Austrian Economics on Marxism. Part One, In Which the Very Basis of All Marxism is Shown to be Absurd.

Marx had first, a long, complicated explanation of why the free market is doomed, and second, a proposed solution to the problems he thought he found, Socialism.

Here at the blog, we have written at length about his proposed solution, Socialism, and why it is inherently flawed from an economic point of view, meaning that the laws of economics guarantee misery and death to any country that institutes Socialism, just like in North Korea, for example. Just do a search for Calculation Problem on this humble site.

Many have shown that politically as well Socialism is a guaranteed nightmare, but that’s not our thing. Politics makes Dave feel sick, so he avoids talking about it.

This article is not about Marx’s solution, Socialism, but about his complicated theoretical edifice, as laid out in his book Das Kapital, which he claims proves that the free market is evil and doomed. The content here is based on this excellent lecture by Richard Ebeling, and on various excellent works by the Austrian School . So let’s start right in.

We have a special guest with us tonight, Karl Marx himself, who has kindly agreed to rise from the grave to chat with us.

1. First mistake, the concept of Exchange Value.

Karl Marx: You’re off on the wrong foot right away, Dave. The great Adam Smith himself invented the concept of Exchange Value. Why are you picking on poor me when I have such a giant on my side?

Smiling Dave: That’s why I’m an Austrian, and not a follower of Adam Smith. The Austrians do not believe in the whole Exchange Value thing. To them the value of anything to anyone is subjective, meaning varies with the individual.

KM: I agree with that. I called it Use Value, you call it Subjective Value, same thing. But I went one step further. I claimed that Use Value is not what counts. What decides prices is something I discovered, called Exchange Value.

SD: Not what counts where?

KM: Go to the store. You see that five dollars can get you, say, a hammer, a sickle, a used math book, a pound of beef. They all have something in common, namely, the price tag. They are all worth five dollars. But they all have completely different uses. So what is it about them that they all have in common, that makes them all worth five bucks?

SD: You are going to say their exchange value.

KM: Exactly. We are forced to posit the existence of something abstract in each of them, some mystical entity that they all have in common, which manifests itself in the market as a price of five dollars. That five dollar price tag reveals to us that the hammer, the sickle, the math book, the beef, all have the same amount of mysterious something in the exact same quantity, that makes them all worth five dollars. I call that mysterious something Exchange Value, and I will later show that there is nothing mystical about it. I will show exactly what is it and where it comes from.

SD: OK, here we are. We have arrived at your first mistake. Exchange value is a flawed concept, and it also is an unnecessary one. The Subjective Value, or what you call the Use Value, is enough to explain everything.

KM: Well, it’s pretty boring down there in the grave. I like being up here. Amuse me with your explanation of how Use Value makes all those things equal, all worth five dollars.

SD: It’s very simple. Five dollars is what the owner of the hammer etc. thinks he can get for his hammer. He thinks he can find a customer who will pay five dollars, so he sets the price at five dollars.

KM: But why will the customer pay five dollars exactly?

SD: There is no such thing as “the customer”. Every customer is different. Some want hammers, some want sickles, some want nothing and stay at home and don’t come to the store.

KM: I knew that.

SD: So you also knew that the five dollar price tag is not meant for every customer. Those who don’t need hammers that much, or at all, will not pay five dollars for the hammer. The seller was not even talking to them when he puts a five dollar price tag on the hammer. To them, the hammer may be worth a dollar, or even zero.

KM: So you are saying that it is absurd to say that the hammer, sickle, book, and beef are all worth five dollars, when there is not a single person in the store or in the city who will pay five dollars for all of them. Smith will pay five for the hammer, but zero for the other stuff, Jones will pay five for the book, but nothing for the other stuff, and so on. And to everyone who stayed home and did not go the store, all of the objects are worth zero. Nobody equates them, nobody considers them of equal value. Certainly they are not worth five dollars to the seller, who is trying to get rid of them.

SD: Yep. The seller is putting a five dollar price tag on each because he thinks he will find one person out there who will want a hammer so badly he will pay five bucks for it, and so on.

KM: I still think I’m onto something, Dave. There must be a reason that the seller assumes there exists at least one person put there willing to pay five for the hammer, another to pay five for the sickle, etc. The fact that for each commodity in the list there exists at least one person willing to pay five bucks means there is something “five-dollary” about them all.

SD: Nah, it’s a coincidence, and I’ll prove it. See that bottled water? It’s going for twenty five cents now. But should the city water supply get infected with Ebola, that same bottle will go for five dollars.

KM: You’re saying that it’s absurd to think there is something inherently five-dollary about a particular item when each person has his own estimation of the worth of the thing, each day, sometimes each minute, these estimations change, outside events unrelated to the object change its price, the whole price system is so personal, and so fluid, and so influenced by events that do not change the composition of the object, that it is foolish to think there is some abstract quality in the object that determines its price.

SD: Yeppers. The whole Exchange Value thing was created to solve a theoretical problem that didn’t exist in the first place. And the concept itself is fatally flawed.

KM: OK. So the very basis of my whole book has now been destroyed. But don’t send me back to the grave. I hate it there. Let’s talk about other flaws in my book.

SD: Maybe next time.

That MIT Paper That Supposedly Knows the Future of Bitcoin.

The paper is right here:

The quotes are from here:

Devil’s Advocate: So MIT Guy. I bet you are a billionaire now. I mean, knowing the future and everything. You must have sold your house and borrowed every last penny you could get your hands on, the better to invest it in bitcoins using your fool proof algorithm.

