Über die Autorin bzw. den Autor

Harry C. Veryser has served as director of the graduate program in economics at the University of Detroit Mercy and chairman of Walsh College’s Department of Economics and Finance. He is also a businessman who owned an automotive supply company for many years. Veryser is an associate scholar of the Ludwig von Mises Institute and serves on the advisory boards of the Mackinac Center for Public Policy and the Acton Institute for the Study of Religion and Liberty. In 2003 he was one of ten professors in the United States selected to receive the Will Herberg Award for outstanding faculty service from the Intercollegiate Studies Institute. He lives in Michigan.

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IT DIDN'T HAVE TO BE THIS WAY

ISI BOOKS

Contents

Introduction It Didn't Have to Be This Way...........................1Chapter 1 A Science of Human Action..................................9Chapter 2 Looking at Today and Dreading Tomorrow.....................21Chapter 3 A Short History of the Austrian School.....................33Chapter 4 The Age of Classical Liberalism............................63Chapter 5 Chaos: The Legacies of World War I.........................79Chapter 6 The Age of Bretton Woods...................................105Chapter 7 Nixon's Folly..............................................115Chapter 8 Reagan's Rally.............................................131Chapter 9 The Division of Labor......................................147Chapter 10 The Prerequisites of Prosperity...........................165Chapter 11 The Nature of Human Action................................191Chapter 12 Inflation and Deflation...................................205Chapter 13 Faustian Bargain: The Trade Cycle.........................225Conclusion The Austrian Moment.......................................257Notes.................................................................261Bibliography..........................................................279Acknowledgments.......................................................295Index.................................................................299

Chapter One

An economist is someone who sees something happen in practice and wonders if it would work in theory. —Ronald Reagan

Does economics have any real value?

That blunt question has been voiced with greater frequency in recent years. After all, mainstream economics, with its cherished theories and complex mathematical models, failed to predict or to prescribe adequate remedies for the economic meltdown that began in 2007. These failures led liberal columnist Paul Krugman, the 2008 winner of the Nobel Prize in Economics, to call the previous thirty years of macroeconomics "spectacularly useless at best, and positively harmful at worst." Similarly, Willem Buiter of the London School of Economics described the past three decades of macroeconomics training at American and British universities as a "costly waste of time."

It's not just macroeconomics that has been called into question. Financial economics was another key culprit in the crisis. The Economist observed: "Convenience, not conviction, often dictates the choices economists make. Convenience, however, is addictive. Economists can become seduced by their models, fooling themselves that what the model leaves out does not matter." Wall Street fell in love with "the quants," the math whizzes who devised new investment technologies to slice, dice, and repackage all sorts of different asset classes. Wedded to its mathematical models, The Economist continued, mainstream economics became "a poor guide to the origins of the financial crisis, and left its followers unprepared for the symptoms."

Investment wizard Warren Buffett put it succinctly: "Beware of geeks bearing formulas."

Claes Ryn, a professor of politics at the Catholic University of America, explains how the embrace of models and formulas led to a decline in morality: "In finance, rationalism and mathematicization inspired trends towards ever-more abstract, amoral operations. It assisted the progressive fiscalization of the economy. Not only equities but also the creation of intricate new fiscal instruments, such as derivatives and, most recently, 'credit default swaps,' created opportunities for shifting assets and control to financiers far removed from the people actually running the business or lending money."

But the practitioners of strictly mathematical economics had the utmost faith in the wisdom of their approach. Several years ago a dean at one of the schools at which I taught economics and finance criticized our department for its lack of "rigor." He advocated a heavily mathematical approach (he used phrases such as "mezzanine financing" and "subordinated debt") and challenged us to teach something called financial engineering. Asked what financial engineering was, he said that it gave one the ability to transform what might be called dodgy debt into AAA bonds by the use of sophisticated statistical tools. When I replied that I thought this method would simply cheat a lot of little old ladies out of their money, he became incensed and told me that he had letters from companies who would not hire our graduates because they were not sufficiently trained in this alchemy.

That was 2005. Today many of those companies are gone, and they left a lot of empty retirement funds. The ladies were cheated out of their money as the world economy suffered a multitrillion-dollar meltdown.

Although the technologies that allowed the proliferation of mathematical models were new, the attitude underlying them was anything but. For centuries, economists have tried to imitate methods from the physical sciences. More important, they have tried to put economics on par with the hard sciences, to afford themselves the lofty status of scientists. F. A. Hayek, one of the leading members of the Austrian School, explained how this process played out in the first half of the nineteenth century:

The term "science" came more and more to be confined to the physical and biological disciplines which at the same time began to claim for themselves a special rigorousness and certainty which distinguished them from all others. Their success was such that they soon began to exercise an extraordinary fascination on those working in other fields, who rapidly began to imitate their teaching and vocabulary. Thus the tyranny commenced which the methods and techniques of the Sciences in the narrow sense of the term have ever since exercised over the other subjects. These became increasingly concerned to vindicate their equal status by showing that their methods were the same as those of their brilliantly successful sisters rather than adapting their methods more and more to their own particular problems.

Therein lies the flaw that has led so many commentators to question the value of economics. The problem lies not in economics per se but rather in a distorted understanding of its role and ambitions. Economics is not like physics or chemistry. One of the fundamental contributions of Austrian economics is to remind us that economics is a science of human action. As Hayek put it, the vigorous attempts to mimic the methods of the physical sciences have "contributed scarcely anything to our understanding of social phenomena." The failure to predict or solve the economic crisis is only the latest and most dramatic example of the lack of understanding that the modern economic approach yields. Mainstream economics has adopted the wrong ambitions and the wrong methods.

To get the economy back on the right path requires a proper understanding of the role of economics.

Economics as a Science: Two Paths

When Hayek refers to "the Sciences in the narrow sense of the term," he reminds us that the sciences have traditionally been understood more broadly than they are today.

Writing more than two thousand years ago, Aristotle divided the sciences into three categories: speculative, practical, and productive. Speculative...