Can the Free Market Stay Free?

Elaborating on the Austrian Time Preference Theory

Elaborating on the Austrian Time Preference Theory
by Alex Merced

I write this article after listening to Robert Murphys lecture Capital and Interest from Mises U 2010

While Listening to this having heard explanations of Time Preference theory plenty of times, I started having flash backs to an Austrian Scholars Conference lecture where Robert Murphey was actually giving a critic of the ATPT based on his dissertation, basically challenging the idea that a future good is always less valued than a present good. This made me start to think, I do understand ATPT, but I'm not sure if it fully explains why this preference exists fully other than a sort of hedonistic view of human nature to want to satisfy all it's wants now. Then again Patience is a virtue, and one can look at virtues as efforts to fight human nature.

First off let's recap the ATPT for those of you unfamilar...


Austrian Time Preference Theory

The Bottom Line: Present Goods are always more valuable then Future Goods

Example: Pre-Sale Tickets (future good) are cheaper than tickets at the door (present good)

This is an important theory for explaining the Austrians view on Capital and the Interest from Capital. For example I have a $100,000 and I have these two choices which would I make.

Buy $100,000 of Bonds and invest them in Bonds that yield 5%

or

Buy a $100,000 of fishing supplies expecting to catch enough fish to make $110,000 (10% yield)

So you see here the capital I have I'll put towards the fish equipment cause In the end I'll have a greater yield from my investments, this is how capital naturally gravitates towards it's most productive purpose. If my calculation was correct I can now buy another $100,000 of fishing equipment and next year catch enough fish to make $220,000. As you can see the more I go through this process the more capital I accumulate and the better my life gets even though no new science or technology has been developed, cause I've accumulated capital and can continue to re-invest that capital for interest.

This is what seperates developed countries from developing countries cause they may only be able to afford $20,000 of fishing equipment so a year later they'd only have $22,000 so it'll take some time and re-investment before the capital accumulation brings them to the developed level.

So where time preference theory comes into play is in the issue of why would someone pay me $110,000 for the fish if they can instead get the same fish by buying the Fishing Supplies for $100,000 and save themselves the $10,000. The reason is cause they have a time preference, they don't want to have to wait for a year of fishing to save $10,000 so they rather pay the extra $10,000 to have the fish now. So as we stated, the current good, these fish I've already fished is worth more than the future good, the fish they'd fish if they made the same capital investment.

Ok, so that should sum it up, so now for my addition...


Is it a "Time" Preference or a "Tangibility" Preference

I think the time preference exists not cause there is a time bias, but because there is a tangibility bias. A future good isn't as tangible as a current good so provokes less of a reaction. This Tangibility preference can not only be applied to intemporal scenarios but also other scenarios of differeing subjective values.

Example 1:

"The Stimulus Bill has saved the Jobs of Teachers and Public Sector Workers"

or

"If the Government had not gotten involved new jobs would've been created from capital reformation"

You ask the typical person which statement seems more plausible, they'd more than likely say the bizzarre keyensian statement I put up first. Why, it's more tangible to them cause they see the jobs that would've been lost, but they can't see the jobs that were prevented from being created. Now of course an Austrian is trained to understand opportunity cost so the increased tangibility from that understanding may have them choose the second statement.

Example 2

"Spend 10% of Income on Your Loved Ones"

or

"Have 10% of your income taxed which hypotheically benefit your loved once objectively just as much"

Which one you'd think a person would subjectvely value more, the first statement cause the results of this same expenditure is tangible, this would probably be true if the tax money got spent in the same way at the same time cause of it's tangibility. Although a left wing Keynesian might actually value the second statement cause they've been trained to value the benefit to society of impersonal expeditures like in the second statement so them it'd be more tangible.

So in conclusion, I feel time preference is a preference that exists but because of the tangibility of intemporal value. I would expect that a Austrian who is trained to think intertemporally would prefer future goods on occasion, cause it's more tangible. For example we prefer the future value of recession that the current good of stimulus spending. While it's a bit more complicated than simply jobs now versus jobs later a lot of Austrian theory actually emphasizes long term benefits over short term.