MIT Guy: Give me your money and I’d be happy to invest it for you.

DA: Did any Austrian Economics go into making up your computerized predictor? You know, trying to actually understand the humans who are buying and selling, and what makes them tick?

MIT Guy: Can we explain the price variation in terms of factors related to the human world? We have not spent a lot of time doing that.

DA: One thing AE says about all these computer predictions is that they work perfectly until they don’t. So I’m sure you tested your gizmo in all kinds of situations, bitcoin going up and down, over a long, long time period, to make sure you weren’t being stupid and cherry picking one tiny interval, say two months,  where bitcoin was going in one direction only.

MIT Guy: Let me show you a summary in graph form:

See? The blue line is the price of bitcoins, and the black line is how much money we made. So 50 days

DA: Oh, I see. 50 whole days. And I notice the ups were huge and the downs were slight.

MIT Guy: Hey, it’s not my fault we picked the one time this whole year bitcoin was going up. And I resent you calling that cherry picking. Give me your money and I’d be happy to invest it for you.

Smiling Dave: What’s worrisome is not that the guy doesn’t know how to do statistics. Plenty of statisticians don’t know their job. What’s worrisome is that he thinks statistics is where to look in the first place.

DA: Take your articles, for instance, Dave. With zero statistical data, using sheer logical reasoning from first principles, Mises and Timothy Terrel and Peter Schiff and others have predicted that bitcoin is going to die, and explained why it was doomed from the get go. And you summarized their work right here at

SD: Yes, the current state of mainstream Economics is sad indeed. But hey, it always has been. I mean, the whole idea of having universities teach economics in the first place was to make sure the students learned govt propaganda. Read up on what happened to Say and Bastiat.

Bitcoin and the Damped Sin Wave.

Devil’s Advocate: Dave, let’s see some real scientific analysis of bitcoin for a change.

SD: I present to you the Damped Sin Wave:

Bitcoins little brother

Wikipedia explains:

A damped sine wave is a sinusoidal function whose amplitude approaches zero as time increases.

Damped sine waves are commonly seen in science and engineering, wherever a harmonic oscillator is losing energy faster than it is being supplied.

DA: What are you saying, Dave?

SD: Bitcoin is losing energy faster than it is being supplied. Yes, there are many suckers left, but people are wising up faster than new suckers can be found.

DA: And its future is?

SD: Amplitude approaches zero as time increases. In fact it’s even worse than a damped sin wave. The damped sin wave has an axis of symmetry which is the x axis. Bitcoin is a damped sin wave, only its axis is tilted from upper right to lower left, like someone dumping a tray of refuse into the trash bin.

DA: Show me.

One day:

Two days:

Five days:

Ten days:

All time:

DA: Wow, it’s like one of those fractal things. Over all image is a damped sin wave, and every little piece is a damped sin wave.

SD: Champions of bitcoin, speak up, defend liberty and freedom and the wave [excuse the pun] of the future.

DA: They’ve lost too much energy.

SD: Those graphs just show bitcoin is dying, but do not explain why it was doomed from the get go. For that, mosey on over to

Saving Austrian Economics from Piero Sraffa.

1. How Piero Sraffa destroyed Austrian Economics, supposedly.

Bob Murphy wrote this article, which lays out Sraffa’s case quite nicely.

Piero Sraffa supposedly demolished the whole Austrian business cycle theory in 1932 by pointing out that a key concept of Austrian Economics, the natural rate of interest, is flawed. There are several rates of interest, Sraffa claimed, one for each commodity. And Bob Murphy helps us understand with the following example. [As usual, all actual quotes are in italics, all others are imaginary, there to make things understandable in simple language]:

In the faraway land Oz, which has a barter economy, one apple trades for one orange. Then a prophet comes and tells everyone that there will be a huge frost next year that will kill off most of next years crop of oranges. Armed with this knowledge, Smiling Dave goes to market with an apple, to see what he can trade it for.

Turns out he can trade his apple for an orange, and just eat the orange.

Or he can find a Wimpy who will gladly pay him 2 apples next year for an apple today.

More Wimpys show up, all promising all kinds of things in the future for his apple today. One of them will give him half an orange next year for that apple today. Why only half an orange? Because oranges will be mighty scarce then, and half an orange will be very expensive.

Of course, since apples now have the same price as oranges, and this Wimpy will eat anything, he will also, if Dave has an orange, gladly trade half an orange next year for an orange today.

Bottom line, there are Wimpys out there who will  gladly take your apple or orange today, and give you either two apples or half an orange next year.

So right here we see how Austrian Economics is all wrong, says Bob. The interest rate for trading apples is 100%, two apples next year for an apple today. The interest on oranges is negative. You get only half an orange next year for an orange today.

So there, Austrian Economics, said Sraffa, I’ve just shown you two interest rates, both perfectly legit. How can you possibly say there is some magic number, called the natural rate? Which one of those two interest rates is the one unique magic number, Austrians? QED that AE is flawed from the get go.

To quote Bob Murphy:

Now, in such a barter economy as depicted in Table 1, what is “the” natural rate of interest? There is no such thing. The own-rate of interest on apples is 100 percent (one present apple in period 1 exchanges for two apples in period 2). But the own-rate of interest on oranges is minus 50 percent (because one present orange only trades for ½ future oranges). Consequently, if we were to introduce a money commodity and a central bank, and someone such as Hayek recommended that the bank set the money rate of interest equal to “the” natural rate, we would be unable to follow his advice.

