The Importance of Time in Explaining Asset Bubbles
Summary
Main Debate: Deep dive into Austrian business cycle theory versus Yudkowsky’s view that bubble pain isn’t caused by prior waste, highlighting the time structure of production and capital consumption.
Malinvestment Mechanics: Analogies (apple picking, farmer’s fields, Crusoe) illustrate how misperceived resources raise short-run consumption while depleting capital, causing later downturns.
Monetary Policy: Yudkowsky’s support for stable nominal GDP level targeting is contrasted with the Austrian view that credit expansion distorts prices and fuels cyclical booms and busts.
Idle Resources & Sticky Prices: Austrian rebuttal (via William Hutt) argues so-called idle resources reflect real choice and frictions; proper price and wage adjustments are needed for sustainable reallocation.
Entrepreneurial Behavior: Post-bust “entrepreneurial malaise” (Joseph Salerno) can prolong recessions as firms hesitate to recommit capital after prior errors, requiring time for genuine price discovery.
Systemic Risks: Attempts to avoid adjustment by reflating perpetuate cycles; banks and credit signals matter, and mispricing leads to unsustainable production lines.
Companies/Tickers: No specific public companies, tickers, sectors, or regions were pitched or recommended in this discussion.
Transcript
[Music] This is the Human Action podcast where we debunk the economic, political, and even cultural myths of the days. Here's your host, Dr. Bob Murphy. Jonathan, welcome back to the Human Action Podcast. >> Hey, Bob. Thanks for having me. >> Sure thing. So folks, what we're going to be doing today is going through a long tweet, but it gets interesting from Elizer Yudkowski, who many of you may know. He founded the the less wrong sort of rationalist website. Um, lately many of you may have heard of him. He is a leading uh warrior over the threat of super AI. Okay? And actually, he's got a recent one. I think it's a best-selling book that's called If Anyone Builds It, Everyone Dies. And it's him and a co-author Nate Sores. So that's just so you know who we're talking about here. And he had this long tweet where he was talking about investment booms. And I think Jonathan, if you'll indulge me, I think I just should read a large portion of his original missive and then just let you respond. And where we're going with this, folks, is I thought this perfectly illustrated why the Austrian school is so important. So part of the punchline, at least from my perspective, I'm curious to hear your reaction, Jonathan, is going to be that Yudowski's analysis makes perfect sense if you didn't take into account the time structure of production or the capital structure, if you want to use that terminology, which is something that's a hallmark of the Austrian school and in particular their theory of the business cycle. So that's my teaser. Let me just go ahead and and read a large chunk of this. You'll see where Yukowski is coming from and then I'll promise Jonathan I'll let you get a chance to talk. So he says, "Hi." So let's talk about the general theory of investment bubbles. You may have heard that it's painful when a bubble pops because investments got wasted on non-productive endeavors. This is physical nonsense. If the waste were what caused the pain, everyone would be sad while the bubble was inflating and a bunch of labor and materials were being poured down the drain, unavailable for real production and real consumption. Once the bubble popped and labor and materials stopped being wasted, you would expect the real economy to feel better and for consumption and happiness to go up. The real waste, the loss of actual goods and services that get poured down the drain of bad investment, happens before the bubble pops. That waste is in fact a bad thing for the economy. But if that waste were the big bad phenomenon that produced the pain of bubbles, it would feel painful while the bubble was inflating. And after the bubble popped and the ongoing wastage ended, everyone would breathe a sigh of relief and it increased real consumption. Instead, what we see is that while the bubble is inflating, a bunch of people feel great. They're consuming lots of goods and services. The economy as a whole seems to be doing fairly well. Then the bubble pops. Suddenly, a lot of everyday people on the street, many of whom weren't even connected to that sector of the economy, are doing more poorly. They consume less. Some of them get fired and stay unemployed for a while. The economy feels sad. You cannot account for this pain as a story of real goods and services that got wasted. The timing is all wrong. The waste was real. The waste was bad. And also, it is physical nonsense to imagine the pain of the bubble popping is the pain of this waste. People were apparently having lots of fun while the waste was was ongoing. That fun involved the consumption of real goods and real services which were not being produced by the investment that wasn't yet productive and later turns out to be just male investment. Okay. So then he goes on to explain well okay smart guy if it's not what the conventional you know man on the street thinks then what is it? and he goes into a thing about the the function of money and when there's sticky prices and wages and it basically he endorses some version of the market monitor school's recommendation for uh predictable and stable nominal GDP growth targeting. Okay, but we can leave that aside uh because we've certainly talked about that a lot, Jonathan. But here I I wanted to focus on his analysis where he thinks he just demonstrated like geez if you just think about it for a second. The standard story that oh the the problem you know the reason the people feel bad the economy is in trouble once a bubble pops is that we realize oops we just wasted we just mail invested a bunch of resources for a long time that no that can't be why the popping of a bubble gives us quote a bad economy. He's just saying it doesn't even physically make sense. So that's what I wanted to isolate and talk about because of course that's the standard Austrian I mean there's more bells and whistles but that's certainly a central element of the Austrian view of what the heck happens in a boom bus cycle. Yeah, and I I read your article in response to to this and uh I think it I mean it's a great response because you highlighted the the time structure of production uh Austrian capital theory uh which which explains why this sort of take on booms and busts is completely false and like you said it would make sense if there was no time structure production or suppose there was just like one stage of production then then yeah the Austrian story uh wouldn't make sense because the then then the the waste would be painful and there would there would be all of this uh pain in terms of like decreased consumption spending uh you know more uh financial stress as firms are are wasting resources. But the fact that it takes time to to bring goods through production and finally to consumer goods explains why you can have this boom period where there's lots of investment in longer uh lines of production uh new capital goods being created uh increase in employment and also increase in consumption uh but those production projects can't be completed. So the Austrian story is about a mismatch between what's happening in investment, what's happening in the structure production and the real supply of savings, the real supply of capital goods that are available to complete those those new projects. Um although you said we'll set it aside, I hope I hope we can talk a little bit about the uh sticky price, sticky wage thing. uh because while you've emphasized correctly I think the uh um the time structure of production uh I do I I think it's it's worth pointing out that the whole sticky wage sticky price thing is such a huge dividing line in macroeconomics specifically between the Austrian school and all other all of the other main macroeconomic schools of thought uh because Austrians had this unique uh take on on idle resources and it's something that I've recommended uh many times before the theory of idle resources by William Hut which shows that there at least there are reasons why people aren't using certain you know factories and machines and such or or even laborers they're not using them in production and once you take into account those reasons then it makes sense why you have this quote underutilized or these underutilized as resources. So hopefully we can talk about that at some point, but yeah, we can we can talk more about the time structure production, get into the meat of your article as well. >> Okay, great. And so I I think I agree with you and you're right, that is something especially for the listeners of the human action podcast who are advanced expert level. Yeah, let's let's tackle that stuff as well because you're right. When when Yukowski gets into his own explanation and why does the boom feel good? Yeah, it it does involve like the utilization of previously idle resources and so yeah, it kind of raises the question, well, why were they idle? And so, okay, good good stuff. So, basically, folks, what we're going to do for the rest of this episode is just unpack what Jonathan just said in three minutes there, but I think it'll be it'll be illustrative and and useful for you. So let me let me try something different because I really my pedagogical style which I got from I mean Mises does this but I think he was copying Bombav is that when they want to attack something they first take like they quote you know the intended recipient of their onslaught in their own words and then they go and they build it up and like say what that person's point was in even more persuasive fashion like to really isolate and crystallize what their point was such that by the end of that part, you're like, "Yeah, that guy was making sense." And then they go ahead and destroy that and you're like, "Oh, yeah." Okay. So, let me just make sure people got what Yudkowski thinks he's demonstrating there. And so, I don't know if this this helps. Uh, but imagine folks that the economy is just there's a bunch of apple trees, but that, you know, the apples are kind of high and so you need the adults to go out, the workers, and they reach up and they grab apples and then they just hand them to people and they eat them. And that's production. That's what how it works, right? So there's not that you have to go build poles or or ladders or anything like that. You just reach up and grab apples and hand to people. But you know that does take some labor to actually go and and pick the apples. Okay. And so if that's the starting point and that's kind of like what 100% of GDP was originally was just the flow of real apple consumption you get from going out and using your labor hours to pick apples with your hands. And then they say, "Okay, let's um instead someone's got the bright idea. You know what? Why don't we instead of everyone just going out and just with their bare hands picking apples every day, why don't we go and take some labor hours and go collect some sticks and like fashion this thing, we'll call it a ladder that we can use and then down the road that will make our labor more productive. And so a given person for an hour of his labor time, able to harvest a lot more apples than he can right now because, you know, he could put the ladder up against a tree and go climb and and reach branches that right now we can't get to. All right. So, and now, you know, just to continue the story, imagine that, you know, so some workers get pulled away from grabbing apples with their bare hands and they go and they spend time looking for sticks and then they put them together and they get vines or whatever, putting them together, maybe some mud that's supposed to be sticky or whatever and they go ahead and they build a bunch of ladders and then they finally go in the unveiling and everyone's really excited and they go and put them up against the tree and then the ladders just collapse when the first person puts their weight on it and they they realize we didn't know how to build ladders because hey, we've never tried this before and the ladders just completely useless and they all collapse. And so I think what Yudkowski is saying is if that's like our metaphor for like an investment bubble that turns out in retrospect to have been a bad idea and so it pops because we realized it was based on an illusion that in that story notice he's saying it's not that all of a sudden there would be a crisis and everybody would have to reduce their apple consumption once the ladders all collapsed cuz he's saying no at that point you would just be back to where you were originally. all