If you agree, we can still call this the ATPT, it'd just now stand for the Austrian Tangibility Preference Theory

Addendum to Robert Murphy's Lecture by Alex Merced

Addendum to Robert Murphy's Lecture 
by Alex Merced

This is just some comments to add my two cents to Robert Murphys Responses to Critics of Austrian Economics.

Critic: How come unemployment wasn't the worst in the states that had the worst housing busts if it's a mal-investment problem?

RPM: The data actually is more in line with the Austrian Theory if you widen the time frame for calculation from the peak of bubble.

My Response: Just cause unemployment doesn't follow the size of the local busts means nothing, the mal-investment is only the seed who's roots implant itself all over the economy in different ways. Since wages increases due to the bubble, industries grow in areas not related to the bubble industries cause all industries suffer a mini bubble from the consumption boom from the high wages that originate in the bubble industry and spread elsewhere (how I'll explain in my response to the next critic). Another factor for differing state data is state and local legislation and culture which might magnify or dampen the effect of the bust.

Critic: If Mal-Investment is the problem during the bust why do consumption and investment move together during the bust and boom, why isn't their unemployment during the boom?

RPM: Murphy does a great refute explaining how people who take on these new higher wage jobs in the bubble sector don't realize it's bubble sector so they consume with the assumption that they'll make those wages forever. He also makes an amazing point that you don't have unemployment during a boom cause no one is losing their jobs but instead leaving their jobs for "seemingly" better ones, while during the bust people are losing their jobs and try to find another at a similar level so it takes time before they adjust their expectations. (I elaborated a little on RPMs response, listen to the lecture itself, it's really good)

My Response: The Only thing I would add it that when people leave their jobs for higher wage jobs in the bubble sector, to attract replacement labor all other sectors will raise their wages making it seem like the economy as a whole is doing well. Although, these wage rises are not cause of productivity gains, but because labor supply issues so this puts more pressure on the price inflation seen on the bubble as businesses charge more for their goods and services to pay these higher wages. So this wage competition aspect of the bubble is what helps systematize the bubble and dig it's root into the rest of the economy, cause now all jobs are paying unsustainable wages to compete with the bubble sectors wages.

Critic: Can the ABCT occur absent of central bank, and during a 100 percent Gold Reserve system?

RPM: Murphy Wrote an article which I read, which he brings back up here during the lecture. Basically he doesn't come down on either side of the question but instead makes Rothbardian arguments for both sides. Read the article to see both his arguments.

My Response: What I want to say that the Austrian business cycle as it's commonly thought about can't happen in a 100% reserve gold standard system cause of one crucial element... expectations. One thing that drives bust from low rates is the expectation of those rates persisting or the money supply continuing to increase. In Murphys example, someone comes upon a huge cache of gold, but this is a one time injection of money and yes there will be price adjustments to all goods from the increased money supply, but I doubt mal-investment will occur because the expectation that he'd continually find huge deposits regularly isn't a logical expectation. Under our current system, it's very logical to conclude the fed will continue to prime the pump, so these expectations drive the bubble behavior. In the end, with 100% reserve banking there is no way to expect a predictable trend of money supply growth to allow the bubble expectations/speculations to be held long enough for a large systematic collapse.

Reading List for learning about Recessions, Depressions, and Financial Crisis'

Hey Guys,

To really appreciate the importantce of understanding economics, and austrian economics primarily in the fight for liberty one must understand history. Why? It's when the economy is at it's weakest that the biggest losses of liberty is justified, so understanding what causes a recession or a depression is important in understanding what leads to liberty lost.

As Far as Understanding the Current Crisis, I would recommend reading the following, in the following order:

Tom Woods - Meltdown: This is probably the best introduction to the current crisis available, it's a quick read yet is able to get a whole lot of information across as well as a solid foundation in austrian economics for any beginner. This is a must read and provides you with the intellectual understanding of history and economics to go toe to toe with any enemy of liberty.

