 Okay, the road to Hayek. As you might have guessed, my title is to take off from Hayek's 1944 book, The Road to Surfing. And actually, to get it more specific, it's my road to Hayek. It's what I'll be talking about the first part of this lecture. But my road to Hayek turns out that allows me, as you will see, a special perspective on Austrian economics. So please forgive me if you can for recounting my own early academic experience that led me through mathematics and engineering, but ultimately to Austrian economics and business cycle theory. So a little bit of autobiographical stuff here. So why mathematics? Well, because I was pretty good at it. Thanks mainly to the excellent teachers I had at junior high and high school and junior college. Now, junior college wasn't my first choice, but it was compatible for my bank account and my ongoing gas station job about a mile from that little school. That's where I started. That's Joplin Junior College in Southwest Missouri, housed at the time in a former high school, just two blocks from Main Street. So I took two semesters, I'm sorry, three semesters of calculus, each being taught by one Martha McCormick. This is a big part of my career, a top-notch math teacher. I remember telling her how that beyond Juco, that's what we call it, Joplin Junior College, Juco, I wanted to major in math. She told me that would be a bad idea. Gee, I thought I was getting it, you know. But no, that's not what she meant. She was thinking of math teacher salaries, so don't go there. But she said you need to think about applied math. Well, alright. Like engineering. And she told me electrical engineering uses some of the most sophisticated math. That was it, okay? Well, in those days, if you lived in Missouri, and the part I lived in was Missouri, and you want to be serious about engineering, you go to the Missouri School of Mines. Now that's M-I-N-E-S, not M-I-N-D-S. Missouri School of Mines. The full name was Missouri School of Mines and Metallurgy. Now, if you close your eyes and say that school's name to yourself two or three times, you'll know it wasn't a party school, okay? It really wasn't. But after graduating at the Little Colleagues, that's where I went. Even though the student body at that little town of Rallah, Missouri, consisted of several thousand guys and I was told eleven girls. Now, someone's here today from Missouri School of Mines. Where is he? There he is. Are there more girls there now? No. Sorry. Well, at the time I graduated with a double E degree, as they say, electrical engineering, the military draft was still in play. Milton Friedman had yet to do his job of bringing it down. So rather than wait to be drafted, and that's really a bad thing to do, because you just wait and wait and wait, and then get drafted, okay? So I took a commission in the Air Force, which allowed me to work in electronics. That's why, that's four years' worth of Air Force, but at least I was in electronics, okay? So I was assigned to a warfare electronics lab, that's not a surprise, housed in an air base in upstate New York. From there I worked long distance, thankfully, on how to deal with antique Russian radars that had been sold to the North Vietnamese, okay? To say the least, there wasn't much high-tech in it, okay? That was what I learned and worked with. Other things too, but similar in scope. Now, I didn't much enjoy my work, and in off hours I read a lot of Ruskin Caldwell novels. Now, that's not good for your mind, okay? But at one point my brother, who was drafted in the Army, contacted me from Vietnam. He did get drafted. And I asked me to send him all of Ein Rands books that I could find. Well, I found Rands books in Syracuse, the bookstore there, and I bought two copies each, mailing one to my brother and reading the other. Now, I have to say that at the time I was pretty much out of my element in dealing with Rands philosophy, warmed up to it eventually. But somehow I took an interest in the economists that were listed in the recommended biography of Ein Rands Capitalism, the Unknown Ideal, okay? Look at that list. I'll give you some of it. It starts out Ludwig von Mises, eight books, okay? And then Henry Haslett, four books. Eugen von Bomberich. Did Ryan actually read Bomberich? I don't know. And still more, Benjamin Anderson, Lawrence Fertig, Harold Fleming, John T. Flynn, and others. Hayek wasn't in that bibliography. I was surprised to say that when I pulled it off of my bookshelf a week or so ago. But with that list of authors, I found my way to his book. Now, that was my road to Hayek, all right? Now, I was inclined to call that even the long and winding road, but that's the Beatles, you know, so my road with Hayek, okay? I eventually met Hayek on a number of occasions on Mont Pelerin Society conferences at Institute for Humane Study Conferences. I wrote my University of Virginia doctoral dissertation at IHS while Hayek was in residence there. That was a good bump for me to be able to do that. But now I'm getting my story ahead here. At the end of my military service, I realized that it might not be easy to find a civilian job given what I'd been doing for four years. Under the circumstances, many of my military comrades with similar departure dates registered to MBA programs. Now, that didn't appeal to me somehow. I didn't want an MBA program, but instead I went for