Published in The Sydney Morning Herald, 11 October 2010
A history lesson on the ideas of a 1920s economist help explain the global financial crisis, write Greg Lindsay and Oliver Marc Hartwich.
Sydney is hosting this year’s general meeting of the Mont Pelerin Society, founded by the Austrian-born economist Friedrich Hayek. The ideas that this group of liberal intellectuals aim to spread remain as relevant as ever, no matter how much some politicians try to discredit them.
When Kevin Rudd stumbled his way through political and economic philosophy in 2006 and 2007, he caricatured some of Hayek’s ideas.
Whether he meant to or not, he elevated Hayek to the national stage, at one point slugging it out on the opinion pages with the then prime minister, John Howard, over aspects of economics and public policy. Rudd claimed Howard was in the thrall of this mysterious Austrian and was leading a government of economic fundamentalists. Historians will judge the economic success or otherwise of the respective governments.
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Discussion of Hayek’s ideas and the Austrian school of economics have had a lot of attention recently.
Hayek was awarded the Nobel prize for his ”pioneering work in the theory of money and economic fluctuations” and for his ”analysis of the interdependence of economic, social and institutional phenomena” based on business cycles in the 1920s, before the Great Depression.
In many ways the 1920s were a time of optimism, just like the years before our global financial crisis. Then many believed economic crises were a thing of the past, just as in our times British prime ministers claimed to have abolished ”boom and bust”.
The British economist John Maynard Keynes boldly declared in 1927: ”We will not have any more crashes in our time.” His US colleague Irving Fisher stated that ”prices have reached what looks like a permanently high plateau”. Just days later, the sharemarket crashed.
Against this widespread optimism, Hayek stood alone as a doomsayer. Where most of his colleagues saw endless prosperity, Hayek warned of the coming depression. What had made him so pessimistic?
Hayek’s research had focused on the role of interest rates in determining the structure of production. He was certain that interest rates had been too low for too long and that the result was widespread malinvestment. The boom of the 1920s, Hayek believed, was suspicious – one that could not last and would end in tears.
Hayek was right. The bubble burst and left the Great Depression, with all its terrible economic, social and political consequences.
If this reminds you of our recent problems, it should. The parallels are all too clear. In the 1990s and early 2000s, interest rates, particularly in the US, were often kept at low levels. At one stage the Federal Reserve lowered them to just 1 per cent to fight off a recession. It would seem our local authorities have been more mindful of Hayek’s warnings.
These circumstances would undoubtedly have reminded Hayek of his earlier work. He would have warned again that interest rates as low as this (effectively free money!) would inevitably lead to highly speculative investments (as they did). The boom before the US subprime collapse would have been as suspicious to Hayek as the 1920s boom had been.
The economic disaster we witnessed was not the result of following Hayekian theories; quite the reverse. It was the consequence of ignoring his warnings of distorting interest rates and reckless monetary policies.
”Past instability of the market economy is the consequence of the exclusion of the most important regulator of the market mechanism, money, from itself being regulated by the market process,” he once wrote.
It sounds as if he had referred to the Federal Reserve’s most recent ultra-loose monetary policies.
These ideas have a particular resonance in Sydney this week, where the society’s 38th general meeting is being held. Past and present members include eight Nobel laureates in economics, political and judicial leaders and academics.
It is appropriate for the society’s international members to visit Australia. Its position of economic strength owes a lot to Hayekian ideas of freedom, competition and discovery. Australia remains one of the best case studies on the power of market-based reforms.