Johan Norberg - Financial Fiasco: While not a book with any ties to austrian economics, this is a great book to fill in the play by play of the events surrounding the Financial Crisis. In this book you learn who were the key players, and go in depth into all the mechanisms that are mentioned by Tom Woods in Meltdown, great follow up read to Meltdown. So while Meltdown paints the big picture very clearly, Financial Fiasco paints all the details of what was the perfect storm.

Charles Goyette - The Dollar Meltdown: After reading the previous two books you will definetley be left with the question... "so what's going to happen to the dollar?". Charles Goyette does a great job of focusing on how the crisis, the response to the crisis effected the US currency and how to prepare for the inevitable currency crisis that will come out of those events. You also learn some great history of money and how inflation has brought many nations to their knees.


After reading those three books, you should have pretty in depth knowledge of the crisis, the response, and what's to come but in all three books a portion is spent revisiting the great depression. While these books serve great introductions to great depression, a part of history clouded by many misconceptions, what are some goods sources to learn more about the great depression?


Robert P. Murphy - The Politically Incorrect Guide to the Great Depression and the New Deal: I just got my copy signed by Murphy himself at the recent Mises Circle in NYC which was a treat. This is a great book that addresses every misconception about the great depression, and can even serve as a great introductory book into economics.

Murray Rothbard - Americas Great Depression: While I've only read certain portions of this book at the moment, this is widely recognized as the source for history of the Great Depression. This is a larger and more advanced book written by one of the greatest economic minds to have ever lived so I'd recommend reading Murphys book before tackling this tome to the great depression.

Enjoy!

Alex Merced

Where Supply Side and Demand Side Economics Went Wrong

Individualism, Creativity, and Innovation

Individualism, Creativity, and Innovation
by Alex Merced

Premise 1: That creativity comes from tapping into your inner child

 Kids say the darndest things don't they? It's this innocent nature that we admire in kids, when they are young before society begins socializing, limits, values, artificial barriers in their minds. Even then, during their adolescents they typically rebel against many of these constructs until one day the fight becomes to much and "they grow up". It's when one loses the ability to think beyond the barriers given to you that creativity dissapears and only your ability to see what is seeable is there, and you lose the ability to see what is not there.

Think of all the people you consider creative, arn't they generally playful and childlike and then think of all the frumpy people you consider an "adult" and put their creativity into perspective. So in economics the idea of seeing the unseen is called "opportunity cost", the unseen costs of every action you take. To be able to appreciate opportunity cost you must have this childlike nature to see beyond the barriers given by society, you must be creative.

This is why I feel I see such a stark difference from when I see Austrian economist who are generally very light-hearted and humorous versus Keynesians who are usually more cynical and serious. Yet, it's the Austrians who are more equipped to see the unseen opportunity costs, and realize what could have been to look to the future to see what could be. Keyensians, on the other hand focus on only known results to draw conclusions, and only draw self-destructing solutions based on actions that have "visible" results even if the results don't accomplish anything.
(For example, deficit spending has the visible result of increasing GDP but it doesn't fundamentally fix the real, unseen problem of diverting capital).

Another place I noticed this was on a recent interview with Ron Paul on Hardball where the serious and cynical Chris Matthew interviews the optimistic and light-hearted Ron Paul and discusses how Paul remind Matthews of his childhood hero, Barry Goldwater, but then he grew up. This was a sad and depressing statement that shows that at some point he gave in to the barriers that society imposes and became an "adult", while Ron Paul was able to this day in his 70's retain that childlike innocense that allows children to see things for what they are not how society wants them to be.

Do an experiment, give the facts to a child on a issue, and ask for their response.