the workers who had been siphoned out of apple collection with bare hands sector would, you know, and had been deployed into the building ladders sector, they could all get returned to just grabbing apples with their bare hands. And he's saying the real uh, you know, the the waste in a sense, you know, expost looking back would have been, oh, we in other words, the waste would not be the destruction of ladders that no, that was always an illusion from the get-go. The real cost, if you will, the way we can see that the people were worse off because of that decision is all the apples that they didn't get to eat during that period when some of the workers got redirected and were building these ladders that ended up being useless, right? That they could have been picking apples and instead they weren't. And so that's what Yukowsky's point there is is to say that yeah, if the boom period, what we think of as the boom, the like the male investment period, if people were hungry and let's you know bearing it and running their cars way beyond when they normally would have and just wearing socks that get holes in them and stuff because they were just promised, oh don't worry, we're taking a bunch of our workers and other raw materials and we're building this spaceship that's going to go to Mars and then bring back stuff or whatever, you know, some grandiose project that then turns out to be a disaster. He's saying if that were the pattern and that the the buildup period was a time of privation and hardship but people kept looking forward to oh it's all going to be worth it eventually and then they realized down the road no it wasn't the cost the waste would felt early on but he's saying in a standard boom bus cycle market economy that's not what it feels like the boom feels good it's good times there's not a bunch of people who are abstaining from possible enjoyment because they falsely believe better times are on the horizon. No, everybody's having a good time during the boom and then the thing pops. And so that's what he's why he thinks the standard man on the street, you know, common sense. Yeah. Yeah. The once the bubble pops, we realize things were wasted and that's why all of a sudden it feels bad. He thinks that doesn't work just mechanically. Again, John, I'll stop and feel free to to talk. >> Oh, sure. Yeah. I I'm just thinking about uh how the Austrian story was characterized as the hangover theory. I think that was Krugman who did that. Is that right? >> Y >> yeah. So um I mean it's a great analogy that uh apparently Yudowski is is rejecting, but it's c it's certainly possible for things to feel good in the short run and and you know for things to be going well for there to be you know boom or excitement. you think about a party or something. Uh but then it turns out to be like those those things that happened during the good time turned out to be a mistake. It turned out to be it's like oh now there's long-term pain or there's this there's this there's this negative consequence associated with my actions in the past. So I mean it's I mean if that can apply like on a personal level with the consumption of various substances like alcohol or cocaine or something like that. Uh I mean it seems uh that it could also apply to the the choices that we make in production. The the choices that entrepreneurs make. It's like oh this this entrepreneur is starting a new project. This looks great. There's lots of new employment. U this seems like it seems like it's going to be profitable. This is going to be great for everybody. you know the economy is booming so like you can imagine consumption is increasing but also there's all these new projects starting there's new investment uh going on as well um so I don't know I would I I'm just basically I'm just mentioning that there's this this hangover characterization and Austrians didn't reject that it's like oh yeah that actually is a pretty good characterization of our of our theory because there are mistakes that you know feel good in the short run so you know people are happy, but then it turns out that there are negative consequences. Uh but like like you emphasize in in order to see why it's a mistake and and see why there's this exciting boom period, you have to have this conception of capital existing in stages of production existing in stages because you need time for the boom period to last and then people realize oh oh we've made a mistake or oh now we have these negative consequences like we have shut down our business. We have to liquidate capital. We have to lay off workers. All those sorts of things that we associate uh uh with recessions. >> Yep. And and you're right, the that's partly why I liked Yudsk's analysis because it looked like he had either he read it from somebody else or he just rediscovered it, reinvented it. But his critique there was exactly why Paul Krugman and then also Tyler Cowan coming from a slightly different angle also didn't think the Austrian story worked and that um and like you say Krugman's theory rejecting the hangover theory and called it like the it's like the Fagistan theory of you know in terms of physics or whatever he just thought that's how crude and outmoded it was you know he he had a similar critique and then Cowan I know specifically was saying in the Austrian story why does that there there seems to be an asymmetry that they say, "Oh, the reason um the recession feels bad is that a lot of workers were in the wrong sector, you know, unsustainable lines that were only fueled by the, you know, cheap money, low credit, low interest rates of the boom period. And so then they have to get laid off and go somewhere else." And so Cowan's point was, well, if that feels painful, how come on the boom side when workers get sucked out of sustainable sectors and get channeled into what in retrospect turns out to be male investments, how come that isn't painful, too, right? And so there I thought the the obvious answer was well when it's fueled by cheap money the workers are bit away from where they originally were like so they're enticed by higher wages whereas in the bus period their employers and the you know in the unsustainable lines tell them you're out of work we got to lay you off and then they take the second best option after searching you know so that's why getting laid off feels worse than quitting your job and taking a better one right which one would think an economist would understand so there's that element so I did like that but let just not leave people hanging Jonathan that after I did such a good job I think with that Apple story trying to illustrate this is what Yowski is saying and you can see in that framework yeah duh obviously the waste happened before so that's when the pain should have been felt and if anything the sooner you recognize that these ladders don't work the better you know off you are because now you can just channel people back and you can get them back to grabbing apples with their bare hands and then consumption can go back to where it was what and so again the I picked that example because grabbing apples with your bare hands is a quick turnaround. You're not in a sense tying up your labor for long stretches before the finished consumer good pops out. But if we change the story to something equally silly and crude, I can show that Yudkowski's logic fails. And so this is what I wrote up in that article that you were alluding to, Jonathan, and we'll of course link to it, folks. But imagine a farmer, right? He's got all these acres um under cultivation and he's in a nice equilibrium where you know each harvest they get a bunch of crops. He and his family eat a bunch and uh you know then they sell some to get the equipment and things that they need just to maintain their operations. And that's a nice little pattern they have going and of course they replant and it takes a year for the full cycle to work, right? That you know they plant the stuff or whatever and then they don't get the harvest from that planting until down the road. And so for that to work physically, they must be carrying stocks of food from prior harvests, right? That the you can't plant today and then eat later today what you just planted. Obviously, there's a time lag and so you have to have previous savings for that to even work physically. So I'm saying in that scenario now suppose the farmer erroneously comes to believe that oh with these new irrigation techniques or maybe I'm getting you know new tractors or something or new fertilizer that I can just plant on half of my land as I was before and my crop you know my harvest will still be the same. Suppose he thinks that and so then he acts accordingly. He only plants on half the land as he previous he would probably pick, you know, the the most arable half of his farmland. And then on the other half now that's freed up. He doesn't need it anymore. He converts it into a golf course and puts in a giant indoor swimming pool with a water slide and everything. And now because he's only working half the land as he was before, he has more free time during this year and he uses that to, you know, play a bunch of rounds of golf. He goes in the in the pool a lot. And so then a year goes by. And so now finally we come to the, you know, the end of the cycle and he goes to harvest crops and he realizes to his horror that rather than doubling the output per acre, he only had like a 10% increase. So when you do the math, you realize he only gets 55% of the yield that he did the prior cycle. And so his family now for that upcoming year has to eat 45% less than they did last year. That's just mechanically that's what's going to happen because that's how much food got pumped out of the ground. And so I'm saying Udkowski if you looked at his analysis there would say to the farmer explain what happened and he would say well I made a terrible mistake. I malinvested my resources last year and that's why right now our consumption is going to plummet 45% and we're really going to be hungry for the next year until we can kind of revamp things and get back to where we were. And Yudkowski would say, "No, that's physical nonsense. Obviously, the waste happened last year. Right now, you're actually fixing things and you're doing the right thing going forward. So, your family should be able to eat fine now. It's last year when you were taking resources away from farming and putting them into the golf course and the uh pool. That's when you should have felt the pain. And yet, you were having a blast. You were out shooting golf and and going in the swimming pool. So clearly you must be mistaken when you think the waste happened in the prior year. Clearly the waste is happening right now. There's some systemic problem with sticky farm prices or something or some mechanical issue about taking food from the dirt into your kitchen. Something now must be going on. The pain, you know, if you think it was the past decisions you made, you would have already experienced that pain. So clearly, right, you can see that's goofy. And the fundamental fallacy in that ostensible critique is that there's a time structure of production that the, you know, the planting that he did during the last cycle would take a year to bear its fruits. And so if something happens, he's got a year mismatch where he could just be going along thinking everything's great and in fact living it up because he erroneously believes that he's setting motion operations that are going to give him a much higher yield down the road than what he previously was getting for his efforts. And that's why he can afford to live it up in the short term. And so that that phenomenon is what Mises classified as capital consumption. And when I responded to Krugman and Cohen back in the day, that's what I pointed out that they're overlooking the role of capital consumption. That that's how it can be that you can be enjoying real goods and services during the boom period even though you're doing male investments is because you're not replenishing the capital stock even though you think you are. that you're not you're not redirecting enough of the current output during the boom years into replenishing the factories and machineries and thing like that and just the complex structure of production such that down the road everyone's going to realize ooh we did not maintain the capital structure correctly and now we're in a pinch and physically it is impossible for real output to be what it was previously. we get we're going to have to suffer a period of privation while we replenish you know the capital structure and then we can return to our previous level but right now we physically painted ourselves into a corner >> yeah at at risk of inundating our listeners with