Devil’s Advocate; Gotcha at last, Smiling Dave. AE is dead. Long live Sraffa! Long live Keynes, who also wrote about this stuff in chapter 17 of his masterpiece. What a buffoon Henry Hazlitt was, who mocked that chapter of Keynes.

2. Sraffa’s First Mistake. Banks Cannot Print Apples.

SD: Now you know why the smart money follows Mises, not Hayek. Hayek did not see through that apples and oranges story, but Mises did.

DA: Oh really? What did Mises say?

Mises: I’ll take over from here, Dave. Let’s look at that last sentence. If “someone such as Hayek recommended that the bank set the money rate of interest equal to “the” natural rate…

Sraffa: I think that’s hot stuff, that sentence. What’s wrong with it?

Mises: The central bank does not “set” an interest rate. The bank prints money. I call on my good friend, Joe Salerno, to explain. Joe?

Joe SalernoBut the Fed does not directly set interest rates. This is the great modern myth, which was designed to conceal the Fed’s true modus operandi. The Fed influences interest rates by creating and injecting dollar reserves into the banking system. The additional reserves increase the supply of loanable funds relative to the economy’s demand and thus induce banks to offer loans at lower interest rates in order to attract borrowers for the additional funds. So causation runs from the increase in Fed–created base money to reduced interest rates. Lower interest rates are just one of the distortions caused by the Fed’s unrestrained power to create money ex nihilo.

Sraffa: I knew that.

Mises: And in a barter economy, can the central bank set the interest rate by printing apples? You can’t print apples, Piero.

Srafffa: I knew that. But I guess it slipped my mind at the time.

Mises: And even in a money economy, the question is not, “What interest rate should the Central Bank set?”, but instead…

Sraffa:…How much money should the Central Bank print?

Mises: And the answer is?

Sraffa: None, not a penny, zilch.

Mises: And the interest rate will then be….

Sraffa: The natural rate, meaning the one that happens when the central bank gets out of the way and doesn’t print money.

Mises: And your apples and oranges story is…

Sraffa: Irrelevant. It’s comparing apples and oranges, heh heh.

DA: I bet Mises never said such a thing, or at best wrote it in some obscure German pamphlet.

Mises: No, I wrote it in Human Action, Chapter 31, section 5:

If a bank does not expand circulation credit by issuing additional fiduciary media (either in the form of banknotes or in the form of deposit currency), it cannot generate a boom even if it lowers the amount of interest charged below the rate of the unhampered market. It merely makes a gift to debtors. The inference to be drawn from the monetary cycle theory by those who want to prevent the recurrence of booms and of the subsequent depressions is not that the banks should not lower the rate of interest, but that they should abstain from credit expansion. Of course, credit expansion necessarily entails a temporary downward movement of market interest rates.

Sraffa: Now you mention it, I see you wrote in that footnote that even if the Central bank lowers the rates below the natural rate, no harm is done:

If a bank does not expand circulation credit by issuing additional fiduciary media (either in the form of banknotes or in the form of deposit currency), it cannot generate a boom even if it lowers the amount of interest charged below the rate of the unhampered market.

DA: So if they give away apples or something, as long as they do not print apples, there is no problem.

SD: By the way, Guillermo Sanchez wrote about that Mises quote long ago, and in much more detail.

3. His Second Mistake. Hayek’s Final Response Is Right on the Money.

SD: But there are more reasons Bob’s story, which is really Sraffa’s critique, is flawed from the get go. When you go into a bank, what do you see?

DA: Huge baskets of apples and oranges, because people go to a bank to borrow apples and oranges. Just kidding, banks lend money.

Sraffa: I knew that.

SD: So even if we accept the whole many-rates-of-interest thing, which rate of interest is the one relevant to banks that lend, you know, money? The apples one?

Sraffa: But Dave, I made it clear I was talking about a barter economy. In that barter economy, there are indeed big baskets full of apples and oranges in their vault.

SD: And if someone comes in to borrow apples and repay in apples, what interest rate should they use?

Sraffa: The apples one. And if he wants to repay in oranges, the oranges one. Oh. I see where you are going with this. So that’s what Hayek meant when he said there would be many natural rates in a barter economy. And to think I mocked him for that. Makes me want to roll around in my grave.

4. Third Mistake. The Concept of Originary Interest Clears Up All Confusion, Guys.

SD: Now there is an even deeper mistake in that whole apples and oranges story, namely going with Hayek and then saying that all Austrians are thus disproven. Hayek is not all of Austrian Economics. Piero, you know Mises had a whole different take on interest.

Sraffa: Yes, he introduced the concept of originary interest.

DA: What’s that, Dave?

SD: Mises explained that there is something called the rate of Originary Interest. Basically, it’s how much people want to be paid if they have to defer their enjoyment. Thus, if Mr Moneybags has $100, and Smith wants to borrow it for a year, that means Moneybags won’t be able to spend it today, obviously. Why will he agree to wait, then? If Smith pays him enough interest, say $5, then that $5 will convince Moneybags that it’s worth the wait, and he will give $100 to Smith today in order to have $105 tomorrow.

DA: Exactly the opposite of Popeye’s friend, Wimpy the hamburger guy. Wimpy is willing to pay more next week in order to enjoy his hamburger today. Moneybags is willing to defer eating his hamburger today to have a bigger one next week.

SD: Which is what Mises meant when he said that $5 was the rate of originary interest as far as Moneybags is concerned.