Premise # 2: Collectivism kills Creativity, while Individualism births it

Creativity must come from an individual with little barriers of the mind as possible, although to think in groups and collectives as done in a collectivist framework would mean imposing more barriers in order define yourself into this "Collective". To see why this would be the case watch this video on the difference between Individualism and Collectivism:









Premise # 3: Innovation comes from Creativity

Innovation results from finding news way to do the same things, which will results in needing less time and resources to survive and spend more time on leisure and personal interests which is a true increase in the standard of life which can be numerically measured. Although innovation requires two things:

1) Investment: These Innovations require capital to develop and distribute, without investment there is no way to develop the most useful innovations.

2) Creativity: You can have all the capital for investment but if there is no ideas to invest in, it's useless, so you need creative people to see the unknown whcih can be developed.

So creativity is pivotal in the process of Innovation, so creating a individualist framework for inviduals to grow up with actually would increase the rate of Innovation and increase the quality of life of these individuals who use these innovations.


Premise # 4: Government Destroys Innovation

Government with it's coercive monopoly on violence accomplishes two things that destroy innovation:

1) They destroy investment through taxation and borrowing which puts incredible constraints on the available investment capital.

2) They destroy creativity by imposing values of the ruling class on society, and creating standards that only impose even more barriers of the mind.

Without creativity and invesment, innovation can occur and this only hurts individuals in their pursuit to impove their individual lives.

Why Money Doesn't Matter

Why Money Doesn't Matter

by Alex Merced

If you spend enough time reading and listening to the media at Mises.org put out by the Mises Institute it becomes quite apparent that the supply of money doesn't change anything fundamentally in the economy. The market always adjust prices in the economy to the supply and demand of goods, so money being a good like anything else will adjust it's prices when the supply of it changes but nothing has fundamentally changed. The way we subjectively value all our goods and services haven't changed, all that has changed is how we value it relative to the changing money supply.

Although prices don't change immediately with any change in supply in demand, a period of price discovery must occur. During this period through trial and error of human action people will overvalue and undervalue goods and services in the search for the “market price” of money and the goods and services relative to it. When this market price is found the overall subjective value of things will not have fundamentally changed, although this allows an opportunity for arbitrage. Arbitrage is the act of taking advantage of over or under evaluations in market prices. Those who best take advantage of this are those who get the new supply of money first or understand this process, cause they have the best knowledge of the undervaluation currently in the economy before prices adjust. This arbitrage of those in the know is the effect that economist feel can benefit or hinder the economy, and they advocate a ever changing money supply to keep this state of arbitrage constant to never let the true “market price” of money and goods be found.

How would prices eventually adjust?

If the money supply increases: If the money supply (inflation) then initially all goods and services are undervalued relative to money, so then a consumption binge occurs which pushes prices up to the market price. Some people may still advocate this course of action cause it'll devalue one money versus another money increasing the purchasing power of the second money to buy goods denominated in the first money, which is temporarily the case during the adjustment. Another consideration though for those using the second money is that while the purchasing power for consumers has increased so has the purchasing power of producers in that money which means that domestic goods in that currency will be cheaper to produce offsetting the increase in the value of the currency overtime. To truly have a sustainable increase in transactions between currencies one must have a true competitive advantage in the goods and services they offer.

If the money supply decreases: If the money supply decreases (deflation) then initially all goods and services are overvalued relative to money, so then some people will prefer to sell assets to take advantage of the overvaluation which will push prices down to the market price. Once again is argued to have a negative consequence between different currencies cause as the first currency increases in value other currencies will depreciate relatively. Only looking at consumer purchasing power it seems that it'd be expensive for foreign consumers to buy domestic goods, although we often forget the purchasing power of domestic produces increases which will lower the price of their goods offsetting the increase in value. So after the adjustment once again a country with a true competitive adjustment will always succeed.

If the money supply is constant: If the money supply is constant then there is no adjustment, instead things are always priced relatively to supply and demand versus a known money supply. If prices want to go higher then the money supply can handle, then prices of the supply chain will be pushed down to operate in the current supply of money, always relative to the changing subjective values of people.