uh too many analogies >> you can never have too many analogies but >> they're they're great they're great for teaching u in the past when I've uh presented Austrian business cycle theory I' I've used this analogy of uh cruso so going back to Cruso and uh suppose he's he's set aside a stockpile of of berries and coconuts uh either as like a buffer because he's not sure uh what his coconut and berry production is going to be in the future and so he he wants to smooth his consumption but also he can use it as a subsistance fund so that he can you know build a net or build a raft to go out and do some fishing. Um, so, so he set aside these saved resources and but suppose one morning Cruso wakes up and he finds these, you know, colorful mushrooms outside of his cave that he's that he's living in and he he thinks, "Oh, this here's here's some mushrooms. I guess I'll try them out." And it turns out that they're hallucinogenic mushrooms. And the nature of these uh uh hallucinations in my thought experiment is that it causes him to see way more resources than actually exist. So he consumes the mushrooms, you know, his eyes get big and he looks he looks at the his stockpile of coconuts and berries and it it looks like they're a hundred times bigger than they actually are. And he looks at his island and there's just, you know, stockpiles of raw timber. There's rope available. There's all these sorts of things uh available to him in his perception that don't actually exist. And so now think about what Crusoe might do in that situation. Suppose the hallucination lasts long enough for for this for this to occur. While while he thinks that he has more resources available to him, he would actually he would increase consumption and he would increase investment and he would start different lines of production than he would uh if he had a correct view a correct perception of his stockpile of resources. So if he sees that he has a hundred times more resources uh than he actually does, then he actually might start building a much bigger raft or he might start building a a huge mansion as opposed to like a small like leanto sort of shelter. Uh he might he might start building all sorts of things that he thinks he can now complete. He can actually go through with those with those projects. But of course uh so so the point is in in that sort of situation he would he would increase his consumption and he would start these new lines of production. It would look like his his little Crusoe economy is doing great. It's it's booming because he's able to do both. But what he's actually doing, you know, apart from his hallucinations is he's actually wasting resources. like he's he's putting the resources that he actually does have into projects that won't be able to be completed and he's also eating into his his subsistence fund. He's he's eating he's eating the coconuts and berries uh uh to a larger extent than than he otherwise would have which means that he's actually he's engaging in what you said capital consumption. He's he's decreasing his uh supply of savings. He's eating into his capital stock. And then once the hallucination wears off, once he has an accurate perception of his available resources, then he has to he has to do that he the best that he can do. He's got to, you know, break down the mansion that he started to build. He's got to uh replenish his uh subsistance fund. he he's he's going to have to constrict his consumption or restrict his consumption uh so that he can you know get back to where he was before uh based on an accurate understanding of of his supply of available resources. And the connection is this this is this is exactly what artificially low interest rates and new easy credit being pumped into the economy does is it gives this uh impression that there are more savings available. It makes it look like longerterm projects are now feasible and profitable. It makes it look like there's there's more consumption goods available to uh to be uh consumed. And so people consume more, people invest more. Uh not only do they invest more, so they're there's an increase in investment, but there's also wasted investment or malinvestment as Mises emphasized because they're putting these capital goods into projects that won't be able to to to pan out. And so there's there's a that realization is the bust. That realization that I've misallocated capital that I've eaten into my capital stock that my subsistence fund is much lower than it actually is. That's when you have to do all the correction. That's when you have to make the, you know, the hard decisions of how much am I actually going to consume on a daily basis now that I realize that my available stock of consumption goods is smaller and that I've wasted all of these capital goods and intermediate products in in in lines of production that aren't going to pan out. >> So, you're saying Ben Bernanki was a drug dealer? Yeah. >> Exactly. Yeah. I mean, it it it works um it works really well because it ties back to the hangover theory as well. It's like there's this there's this, you know, short-term boom that's fueled by wrong perceptions, right? Well, it's it's the same as, you know, somebody at a party who's drinking too much or or somebody who's, you know, taking cocaine and they feel great. They things are going, they feel like they can, you know, conquer the world, but then, you know, the high wears off, you have a hangover, the the real world strikes again. >> Yeah. Let me just So, I I like that and thank you for going through that. Let me just make sure though that the some viewers aren't taking the wrong lesson from this. We're not saying that, oh, it's all in your head, right? Because because I think that's what Yutoowski believes is that he's trying to show I don't care what people's perceptions are. No, they really are in measurable terms physically consuming more goods and services during the boom period. So, what are you guys talking about male investment? In other words, he's saying, "Yes, male investment does occur, don't get me wrong, but that's insignificant." Like that's that's swamped by something else is going on during the boom period that allows for people to consume more than they normally were. And that's why it feels good. And that's not just all in your head. They really are. And so that's so in Jonathan's story there, folks, the it was the misperception fueled by the hallucinogenic mushrooms of thinking he had more resources at his disposal than he really did that led Crusoe to make the mistake of eating more of his stockpile than he really would have had he understood the situation better. So he really, it's not just that he was imagining that he was better off. he really was eating more berries and coconuts or what you know fish whatever you said to stockpile was than he would have had he remained sober the whole time and so it's not merely an illusion he really was like did have quote a higher standard of living if those are the terms you want to use like like if he if he somehow knew like he saw a distant rescue ship or something and Crusoe realized oh wait I'm getting rescued in 3 days and then he just ate all the stuff he had stockpiled because he knew I'm fine in 3 days there's that's a sense in But you would have said, "Oh, yeah, he's he's better off." Like he like those three days would have had a higher standard of living for him than the prior three days. But then at the end of that, if it turned out he was mistaken and what he saw was just, you know, some smoke or something in the distance and no, no ship ever showed up, then he would be horrified and realize, "Oo, I just made a terrible mistake. I just completely ate all my savings." Right? So, and there again, it wouldn't work to say that. Oh, no. Really, the problem was So, anyway, there you there you go. I think we're just, you know, showing people that was the mistake Ukowski made in his sort of breezy armchair chair analysis. So now maybe in the remaining time I do want to go back to what you were asking about Jonathan. It's worth pursuing what Yudkowski what he thought a better explanation was because that also showcases I think the superiority of the Austrian approach and like you say drawing on insights from uh William Hut. And so I'll try to make this real brief what Udkowski says and and I should clarify. He wasn't saying the boom he wasn't praising the male investments of the boom. He was acknowledging that there is a wastage of real resources and if you could avoid that that would be better than not. Okay. Okay. So, and the reason I'm saying that, John, is because I made like kind of a smart Alec tweet because the guy Curtis Jarvin, some people may know him, I think it was like the same day or the day before, had said, "Oh, Trump should just order the Fed to to mint a million dollar or trillion dollar coin and platinum coin and we just solve this problem, go around Congress." And so, it was like all these right-wingers are coming out with, you know, wanting the trillion dollar coin and now Yudowski's praising the boom and what the heck. And so I was a little bit it wasn't what I that I said was wrong, but it was a little bit uh perhaps misleading and unfair. Udowski's position as I understand it is he's saying yes during the boom the way that plays out in a typical boom. There are investments made. People do invest re real resources into lines that they shouldn't that really is waste. The consumers really do end up with less stuff than would be the case if those resources hadn't been misdirected. That's all true. But he's saying there's something else that's superimposed on that that swamps that effect and helps us understand why does the boom feel good? And he's saying because at the start of the boom there were idle resources that there were a lot of workers looking for work. They were happy to work but they just couldn't find a match you know with their skill set and whatever and then there was employers out there and they just hadn't connected. Even though on paper there is a connection there that should have happened, but for some reason the market didn't do its job properly in this case, there's factories that could be running at higher capacity and they're not. And there's, you know, all sorts of real resources that are not being fully utilized for some reason on the eve of the boom. And then by creating more money and flooding the system with more money and making prices rise, that allows these win-win transactions to occur that otherwise wouldn't have. And he's saying that is what why the boom feels good is because the injection of money even though it does as an, you know, a byproduct cause some male investment, it's actually fueling a bunch of legitimate transactions that should be occurring and for some reason were not occurring on the eve of the boom. He's saying that's why the boom feels good. And then with the bust, he's saying the reason that feels bad, it's not because everyone realized, oh no, those male investment or those investments turn out to be male investments. He's saying, no, because again, the damage was already done with that. He's saying the reason the boom or the the bust feels bad is because of sticky prices and wages. And so when the central bank stops pumping in money and then all of a sudden there's downward pressure on prices that now the you get the you know the return of uh idle capacity that there's a bunch of workers now who can't get hired because you know the employer what the worker wants to get paid in nominal money terms is too high relative to the products that he he would help produce. And so the employers won't pay. that's not a that's not a real problem like the workers should be going to those jobs but there's a mismatch with the with the money prices and that's because of the central bank's mismanagement and so that's why he's saying as a final thing here uh Jonathan I'll turn over to you that's why Udkowski concludes and so if I'm right and this is the story of what goes on the long run solution is the central bank just needs to target stable nominal GDP growth in level terms like just to let everyone know oh yeah going forward ward the level of nominal GDP will rise whatever 5% every year and you can bank on that if it if it's only 2% one year then we'll make up for it and do what 8% the next year so that in the long run like we know what's nominal GDP in the year 2040 going to be people can be pretty sure about that because if it's if it overshoots or undersshoots the central bank will make up for it and he's saying that would totally solve all these problems you wouldn't have these recurring periods of idle capacity and then also you wouldn't have the male investment that happens right now with our current silly