economics. Now, I can't say that the mathematics and electrical engineering prepared me for a study in economics. But here's the punchline. Here's what I can say. I can say that by not having been immersed in Keynesian economics gave me a clear head to read and study Hayek and Mises. Almost all undergraduates end up studying Keynes even if it's not labeled as Keynesianism. Since then, of course, I've read Keynes and particularly his 1936 general theory, which I've read more times than I like to think about. So once out of uniform, I registered for a master's degree at the University of Kansas City. I left that and I stayed within the Missouri gambit because I'm coming out of engineering and going into graduate work in economics. It was there that for the first time I got some Keynesianism. So that's my start with Keynesianism. And it was, as some of you may already expect, Keynesianism of the ISLM variety. How many people know what that means? Okay, good. Good. IS is investment in saving and LM is liquidity and money. There's a bunch of graphs that show how it all hangs together. Also, there was some heavy doses of institutionalism. At Kansas City, pronounced by three syllables, institutionalism. And who is that? Thorstein, Veblen and Clarence Ayers. I couldn't handle that. I'm sorry. And even Marxism. Well, we know what to say about that, too. Now, there was some neoclassical micro there, some good neoclassical micro. But my focus was on macro and especially the Austrian theory of the business cycle. I was intrigued by the interlocking graphs of ISLM that set out the Keynesian vision. But I wasn't actually won over for it. Still, though, I was intrigued. And my challenge was to create interlocking graphs that capture the Hayekian view. Nobody had tried to do that. There are graphs in Rothbard and elsewhere, but interlocking, you know, that's what you have to have going to see the full picture at once, okay? And I say that I do these graphs to capture Hayek's view. And I say Hayekian rather than Necessian. Only because Mises didn't do graphs from through human action. You don't find them. And somewhere he wrote, I know Ebling knows this, somewhere he wrote, graphs are only for undergraduates. Sorry. Richard will tell you where that came from. Somewhere. And my challenge was to create interlocking graphics. My title was Austrian macroeconomics and diagrammatic exposition. I got a respectable grade from the professor and surprisingly he suggested that I present it at an upcoming Midwestern Economic Conference in Chicago. Well, I wasn't sure. It turns out the paper had only been read by two people. And that was my professor and me, okay? So somehow I got it in my head that I needed to send the paper to Murray Rothbard. I'd read some of his too, but I'd never met him. Didn't know what he was all about personally. And I did send it to Rothbard. And in a little less than a week, the phone rang and it was Joey Rothbard. And she handed over the phone to Murray right away. And we had a long talk and it was great. Even during the phone conversation, I thought, I'm going to Chicago. It's going to work. But at some point Murray said, will you be in New York anytime soon? I was in Kansas City. I was working in the semester. I had no thought of going to New York or going out of state anywhere. But I had the gumption to say, I'll be there spring break. And it worked out. I was a guest for dinner at Rothbard's apartment. And then more guests arrived with copies of the paper to discuss the graphics. One of those people was Walter Block. Walter Reinder was also there and a few others. And I didn't know Murray very personally at all. But after dinner, we started conversations that went on and on. It was great. I mean, I wanted to hear all this stuff and a lot of chitchat about other people and so on. And I kept looking at my watch and it was midnight and then one o'clock and then two o'clock kept going. And I kept trying to get my stuff together and moving towards the door. And nobody would recognize that. And essentially I got away at four o'clock. So Murray was a total night owl. But it was a great evening for me for sure. So Rothbard, looking back, I think I'd be surprised that he would like that as much as he seemed to. But the reason he liked it is because he saw it beating the diagrams or beating Keynesianism at their own game. Keynesianism has all the interlocking. Well, so do we, you know. And it tells you another story. So that's what he liked. And the paper eventually got published as an Institute for Humane Study monograph in 1980 in 1978. And also in Luis Paderro's edited volume, New Directions in Economic Education. And I should add, not long ago, some of those graphics made it in an appearance at a Mises Institute t-shirt. I think that might be sold out, but, you know, hey, we had them. Now, I got through Kansas City. Here I was at University of Missouri at Kansas City and I got through that. Let me confess, so up front, that as an upstart Austrian, I wasn't always on the straight and narrow. One of my Kansas City professors was also an economist at the Kansas City Federal Reserve Bank. And after finishing my master's degree, I took a job at the Kansas City Fed. Maybe I shouldn't have mentioned that. But the bright part of it is that I shared an office with Thomas Haunig. Some of you might know who that is. He