Book Review: What Every Investor Should Know About Austrian Economics and the Hard-Money Movement – Mark Skousen
In my review of Thomas J. Dorsey’s book: Point & Figure Charting, I wrote that technical analysis (especially Point & Figure charting) could be seen as a form of entrepreneurship in the financial sector. When betting on the stock market, technical analysis is an important tool investors use when he is trying to get the odds in his favor.
This is especially relevant in the short term, where prices tend to move according to sentiment and peoples expectations. In the medium to long term, sentiments and expectations play a much smaller part in determining the overall trend. Here, fundamentals become more important as prices tend to conform to the underlying supply and demand dynamics.
In this analysis, Austrian economics can be very beneficial. For people not familiar with Austrian economics, What every Investor should know about Austrian economics and the hard-money movement (1988 ) by Mark Skousen, is a must read. This is a beautiful little book (and perfect for weekend reading), with a very interesting theme: Austrian Economics applied to finance.
However, for people already familiar with Austrian economics, I doubt that What every Investor should know about Austrian economics and the hard-money movement will add much new insight, as it is an introduction. But, because of the scarce supply of Austrian investment books on the market, I still think this little book deserves a place in every serious investor’s personal library.
Skousen does a great job in pointing out some important features of Austrian economics that you don’t easily find in the average text book. In the part called, Followers of the Austrian School of Economics, he mentions the obvious, but often ignored fact, that one of the keys to economic growth and prosperity is a high rate of personal savings and capital formation.
The Keynesian framework provides a relevant example. Here, focus lies completely on consumption, and not on savings. This misconception has serious effects on the economy, as government consumption is believed to produce prosperity.
On Wednesday this week, we could see another example resulting from ignoring this key insight, the GDP report. GDP are supposed to measure the health of the economy for a country. Although GDP is an important number, it almost completely consists of consumption related spending. This takes focus away from what is really the driver of economic prosperity and capital formation, namely savings.
Another Austrian insight mention in the book is that government inflationary policy is responsible for the boom-bust business cycle. What Skousen is refereeing to here is the Austrian business cycle theory (ABCT), first developed by Ludwig von Mises.
In the part called How to profit from the business cycle, Skousen gives a brief overview of how he sees the business cycle. He divides the cycle into four stages: (1) The inflationary boom, (2) The credit crises, (3) Recession, and (4) Economic recovery. Depending on which stage the business cycle is experiencing, different types of assets are more suitable than other in an investors portfolio.
However, Skousen points out, as also many other Austrians do, that no one rings the bell when we go from one stage to the next. This fact has even made some people question the value of Austrian economics in practical investing.
However, It should be clear, even if Austrian economics cannot answer that question, by understanding the causal relation ship between credit expansion, inflation and the business cycle, people familiar with Austrian economics have a direct advantage over the average nonaustrian economist, in making appropriate long term investment decisions.
Nice writing. You are on my RSS reader now so I can read more from you down the road.
Allen Taylor
Allen Taylor
May 2, 2008 at 11:34 pm
Pinpointing in advance the exact day, or even week or month, when a market well reach a peak or bottom is indeed impossible. Still, that doesn’t mean you can’t use Austrian business cycle theory to first relatively early identify the existence of an inflationary boom, and then invest in the asset classes -stocks, real estate- that are booming and will continue to boom for a while. Many Austrians identified the stock bubble of the late 1990s already in 1996 and, something which could be used to invest in the stock market and enjoy rising prices until March 2000. Similarly, many Austrians identified back in 2004 the housing bubble, something which could similarly be used for investing purposes.
The gains during such a period are so large that one can afford to buy risk insurance in the form of put options and still enjoy very high returns while the potential losses will be very limited thanks to the put. And of course, the de facto puts people like Greenspan and Bernanke provides for free limits the potential losses even if one does not want to buy a formal put.
Stefan Karlsson
May 4, 2008 at 11:22 am
Allen, thanks for your comment, I appreciate it.
Daniel Halvarsson
May 4, 2008 at 7:25 pm
To avoid any misunderstanding, I should add that, when I say “Austrian economics cannot answer that question”, I am only referring to the timing aspect of investing. As my good friend Stefan Karsslon points out, timing is really a hard part when it comes to investing.
You can view timing with the following analogy. Let’s say, reality is the chamber of a gun. When some Austrians identified the housing bubble in 2004, they did so by seeing imbalances in the underlying economy, which they knew, sooner or later would materialize in the stock market. These imbalances can be seen as bullets in the same chamber. Once every while, someone push the trigger. With the gun loaded, the Austrian investors are waiting for the gun to fire.
The fact that the gun didn’t fire until august 2007, when subprime hit Wall Street, didn’t invalidate the fact that there, actually where bullets in the chamber. How long the gun would click until firing, is the timing part. Austrian investors know that, the more bullets there are in the gun, the more likely the gun will fire when you push the trigger. However, because the future is uncertain, we cannot know for sure how long it actually will take for the gun to fire.
By correctly identifying the nature of these bullets, and the chain of events, should the gun fire, I believe Austrian economics is the only theoretical framework, that time-and-time again has proved to be right, even from the investors perspective.
From the investment point of view, what is also needed, except Austrian economics is knowledge of the existing supply of possible investment alternatives. Stefan mentions one example, the put option, this knowledge is necessary in order to implement the Austrian analysis to good portfolio management.
Looking at present time, as credit expansion is accelerating; more bullets have been put into the chamber. The inevitable result from the gun firing is what we currently are starting witness: The subprime crises, collapsing housing market and a recession ahead.
The fact that Austrian economists are good predictors are no new occurence. Looking back prior to the great stock market crash in 1929, Mises and Hayek were pretty much the only one who believed that stocks were going bust. Compared to Mises, Irwin Fischer (nonaustrian) wasn’t so lucky, when he said, two days after reaching the peak of the bull market 1920, that he saw no problems in the stock market ahead.
Daniel Halvarsson
May 4, 2008 at 7:26 pm