monetary policy. So that's his overall take. And now what what what do you say to that? >> I say people should read uh Joe Serno's reformulation of Austrian business cycle theory in light of the financial crisis. I think that's the full title. Uh and actually in that article he addresses I think it's uh Cowan's which you've also addressed in this episode and in your article uh Cowan's take on on what he sees as the the flaws of of Austrian business cycle theory and one thing that Serno points out in that article uh first first of all he sort of uh explodes the hydraulic view I would say that Cowan's view and Ykowsk's view and also Krugman's view is like this hydraulic view of of the economy that we just need to get spending in the right levels uh in in order to keep the economy on on this uh even track. Uh but another thing that or that he does later in the article is he he's he tries to explain uh successfully I think uh why why is it that we see these painful drawn out recessions you know even even taking out the uh government interventions that usually happen during a recession? Why why does it take time for an economy to to uh reallocate resources in a in a long run sustainable profitable sort of way and one thing that he points out as as a cause for this is he calls it entrepreneurial malaise which is interesting because it's sort of similar to uh uh like the Keynesian animal spirit sort of idea uh but but this is this is better this is like an appropriate way to bring in market psychology is what Serna says is that entrepreneurs in the bust uh they're going to be very reluctant to to commit resources into lines of production be because they were mistaken in the past. So like they they see we made all these errors. Um they see like big financial institutions are failing. Uh it's it's it's very risky. It's like this is not a you know a sure sort of thing for me to try to you know restart my business or start a new business in this time and so there's this reluctance on the part of entrepreneurs to reenter uh production because of what Solerno calls this entrepreneurial malaise and this explains why it it can take some time like years maybe for um the for production to get kickstarted again for for people to to become employed for capital to be uh reemployed in production. It's because it's because they were fooled before. They were they were given bad information. It's like Cruso with the hallucinogenic mushrooms or the farmer who had this incorrect anticipation of what his his yield would be on on even the half uh the half portion of of his farm. They so they had this incorrect information and so they might be a little more reluctant to to to make those decisions going forward. And so this explains why it it can take some time. Okay. So so this is where the sticky prices and sticky wages and idle resources come into play. So if you think about like what what needs to happen during the correction is you need entrepreneurs to see profitable lines of production and and then employ people and create capital goods and get those lines of production going. In order for that to happen, they have to have market prices that reflect the the real scarcities of those things and the the real uh values of those things and and and actually correct or a better anticipation of what revenues will be in the future. And so if you if you try to interrupt that process or if you try to um hasten that process, I guess I should say, with with more money printing, even in the name of something like nominal GDP targeting, what you're doing is you're actually distorting those prices yet again. You're you're just you're giving the economy the same thing that caused the entrepreneurs to make those mistakes in the first place. And so what needs to happen is you need you need prices to change. Sometimes that can take a while. You need wages to change. You might need wages to fall in some cases and and that's painful, right, for somebody to take a pay cut, but you need those sorts of things to happen so that entrepreneurs can find the profitable lines of production that are sustainable that are in accordance with the actual supply of of real resources. Now, with the the sticky price and sticky wage thing, uh like one uh um one thing that we can say about that is that it actually represents people's real values. So like if if a work suppose I'm a worker and I'm reluctant to take a pay cut. So which would mean that it would take longer for my wages to decrease. Uh what that what that means is that I anticipate that there are better prospects for me uh in in seeking alternative employment than staying in the same job and receiving a pay cut. So this worker is actually doing the same sort of corrective thing, same sort of corrective process that the entrepreneurs need to do in in seeing all of their different options in including what uh Solerno and Hut have called employment and job prospecting. It sort of sounds like a euphemism, right? It's like we're just trying to make unemployment sound better, but that's not the case at all. like we're what we're trying to or what they are trying to say is that if if somebody thinks that I I can spend my time better by looking for other jobs, other employment opportunities that would pay pay me at least as much or even higher, then I think that that's a better use of my time than staying in my same job and receiving a pay cut. So, it's the it's the same sort of thing. It's market participants seeing the options available to them. And if we allow prices and wages to do the adjustments that need to happen, then we'll get then we'll correct the errors. We'll get into a a more long run sustainable structure of production that actually can be completed with the actual supply of real savings. >> Yeah, great stuff there. And uh for the more academically inclined listeners, let me just mention that piece that Jonathan just alluded to there in terms of like you can say, oh, there's search costs or something like that. You know, when when a worker's laid off, they have a skill set and there's employers out there that might be willing to hire them and then it's a matter of just them finding each other and you know, you got to know at some point, well, do I keep looking for a job? The on the margin am I likely to find a better offer? you know, there's decision problems you can cast in those terms. And so there's a whole neocclassical literature on that stuff and it's part of it's related to what's called real business cycle theory. And so what I like about the Austrian approach is, you know, and this goes back to at least 1912 when Mises first laid this stuff out is that the Austrians I think from the beginning their theory involved the strengths of all the different subsequent schools. like the Keynesians just focus on spending and you know monetary factors and things like that you know nominal magnitudes monetary issues not real ones whereas of course the real business cycle theorists view oh what happens in a recession is there's a a shock to productivity and then there's this mismatch and then yep unemployment jumping to 12% that's the optimal response given that shock and so blah blah blah and the Keynesians make fun of them and say oh so your theory of the 1930s is to call it the great vacation because workers all optimally dec you know what I mean So I think that the two schools like like they both have strengths and weaknesses and the Austrians I think take what's good in both but it's not just because the Austrians expost looked around and had went to a buffet. It's like the Austrian had their coherent theory at the beginning which I think you know has the right elements these layer people are just grappling with in terms of like you know one guy touching the elephant in one spot versus the other. And so the Austrian theory is like a a monetary theory of disturbance, but then it has real effects, right? And and Mach has a a quote to that effect that I'm I'm not going to remember the exact wording of it right now. So that's why I think it is good that yes, there are monetary disturbances and it's not just that the economy's h chugging along and then there's some shock to you know agricultural output or you know sunspots or what like no there's the shock comes from the financial sector. So that banks matter even though guys like Scott Sumner literally don't have banks in their model and are proud of that fact. So I think the Austrians acknowledge that yeah banks do matter but they also realize that you know once a bunch of workers have been in the wrong line for two years you can't just snap your fingers and have them go to the right spot and just to say oh why don't we just have the the federal government run huge budget deficits that'll fix it. Like you're leaving out a lot of nuance and no it matters where people are working. It's not just get people to work so they can spend again like that's way too crude. I can't believe we're having this conversation and yet we are. So um one thing Jonathan on this issue of idle capacity that I know Mises does in human action is he's like he he first explains his theory of you know the what we call Austrian business cycle theory there. I think you call it the circulation credit theory of the trade cycle. But um as if the economy originally is in like total long run equilibrium and then out of the blue for no reason the banking system decides to inflate and push interest rates down artificially to the levels that sets off a boom and so on. But Mises acknowledges in the real world often what happens is you start out with the hangover, no pun intended, from a prior cycle. And so that's why you do start out not at full employment. And so there does seem to be a primmaacia justification for oh yeah, why don't we just in expand the supply of credit and get a bunch of people back to work? How could anyone complain about that? And so Misa's point is like you said, Jonathan, you're just continuing the same cycle. You're never going to get out of this. keep spawning the very thing that's causing the problem on the back end. The only way you're going to get to a long run sustainable level of full employment, if you want to use that kind of terminology, is if you stop inflating and just let let it play out once and then you'll hit rock bottom and then going forward will be sustainable growth. Whereas if every time you can't tolerate the last vestages of the bus because it's too painful and you decide to inflate again, all you do is just blow up another bubble that's going to then lead to the same thing five years from now. Yeah, another uh great quote. So, like you sort of went back into the history of thought. One thing that I uh pointed out uh in response to Yudkowsk's uh very very very long uh tweet, he he probably could have been more brief, don't you think? >> He could have he wasted some some resources. >> I I pointed out that uh uh back all the way back in 1867, there was this guy named John Mills uh who was friends with uh Jebans, by the way. Uh you mentioned the sunspot theory. Jebans is famous for the sunspot theory. But John Mills uh he he wrote this um this essay on the credit cycle and he actually pointed out he he said uh as a rule panics do not destroy capital. They merely reveal the extent to which it has been previously destroyed by its betrayal into hopelessly unproductive works. And so I was very intrigued by that quote. It's like it's like this little nugget of Austrian business cycle theory all going all the way back to 1867. So I I went through John Mills um credit cycle as he called it and what what was interesting is that there were some Keynesian elements there because he he brought in a lot of market psychology like you know there's there's over optimism and there's pessimism and like those sorts of things are changing and it depending on the the phase of the cycle but near the end of the essay the thing that he pinpoints is what causes this this phenomenon of of people putting capital into what he called hopelessly unproductive works was artificial credit. It it was an extension of credit beyond real savings. And he's got some graphs to show that as well. So I I sort of latched on to that and did I wrote an article about how there were some like protocanesian and protoastrian elements. Um but the reason I bring it up is just to show economists have been talking about this sort of stuff for a very long time. Uh, and it seems like Yudkowski is is stuck in in this market psychology view, sticky wage view, sticky price view, idle resource view, and also a hydraulic view of the economy that has I think has been destroyed by economists since then. >> Yeah, definitely. And that's interesting. I hadn't heard of that and I'll you'll have to after. >> You haven't read my article. Come on, Bob. >> I No, you can send it to me and we'll link to it, too, folks. It'll be good stuff. Well, at this point, I think we should wrap up. Otherwise, our discussion will end up being longer than Yukowsky's original tweet, which was quite long. And so, we will end there. So, thank you, Jonathan, for your time and insights as always. >> Yeah. Thanks for having me, Bob. >> Thanks everybody for tuning in. We'll see you next time. Check back next week for a new episode of the Human Action podcast. In the meantime, you can find more content like this on mises.org. [Music] [Applause] [Music] Heat. Heat. [Applause]