Sraffa: And this is relevant to my apples and oranges story how?

SD: Let’s have a closer look at those interest rates in your story. One apple today gets you two apples next year. So the rate of originary interest is 100%.

Sraffa: With you so far.

SD: Now if one orange today gets you a half an orange next year, does that mean originary interest is minus 50%?

Sraffa: Of course not. That would be saying that a person is only willing to defer his enjoyment if he will get even less enjoyment in the future. Nobody is that crazy.

DA: Then where did that minus 50% number come from, if not from originary interest?

SD: Obviously, minus 50% is not a rate of interest. It has nothing to do with interest. It’s an adjustment for “inflation”. Since the price of oranges is known to be four times that of an apple in the future, and the payment will be in the future, when that orange is worth four apples, then a 100% interest fee will be half an orange, which is exactly two apples. The rate of originary interest is 100% for both apples and for oranges.

Bob: But Dave, when a bank anticipates inflation, and they charge you more because of that, they call that extra charge interest. So an adjustment for inflation is interest, too.

SD: Let us not confuse things with mere semantics. The bank calls the adjustment for inflation by the name of interest. So what? Is it originary interest? What has that to do with what we are talking about? How does what the bank calls something refute Austrian Economics?

5. Huge Fourth Mistake. Adjustment for Inflation is Not Interest.

Sraffa: You know, once we realize that in Mises’s definition of originary interest, that minus 50% is not originary interest at all, then why not go all the way? Why not say that no matter how you define interest, an adjustment for inflation is a stupid thing to include in the definition of interest? And that if a bank introduces an adjustment for inflation, that does not refute Austrian Economics. So that my whole story is pointless.

DA: People are used to thinking that whatever money you collect in the future for handing over a good today is principal plus interest. So if next year all you get is half an orange for your original orange, that must be a negative interest rate. What you’re saying, Dave is that it’s not interest at all, it’s adjusting for inflation.

Hazlitt pointed out that Keynes mistakenly thought [in chapter 17] that whatever extra you have to pay because there is risk involved is also interest. Again, it’s not interest, it’s a risk premium.
Mises’s basic insight is that interest is what you have to pay because the other guy will have to wait, and only that is interest. Everything else is, well, everything else. He first published his insight in 1949, and it has still not sunk in yet in some circles.

SD: I knew that.

6. Reisman in His Classic Work “Capitalism” Explains Why the Futures Market has Nothing to do With Interest.

It’s in Chapter2, Section 7.

What have you to say, Prof George Reisman?

GR: The principle of time preference is not contradicted
by the fact that the prices of commodity futures are usually
higher than the prices of the corresponding “cash” commodities
available for immediate delivery. For example, in the month of
September, the price of corn for delivery in December is always
higher than the price of corn for immediate delivery,
while the price of corn for delivery in the following March is still higher

than that for delivery in December. Such a price structure does
not mean that, other things being equal, people prefer
commodities in the future to commodities in the present.

DA: Why not?

GR: On the contrary, month by month they are consuming the stocks
of commodities, demonstrating that they prefer present
consumption to future consumption. 

DA: So why are futures more expensive?

GR: The ascending price
structure of commodity futures is the reflection of the
prospectively increasing scarcity of commodities between
harvests, and/or of the need to compensate those who store
supplies of commodities for future sale for the costs they incur
in so doing and for tying up their capital in such investments.
In the absence of such an ascending price structure, time
preference would result in the unduly rapid consumption of
stocks of commodities.

SD: In other words you’re paying a storage fee, which I hope even Sraffa understands is not interest,
or you’re paying more because the supply is dwindling and prices are going up, exactly what happened to the oranges in the fable.
And the good professor is making it clear that paying more because of those things has nothing to do with time preference, obviously.
And paying because of time preference is what interest is all about, as Mises explained in section 4 above, where we talked about originary interest.

Smiling Dave Was Wrong About Bitcoin.

Bitcoiners, don’t celebrate just yet.

My analysis of why bitcoin is not now, and never will be, a medium of exchange or a money, still stands. I explained why here, and that still stands.

The only thing I was wrong about was my optimistic prediction that bitcoin will ride high until the next great general depression. Turns out it will die way sooner than that.

Devil’s Advocate: Well, oh mighty prophet, I see you were totally wrong. You predicted bitcoin would keep on rising until the next great recession. And yet, here it is October 2014, and bitcoin is in a steady decline since last December, with no end in sight.

Smiling Dave: Indeed I did predict that. And I goofed. You will remember that the article makes two assumptions. It takes as a given that there are actually people out there besides hoarders, buying things with bitcoins. It also assumes confidence among the hoarders that everything will be fine.

Both those assumptions, it turns out, are no longer true. Which is why bitcoin has been dropping like a stone since December 2013

That article assumed there were people actually using bitcoin to buy stuff. And there were, for a while, the Silk Road drug buyer crowd. But after the Silk Road got closed down, there was nobody left who wanted to use bitcoins to actually pay for things with them. It was those people who would drive up the price constantly, as explained in my analysis in that article.

But there are no such people anymore. Turns out only the Silk Roaders were using their bitcoins. Everyone else was a hoarder.

DA: You believed all the hype from the bitcoin crowd, how is accepting bitcoin, and how some tiny village in Germany has a few students using it, when your common sense should have told you that no one has a reason to buy things with bitcoin, unless he’s buying drugs. Why should he?

SD: So now all we have left are the hoarders.