eventually became the Kansas City Fed president and later serving on the Federal Open Market Committee, most always casting the vote no on the Fed's keeping interest rates exceedingly low. That's Austrian views for sure. So as you know, that advice was wholly compatible with the Austrian view. Haunig put me on the actual Landhoof it. That was his hero. And that's the 1988 book on Keynesian economics and the economics of Keynes. That's a great book and there's a lot of Austrianism there, even though he doesn't necessarily talk to it about that. I could see that Landhoof it had a streak of Austrianism in him. And I like to think that I put Haunig on Hayek. It was after my short-lived Fed experience that on the recommendation of guess who Murray Rothbard, I went for the doctorate degree at the University of Virginia. I recognized early on at that very basic level that Keynesian views and Hayekian views were fundamentally different. In dealing with the macroeconomy, Hayek adopted a healthy approach to understanding business cycles. And here's the quote out of Hayek. Hayek says, before we can even ask how things might go wrong, we must first explain how they could ever go right. And as you'll see when we develop this, that's exactly what Keynes did not do. He forgot that part of it. How could things ever go right? By contrast, Keynes adopted a sharply different and less than helpful view. His notions seemed to embrace the view that apart from full employment happened so. That's my expression, but that's what it is. Just apart from that, the economy can languish in depression possibly for decades. And here, right out of the general theory, Keynes wrote, the rate of interest may fluctuate for decades. It's my italics about the level which is chronically too high for full employment. So that doesn't lead you to think that there's somehow it could go right. It simply always goes wrong. Market failure for Keynes is hardwired into the Keynesian theory. That's sort of the bottom line. If you have a theory like he has, then you're not going to have any good economics. Market failure is what you get. In my day and even now, Keynesianism sometimes not labeled as such. You have to watch out for that. It's often the first thing students learn in their macroeconomic course. And the asset test for the Keynesian view is the relative movements of consumption and investment. We'll see. Let me illustrate the world of difference between Keynes and Hayek. I'll take Keynes first. In his view, those two magnitudes, consumption and investment, can increase together, or they can decrease together. But there's no scope in Keynes' theory for opposing movements of those two magnitudes, which there is in Hayek, as we'll see. But Keynes doesn't allow that at all. And again, once you disallow that, then you're going to have an economy in trouble. Before the students had time to think about just what Keynes' theoretical construction entails, the professor's attention is on the relative rates of downward and upward co-movements of consumption and investment. So I'll spare you the algebra that quantifies those relative rates. I'm sure some of you have gone through Keynesianism and they know exactly what that is. Typically, neither the student nor the professor realizes that Keynes has put consumption and investment in a stray jacket. Look at what happens according to Keynes if income earners begin to save more. What happens when they begin to save more? Well, I've got some pictures to show you that. Oh, I've got things to write on too. That'll be good. That'll be good. I've got red and green. I think I'll use red just for danger. We'll see how that goes. I'll start with an economy that's just a private economy with no government spending. You know what that looks like. Look at the left there. I'm just saying that's what I'm looking at. Y equals C plus I. We can add to that in a little bit, but now just Y equals C plus I. Now, on the right, we have three steps here. The first step is that we're imagining, and this happens sometimes, that saving increases. And it's because of demographics and all sorts of things. It's not that people just get a big boost saying, oh, I've got to save. That's not it. It's just over time, depending on the population and so on, then you might get more savings than you've had before. There is such a thing as people saving more, all right? So people saving. Well, if they're saving more, means they're consuming less, isn't it? So that's C going down. Oh, that sort of upsets the equation. And in fact, even worse so, because according to Keynes, if people aren't going to be consuming much, we don't have to be producing as much. I goes down too. But a lot of people lose their jobs and income goes down. That's the third step. So this is the problem that Keynes has. In fact, he has a label for it that you probably already know what it is. It's the paradox of thrift. Because if this is what happens, then everything goes down, and you tried to save, but you can't save because you don't have enough income. That was the problem. That was the problem. That's the way Keynes looked at it. Now, I could, in fact, I didn't do this on the screen, because that's as far as it goes to show you what the problem is. And if you look at what the solution might be, or at least what the solution might be in the Keynesian view, there's one more thing