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Bernanke Versus the Austrians

Originally published at The American Spectator

Vermont Senator Bernie Sanders announced Wednesday that he is stepping into the path of Ben Bernanke’s nomination to a second term as Federal Reserve chairman. If Sanders sticks to his guns, Bernanke’s supporters will need 60 Senate votes to confirm the nomination.

Good for Sanders. We need a robust Senate debate about Bernanke’s policies, since they helped to create the housing bubble and crash we’re now experiencing. Bernanke’s policies come out of the same Keynesian bag of tricks that turned the 1930 contraction into a decade-long Great Depression, and that gave us the stagflation and malaise of the Carter years.

Two planks in Bernanke’s recovery strategy: Expand the money supply like a banana republic dictator and throw sackfuls of cash at failed companies with a proven track record of mismanaging their assets. The justification? According to the late John Maynard Keynes, this is supposed to restore the “animal spirits” of the cowed consumer, the benighted creature who foolishly imagines that after a period of prodigality and mismanagement, maybe a country should rediscover its inner Dave Ramsey — tighten its belt, get its financial house in order, and with some of the extra savings, invest for future productivity.

Can’t have that, now can we?

Bernanke’s prescription is designed to get people to borrow and consume more in the short term. But the way an economy gets richer is by producing more goods and services that people value. The Fed can print money. It cannot print cars and groceries and doctors. The math is pretty straightforward: More money chasing the same number of goods doesn’t magically generate more goods. Nor do artificially cheap interest rates magically generate more loanable goods and labor for starting, expanding and modernizing businesses.

Bernanke’s enthusiasm for bailouts is equally misguided. Bailing out failed companies allows these broken businesses to go right on mismanaging resources, instead of selling off their assets to well-managed companies. And since the failed company can assume the government will bail it out again if need be, its now a mismanaged company that doesn’t even have to worry about the consequences of its own stupid decisions — the spoiled, unproductive rich kid whose daddy owns the town.

We need a Fed Chairman who will let the free market guide interest rates, and who understands that unproductive companies should be allowed to go bankrupt. What’s useful in those companies doesn’t disappear in a bankruptcy. The valuable assets are purchased and put to better use by more productive companies. And when interest rates are allowed to float upward to reflect the scarcity of current savings, people will be more careful what they borrow for, while others will be enticed to save more, attracted by the higher interest rates paid for bonds. This, in turn, will boost available capital for longer-term business ventures aimed at enhancing productivity.

Consider the short depression of 1920. A decade before the Great Depression, World War I had just ended and a flood of American soldiers returned home in search of work. Meanwhile, the Federal Reserve, having roughly doubled the money supply during the war, now put the brakes on the easy money by moving interest rates closer to where they might sit if simply left to market forces. The government also largely refrained from bailing out failed businesses or trying to juice the economy with big stimulus packages.

All of this is the opposite of what the Keynesians recommend in an economic slowdown. It’s the opposite of the Keynesian strategy pursued by both FDR and Hoover during the Great Depression. And it’s the opposite of what our government is doing now.

So how did the depression of 1920 play out? The readjustment to a peacetime economy was severe. Production fell by some 20%. Unemployment shot past 11%. But then the depression quickly reversed itself.

Many companies had gone broke, but their useful assets were sold to well-run companies. During the early phase of the contraction, goods and savings were tight, but the higher interest rates signaled to people, “Hey, if you want to borrow money, you’d better have a good, productive use for the money because you’re going to have pay a premium for it” — not because of a bunch of mean old capitalists but because there wasn’t a lot of savings to loan out right then. People got the message. Money got loaned to the most productive enterprises, and before long, the economy was humming again. The unemployment rate dropped below 7% in 1922, and below 3% in 1923. The government allowed the free market to readjust itself, and it quickly did.

This is the strategy recommended by the Austrian school of economics (which incidentally has more adherents in the United States than in Austria). The Austrian school is the polar opposite of the Keynesian school. The Austrian school predicted the Great Depression when others were preaching permanent prosperity. And it predicted our current recession when Bernanke the Keynesian was saying everything was right as rain.

This should give the Senate pause. If reason still has a governing role in that august body (and that’s an open question, I realize), they would arrange a substantive public debate between the Keynesians and the Austrians.

As for Senator Sanders, a self-described democratic socialist, he may want to proceed cautiously. If such a debate were to occur, he might look too closely into what economists such as Ludwig von Mises and Nobel Laureate Friedrich Hayek have to teach us about the failed economic policies of Ben Bernanke.

In the work of these economists, Sanders would find proven methods for lifting up the masses, along with tested arguments against Bernanke’s brand of centrally managed capitalism, a pseudo-capitalism in which the government is forever partnering with “too-big-to-fail” corporations with million-dollar lobbying budgets. If he’s not careful, the senator from Vermont might just find that he’s become an Austrian.

Jonathan Witt

Executive Editor, Discovery Institute Press and Senior Fellow, Center for Science and Culture
Jonathan Witt, PhD, is Executive Editor of Discovery Institute Press and a senior fellow and senior project manager with Discovery Institute’s Center for Science and Culture. His latest book is Heretic: One Scientist’s Journey from Darwin to Design (DI Press, 2018) written with Finnish bioengineer Matti Leisola. Witt has also authored co-authored Intelligent Design Uncensored, A Meaningful World: How the Arts and Sciences Reveal the Genius of Nature, and The Hobbit Party: The Vision of Freedom That Tolkien Got, and the West Forgot. Witt is the lead writer and associate producer for Poverty, Inc., winner of the $100,000 Templeton Freedom Award and recipient of over 50 international film festival honors.