And of those hoarders, some of them got a real scare when mtgox stole so many millions. They realized they were unprotected. Their profits, they were told, would be taxed. There were hoarders who thought they could use bitcoin to smuggle their money outside their repressive countries. But Russia and China cracked down on them. And a top bitcoin guy announced that bitcoin gives you no secrecy and security at all. So they figured the time has come to cash out. Bitcoin had its day, I made my money, it’s unsafe and unsecret, time to move on.

Which started a snowball effect that is ongoing to this day. Nobody wants to hoard even more bitcoins, or at least the ones who do are outweighed by the ever increasing number of those who see the thing falling like a stone and want out. That’s why we see the optimists buying when it drops so much every day, and they raise it a little. But that precipitates an even greater number to opt out while the opting is good.

DA: So you were wrong all along about bitcoin, hey?

SD: Not exactly. My analysis of why it is not now, and never will be, a medium of exchange or a money, still stands. The only thing I was wrong about was my optimistic prediction that bitcoin will ride high until the next great general depression. Turns out it will die way sooner than that.

Enjoy all my articles about bitcoin here.

Top Ten Blunders of Econometrics, According to a Respected Mainstream Economist.

Paul Pfleiderer of Stanford University writes a long paper pointing out the absurdities of econometrics .Podcast here

He doesn’t go the whole distance [like McCloskey did years ago] and claim that 95% of all published econometrics is garbage, and certainly doesn’t do the Austrian thing and reject the whole sordid business as not even economics, but he does point out where the huge gaping logical holes are in econometrics.
And all written in clear, jargon free language anyone can understand.

Some tidbits:
My reason for introducing the notion of theoretical cherry picking is to emphasize that
since a given result can almost always be supported by a theoretical model, the existence
of a theoretical model that leads to a given result in and of itself tells us nothing definitive
about the real world. Though this is obvious when stated baldly like this, in practice
various claims are often given credence – certainly more than they deserve – simply
because there are theoretical models in the literature that “back up” these claims. In other
words, the results of theoretical models are given an ontological status they do not
deserve. In my view this occurs because models and specifically their assumptions are
not always subjected to the critical evaluation necessary to see whether and how they
apply to the real world.

What’s astounding are the assumptions accepted in the econometrics community that he has to stoop to refute. Smiling Dave knew it was bad, but he didn’t know it was that bad. Here are a few that he mentions:

1. It’s OK to apply the model’s results to the real world without bothering about whether it is remotely connected to reality. He gives many examples of this.

2. Models should only be judged by their predictions and not by the realism of
their assumptions. Milton Freidman.

3. All models have equal standing until definitive empirical tests are conducted.

4. Quantum mechanics makes no sense, so why can’t econometrics do the same?

5. It’s OK to distort reality in our model to make the math easier.

6. Gross circular reasoning. The process goes like this. Assume solution X is optimal. Root around until you have a model based on various assumptions that will conclude X is optimal. Then say you have proven X is optimal because your model shows it to be so.

7. CFOs and other managers solve extremely complex programming problems that ultimately must be
solved numerically on a computer using programs that took weeks or months for a
researcher to write. And they do this in their heads, instantly, with no computer and with no knowledge whatsoever of math. It’s also OK to assume that everybody does this, all the time.

8. If I get very precise results in my simplified model, then I will get very precise results applying the model to the real world.

9. The better model is the more complicated one.

10. The better model is the one that uses deeper math.

Devil’s Advocate: But Dave, surely this guy is a nobody, some uneducated bum with no standing in the mainstream.

SD: Here’s some info about him: BA, MPhil and PhD in Economics from Yale University. Academic Appointment at Stanford since 1981. Has consulted for various corporations and banks and has been involved in developing risk models and optimization software for use by portfolio managers. A member of the Stanford Graduate School of Business research faculty, he is C.O.G. Miller Distinguished Professor of Finance, and Senior Associate Dean for Academic Affairs. Somebody even gave him a free law degree. Take a look at the long list of articles in journals and the like that he’s published right here.

What is Thymology?

One sees the word thrown around a lot.

I found how Mises defines it in Theory and History, Chapter 12, as “the knowledge of human valuations and volitions.” In simple language, “What were they thinking?”
So that we have Praxeology, the study of what people do given that they have a certain goal, and Thymology, the study of why do they have that goal.

Here are the two studies at work, talking about the future.
Smith goes into a room. It is a dark room. We know somehow that his goal is to have a well lit room.
Praxeology tells us that, ceteris parebis, he will flick the light switch.
Thymology tells us why he wants a well lit room. This is clearly a much more difficult question to answer.

Here they are again, this time talking about the same event in the past.
Smith went into a room. It was a dark room. We know somehow that his goal is to have a well lit room. He flicked the light switch and behold, the room was lit. He then sat down and read a book.
Praxeology tells us that he flicked the light switch because it was the easiest way he knew of to get what he wanted, a well lit room.
Thymology tells us why he wanted a well lit room, because he wanted to read the book.

Is thymology of the past always that easy? Not at all. Who knows what people were thinking? Mises writes:

Thymology is on the one hand an offshoot of intro-
spection and on the other a precipitate of historical ex-
perience. It is what everybody learns from intercourse
with his fellows. It is what a man knows about the way
in which people value different conditions, about their
wishes and desires and their plans to realize these
wishes and desires. It is the knowledge of the social
environment in which a man lives and acts or, with
historians, of a foreign milieu about which he has
learned by studying special sources. If an epistemolo-
gist states that history has to be based on such knowl-
edge as thymology, he simply expresses a truism.