The Importance of Time in Explaining Asset Bubbles
Summary
Transcript
[Music] This is the Human Action podcast where we debunk the economic, political, and even cultural myths of the days. Here's your host, Dr. Bob Murphy. Jonathan, welcome back to the Human Action Podcast. >> Hey, Bob. Thanks for having me. >> Sure thing. So folks, what we're going to be doing today is going through a long tweet, but it gets interesting from Elizer Yudkowski, who many of you may know. He founded the the less wrong sort of rationalist website. Um, lately many of you may have heard of him. He is a leading uh warrior over the threat of super AI. Okay? And actually, he's got a recent one. I think it's a best-selling book that's called If Anyone Builds It, Everyone Dies. And it's him and a co-author Nate Sores. So that's just so you know who we're talking about here. And he had this long tweet where he was talking about investment booms. And I think Jonathan, if you'll indulge me, I think I just should read a large portion of his original missive and then just let you respond. And where we're going with this, folks, is I thought this perfectly illustrated why the Austrian school is so important. So part of the punchline, at least from my perspective, I'm curious to hear your reaction, Jonathan, is going to be that Yudowski's analysis makes perfect sense if you didn't take into account the time structure of production or the capital structure, if you want to use that terminology, which is something that's a hallmark of the Austrian school and in particular their theory of the business cycle. So that's my teaser. Let me just go ahead and and read a large chunk of this. You'll see where Yukowski is coming from and then I'll promise Jonathan I'll let you get a chance to talk. So he says, "Hi." So let's talk about the general theory of investment bubbles. You may have heard that it's painful when a bubble pops because investments got wasted on non-productive endeavors. This is physical nonsense. If the waste were what caused the pain, everyone would be sad while the bubble was inflating and a bunch of labor and materials were being poured down the drain, unavailable for real production and real consumption. Once the bubble popped and labor and materials stopped being wasted, you would expect the real economy to feel better and for consumption and happiness to go up. The real waste, the loss of actual goods and services that get poured down the drain of bad investment, happens before the bubble pops. That waste is in fact a bad thing for the economy. But if that waste were the big bad phenomenon that produced the pain of bubbles, it would feel painful while the bubble was inflating. And after the bubble popped and the ongoing wastage ended, everyone would breathe a sigh of relief and it increased real consumption. Instead, what we see is that while the bubble is inflating, a bunch of people feel great. They're consuming lots of goods and services. The economy as a whole seems to be doing fairly well. Then the bubble pops. Suddenly, a lot of everyday people on the street, many of whom weren't even connected to that sector of the economy, are doing more poorly. They consume less. Some of them get fired and stay unemployed for a while. The economy feels sad. You cannot account for this pain as a story of real goods and services that got wasted. The timing is all wrong. The waste was real. The waste was bad. And also, it is physical nonsense to imagine the pain of the bubble popping is the pain of this waste. People were apparently having lots of fun while the waste was was ongoing. That fun involved the consumption of real goods and real services which were not being produced by the investment that wasn't yet productive and later turns out to be just male investment. Okay. So then he goes on to explain well okay smart guy if it's not what the conventional you know man on the street thinks then what is it? and he goes into a thing about the the function of money and when there's sticky prices and wages and it basically he endorses some version of the market monitor school's recommendation for uh predictable and stable nominal GDP growth targeting. Okay, but we can leave that aside uh because we've certainly talked about that a lot, Jonathan. But here I I wanted to focus on his analysis where he thinks he just demonstrated like geez if you just think about it for a second. The standard story that oh the the problem you know the reason the people feel bad the economy is in trouble once a bubble pops is that we realize oops we just wasted we just mail invested a bunch of resources for a long time that no that can't be why the popping of a bubble gives us quote a bad economy. He's just saying it doesn't even physically make sense. So that's what I wanted to isolate and talk about because of course that's the standard Austrian I mean there's more bells and whistles but that's certainly a central element of the Austrian view of what the heck happens in a boom bus cycle. Yeah, and I I read your article in response to to this and uh I think it I mean it's a great response because you highlighted the the time structure of production uh Austrian capital theory uh which which explains why this sort of take on booms and busts is completely false and like you said it would make sense if there was no time structure production or suppose there was just like one stage of production then then yeah the Austrian story uh wouldn't make sense because the then then the the waste would be painful and there would there would be all of this uh pain in terms of like decreased consumption spending uh you know more uh financial stress as firms are are wasting resources. But the fact that it takes time to to bring goods through production and finally to consumer goods explains why you can have this boom period where there's lots of investment in longer uh lines of production uh new capital goods being created uh increase in employment and also increase in consumption uh but those production projects can't be completed. So the Austrian story is about a mismatch between what's happening in investment, what's happening in the structure production and the real supply of savings, the real supply of capital goods that are available to complete those those new projects. Um although you said we'll set it aside, I hope I hope we can talk a little bit about the uh sticky price, sticky wage thing. uh because while you've emphasized correctly I think the uh um the time structure of production uh I do I I think it's it's worth pointing out that the whole sticky wage sticky price thing is such a huge dividing line in macroeconomics specifically between the Austrian school and all other all of the other main macroeconomic schools of thought uh because Austrians had this unique uh take on on idle resources and it's something that I've recommended uh many times before the theory of idle resources by William Hut which shows that there at least there are reasons why people aren't using certain you know factories and machines and such or or even laborers they're not using them in production and once you take into account those reasons then it makes sense why you have this quote underutilized or these underutilized as resources. So hopefully we can talk about that at some point, but yeah, we can we can talk more about the time structure production, get into the meat of your article as well. >> Okay, great. And so I I think I agree with you and you're right, that is something especially for the listeners of the human action podcast who are advanced expert level. Yeah, let's let's tackle that stuff as well because you're right. When when Yukowski gets into his own explanation and why does the boom feel good? Yeah, it it does involve like the utilization of previously idle resources and so yeah, it kind of raises the question, well, why were they idle? And so, okay, good good stuff. So, basically, folks, what we're going to do for the rest of this episode is just unpack what Jonathan just said in three minutes there, but I think it'll be it'll be illustrative and and useful for you. So let me let me try something different because I really my pedagogical style which I got from I mean Mises does this but I think he was copying Bombav is that when they want to attack something they first take like they quote you know the intended recipient of their onslaught in their own words and then they go and they build it up and like say what that person's point was in even more persuasive fashion like to really isolate and crystallize what their point was such that by the end of that part, you're like, "Yeah, that guy was making sense." And then they go ahead and destroy that and you're like, "Oh, yeah." Okay. So, let me just make sure people got what Yudkowski thinks he's demonstrating there. And so, I don't know if this this helps. Uh, but imagine folks that the economy is just there's a bunch of apple trees, but that, you know, the apples are kind of high and so you need the adults to go out, the workers, and they reach up and they grab apples and then they just hand them to people and they eat them. And that's production. That's what how it works, right? So there's not that you have to go build poles or or ladders or anything like that. You just reach up and grab apples and hand to people. But you know that does take some labor to actually go and and pick the apples. Okay. And so if that's the starting point and that's kind of like what 100% of GDP was originally was just the flow of real apple consumption you get from going out and using your labor hours to pick apples with your hands. And then they say, "Okay, let's um instead someone's got the bright idea. You know what? Why don't we instead of everyone just going out and just with their bare hands picking apples every day, why don't we go and take some labor hours and go collect some sticks and like fashion this thing, we'll call it a ladder that we can use and then down the road that will make our labor more productive. And so a given person for an hour of his labor time, able to harvest a lot more apples than he can right now because, you know, he could put the ladder up against a tree and go climb and and reach branches that right now we can't get to. All right. So, and now, you know, just to continue the story, imagine that, you know, so some workers get pulled away from grabbing apples with their bare hands and they go and they spend time looking for sticks and then they put them together and they get vines or whatever, putting them together, maybe some mud that's supposed to be sticky or whatever and they go ahead and they build a bunch of ladders and then they finally go in the unveiling and everyone's really excited and they go and put them up against the tree and then the ladders just collapse when the first person puts their weight on it and they they realize we didn't know how to build ladders because hey, we've never tried this before and the ladders just completely useless and they all collapse. And so I think what Yudkowski is saying is if that's like our metaphor for like an investment bubble that turns out in retrospect to have been a bad idea and so it pops because we realized it was based on an illusion that in that story notice he's saying it's not that all of a sudden there would be a crisis and everybody would have to reduce their apple consumption once the ladders all collapsed cuz he's saying no at that point you would just be back to where you were originally. all the workers who had been siphoned out of apple collection with bare hands sector would, you know, and had been deployed into the building ladders sector, they could all get returned to just grabbing apples with their bare hands. And he's saying the real uh, you know, the the waste in a sense, you know, expost looking back would have been, oh, we in other words, the waste would not be the destruction of ladders that no, that was always an illusion from the get-go. The real cost, if you will, the way we can see that the people were worse off because of that decision is all the apples that they didn't get to eat during that period