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  1. #1
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    Intro to Austrian Economics

    Intro to Austrianeconomics. Just a basic run down of how the economy works in key areas of interest. Tried to keep it concise, but there was a lot to say. Hope people fine it enlightening.

    What is money?

    If we’re going to talk economics, the most important thing, and the thing which we must cover first, is money. Really, what is money? Well, let’s start at the beginning. In any human society, the first, and the most primitive, form of trade that arises is bartering. In this system, people trade their goods for other goods which they desire, directly. For example, if I have fish, and you have wheat, we can trade. However, this is an inconvenient form of trade. The reason is that, if I have fish, and want wheat, I cannot merely seek out someone who has wheat. I must find someone who has wheat, and also wants fish. For obvious reasons, this quickly places challenges on advanced economic activity. We cannot always find people that have exactly what we want and want exactly what we have. For this reason, some good always arises in society which all people are confident they will be able to trade. In frontier era America, this was the beaver pelt. For most of western history, it has been gold and silver. This good, which all members of the economy are confident they will b able to trade, becomes money. Let’s go back to the original example. I have fish and want wheat. However, I am incapable of finding anyone who has wheat and wants fish. What I do know, however, is that nearly everyone wants gold. So I sell my fish to someone, taking gold in exchange. Then, taking my gold, I in turn trade it for wheat. This is money. It is the mutually agreed upon, freely arising, medium of exchange in economy. In the west today, money is government printed notes, such as the Dollar and the Euro.

    However, when I am originally trading fish for gold, I do not simply give away a random amount of fish for a random amount of gold. This would truly be a ludicrous arrangement!

    Rather, myself and my customers will arrive at a mutually agreed upon rate of exchange. This is known as price.

    What is price?

    Price is, as succinctly as possible, the rate at which producers are willing to depart with their property. It is the artificial value that humans place on goods and services. It is important to note here that the value of any good and service is entirely subjective. There is no objective value of any good or service, which it possesses cosmically, and which is unchanging. Rather, the value of any thing is only that which is set on it by humans. For this reason, activities such as “price gouging” are purely mythical. After all, a firm can charge no higher for any given good or service than consumers are willing to pay for it. Price, then, is the rate at which consumers and producers mutually agree to exchange money for goods or services. It is also the one and only way to make economic calculations. It is often asserted that we need government programs to help the poor, to control prices, or to myriad other things. However, these programs can work only through dumb luck. Price is the only way to tell what it is that consumers want, how much of it they want, when they want it, and how highly they value it relative to other goods. That is to say, the higher the price of a good or service, the more consumers must value it. How much of it is sold and when it is sold tell us how much of, and when, consumers want this good or service. Because government is not subject to a price mechanism, it does not know when it should invest resources, how much of them it should invest, when, and where it should invest them. It cannot, because it does not have price, which is only derived through mutually consenting market transactions. Instead, government answers all these questions through purely political considerations which are inimical to the type of conscious, self-interested investing which consumers and producers engage in.

    What is market clearing?

    An example:

    A man sells apples at a price of two dollars per apple. In his current situation, he has more apples than there are people who want to buy apples. Apples are of no use to him, in and of themselves, but money is. So then, pursuing his own self interest (acquiring money) he is forced to cut the price on his apples until people are willing to buy all of his apples. In this way, the market clears itself of surplus.

    A similar situation. The same man is still selling apples, now at a price of fifty cents per apple. However, it has recently been discovered that apples cure cancer. Now there are more people looking to purchase apples, at fifty cents an apple, than the amount of apples which he owns. Again, pursuing his own self-interest, he realizes he can now raise prices. He will raise prices again and again, until he reaches the point where there are fewer customers for his apples than he has apples. He will lower his prices again, until he reaches the equilibrium price; The price where the amount of consumers who want to buy apples is equal to his supply of apples. In this way, the market clears itself of shortages.

    The apple-seller is, of course, an extremely simplified example. However, it illustrates the principle. Markets clear.