out here, C plus I plus what? G, okay, government, okay? So you can get government and say, look here, both of these things are going down. The whole thing's going down. There's something to go up. Well, how about G? There's G, and let's let it go up, and then that'll fix things. A boy won't it. And the way you see it, you can see it two different ways. And in reading Keynes, you're not quite sure which way he's thinking, but neither one of them worked. If you have all this G to fix the picture, to fix the whole thing, you need to get some money for it. And if you get it from taxes, it comes out a Y, then after tax wise, it's going to be way down. That's not going to work very well, okay? And the alternative, of course, is getting the G from the central bank. And if you do that, it seems okay for a while, right? It seems okay for a while. But that's what gets you into a business cycle, right? So there's nothing I could put there that would show you how, okay, this will fix it. This will work outright. It ain't going to happen. It's just a question of which way do you try to do it? And what's the outcome, okay? So G to the government or the rescue just isn't going to do it, all right? Okay, people may lower their consumption in order to save more, and then there's the C plus I. And with I and then Y going down, you have trouble saving. This is Keynesian's paradox of thrift, okay? The high act didn't have any paradox of thrift, okay? Now we put G in the picture. And it turns out here that if that's what you do, then you get an artificial boom or other problems all along. So Keynesian's vision is very different than high act. Normally, this is in Keynes, or at least frequently, and for long periods the economy is inside the production possibilities frontier. Well, we know how that goes. And it looks like that, that there's no way that it can move along the frontier, all right? You see, they're inside the frontier or it could be going up towards the frontier, but if it happens to hit the frontier, well, that's a miracle. I mean, there was no way that that would do that except just by happen so from Keynes. So the co-movements of C and I consist of movements inward away from the frontier and outward towards the frontier or with the central bank's help beyond the frontier but only in nominal terms, that is inflation, which eventually gives you the whole business cycle business, okay? Keynes theory simply doesn't allow for opposing movements of consumption and investment, consuming less and investing more in order to have increased C in the future. That just doesn't happen. It does happen in Hayek. And so now I show you what Hayek would be doing. So we're going to contrast this view with Hayek, showing here how in Austrian theory opposing movements can actually happen when there's increased saving behavior and showing that the market economy can stay out of the Keynesian straight jacket, okay? We add a temporal dimension to the investment and we allow for some entrepreneurship. That's not a hard thing to do. Allow for some entrepreneurship. So first, let's look at the loanable funds market, which reacts to the increase in saving. S-saving shifts to the right, lowering interest rates. You're all familiar with that. If I just do the loanable funds market, it looks like that. But if people save more, it just means that curve goes to the right like so. Well, okay, it goes to the right. But that causes it to lower interest rates, right? And so that's the thing that is in play here that is not in play in any meaningful sense in Keynes's view of these matters, okay? Now, so you see that you have the economics to get more investment and less consumption. But there's a time element here, and of course, that turns out to be the Hayekian triangle. Now, before I show a Hayekian triangle, I have to say that my triangle looks different than Hayek's. It still has three sides, okay? But different. And the difference is, if you've read prices in production, that for some reason, and I think I can guess what the reason is, Hayek had time coming down the vertical axis, okay? And I claim, if someone knows I'm wrong, please tell me, I claim that's the only graph in all of economics that has time coming down the vertical axis. It makes you wonder what happens to time when it hits the origin. It just doesn't commute, doesn't, can't think of it that way, okay? And so it's an easy fix. You just yank the triangle around where time goes left to right. And that's the way it works. So, don't get upset if it's my triangle and not the Hayekian triangle. So here's our triangle, crooked, okay? It looks good, okay? That's a Hayekian triangle. And if you insist on flipping it around and looking like Hayek, that's fine. But that's the triangle. And again, in this picture, we see that if people really want to save more, it means they consume less, right? They consume less. And so that's the arrow that shows they're really going to reduce consumption. Now, as Keynes would have had it, I mean, okay, it means reduced investment as well. No, it doesn't work that way. Precisely because, as you saw with the loanable funds market, the interest rate is lower. And if the interest rate is lower, that makes longer term projects more profitable. You don't have to spend too much money with interest because they're lower now. So when that happens, what we get is a