when some of the workers got redirected and were building these ladders that ended up being useless, right? That they could have been picking apples and instead they weren't. And so that's what Yukowsky's point there is is to say that yeah, if the boom period, what we think of as the boom, the like the male investment period, if people were hungry and let's you know bearing it and running their cars way beyond when they normally would have and just wearing socks that get holes in them and stuff because they were just promised, oh don't worry, we're taking a bunch of our workers and other raw materials and we're building this spaceship that's going to go to Mars and then bring back stuff or whatever, you know, some grandiose project that then turns out to be a disaster. He's saying if that were the pattern and that the the buildup period was a time of privation and hardship but people kept looking forward to oh it's all going to be worth it eventually and then they realized down the road no it wasn't the cost the waste would felt early on but he's saying in a standard boom bus cycle market economy that's not what it feels like the boom feels good it's good times there's not a bunch of people who are abstaining from possible enjoyment because they falsely believe better times are on the horizon. No, everybody's having a good time during the boom and then the thing pops. And so that's what he's why he thinks the standard man on the street, you know, common sense. Yeah. Yeah. The once the bubble pops, we realize things were wasted and that's why all of a sudden it feels bad. He thinks that doesn't work just mechanically. Again, John, I'll stop and feel free to to talk. >> Oh, sure. Yeah. I I'm just thinking about uh how the Austrian story was characterized as the hangover theory. I think that was Krugman who did that. Is that right? >> Y >> yeah. So um I mean it's a great analogy that uh apparently Yudowski is is rejecting, but it's c it's certainly possible for things to feel good in the short run and and you know for things to be going well for there to be you know boom or excitement. you think about a party or something. Uh but then it turns out to be like those those things that happened during the good time turned out to be a mistake. It turned out to be it's like oh now there's long-term pain or there's this there's this there's this negative consequence associated with my actions in the past. So I mean it's I mean if that can apply like on a personal level with the consumption of various substances like alcohol or cocaine or something like that. Uh I mean it seems uh that it could also apply to the the choices that we make in production. The the choices that entrepreneurs make. It's like oh this this entrepreneur is starting a new project. This looks great. There's lots of new employment. U this seems like it seems like it's going to be profitable. This is going to be great for everybody. you know the economy is booming so like you can imagine consumption is increasing but also there's all these new projects starting there's new investment uh going on as well um so I don't know I would I I'm just basically I'm just mentioning that there's this this hangover characterization and Austrians didn't reject that it's like oh yeah that actually is a pretty good characterization of our of our theory because there are mistakes that you know feel good in the short run so you know people are happy, but then it turns out that there are negative consequences. Uh but like like you emphasize in in order to see why it's a mistake and and see why there's this exciting boom period, you have to have this conception of capital existing in stages of production existing in stages because you need time for the boom period to last and then people realize oh oh we've made a mistake or oh now we have these negative consequences like we have shut down our business. We have to liquidate capital. We have to lay off workers. All those sorts of things that we associate uh uh with recessions. >> Yep. And and you're right, the that's partly why I liked Yudsk's analysis because it looked like he had either he read it from somebody else or he just rediscovered it, reinvented it. But his critique there was exactly why Paul Krugman and then also Tyler Cowan coming from a slightly different angle also didn't think the Austrian story worked and that um and like you say Krugman's theory rejecting the hangover theory and called it like the it's like the Fagistan theory of you know in terms of physics or whatever he just thought that's how crude and outmoded it was you know he he had a similar critique and then Cowan I know specifically was saying in the Austrian story why does that there there seems to be an asymmetry that they say, "Oh, the reason um the recession feels bad is that a lot of workers were in the wrong sector, you know, unsustainable lines that were only fueled by the, you know, cheap money, low credit, low interest rates of the boom period. And so then they have to get laid off and go somewhere else." And so Cowan's point was, well, if that feels painful, how come on the boom side when workers get sucked out of sustainable sectors and get channeled into what in retrospect turns out to be male investments, how come that isn't painful, too, right? And so there I thought the the obvious answer was well when it's fueled by cheap money the workers are bit away from where they originally were like so they're enticed by higher wages whereas in the bus period their employers and the you know in the unsustainable lines tell them you're out of work we got to lay you off and then they take the second best option after searching you know so that's why getting laid off feels worse than quitting your job and taking a better one right which one would think an economist would understand so there's that element so I did like that but let just not leave people hanging Jonathan that after I did such a good job I think with that Apple story trying to illustrate this is what Yowski is saying and you can see in that framework yeah duh obviously the waste happened before so that's when the pain should have been felt and if anything the sooner you recognize that these ladders don't work the better you know off you are because now you can just channel people back and you can get them back to grabbing apples with their bare hands and then consumption can go back to where it was what and so again the I picked that example because grabbing apples with your bare hands is a quick turnaround. You're not in a sense tying up your labor for long stretches before the finished consumer good pops out. But if we change the story to something equally silly and crude, I can show that Yudkowski's logic fails. And so this is what I wrote up in that article that you were alluding to, Jonathan, and we'll of course link to it, folks. But imagine a farmer, right? He's got all these acres um under cultivation and he's in a nice equilibrium where you know each harvest they get a bunch of crops. He and his family eat a bunch and uh you know then they sell some to get the equipment and things that they need just to maintain their operations. And that's a nice little pattern they have going and of course they replant and it takes a year for the full cycle to work, right? That you know they plant the stuff or whatever and then they don't get the harvest from that planting until down the road. And so for that to work physically, they must be carrying stocks of food from prior harvests, right? That the you can't plant today and then eat later today what you just planted. Obviously, there's a time lag and so you have to have previous savings for that to even work physically. So I'm saying in that scenario now suppose the farmer erroneously comes to believe that oh with these new irrigation techniques or maybe I'm getting you know new tractors or something or new fertilizer that I can just plant on half of my land as I was before and my crop you know my harvest will still be the same. Suppose he thinks that and so then he acts accordingly. He only plants on half the land as he previous he would probably pick, you know, the the most arable half of his farmland. And then on the other half now that's freed up. He doesn't need it anymore. He converts it into a golf course and puts in a giant indoor swimming pool with a water slide and everything. And now because he's only working half the land as he was before, he has more free time during this year and he uses that to, you know, play a bunch of rounds of golf. He goes in the in the pool a lot. And so then a year goes by. And so now finally we come to the, you know, the end of the cycle and he goes to harvest crops and he realizes to his horror that rather than doubling the output per acre, he only had like a 10% increase. So when you do the math, you realize he only gets 55% of the yield that he did the prior cycle. And so his family now for that upcoming year has to eat 45% less than they did last year. That's just mechanically that's what's going to happen because that's how much food got pumped out of the ground. And so I'm saying Udkowski if you looked at his analysis there would say to the farmer explain what happened and he would say well I made a terrible mistake. I malinvested my resources last year and that's why right now our consumption is going to plummet 45% and we're really going to be hungry for the next year until we can kind of revamp things and get back to where we were. And Yudkowski would say, "No, that's physical nonsense. Obviously, the waste happened last year. Right now, you're actually fixing things and you're doing the right thing going forward. So, your family should be able to eat fine now. It's last year when you were taking resources away from farming and putting them into the golf course and the uh pool. That's when you should have felt the pain. And yet, you were having a blast. You were out shooting golf and and going in the swimming pool. So clearly you must be mistaken when you think the waste happened in the prior year. Clearly the waste is happening right now. There's some systemic problem with sticky farm prices or something or some mechanical issue about taking food from the dirt into your kitchen. Something now must be going on. The pain, you know, if you think it was the past decisions you made, you would have already experienced that pain. So clearly, right, you can see that's goofy. And the fundamental fallacy in that ostensible critique is that there's a time structure of production that the, you know, the planting that he did during the last cycle would take a year to bear its fruits. And so if something happens, he's got a year mismatch where he could just be going along thinking everything's great and in fact living it up because he erroneously believes that he's setting motion operations that are going to give him a much higher yield down the road than what he previously was getting for his efforts. And that's why he can afford to live it up in the short term. And so that that phenomenon is what Mises classified as capital consumption. And when I responded to Krugman and Cohen back in the day, that's what I pointed out that they're overlooking the role of capital consumption. That that's how it can be that you can be enjoying real goods and services during the boom period even though you're doing male investments is because you're not replenishing the capital stock even though you think you are. that you're not you're not redirecting enough of the current output during the boom years into replenishing the factories and machineries and thing like that and just the complex structure of production such that down the road everyone's going to realize ooh we did not maintain the capital structure correctly and now we're in a pinch and physically it is impossible for real output to be what it was previously. we get we're going to have to suffer a period of privation while we replenish you know the capital structure and then we can return to our previous level but right now we physically painted ourselves into a corner >> yeah at at risk of inundating our listeners with uh too many analogies >> you can never have too many analogies but >> they're they're great they're great for teaching u in the past when I've uh presented Austrian business cycle theory I' I've used this analogy of uh cruso so going back to Cruso and uh suppose he's he's set aside a stockpile of of berries and coconuts uh either as like a buffer because he's not sure uh what his coconut and berry production is going to be in the future and so he he wants to smooth his consumption but also he can use it as a subsistance fund so that he can you know build a net or build a raft to go out and do some fishing. Um, so, so he set aside