    A state program is incapable of clearing. Because the state is not responsible to make a profit, and does not give its “customers” (the citizenry) a choice about whether or not they pay, the state has no knowledge of whether its programs have surpluses or shortages. It simply does not know, and therefore does not clear. An inefficient state of affairs persists. How would the state find out whether it was producing enough apples at any given time, or too many apples? How would it know whether it was charging too much or too little for apples? It couldn’t answer any of these questions.

    Because markets clear, markets are always (with the exception of fractional periods when prices are still being adjusted) producing, essentially, exactly the correct amount of goods, at exactly the correct times, for exactly the correct amount of consumers. Because state-run programs do not clear, it is nearly a certainty that government is producing the wrong amount of goods, at the wrong times, for the wrong consumer base.
    What are wages?

    Wages are simply another expression of price. Here, the service is labor, or rather, productivity, being sold by workers to producers. Because this is the case, as the market clearing principle illustrated above demonstrates, wages/compensation for labor will always be nearly identical to the added productivity of any given worker to a firm. Suppose I own an cabbage farm, and a firm selling cabbages. For each worker I hire, I get an additional five dollars an hour in productivity from my farm. I cannot hire workers for over five dollars an hour at my farm. If I do, I will lose productivity on each worker I hire. That will force me either to raise prices in an uncompetitive way, or to make less than profit. Either is a recipe for disaster. So, I must hire workers at less than five dollars an hour, in order to ensure that I make a productivity profit on them. So why not hire my workers at one dollar an hour? I will gain a four dollar an hour productivity profit per hour.

    But suppose you also own an cabbage farm. Seeing that I am paying my cabbage pickers one dollar an hour, you will find it in your interests to pay your own workers two dollars an hour. You will make a three dollar per hour productivity profit on each cabbage picker, and, since pickers will be far more willing to work for you than for me, you will be able to choose only the most productive cabbage pickers. If you have only the most productive pickers, you may even be able to raise your productivity per worker, per hour, to six dollars. That way, you can pay your workers more, make a higher productivity rate on each one, and cut prices at the cabbage stand. It won’t be long before this spells doom for my own orchard! Which is why it is in my interest to raise wages to three dollars an hour for each cabbage picker.

    And so on. This bidding war will end only when each of us is paying our workers close enough to productivity that we cannot raise our wages again, at any real amount, without making a productivity per hour profit of zero or less.

    This is why Peyton Manning makes millions of dollars. Since he is paid unusually high, even for a football player, we can conclude that his pay is not the result of his membership in the NFL player’s union. Rather, it is his productivity. Peyton Manning is not the only man who can play quarterback, but almost no man can play quarterback like he does. Mr. Manning’s performance can fill a stadium, and that is why he is paid what he is paid.

    What is banking?

    There are two types of banking, essentially. The first is free banking, while the second is fractional reserve banking.

    In free banking, the economy continues in its natural order, as described in What is money?. Eventually, a good of universal exchange arises. That is to say, the societies’ freely arrived at money. Again, for these purposes I assume gold. However, goods, such as gold, are expensive and irritating to lug around. For this reason, I might seek to have them stored. I would take this money to a bank, where I would pay a fee to have it stored. In exchange, I would receive receipts in the amount of my deposit. That is to say, bank notes. I could use this promissory notes as currency, giving anyone to whom I gave the notes the knowledge that they could use them to receive some of my gold from the bank. Banks would compete to have the notes carrying with them the least inflation, and the most reliable promise behind them, leading to constantly lowering inflation and nearly no depreciation of money supply. After all, would you lend your material goods to someone whom you knew to be unreliable? So goes with money.

    The second system is fractional reserve banking. This system, at all times, operates under a money supply set by government monopoly. In this system, I take my dollars and deposit them at the bank. The bank then puts checking dollars in the amount of my deposit in my account. Meanwhile, they loan my actual dollars out to others, attaining a profit by charging a higher rate of interest for their loan than they pay on my account. They also use my dollars to pay withdrawals towards other accounts. In this way, they multiply the money supply. For each dollar given to them, they create more than one dollar. One checking dollar for me, one loaned dollar to an investor, one actual dollar given out to pay another withdrawal et cetera. This system is called “fractional reserve” because only a fraction of money deposited at the bank is actually kept. The result of this is ever increasing inflation. It also alters the time preferences of consumers.