new triangle. Okay, if people aren't consuming currently the consumer goods, then we can use our monies to increase investment in earlier stages. It'll still be profitable, all right? And in fact, if you look at the triangles, I've shown it so that you get more investment than you lost. You lost some investment in the upper stage, but you got more investment in the lower stages because when people are saving more, then that leaves a lot of stuff they're working and making available for use in the triangle, all right? So that's the way that works. So anyhow, Cain's focus then has been missing the cause of the economic downturns. I can best introduce... Here's directly from the general theory. And just think about it and see if you think it makes any sense. He says, I can best introduce what I have to say about depressions, about downturns by beginning with the later stages of the boom and the outset of the crisis. No, he's already missed the boat at that point. He needs to look at the early stages and see what happens there. And that's where all of the problems are created. And then near the crisis, you know, you get the crisis. But he says he wants to look at the beginning of it. So here, apart from psychological factors, the early and middle stages of the boom had no acclaim on his attention. It's worth noting that Friedman too points to a normal or ordinary downturn. I've got books where I always underline those kinds of words. What does it mean, a normal downturn? Or ordinary, just an ordinary downturn. Which is to say, we're not going to bother with thinking about that. It's a normal downturn. And then deals with the slide into deep depression, which is characterized with massive uncertainty, hoarding behavior, and ill-conceived government programs. So in contrast, Hayek focuses on the dynamics of the inflationary central banks, unsustainable boom, which leads to a crisis. And I've heard Hayek say that when he used that term crisis in this context, he didn't mean the entire falling to a deep level of the economy. He didn't mean that. The crisis was simply the economy has quit going up and it started going down. And the whole notion about the interest rate effect is what gives that to us. We know that if you have the interest rate too low, then you have too much early stage investment and you run out of stuff in order to finish. And so that's the crisis. It's another thing about what happens all the way down. It's the same things I mentioned a minute ago. There's massive uncertainties. Well, we know why that is hoarding behavior, ill-conceived government programs. So it snowballs. It gets worse and worse because people are doing their own things to try to fix it. So in contrast, Hayek focuses on dynamics of inflationary central banks unsustainable boom that leads to a crisis, again, causes it to start to turn down. That means that initial downturn. Let me recognize that Keynes and Hayek, face-to-face, were always collegial with one another. But the writings elsewhere, not so much. I'll just mention two to give you the flavor. One has to do with the concept of forced savings. This is mentioned in the general theory. If any of you have worked for that term, you've got to be real careful and decide which of the half-dozen meanings that that's supposed to happen. Because it's not clear just what forced saving means in this context. And that's the phrase Hayek used. And he and others had a meaning to it that seems almost, well, almost counter to the idea of forced savings. And it goes like this. Hayek has explained in a footnote, I guess he realized that term isn't exactly right, but he has in a footnote, that forced saving, what it means is despite their using any actual savings. That's not forced. People aren't forced to save, literally. That could carry the investment to completion. So it turns out that in the early stages, too much stuff is being used. That could be called real forced saving as opposed to handing over the money as savings. So that real forced saving means that people are building too many things at the early stages and they're going to run out and it's not going to work and you're going to have a downturn. That's what it means. And so the question we could ask Keynes and we're happy to get an answer because we just need to know. So let me recognize, let's see. I say one issue in the general theory focuses on the increase in the quantity of money that supposedly causes forced savings. But we've gone through, we know what it actually means. So if we ask Keynes what that means, here's what he says. You need to write this down because he says it in the general theory at the time where he's asked, what can you say about forced savings? And here it is. He says, at this point we're in deep water. The wild duck has dived down to the bottom as deep as she can get and bitten fast hold of the weed and stangled and all the rubbish that's down there. It would take an extraordinary clever dog to dive down and fissure up again. Now, I mentioned Landhoffett before. I have it from Landhoffett. He says this is an obvious reference to Keynes. I didn't pick that up the first time I read it in the general theory. But I think Landhoffett was right that he knew that Keynes used forced savings and he knew that the Austrian theory was a bunch of bunk. He didn't like it. And so that's what he said. That was Keynes' reason