these saved resources and but suppose one morning Cruso wakes up and he finds these, you know, colorful mushrooms outside of his cave that he's that he's living in and he he thinks, "Oh, this here's here's some mushrooms. I guess I'll try them out." And it turns out that they're hallucinogenic mushrooms. And the nature of these uh uh hallucinations in my thought experiment is that it causes him to see way more resources than actually exist. So he consumes the mushrooms, you know, his eyes get big and he looks he looks at the his stockpile of coconuts and berries and it it looks like they're a hundred times bigger than they actually are. And he looks at his island and there's just, you know, stockpiles of raw timber. There's rope available. There's all these sorts of things uh available to him in his perception that don't actually exist. And so now think about what Crusoe might do in that situation. Suppose the hallucination lasts long enough for for this for this to occur. While while he thinks that he has more resources available to him, he would actually he would increase consumption and he would increase investment and he would start different lines of production than he would uh if he had a correct view a correct perception of his stockpile of resources. So if he sees that he has a hundred times more resources uh than he actually does, then he actually might start building a much bigger raft or he might start building a a huge mansion as opposed to like a small like leanto sort of shelter. Uh he might he might start building all sorts of things that he thinks he can now complete. He can actually go through with those with those projects. But of course uh so so the point is in in that sort of situation he would he would increase his consumption and he would start these new lines of production. It would look like his his little Crusoe economy is doing great. It's it's booming because he's able to do both. But what he's actually doing, you know, apart from his hallucinations is he's actually wasting resources. like he's he's putting the resources that he actually does have into projects that won't be able to be completed and he's also eating into his his subsistence fund. He's he's eating he's eating the coconuts and berries uh uh to a larger extent than than he otherwise would have which means that he's actually he's engaging in what you said capital consumption. He's he's decreasing his uh supply of savings. He's eating into his capital stock. And then once the hallucination wears off, once he has an accurate perception of his available resources, then he has to he has to do that he the best that he can do. He's got to, you know, break down the mansion that he started to build. He's got to uh replenish his uh subsistance fund. he he's he's going to have to constrict his consumption or restrict his consumption uh so that he can you know get back to where he was before uh based on an accurate understanding of of his supply of available resources. And the connection is this this is this is exactly what artificially low interest rates and new easy credit being pumped into the economy does is it gives this uh impression that there are more savings available. It makes it look like longerterm projects are now feasible and profitable. It makes it look like there's there's more consumption goods available to uh to be uh consumed. And so people consume more, people invest more. Uh not only do they invest more, so they're there's an increase in investment, but there's also wasted investment or malinvestment as Mises emphasized because they're putting these capital goods into projects that won't be able to to to pan out. And so there's there's a that realization is the bust. That realization that I've misallocated capital that I've eaten into my capital stock that my subsistence fund is much lower than it actually is. That's when you have to do all the correction. That's when you have to make the, you know, the hard decisions of how much am I actually going to consume on a daily basis now that I realize that my available stock of consumption goods is smaller and that I've wasted all of these capital goods and intermediate products in in in lines of production that aren't going to pan out. >> So, you're saying Ben Bernanki was a drug dealer? Yeah. >> Exactly. Yeah. I mean, it it it works um it works really well because it ties back to the hangover theory as well. It's like there's this there's this, you know, short-term boom that's fueled by wrong perceptions, right? Well, it's it's the same as, you know, somebody at a party who's drinking too much or or somebody who's, you know, taking cocaine and they feel great. They things are going, they feel like they can, you know, conquer the world, but then, you know, the high wears off, you have a hangover, the the real world strikes again. >> Yeah. Let me just So, I I like that and thank you for going through that. Let me just make sure though that the some viewers aren't taking the wrong lesson from this. We're not saying that, oh, it's all in your head, right? Because because I think that's what Yutoowski believes is that he's trying to show I don't care what people's perceptions are. No, they really are in measurable terms physically consuming more goods and services during the boom period. So, what are you guys talking about male investment? In other words, he's saying, "Yes, male investment does occur, don't get me wrong, but that's insignificant." Like that's that's swamped by something else is going on during the boom period that allows for people to consume more than they normally were. And that's why it feels good. And that's not just all in your head. They really are. And so that's so in Jonathan's story there, folks, the it was the misperception fueled by the hallucinogenic mushrooms of thinking he had more resources at his disposal than he really did that led Crusoe to make the mistake of eating more of his stockpile than he really would have had he understood the situation better. So he really, it's not just that he was imagining that he was better off. he really was eating more berries and coconuts or what you know fish whatever you said to stockpile was than he would have had he remained sober the whole time and so it's not merely an illusion he really was like did have quote a higher standard of living if those are the terms you want to use like like if he if he somehow knew like he saw a distant rescue ship or something and Crusoe realized oh wait I'm getting rescued in 3 days and then he just ate all the stuff he had stockpiled because he knew I'm fine in 3 days there's that's a sense in But you would have said, "Oh, yeah, he's he's better off." Like he like those three days would have had a higher standard of living for him than the prior three days. But then at the end of that, if it turned out he was mistaken and what he saw was just, you know, some smoke or something in the distance and no, no ship ever showed up, then he would be horrified and realize, "Oo, I just made a terrible mistake. I just completely ate all my savings." Right? So, and there again, it wouldn't work to say that. Oh, no. Really, the problem was So, anyway, there you there you go. I think we're just, you know, showing people that was the mistake Ukowski made in his sort of breezy armchair chair analysis. So now maybe in the remaining time I do want to go back to what you were asking about Jonathan. It's worth pursuing what Yudkowski what he thought a better explanation was because that also showcases I think the superiority of the Austrian approach and like you say drawing on insights from uh William Hut. And so I'll try to make this real brief what Udkowski says and and I should clarify. He wasn't saying the boom he wasn't praising the male investments of the boom. He was acknowledging that there is a wastage of real resources and if you could avoid that that would be better than not. Okay. Okay. So, and the reason I'm saying that, John, is because I made like kind of a smart Alec tweet because the guy Curtis Jarvin, some people may know him, I think it was like the same day or the day before, had said, "Oh, Trump should just order the Fed to to mint a million dollar or trillion dollar coin and platinum coin and we just solve this problem, go around Congress." And so, it was like all these right-wingers are coming out with, you know, wanting the trillion dollar coin and now Yudowski's praising the boom and what the heck. And so I was a little bit it wasn't what I that I said was wrong, but it was a little bit uh perhaps misleading and unfair. Udowski's position as I understand it is he's saying yes during the boom the way that plays out in a typical boom. There are investments made. People do invest re real resources into lines that they shouldn't that really is waste. The consumers really do end up with less stuff than would be the case if those resources hadn't been misdirected. That's all true. But he's saying there's something else that's superimposed on that that swamps that effect and helps us understand why does the boom feel good? And he's saying because at the start of the boom there were idle resources that there were a lot of workers looking for work. They were happy to work but they just couldn't find a match you know with their skill set and whatever and then there was employers out there and they just hadn't connected. Even though on paper there is a connection there that should have happened, but for some reason the market didn't do its job properly in this case, there's factories that could be running at higher capacity and they're not. And there's, you know, all sorts of real resources that are not being fully utilized for some reason on the eve of the boom. And then by creating more money and flooding the system with more money and making prices rise, that allows these win-win transactions to occur that otherwise wouldn't have. And he's saying that is what why the boom feels good is because the injection of money even though it does as an, you know, a byproduct cause some male investment, it's actually fueling a bunch of legitimate transactions that should be occurring and for some reason were not occurring on the eve of the boom. He's saying that's why the boom feels good. And then with the bust, he's saying the reason that feels bad, it's not because everyone realized, oh no, those male investment or those investments turn out to be male investments. He's saying, no, because again, the damage was already done with that. He's saying the reason the boom or the the bust feels bad is because of sticky prices and wages. And so when the central bank stops pumping in money and then all of a sudden there's downward pressure on prices that now the you get the you know the return of uh idle capacity that there's a bunch of workers now who can't get hired because you know the employer what the worker wants to get paid in nominal money terms is too high relative to the products that he he would help produce. And so the employers won't pay. that's not a that's not a real problem like the workers should be going to those jobs but there's a mismatch with the with the money prices and that's because of the central bank's mismanagement and so that's why he's saying as a final thing here uh Jonathan I'll turn over to you that's why Udkowski concludes and so if I'm right and this is the story of what goes on the long run solution is the central bank just needs to target stable nominal GDP growth in level terms like just to let everyone know oh yeah going forward ward the level of nominal GDP will rise whatever 5% every year and you can bank on that if it if it's only 2% one year then we'll make up for it and do what 8% the next year so that in the long run like we know what's nominal GDP in the year 2040 going to be people can be pretty sure about that because if it's if it overshoots or undersshoots the central bank will make up for it and he's saying that would totally solve all these problems you wouldn't have these recurring periods of idle capacity and then also you wouldn't have the male investment that happens right now with our current silly monetary policy. So that's his overall take. And now what what what do you say to that? >> I say people should read uh Joe Serno's reformulation of Austrian business cycle theory in light of the financial crisis. I think that's the full title. Uh and actually in that article he addresses I think it's uh Cowan's which you've also addressed in this episode and in your article uh Cowan's take on on what he sees as the the flaws of of Austrian business cycle theory and one thing that Serno points out in that article uh first first of all he sort of uh explodes the hydraulic view I would say that Cowan's view and Ykowsk's view and also Krugman's