In other words, you learn what the other fellow was thinking in two ways.
First, by introspection.
You see Jones standing taller when a girl enters the room. Why did he do that? What was he thinking? By introspection, you realize that if a girl you wanted to impress entered a room, you would stand taller. So you understand that is why Jones did it, too.

Second, by experience. If you are Mr Spock the Martian, you would never stand taller to impress some Earthling, a species you consider inferior and repulsive. But you have been around Earthlings long enough to have seen them do it many times, and they have taken you into their confidence and told you why. So the next time it happens, you understand that’s why Scotty is doing it now.

That’s what Mises meant by thymology. However, in recent times, the word is being used for yet another branch of study, predictive economics of the real world. Say Peter Schiff, by a mixture of his knowledge of Austrian Economics, his experience in the world of finance, and intuition and creativity, predicts that there will be a crash in the housing market. Such a prediction is not exactly pure praxeology, and there is no convenient word yet coined to describe it. So some people have started calling what he did thymology, for want of a better word.

Here is Walter Block, for example:
…allow me a few methodological, philosophical words. Austrian economists, qua Austrian economists, or praxeologists, do not predict. Period. In what sense, then, am I putting together this list of Austrians who have predicted the housing bubble? It is in the sense that they predicted this phenomenon not as formal economists, or praxeologists, but, rather, in their role as thymologists, or economic historians; see on this here.

I disagree with both his assertions. Of course praxeologists predict. That is the whole purpose of praxeology. Here’s Mises in Theory and History:

Economics deals with a regularity in the concatena-
tion and sequence of phenomena that is valid in the
whole field of human action. It can therefore contribute
to the elucidation of future events; it can predict within
the limits drawn to praxeological prediction….

Praxeology, the a priori science of human action,
and, more specifically, its up to now best-developed
part, economics, provides in its field a consummate in-
terpretation of past events recorded and a consummate
anticipation of the effects to be expected from future
actions of a definite kind….

I also disagree with the esteemed Prof Block calling a predictor of future
events a “historian”. History is the past, not the future.

Maybe Prof Block thought that since Mises wrote in Chapter 14 of Theory and History that we need thymology to predict the future, that thymology is the prediction of the future.
No. We need heat to bake a cake, but heat is not a cake.
Here’s Mises on the subject:

First he talks about thymological experience:
Thymological experience is what we know about hu-
man value judgments, the actions determined by them,
and the responses these actions arouse in other people.
As has been said, this experience stems either from in-
trospection or from intercourse with other men, from
our acting in various interhuman relations.

Like all experience, thymological experience too is
necessarily knowledge of things that happened in the
past…Thymology is a historical discipline.

Then he says:
For lack of any better tool, we must take recourse to
thymology if we want to anticipate other people’s fu-
ture attitudes and actions. Out of our general thymo-
logical experience, acquired either directly from observ-
ing our fellow men and transacting business with them
or indirectly from reading and from hearsay, as well as
out of our special experience acquired in previous con-
tacts with the individuals or groups concerned, we try
to form an opinion about their future conduct.

Clearly, he is not saying that thymology is prediction. Thymology is an understanding of the past.
But we have to use thymology, use our understanding of the past, to help us predict the future.
Just like an oven is not a cake, but we must use the oven to bake a cake.

But hey, language is what people decide it is.
A word means what people use it to mean.
When Mises used it, it meant an understanding of motives.
Block started using it to mean as well the use of that understanding to predict the future.
If that use catches on, and it looks like it has to some extent, then that it what the word means today.

A Fantastic Twelve Months For Bitcoin.

This one is really amusing. Over at the blog, they quote one Charlotte Bowyer, who is really excited about bitcoin, especially in the last twelve months:

In many ways the last 12 months have been incredible for Bitcoin. It’s gone from an underground obsession to a mainstream curiosity and the darling of the FinTech world. Huge companies such as Overstock and IBM now accept payment in it, and the currency is on track to attract more VC funding in 2014 than the Internet did in 1995.

This is like the doctor telling the patient “These last twelve months have been fantastic for you. You have lost a lot of weight, are no longer obese, I mean it’s time to celebrate.”

“What about my terminal cancer, Doc?”

“Oh, it’s gotten worse. But that’s nothing.”

Here’s the bitcoin chart for the last twelve months:

Bitcoin Dying These Last Twelve Months.

And last week? Hoo wee, was it fantastic:

Bitcoin’s price rallied significantly after a long period of decline following the PayPal announcement.

She wrote that today. The Paypal announcement was on Sep 23. Let’s feast our eyes on the significant rally from Tuesday till now:

Bitcoin Last Week

With rallies like these, who needs panics?

Peter Klein, who should know better, quotes her about bitcoin theory:

For instance, Bitcoin is much more than the new PayPal, for it’s simultaneously both a currency and a payment processor.

“Jabba, They say you are the new LeBron James of basketball.”
“Oh, I am much more than the new LeBron. You see, I’m confined to a wheelchair.”

The fact that it’s both a currency [haha] and whatever is the tragic flaw than means bitcoin’s doom, as Timothy Terrel prophetically recognized in 2001, many years before there even was a bitcoin.

For the real scoop on bitcoin, with quotes from Mises backing up every word of Terrell’s article, and so much more, mosey over to

Human Action, Chapter 19, First Paragraph, Smiling Dave Style.

Devil’s Advocate: So you started skipping around, hey? You have written about the Intro and a bit of Chapter 1, and now we’re jumping to Chapter 19?