there. So now let me offer a tucked away passage in high-expear theory of capital. And in fact it's in the part of that theory where capital isn't that pure, okay, near the end of the book. But here's what Keynes says. It's not surprising that Mr. Keynes finds his view anticipated by the mercantilist writers and gifted amateurs. Concern with the surface phenomenon has always marked the first stage of the scientific approach to our subject. But it's alarming to see that after we have gone through the process of developing systematic account of those factors, which in the long-term determine prices in production, we are now called upon to scrap it in order to replace it by the short-sighted philosophy of a businessman raised to the dignity of a science. That's what he had to say about Keynes' general theory. Now I've allowed myself enough time to say something about Friedman and Hayek. And here I'm going to quote Friedman in his 1963 Monetary History of the United States. And this is something he just blurted out in one of his chapters. And he says, what he was talking about is how deviations of interest rates can or maybe can't influence much. You know, they go up and down, but not very much. Just about like this, you know, something like that. And so Friedman says it's a sound general principle that great events have great origins. Now, I'd say independent of the context, that's not true. That's just not true. But that's what he says. And he goes on to say, well, you know, sometimes there might be. But I guess he didn't want to apply it to changes in the interest rate. And we have to recognize that sometimes there are great events and great origins. Volcanoes dumping on cities, for instance. Volcanoes of big cause and destruction of the city is a big effect. But apart from that, we've got a lot of leeway in between. And I write here that now in a follow-up, in the same paragraph, they do a little whistling in the dark. In other words, you know, it's a sound principle, but not quite sure. Now, I'm going to jump now from Friedman to Robert Lucas, who made something out of this. And Lucas, we can call him a monetarist if we choose. We say who's new classicism is a dynamic general equilibrium vision of Friedman's monetarism. That he shares with Friedman in Schwartz. So they're both in the same tract. And he endorses this view about you have to have big causes and big effect. And without any whistling, there's no question about it to him. It says the magnitude of the cause alleged by the Austrians. This is Lucas, my rendition. A policy induced decrease in interest rate is so small compared to the magnitude of the alleged effect, a dramatic economy-wide downturn that Austrian theory of boom and bust cannot be entertained, period. And now in his own words, and you'll see I've seen the same thing. He just writes a little differently. Given the cyclical amplitude of interest rates, the investment interest elasticity needed to account for the observed magnitude in investment is much too high, and it's his italics, much too high to be consistent with other evidence. So out with the Austrians, they need to be saying those things that they've been saying for years. Now, in an article, a chapter that I contributed to a book on Keynesianism, I claim that he's wrong on three counts. And yet, in getting ready for this lecture, I realize that I made a mistake. There are four counts. And it goes like this. The first count is failing to recognize that small, persistent causes can have large effects. And that's easy to recognize. Two, he thinks of interest elasticity of investment as a whole. Rather than divergent interest elasticities of early stage and late stage investment goods. In fact, that's what causes the problem. You get too much stuff in the early stages and not enough stuff in later stages. And if you try to quantify the elasticity as a whole, and if you try to quantify the elasticity as a whole bunch, well, you'll miss the problem. So that's number two. He's wrong about that. And thirdly, he takes effect, the effect to be the entire peak trough, a movement that will invariably entail complicated factors, including ill-conceived policies aimed at rekindling the boom. And now here, we go back to business about the crisis. He's not talking about the whole shebang. He's talking about the downturn, which can get amplified by a lot of things that go wrong and a lot of things that go stupid with the government trying to do all the wrong things to solve the problem, makes the problem worse. Though that's the third thing. And now the fourth thing, he's talking about relative movements. What about that movement in interest rate, as opposed to the movement top to bottom to the depression? He fails to realize that even if the Federal Reserve just kept interest rates from rising when market forces were pressing upwards, that too would trigger the eventual downturn. That's what I claim. And yet if Lucas tried to do his math, he'd have trouble because there wasn't any change in the interest rate. But if there was a change in market forces that isn't detected, nobody noticed what that was, then his results just have our meaningless. There wasn't any change in the interest rate, but there should have been. It should have been allowed if market forces were pushing upward. Okay, that's where I'm quitting. Okay, thank you very much.