    What are time preferences?

    The time preference of consumers is the consumers preference for consuming nor or later, consuming later at a higher rate of consumption. This can work in two different ways, again differentiated between free banking and fractional reserve banking.

    In a system of free banking, the time preference of a consumer is simply whatever his personal preference is. Since, unlike in fractional reserve banking, inflation over the long term is not inevitable, time preference is once again a pure subjective occurrence.

    However, in a system of fractional reserve banking, inflation is guaranteed. For this reason, the longer one waits before spending one’s dollar, the less purchasing power one’s dollar will have. For this reason, one has a much greater incentive to borrow than to save. This is illustrated by the constantly declining savings rates in the US since 1970, when the gold standard was abandoned and fractional reserve really came into its own, with totally floating currency. In this system, incentive to save is ever decreasing, and incentive borrow ever increasing. Eventually, savings rates always reach zero, or near enough to zero, that there are no savings left to fuel loans, and the system collapses. This is known as the business cycle.

    The Business Cycle

    The business cycle is what we know as “boom and bust” capitalism. It is not a feature inherent to capitalism, but it is a creation of the fractional reserve banking system. To find out why, we need to answer the questions “What are booms?” and “What are busts?”

    A boom begins very simply. An entrepreneur takes a loan from a bank, and, with his loaned funds, makes a highly successfully investment, often with some new invention or new way of doing things. Soon, other firms see the success of what he is doing, and begin investing in the area themselves, also fueling their investments through loaned funds. Widespread success ensues, and firms being stepping up production, hiring more workers, raising wages and benefits, etc. Workers, taking this money, at first, go and put it back in the bank. In turn, this allows banks to cut the interest rates which they charge on loans. The result is that firms borrow even more, investing even more, and continuing to expand production. However, as production expands, workers begin to have less incentive to save. People are less likely to put money away for tomorrow when today is good, after all. Why put money into savings when you could buy that new 60” HDTV, or get the kids iPods for Christmas? So people save less. But do firms borrow less? No, not at all. After all, they are now caught up in the whirlwind of the boom. If they want to stay competitive, they need funds for investments. This is when the bust occurs.

    So what is a bust?

    The bust occurs like this: It is inevitable that some portion of investments made with loans are mal-investments. That is, they are investments for which a firm does not regain the funds to pay back its loan and its interest. Meanwhile, savings is also going down as consumers are caught up in the boom. The result is that banks are forced to raise their interest rates on loaned funds dramatically in a short period of time. Firms however, have been relying on low-interest loans for their profits. They have made investments they never would have made under higher-interest loans, since they would not have been profitable. Across the board, investments are being turned into mal-investments, workers are being laid off, wages are being slashed and prices raised to pay for loans that have come due. Before long, runs on banks are occurring as consumers smell blood in the water. This leads to the fed throwing more dollars into the money supply, which only worsens the problem of inflation. This is the bust. That is to say, the business cycle.

    How do we avoid boom-bust capitalism? The answer is simple. Do away with fractional reserve banking, by doing away with government monopoly of the money supply. Only a system of genuine free banking can stop boom-bust economics.

    Recommended Readings:

    Economics in One Lesson by Henry Hazlitt

    The Case Against the Fed by Murray Rothbard

    Economic Calculation in the Socialist Commonwealth by Ludwig von Mises
    Feel free to PM me if you have questions about Austrian economics or Anarcho-Capitalism as a political system.

    There's nothing in the street
    Looks any different to me
    And the slogans are replaced, by-the-bye
    And the party on the left
    Is now the party on the right
    And their beards have all grown longer overnight

    Meet the new boss, same as the old boss

  2. #2
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    Re: Intro to Austrian Economics

    I would also point out that time preference is actually what we call the interest rate. Because everyone prefers a good sooner rather than later, to get them to stave off consumption and invest, they must have some sort of incentive. This is what the interest rate is.

