FYI | Oct 06 2010
By Tim Price
"There is no more persistent and influential faith in the world today than the faith in government spending. Everywhere government spending is presented as a panacea for all our economic ills."
Henry Hazlitt, "Economics in one lesson", published 1946.
"In retrospect, I see nothing that we did that was inappropriate in terms of policy."
Alan Greenspan, former chairman of the US Federal Reserve.
"The true measure of a career is to be able to be content, even proud, that you succeeded through your own endeavours without leaving a trail of casualties in your wake."
Alan Greenspan again, evidently no stranger to irony.
The financial crisis has claimed more than its fair share of victims. Losing a job is bad. Losing wealth is bad. Losing a home is worse. But perhaps the most grievous devastation has been visited upon the entire economics profession, which has surely lost whatever grains of credibility it once enjoyed. In the interests of full disclosure, the author does not possess a degree in economics.
The author used to feel mildly defensive about this perceived oversight given a subsequent career in investment management, but he now experiences something akin to utter relief on a daily basis, like having miraculously escaped from a train crash. Can there be any practical use to a profession whose members to this day continue to squabble ineffectually about the best way out of the hole we're in ? John Kenneth Galbraith had particular facility in answering that question; try
"Economics is extremely useful as a form of employment for economists" or better still,
"Economics is a subject profoundly conducive to cliché, resonant with boredom. On few topics is an American audience so practised in turning off its ears and minds. And none can say that the response is ill-advised."
Or,
"In economics, hope and faith coexist with great scientific pretension and also a deep desire for respectability."
And this from a professional economist. Imagine what a concentrated hatchet job from a non-believer might achieve.
Compared to those actually tasked with stewarding wealth, the role of economists would seem to be akin to that played by scientists busily proving that bumble bees are incapable of flight.
Were the role of the economist limited to that of irrelevant chorus it would be practically benign. But because members of the profession continue to squat at the ear of politicians, this is a dangerous fraternity – most dangerous for their near-consensus policy belief that the only way out from a debt-induced disaster is yet more debt and stimulus. But enough of the neo-Keynesians. Pace Messrs Friedman and Nixon, those with any obvious evidence of brain activity either are or should all be Austrians now.
For anybody considering an economics degree or otherwise nursing a vague and unwarranted sense of intellectual inadequacy, the advice is straightforward: just read Henry Hazlitt's "Economics in one lesson". For those of the old school, decent second-hand copies can be sourced from Amazon for around £6. For the congenitally illiberal and for the pixel-squinters, the full PDF can be found here.
"Economics in one lesson" is superb, but a note of caution is due. On completion, you may have no respect or time left for what passes for conventional economists. Tant pis.
Hazlitt begins his very readable guide with a version of Frédéric Bastiat's "broken window fallacy". Imagine that a small boy lobs a brick through a baker's shop window. Hubbub is created and a crowd gathers. Shattered glass decorates loaves and cakes. While the baker seethes with anger, some among the crowd are minded to look on events with an optimistic air: at least a glazier will get some business out of it.
Then, what the glazier earns from replacing the baker's window will be spent with other tradesmen, who in turn will spread the wealth around in an ever-widening ripple of trade. The broken window will be a huge boost to the local economy. Perhaps we should break some more, and prepare for the upturn. (Some readers may conclude that this has been the precise policy of the banks these last three years.)
Bastiat's fallacy is perhaps the best known theory in economics. As with many economic theories, there is a big problem, in that it doesn't work. While the glazier will benefit from a boost to his own income, the shopkeeper will lose out by exactly the same amount. Imagine, says Hazlitt, that the baker was planning to buy a new suit. By having to pay to replace his window instead, that purchase can no longer be made. No new "employment" has been created
The people in the crowd were thinking only of two interested parties: the baker, and the glazier. They never saw the potential third party: the tailor. They will see the new window once installed. They will never see the new suit, because it will never be made. They see only what is obvious to the naked eye.
Bastiat's broken window was first shattered in an 1850 essay, "Ce qu'on voit et ce qu'on ne voit pas" – "That which is seen, and that which is unseen". It is pleasing to note that the French have contributed something to the world of finance other than extravagant frauds and unwise speculation in sovereign debt.
As Hazlitt quickly points out,
"..the broken window fallacy, under a hundred disguises, is the most persistent in the history of economics."
In one form or another, it is repeated by industrialists, union leaders, politicians, financial writers and economists. The irony is that while these people can often see little merit in small acts of destruction, they can, in Hazlitt's words, "see almost endless benefits in enormous acts of destruction".
When considering policy action, chancellors would do well to remember Bastiat's tailor, who will never get the income from the baker's now deferred new suit. Unintended, or stupidly unseen or unconsidered, consequences lie behind a multitude of "economic" sins, policy errors and terrible oversights or misunderstandings. This work has an astonishing relevance given the Niagara of discredited advice pouring out of Keynesian economists everywhere.
Consider the quote about government spending that begins this commentary. Funds that are dedicated to one project by definition cannot be directed to another project that may have a more deserving nature. Happily, our new coalition government has recognised the urgency of tightening up the spending taps. (The US body politic shows no such grasp of the urgency of affairs.)
The second popular misconception is that government spending without limit is never a problem – governments can pile up debt upon debt because "we owe it to ourselves". Again, under the new coalition, wiser heads now prevail. But the industrialised world is full of governments that have yet to recognise the severity of their fiscal circumstances. A generation of bond investors will therefore ultimately be taught harsh lessons about the meaning of the adjective "riskless".
"Economics in one lesson" will repay its purchase price indefinitely. By seeing beyond the populist misconceptions of economic theoreticians, we will be better informed as to the efficacy and relevance and potential destructive power of their advice – and we can pre-emptively steer away from some of the road accidents in the markets they are likely to cause. For more on this theme, simply Google "quantitative easing".
Secondly, by looking further than just the proximate impact of economic policies or exogenous market events, we may gain a more profound and robust longer term insight into profitable investment trends. To sum up Hazlitt's wonderful book, Friedrich Hayek himself wrote of it that
"It is a brilliant performance. It says precisely the things which need most saying and says them with a rare courage and integrity. I know of no other modern book from which the intelligent layman can learn so much about the basic truths of economics in so short a time."
Considering an economics degree or otherwise sacrificing valuable time on the study of economics? Just buy Hazlitt instead.
Tim Price
Director of Investment
PFP Wealth Management
4th October 2010.
Email: tim.price@pfpg.co.uk Weblog: http://thepriceofeverything.typepad.com
All views expressed above are the author's, not FNArena's (see our disclaimer).
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