view is like this hydraulic view of of the economy that we just need to get spending in the right levels uh in in order to keep the economy on on this uh even track. Uh but another thing that or that he does later in the article is he he's he tries to explain uh successfully I think uh why why is it that we see these painful drawn out recessions you know even even taking out the uh government interventions that usually happen during a recession? Why why does it take time for an economy to to uh reallocate resources in a in a long run sustainable profitable sort of way and one thing that he points out as as a cause for this is he calls it entrepreneurial malaise which is interesting because it's sort of similar to uh uh like the Keynesian animal spirit sort of idea uh but but this is this is better this is like an appropriate way to bring in market psychology is what Serna says is that entrepreneurs in the bust uh they're going to be very reluctant to to commit resources into lines of production be because they were mistaken in the past. So like they they see we made all these errors. Um they see like big financial institutions are failing. Uh it's it's it's very risky. It's like this is not a you know a sure sort of thing for me to try to you know restart my business or start a new business in this time and so there's this reluctance on the part of entrepreneurs to reenter uh production because of what Solerno calls this entrepreneurial malaise and this explains why it it can take some time like years maybe for um the for production to get kickstarted again for for people to to become employed for capital to be uh reemployed in production. It's because it's because they were fooled before. They were they were given bad information. It's like Cruso with the hallucinogenic mushrooms or the farmer who had this incorrect anticipation of what his his yield would be on on even the half uh the half portion of of his farm. They so they had this incorrect information and so they might be a little more reluctant to to to make those decisions going forward. And so this explains why it it can take some time. Okay. So so this is where the sticky prices and sticky wages and idle resources come into play. So if you think about like what what needs to happen during the correction is you need entrepreneurs to see profitable lines of production and and then employ people and create capital goods and get those lines of production going. In order for that to happen, they have to have market prices that reflect the the real scarcities of those things and the the real uh values of those things and and and actually correct or a better anticipation of what revenues will be in the future. And so if you if you try to interrupt that process or if you try to um hasten that process, I guess I should say, with with more money printing, even in the name of something like nominal GDP targeting, what you're doing is you're actually distorting those prices yet again. You're you're just you're giving the economy the same thing that caused the entrepreneurs to make those mistakes in the first place. And so what needs to happen is you need you need prices to change. Sometimes that can take a while. You need wages to change. You might need wages to fall in some cases and and that's painful, right, for somebody to take a pay cut, but you need those sorts of things to happen so that entrepreneurs can find the profitable lines of production that are sustainable that are in accordance with the actual supply of of real resources. Now, with the the sticky price and sticky wage thing, uh like one uh um one thing that we can say about that is that it actually represents people's real values. So like if if a work suppose I'm a worker and I'm reluctant to take a pay cut. So which would mean that it would take longer for my wages to decrease. Uh what that what that means is that I anticipate that there are better prospects for me uh in in seeking alternative employment than staying in the same job and receiving a pay cut. So this worker is actually doing the same sort of corrective thing, same sort of corrective process that the entrepreneurs need to do in in seeing all of their different options in including what uh Solerno and Hut have called employment and job prospecting. It sort of sounds like a euphemism, right? It's like we're just trying to make unemployment sound better, but that's not the case at all. like we're what we're trying to or what they are trying to say is that if if somebody thinks that I I can spend my time better by looking for other jobs, other employment opportunities that would pay pay me at least as much or even higher, then I think that that's a better use of my time than staying in my same job and receiving a pay cut. So, it's the it's the same sort of thing. It's market participants seeing the options available to them. And if we allow prices and wages to do the adjustments that need to happen, then we'll get then we'll correct the errors. We'll get into a a more long run sustainable structure of production that actually can be completed with the actual supply of real savings. >> Yeah, great stuff there. And uh for the more academically inclined listeners, let me just mention that piece that Jonathan just alluded to there in terms of like you can say, oh, there's search costs or something like that. You know, when when a worker's laid off, they have a skill set and there's employers out there that might be willing to hire them and then it's a matter of just them finding each other and you know, you got to know at some point, well, do I keep looking for a job? The on the margin am I likely to find a better offer? you know, there's decision problems you can cast in those terms. And so there's a whole neocclassical literature on that stuff and it's part of it's related to what's called real business cycle theory. And so what I like about the Austrian approach is, you know, and this goes back to at least 1912 when Mises first laid this stuff out is that the Austrians I think from the beginning their theory involved the strengths of all the different subsequent schools. like the Keynesians just focus on spending and you know monetary factors and things like that you know nominal magnitudes monetary issues not real ones whereas of course the real business cycle theorists view oh what happens in a recession is there's a a shock to productivity and then there's this mismatch and then yep unemployment jumping to 12% that's the optimal response given that shock and so blah blah blah and the Keynesians make fun of them and say oh so your theory of the 1930s is to call it the great vacation because workers all optimally dec you know what I mean So I think that the two schools like like they both have strengths and weaknesses and the Austrians I think take what's good in both but it's not just because the Austrians expost looked around and had went to a buffet. It's like the Austrian had their coherent theory at the beginning which I think you know has the right elements these layer people are just grappling with in terms of like you know one guy touching the elephant in one spot versus the other. And so the Austrian theory is like a a monetary theory of disturbance, but then it has real effects, right? And and Mach has a a quote to that effect that I'm I'm not going to remember the exact wording of it right now. So that's why I think it is good that yes, there are monetary disturbances and it's not just that the economy's h chugging along and then there's some shock to you know agricultural output or you know sunspots or what like no there's the shock comes from the financial sector. So that banks matter even though guys like Scott Sumner literally don't have banks in their model and are proud of that fact. So I think the Austrians acknowledge that yeah banks do matter but they also realize that you know once a bunch of workers have been in the wrong line for two years you can't just snap your fingers and have them go to the right spot and just to say oh why don't we just have the the federal government run huge budget deficits that'll fix it. Like you're leaving out a lot of nuance and no it matters where people are working. It's not just get people to work so they can spend again like that's way too crude. I can't believe we're having this conversation and yet we are. So um one thing Jonathan on this issue of idle capacity that I know Mises does in human action is he's like he he first explains his theory of you know the what we call Austrian business cycle theory there. I think you call it the circulation credit theory of the trade cycle. But um as if the economy originally is in like total long run equilibrium and then out of the blue for no reason the banking system decides to inflate and push interest rates down artificially to the levels that sets off a boom and so on. But Mises acknowledges in the real world often what happens is you start out with the hangover, no pun intended, from a prior cycle. And so that's why you do start out not at full employment. And so there does seem to be a primmaacia justification for oh yeah, why don't we just in expand the supply of credit and get a bunch of people back to work? How could anyone complain about that? And so Misa's point is like you said, Jonathan, you're just continuing the same cycle. You're never going to get out of this. keep spawning the very thing that's causing the problem on the back end. The only way you're going to get to a long run sustainable level of full employment, if you want to use that kind of terminology, is if you stop inflating and just let let it play out once and then you'll hit rock bottom and then going forward will be sustainable growth. Whereas if every time you can't tolerate the last vestages of the bus because it's too painful and you decide to inflate again, all you do is just blow up another bubble that's going to then lead to the same thing five years from now. Yeah, another uh great quote. So, like you sort of went back into the history of thought. One thing that I uh pointed out uh in response to Yudkowsk's uh very very very long uh tweet, he he probably could have been more brief, don't you think? >> He could have he wasted some some resources. >> I I pointed out that uh uh back all the way back in 1867, there was this guy named John Mills uh who was friends with uh Jebans, by the way. Uh you mentioned the sunspot theory. Jebans is famous for the sunspot theory. But John Mills uh he he wrote this um this essay on the credit cycle and he actually pointed out he he said uh as a rule panics do not destroy capital. They merely reveal the extent to which it has been previously destroyed by its betrayal into hopelessly unproductive works. And so I was very intrigued by that quote. It's like it's like this little nugget of Austrian business cycle theory all going all the way back to 1867. So I I went through John Mills um credit cycle as he called it and what what was interesting is that there were some Keynesian elements there because he he brought in a lot of market psychology like you know there's there's over optimism and there's pessimism and like those sorts of things are changing and it depending on the the phase of the cycle but near the end of the essay the thing that he pinpoints is what causes this this phenomenon of of people putting capital into what he called hopelessly unproductive works was artificial credit. It it was an extension of credit beyond real savings. And he's got some graphs to show that as well. So I I sort of latched on to that and did I wrote an article about how there were some like protocanesian and protoastrian elements. Um but the reason I bring it up is just to show economists have been talking about this sort of stuff for a very long time. Uh, and it seems like Yudkowski is is stuck in in this market psychology view, sticky wage view, sticky price view, idle resource view, and also a hydraulic view of the economy that has I think has been destroyed by economists since then. >> Yeah, definitely. And that's interesting. I hadn't heard of that and I'll you'll have to after. >> You haven't read my article. Come on, Bob. >> I No, you can send it to me and we'll link to it, too, folks. It'll be good stuff. Well, at this point, I think we should wrap up. Otherwise, our discussion will end up being longer than Yukowsky's original tweet, which was quite long. And so, we will end there. So, thank you, Jonathan, for your time and insights as always. >> Yeah. Thanks for having me, Bob. >> Thanks everybody for tuning in. We'll see you next time. Check back next week for a new episode of the Human Action podcast. In the meantime, you can find more content like this on mises.org. [Music] [Applause] [Music] Heat. Heat. [Applause]