fed abruptly contracted this credit in May of 1920 which within a year caused the farmers, who could not make payments on their new loans, to break these regional Non-member banks. These assets eventually became property of the Fed Member banks. Fed-Member banks were helped by the Fed to ride out the slump. Even Charles Lindbergh's father who was a congressman wrote about this set up of these banks in 1923.

Jim Mulcahy| 12.7.09 @ 2:25PM

Be careful of what you wish for. The big problem with Bernie Sanders/Ron Paul attacks on the FED is that Bernie and all of the others that want more oversight is that they want to to run monetary policy. Be clear about this, reworking the FED will not eliminate regardless of how fervently the Austrians and Ron Paul want it. What will hapen is that 535 self-annointed economic geniuses will meddle into every decision the FED makes. Interest rates will always be too high; banks that want to expand will be required to shovel more shareholder wealth into subsidized schemes; etc.

One more thing. The gold standard worked the best between 1870 and 1914. The was the time period when the Bank of England ruled the roost. They actually played by the rules. The glory years of the gold standard could equally be characterized as the glory years of the Bank of England.

Walking Horse| 12.7.09 @ 2:37PM

Helicopter Ben does need to go, but one can only shudder at what manner of 'economist' might replace him.

It is probable that Sen. Sanders complaint may be that Mr. Bernanke hasn't been sufficiently radical.

Howard| 12.8.09 @ 12:48AM

Having Bernie Sanders as an advocate of Austrian economics, is about the same as Hitler being a Shabbos goy. Not likely.

Ned Netterville| 12.7.09 @ 3:45PM

As Pogo said, "We have met the enemy, and he is us!" When the people of America, beginning with their silly Constitution, gave their government, rather than the market, the power to "to regulate the value (of money)," the gave away the store to profligate spenders of OPM (sounds like opium, is equally addicting, stands for other people's money). And when they thrice recurred to central banking, and replaced the discipline of gold with the shenanigans of central bankers they sealed their impoverished future, ensuring themselves that the Bernankes, Greenspans, Volkers, etc. of the nation's "monetary system" would be in a position to buffet their economy and their welfare to and fro by manipulating (regulating, dictating) the value of their money.

JPK| 12.7.09 @ 4:13PM

DatsunMark,

"The farmers were profitable and placed their assets in non-fed member regional banks during this time. The fed extended easy credit to these banks which in turn the farmers were encouraged to purchase new lands and use these loans."

That sounds exactly what happened circa 1978-1983. The FHA extended cheap credit to farmers during the commodities bubble in the late 1970s. When the bubble burst in 1982, small farmers couldn't repay the loans, and the banks siezed thier farms. Granted, the farmers never should have been seduced by the low interest rates and high grain prices. In business, nothing lasts forever -especially commodity bubbles. But, here was another example of federal government interference, which had the unintended effect of destroying thousands of small family owned farms.

JP| 12.7.09 @ 4:17PM

There is no returning to the days that predated the Federal Reserve Bank. What should occur is a rewriting of the Fed's charter. Yes, the Fed Chairman should enjoy independence from political interference. However, in light of Alan Greenspan' and Bernecke's performances some kind of reform is needed. Both of these men shamelessly inject themselves into the politics of the day, and attempt to engineer the economy to benefit thier political agenda. How this can be prevented in the future is anyone's guess. Any ideas?

Robert Rosencrans| 12.7.09 @ 6:10PM

To quote Ludwig Von Mises, founder of the Austrians, "Easy credit always ends badly."

DatsunMark| 12.7.09 @ 6:38PM

JPK,
In 1921 the target was the non-Fed Member banks because the NY money interests (Fed Members) saw these *cowboy* banks taking profits they felt were theirs. The Farmers were just colateral damage.

Jump forward to today: the Friends of Hank Paulson bailout.

rainbow anarcho-capitalist77| 12.7.09 @ 8:08PM

Not really a big issue, but it is a correction that must be made. Bernanke is not a Keynsian like everybody claims, at least he doesn't claim John Maynard Keynes as his inspiration. Rather, he claims to be a disciple of Milton Friedman (which he might as well have been a disciple of Keynes with Friedman as an inspiration). When he was learning about the Great Depression, a lot of what he knows comes from the Chicago Friedmanite tradition. Now note, making this correction doesn't mean too much, Friedman was as Keynesian as they come. I mean he used the positivist methodology, the Keynesian cross. One thing that he was worse than Keynes on was his macroeconomic model aggregates further than Keynes ever dared do, making Friedman's models devoid of any usefulness whatsoever. One policy difference between Keynes and Friedman: Keynes wildly supported deficit spending and was somewhat indifferent on monetary policy (it was considered to be secondary and slow at exacting change) whereas Milton Friedman was indifferent to deficit spending and was wildly supportive of inflationary monetary policy. Just so you know.

Raghav| 12.13.09 @ 12:40AM

Why does Witt stop at 1923? 'The unemployment rate dropped below 7% in 1922, and below 3% in 1923. The government allowed the free market to readjust itself, and it quickly did.' If free markets were so effective in getting the economy to full employment equilibrium, why did the world face the Great Depression?!!! Is that not a failure of free markets.....

Vicky| 1.9.10 @ 1:12AM

I agree, how can a free market work in a manipulted monetary system. I say abolish the FED, (greedy private banker elites) and have our U.S. Treasury make up our own money interest free, we can do that legally in crisis. FEDS are foreigners. They didn't calculate for all of the variables in the outcome in Keynesian Economics , what do they do now?? we’re… starting to see fault lines develop, where one side blames the government while another side blames Wall Street for the messes of the last two decades…Incumbent politicians and policymakers retain power by looking the other way and allowing special interests an unfair profit advantage. Usually, this goes to excess. Irrational exuberance takes over and losses ensue – losses which are not borne by the economic actors but taxpayers.
So, if the question goes to the whole Red/Blue partisan back and forth, Taibbi is right that this is a side-show. We effectively have a one-party system when it comes to investment in the present economic, power, and wealth structure.

The blame is on the entire profession, and those who study the structure of the banking industry and regulation in particular. Many of the economists who are the most critical today were among those supporting deregulation (or they said little or nothing about it).
•The goal, i should be to devise a way to prevent contagion when individual companies, sectors of the economy, or regions collapse without having a significantly negative effect on long-term growth or income and wealth distribution.

1.Commercial banks as utilities model. One view says to firewall sectors of the economy, particularly the financial sector in a way that maintains its core function but allows peripheral ‘innovative’ functions to suffer with the swings in the economy. This is the Paul Volcker view.
2.Regulation-Heavy model. Another view says to forget about the firewalls as they will be ineffective at best and retarding to growth at worst. Regulate the heck out of all actors and constrain their ability to be reckless. This is the Geithner view.
3.Regulatory and Resolution model. A third view says we should allow the actors to do as they wish but set up robust bankruptcy resolution process for all private sector companies, especially in the financial sector and including hedge funds and too-big-to-fail institutions.

Also there is discovery of Barack Obama by early 2007 . Obama had strong Wall Street ties from the start.

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