    For a long time the Catholic Scholastics didn't really understand usury laws and their importance, but this is it.

    In order for there to be savings and investment, there needs to be an accurately represented interest rate. If this rate gets distorted by government intervention, then people either save or consume too much. This leads into your discussion on the boom/bust cycle.

    I will write later on the praxeologic foundations of Austrian economics...

    ...then I'll write a little about its history...


    ...and then I'll write a little bit on marginal utility and why it is such an important concept to understand...as well as maybe use double-inequality of value and Bohm-Bawerk to critique any Marxoids who decide to pop up.
    "If you wish to know how libertarians regard the State and any of its acts, simply think of the State as a criminal band, and all of the libertarian attitudes will logically fall into place." -Murray Rothbard

    "There are a thousand hacking at the branches of evil to one who is striking at the root." -Henry David Thoreau

  3. #3
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    Re: Intro to Austrian Economics

    Yea I was talking to Kaizen about it last night, whether I should include Praexology. I decided not to on the grounds that it deserves its own thread.
    Feel free to PM me if you have questions about Austrian economics or Anarcho-Capitalism as a political system.

    There's nothing in the street
    Looks any different to me
    And the slogans are replaced, by-the-bye
    And the party on the left
    Is now the party on the right
    And their beards have all grown longer overnight

    Meet the new boss, same as the old boss

  4. #4
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    Re: Intro to Austrian Economics

    I guess let me write a little bit about the history of the Austrian School.

    The first thing that everyone needs to understand is that economics did not begin with Adam Smith, like Athena sprining from the brow of Zeus. It really all begins with the Greeks, with Aristotle coming up with the concept of private property, but we're just gonna skip all that stuff and begin with Carl Menger. Actually I should mention that the first economist who wrote solely on the subject matter would be Richard Cantillon. He was one of the founders of the French Continental Tradition, which included writers like Frederic Bastiat, ARJ Tugot, and the rest of those guys.

    Ok.

    But The Austrian School of Economics really begins with Carl Menger at the University of Vienna in 1871 with the publication of his Principles of Economics. Unlike the British Classical School, the Austrian one was built on a solid framework of praxeology. The early Austrians accepted value subjectivism in contrast to the labor theory of value of the classical and Marxist schools.

    What Carl Menger does is essentially use praxeology to expound the theory of marginal utility, and while although Jevons and Walras did too, Menger was the one to do it using logic instead of matematics. The economic law of marginal utility basically states that the more of any homogeneous good you have the less you value each individual one. This is huge. It basically solved the water-diamond paradox of Smith (who had actually solved it 20 years before he wrote Wealth of Nations during his lecturing...but never mind).

    Okay so while Menger teaches this guy Frederick von Weiser...the important guy you need to know about is Eugen von Bohm-Bawerk.

    He takes Menger's methodological individualism and, along with the law of marginal utility and Menger's other contributions, writes his History and Critique of Interest Theories where he really dispels many of the fallacies of interest rates. He basically comes to the conclusion, along with his istory and Critique of Interest Theories, that the interest rate reflects people time preferences.

    He complete destroys Marx with his explanation of the roundaboutness of the structure of production and explains that the function of the capitalist is to make sure that people work and make money regardless of whether or not a business venture succeeds. Without the capitalist car factory workers would have to work for years without making a profit because of all the things they needed to buy. Well Bohm-Bawerk explains that this is the job of the capitalist.

    Okay...I will write more later.

    (and believe me, I know I didn't do BB justice)
    "If you wish to know how libertarians regard the State and any of its acts, simply think of the State as a criminal band, and all of the libertarian attitudes will logically fall into place." -Murray Rothbard

    "There are a thousand hacking at the branches of evil to one who is striking at the root." -Henry David Thoreau

 

 

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