Recently Margaret and Bob attended an economic forum in San Francisco which was sponsored by the Mises organization (named for the Austrian economist, Ludwig von Mises) to promote the study of the Austrian School of Economics.
Most readers have never heard of the Austrian School, but in our opinion, they make the most sense of all. When I was in college, Keynes was dead. Though it has been more years than I care to remember, during those days, there was no conviction of deficit spending. To refresh your memory, John Maynard Keynes (pronounced "canes") was the famous English economist credited with pulling the world out of the Great Depression. His solution was to spend, spend, spend and then spend more. He theorized that if a government spent money they did not have (deficit spending) then the extra money in the money system would circulate and eventually be spent by the citizens and businesses of the country. This would lift them out of any recession.
This is precisely what our Federal Reserve System and Treasury Department are doing. They are racking up huge obligations in an attempt to stimulate our economy. So far the results are mixed. They (the Fed and Treasury) are patting themselves enthusiastically on the back and congratulating themselves for staving off the Second Great Depression. The truth of this may elude us for many years but suffice it to say, they are at odds with the Austrian School of Economics. And, the Austrian School fits our beliefs.
Basically, the Austrian School believes that all economics is a matter of choices. Those choices involve making decisions either to meet present desires and needs (through consumption) or to stall off future pain by saving and investing. The most interesting thing about the Austrian School is they have almost no math in their study! Today, if you are going to get a PhD in economics from a major university, you had better be a closet math major. Today's world of economics is all about complicated financial engineering and complex models that only an economist can interpret. The Austrian School believes that human nature and their decisions cannot under any circumstances be modeled or put into a nice box.
The reason AIG failed and so many of the banks failed is because of the financial engineering and modeling of derivatives. While it is not our purpose to discuss derivatives and how they work, they are basically a speculative instrument or a risk management instrument, depending on how it is used. Today, there are over $600 trillion of derivative contracts worldwide, a number that easily surpasses all world economies by a factor of twelve. In other words, the total annual GDP is about $50 trillion so all the derivatives are worth more than twelve times all the world's economies, a truly frightening number. The collapse of many of these can be traced to AIG and some large banks. AIG was brought down by their financial products division of about 250 folks in the London office who thought that they were smarter than human nature.
It has been our belief that the recession will not end the way most economists believe. Most of them are convinced that Americans will soon pick up their pens and checkbooks and resume their free-wheeling spending habits. We respectfully disagree. We believe that we are seeing a true paradigm shift in behavior. Americans are no longer satisfied with consumption to keep up with the Jones but are actually looking for a better quality of life. They want peace of mind, family relationships and a sense of community. After all, many thought they would get that better quality of life by spending more. Now they know that is a false assumption.
Meanwhile, economists around the world are busy constructing more models to show why consumers ended the recession in July. Enter the Austrian School. They postulate that deficit spending is bad and that the solution to a recession is to allow the free markets to work. In other words, if housing prices drop low enough, then people will buy. There is no need to prop up prices. They also believe that savings and investments are the key to stimulating an economy. By delaying gratification into the future through savings, money can later be used to build manufacturing plants, build equipment, and hire employees. In other words, we save for the "golden goose" so we have a steady supply of "golden eggs." The current Keynesian belief is throw lots of money to everyone and they will spend. This is much like the Field of Dreams philosophy (our interpretation) which says "spend it and they will come!"
Happily, we are seeing evidence to suggest that the economists of today are truly clueless. One year after the feared collapse of the banking system, very little has changed. Derivatives are still being used for speculation, risk has not diminished and the banks have shifted causing more big banks to get bigger and bonuses are expected to be at record levels this year. The reason is simple: economists are expecting life to return to normal.
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Americans are smarter than economists! Furthermore, they are sick and tired of being in debt, not having savings and being pressured with declining losses in the stock market, their 401(k) and home values. The Fed quietly announced (can't let this news out to economists) last week that Americans are shedding debt. Not only that but they are doing it at an accelerating pace. In July, debt reduction was at 10.3%, the largest annual amount since 1975. Take a look at the chart below:
Credit peaked in mid 2008 which was right before the major collapse. Since then, over $100 billion of credit and debt has been slashed. This is a huge reduction indeed and has taken a huge chunk out of loanable funds.
This is truly exciting news! You gotta be proud of all of us right now. We all bucked up like old pards and weaned ourselves off the easy money. We turned away from the seductive call of the Sirens and eschewed digging a bigger hole. Interestingly enough, the economic modelers predicted that credit would contract by $4 billion in July and not the $20 billion that actually happened. Another interesting point is this occurred during the "cash for clunkers" program. That was the governments attempt to get people to trade in their old automobile for $4,500 and a debt service obligation of $20,000. People still de-leveraged and paid down bills. As we said, Americans are wising up.
Take a look at the next chart. This shows the rapid escalation in debt since 1990 when the good times really started to roll. Consumer debt and credit almost doubled from 1999 when the housing boom started to take off to 2008. All of this implies that Americans lost interest in saving and found that their house was a great ATM machine to help them buy new autos, furniture, remodels, timeshares and just about anything else to help fuel a better lifestyle. As the chart shows, that is ending and the debt picture is really looking much better.
Since 2006 when the savings rate was less than 0% (actually we saved a negative -0.2% at our worst) we are now just shy of 7%. This is huge and is truly what Americans are made of. We have seen the enemy and he is us, as Pogo would say and now we are taking corrective action. We are losing our taste, not for the good things, but for the good things that enslave us. We had fun while the party lasted and the punchbowl was full but we had our fill and pay back time is here.
The Austrian economists point to this as evidence that you cannot model human behavior. You cannot force someone into a box and assume that they will spend just because we tempt them with incentives. At some point, people realize that the cost of long term future pain is simply not worth the short lived joy of immediate gratification. As our government and politicians grapple with trying to make utter nonsense work, everyday folks are quietly doing the right thing. Our prediction is this will create a better and happier society and leave the experts scratching their propeller heads for years to come!
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