Smiling Dave: Devil, we’re going for the jugular. Chapters 19 and 20 are the hardest ones, so we’re tackling them. Without further ado, here’s Mises, Chapter 19, section 1:

Mises: Thank you Dave.

1. The Phenomenon of Interest
It has been shown that time preference is a category
inherent in every human action.
Time preference manifests itself in the phenomenon of originary interest,
i.e., the discount of future goods as against present goods.

DA: Plenty of big words here. What does it all mean?

SD: We begin with Category, a word Mises picked up from reading Kant. Let’s ask Bertrand Russell what it means.

Russell: What, exactly, is meant by the word “category,” whether in Aristotle or in Kant and Hegel, I must confess that I have never been able to understand. I do not myself believe that the term “category” is in any way useful in philosophy, as representing any clear idea.

SD: Elsewhere, Russell talks about “those …general concepts which Kant calls ‘categories.'” So we are going to go with category meaning “concept”, and leave it at that.

DA: So we are talking about the concept of originary interest. And what is that, pray tell?

SD: Interest is a very deep subject, that has confused many since the beginning of time. The latest stumbler was Keynes, who went along with the hoary viewpoint that interest is an unfair, parasitic exploitation that the rich man does to the poor man. He spent his life scheming for ways to force the interest rate be zero forever. In this classical exposition, Mises is going to explain that interest is composed of many layers. Not all layers exist in every situation. But the most basic layer, the interest that is charged in every loan, is what he calls originary interest.

DA: But what about if Smith gives his pal Jones an interest free loan?

SD: Then besides the loan, Smith is also giving Jones charity, waiving the interest.

DA: Some people say the Old Testament agreed with Keynes, because it forbade interest.

SD: Not so, certainly not according to ancient Jewish tradition. The Talmud explains that interest is not theft or extortion, and indeed if someone pays an interest fee he cannot go to court and sue for his money back, as would be the case if his money was stolen or extorted. Also, the Old Testament allows lending Gentiles at interest, although it never allows stealing from anyone.

DA: So why does the Old Testament forbid taking interest?

SD: The Old Testament is full of various forms of charity one is supposed to give. For example when harvesting ones field, one is supposed to leave the corners of the field untouched for the poor to come and take for themselves. The prohibition on interest is actually a form of charity, not binding on non Jews at all.

It is odd that Keynes latched on that one charity. He was not a generous man. I mean, you don’t see Keynes running around insisting that farmers leave the corners of their fields untouched for the poor to take.

DA: But I thought interest is something Smith demands of Jones if Jones wants to borrow his money. What does Mises mean that interest is a concept inherent in every human action. When I make coffee in the morning, where’s the interest?

SD: Would you rather have your coffee sooner than later?

DA: I sure would. Ideally, the stuff would be ready and piping hot the moment I awoke, instead of me having to stumble around setting it up and waiting for the water to boil.

SD: That means you have a time preference. You would rather have the coffee right now than have to wait for it.

DA: Are you kidding? I’d even pay someone a small amount to get up early and make the coffee for me, that’s how intense my time preference is for that coffee.

SD: Mises is saying that time preference happens with everything people do. They always want what they want right now, if possible. Not later.

DA: And if they are willing to pay to have it right away, that’s interest?

SD: Not quite. Interest is the other side of the coin. It’s what you have to pay someone to relinquish his time preference.

For example, say you are waiting in line at Starbucks, dying for coffee. There is some battle ax of a woman ahead of you in line. You know from experience that she takes her sweet time reading the menu, gossiping with the barista, and in general torturing you as you are Jonesing for your coffee. So you want to cut ahead of her in line. You cannot appeal to her better nature, because she doesn’t have one. So you offer her some money for her to waive her place in line, in other words her right to get the coffee sooner, and give that right to you. According to Mises, you are paying her interest.

DA: So when Smith borrows money from Jones for a year, he is paying say 5% interest to compensate Jones for cutting ahead of him in line, as it were, for making Jones wait a year before he can spend his own money.

SD: You got it.

DA: This has gotten pretty long, Dave. I mean a thousand words on the first paragraph.

SD: I told you it was deep stuff. To be continued, hopefully.

Matrix Redux. Start With Consumer Prices and Solve Mises’s Calculation Problem?

We’ve written quite a few articles explaining Mises’s Calculation Problem, the problem he says any Socialist economy will have that will bring on its downfall.

Recently, we have discussed solving the problem with good old linear algebra. One Mabel suggested we just input all the costs of production in Column A of some gigantic matrix, other stuff in the other columns, and then solve the system of equations the matrix represents, using our sophisticated computers, and lo and behold, the solution will be exactly how much of everything we need to make, using what ingredients. She even linked to a sample matrix that does exactly that.

I explained that the heart of the calculation problem is that we don’t know what to put in Column A.

Devil’s Advocate: Felt pretty smug, didn’t you? Until you got that cryptic comment from Michele which left you scratching your head.

Here’s her comment:

hi Mabel,

just a fast reply

if you do have the explicit preference structure of all the individuals in an economy you can solve the calculation problem with a good matrix. that’s for sure.

but that’s also not the problem

the calculation problem lies in the impossibility to obtain the preference structure of the individuals which is only revealed through the market process.

Smiling Dave: I admit I was mystified. But reading around a bit, I think I know what she’s saying. Allow me to elaborate.

if you do have the explicit preference structure of all the individuals in an economy you can solve the calculation problem with a good matrix. that’s for sure.

The idea here is simple. We don’t know what numbers to put in Column A? Then we will work backwards. Austrian Economics says that costs of production are determined by the profits to be made.

DA: Say what?

SD: Why does steel, say, cost 40 cents a pound? In the old days, people thought it’s because of the amount of labor that went into making it, or some other reason inherent in the properties of steel. But Austrian Economics says it costs forty cents a pound because there is someone out there who has figured out that he can make a profit large enough to keep himself happy if he pays forty cents a pound for that steel, uses it to make steel mixing bowls, and sell the bowls at ten bucks each. His bid for the steel is the highest, and that’s what determines the price of steel.

DA: But his profit depends on what he can charge the customers.

SD: Exactly. That’s why the prices for factors of production depends on the prices of consumer goods, and not vice versa.

DA: So what Michele is saying is that if we know all prices consumers are willing to pay for consumer goods, we can work backwards to figure out costs of production, fill in column A of that matrix Mabel was talking about, and voila! Calculation problem solved.

So that’s what she meant in the first sentence. What did she mean in the second?

Here it is again:

but that’s also not the problem

the calculation problem lies in the impossibility to obtain the preference structure of the individuals which is only revealed through the market process.

DA: So what does that mean?

SD: I think what she’s saying is that there is no way to find out the prices people are willing to pay for consumer goods unless there is a market selling them.

DA: So what’s the problem? In a Socialist economy Mises was talking about, there are stores, there is money, there are consumer goods for sale. The only change from a free market economy is that the govt owns all the factors of production. What part of “the market process” is missing?

SD: Yep, I agree. That’s why I think she missed the boat.

DA: So is the calculation problem solved, at least in theory? I mean, I know that current estimates of how long it would take to solve such a matrix using existing computer power is about a quadrillion years. So it’s practically impossible. But I’m asking about in theory. Is Michele right? Has she solved the calculation problem “for sure”?

SD: I think not. And here we enter deep waters. The thing is, costs of production are not determined by actual market prices. They are determined by the estimate of some entrepreneur as to what market price will be.

In other words, steel is not forty cents a pound because somebody can make a nice profit buying it at forty cents a pound, making steel mixing bowls, and selling them for ten bucks apiece. It is forty cents a pound because somebody thinks that what will happen, and is willing to gamble his fortune on it.

DA: But isn’t that a quibble, really? All the Socialist planner has to do is see what mixing bowls are selling for now, and assume that’s what they will sell for when the next batch of bowls are made.

SD: Let’s begin with a dialog between J. K. Rowling and the Socialist Office of Book Publishing.

JKR: I have this wonderful new book, Harry Potter meets the Vampire. I bet the public will pay $25 a copy for it, just like my other books back in the day.

S. O. of Book P: I don’t like it. My mother in law has written a new book, Comrade Potter Defeats the Imperialist Bourgeoisie, and I think that is what will sell.

SD: You get the idea. It’s the nature of people that they get tired of the same old same old. On the one hand, you cannot keep making more copies of the old Harry Potter books and expect them to sell at the same price forever. On the other hand, the public wants reading material. On the third hand, who decides what new stuff to offer, what price to charge, and based on what criteria?

DA: So there will have to be entries for which the consumer price is unknown.

SD: Yep. Books, music, the latest fashion in clothing, new inventions, new ideas, [assuming the Socialist economy has a provision for that. I mean, imagine of the Socialist got their wish right after Marx wrote his book. Would we not have cars, computers, all the inventions that came after Marx, in a Socialist economy? Sounds pretty horrific already].

DA: But how does a free market know what prices to set for goods that have never been offered before? How does it know whether to publish Harry Potter or Boring Potter?

SD: The free market has something the Socialist economy, by definition, lacks, namely people who are willing to bet their fortunes that they have guessed right about these things.

DA: So you are saying that yes, costs of production are indeed determined by consumer prices, but by future consumer prices, [as estimated by the fellow buying the factors of production], not by present consumer prices. Because he might be planning on making something for which there is no precedent.

SD: Exactly. And once we understand that it’s future prices that determine the prices of factors of production, then it becomes obvious that we cannot know the price of any consumer good tomorrow, not just of unwritten Harry Potter books, but of anything. Who can foresee the future? Consumers are fickle. They change their minds all the time. Just because yesterday they paid ten dollars for the mixing bowl doesn’t mean they will pay ten dollars six months from now. They may decide to spend their money elsewhere. It takes an expert to know these things.

DA: So we cannot start with prices of consumer goods and work backwards, because that’s using actual consumer prices today. But the price of factors of production is determined, not by them, but by imaginary numbers in the mind of some aspiring entrepreneur, as he imagines himself making big bucks.

SD; Exactly

DA: But why not put him in charge?

SD: So already we are throwing away the matrix, and getting back to people making the decisions based on their understanding of the future.

DA: Yes, the matrix is dead. Long live the Planning Board of Experts.

SD: Well that old chestnut, the Planning Board pretending they are real businessmen, has been refuted long ago by Mises in Human Action.

DA: Dave, could you give a summary here?

SD: I’m glad you asked.

The calculation problem is that you do not know what numbers to fill in Column A of your matrix, costs of production.

And you cannot compute Column A from current consumer prices, because costs of production are not determined by them, but by totally unknowable future prices of consumer goods that exist in the imagination of someone thinking about going into business.

In a free market, there are people who can make good guesses what those prices will be. But such people can only exist in a free market. See Human Action Chapter 26, section 5.


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