 We're looking at prediction in the business cycle here today. There's a couple of readings by Ludwig von Mises that I would highly recommend. The Ultimate Foundation of Economic Science, which is his book about methodology as it relates to prediction and the manipulation of money and credit, which contains three monographs that I'm going to be discussing about in addition to additional writings of his on the issues of money and credit. With respect to more modern and practical issues related to business cycles and as well as some of the material I'm covering in here in this class today, you can go to Mises.org and search for the two words prediction articles and you will find a it's actually a Word document with links to all my articles that I've written about prediction, mostly about specific predictions concerning the last couple of boom and busts and especially my article on skyscrapers and business cycles, which so far has pretty good record pretty much say over 90% shows that I'm not going to really be discussing it and ask questions about it, but basically it shows that a record-setting skyscraper is a signal for an economic crisis. If it's a worldwide record, it's a worldwide crisis. If it's a record for the country of Uganda or Chile or whatever, then it tends to be a national or regional crisis. Current situation of course with respect to the business cycle is just not good. Mr. Bernanke, who is the chairman of the Federal Reserve and who has at his disposal literally hundreds of economists and statisticians to do his bidding, has basically given us the idea that he senses based on all this information that there are green shoots coming up in the economy and as a matter of fact he's been saying this now for over two years and the shoots are yet to be big enough so that any of us can actually see them. He believes that those shoots are out there based on his low interest rate policy, essentially zero percent, as well as the fiscal stimulus combined with his quantitative easing, which is another one of his unprecedented monetary policy maneuvers where he's essentially force-feeding monetary liquidity into the economy. Most Austrians I know do not see a recovery currently in the business cycle. The notable economist at NBER, the National Bureau of Economic Research, which is supposed to tell us whether the economy is in a recession or in a recovery, told us that we were out of the crisis and into our recovery quite some time ago and yet all the real indicators that I look at and that most people look at like the unemployment rate have not gotten any better. The reason for this, as most Austrians see it, is a combination of factors. We see the stimulus in the bailouts as actually stymying the economic recovery or the recovery process by discouraging entrepreneurial investment. There's a whole general category of entrepreneurial uncertainty. There's economic uncertainty directly due to the stimulus in the bailouts because entrepreneurs and even policymakers themselves at this point don't know who's going to get the next round of stimulus or the next round of bailouts and more importantly they don't know who is going to be made to pay for those. There's regulatory uncertainty. The Dodd-Frank regulatory overhaul bill has been passed but most of its provisions do not go into effect or are not even yet determined at this point in time. Many financial institutions feel for example that they can't lend money because they don't know what they are going to be required to do when these regulations actually go into effect like how much capital will I have to hold. There's uncertainty around energy. There's regulations, tax holes, loophole closings that are essentially a tax on all of the various companies in the energy sector. There's tax system uncertainty whether or not tax rates are going to go up or stay the same. No one's really worried too much that they're going to fall at this point in time and then of course another giant category of uncertainty is the government's budget, its deficit and its debt and of course that point is being driven home real hard at this present moment given the uncertainty around raising the debt ceiling and whatever might be attached to that such as budget cuts, tax rule changes and so forth. Just considering those factors it's obviously difficult to make predictions. No one has ever claimed that it was easy but in a scientific sense the Austrian believes that prediction is simply not scientific. Yes sure people can make predictions and yes sure they can come true. They might even be very specific but in a scientific sense we can't develop a method that would actually make correct predictions over and over again. I want to compare and contrast the mainstream neoclassical view of prediction in the Austrian view and the differences are quite stark. First of all for the mainstream prediction is the goal of economics. Prediction is their purpose. That's what they're in business for is to make predictions. They are willing to make unrealistic assumptions about human behavior and markets if it can justify improved predictions. Success within mainstream economics is measured by prediction and progress over time is achieved by better predictability. We get better data, better models, better computers, more specific, more accurate. We can make better predictions closer to the truth over time. As a matter of fact the motto of the econometric society is science is prediction and this is all these tenants are built on the model of physics. When Edmund Haley studied a comment that he saw coming through our solar system he did some calculations and he made the prediction that that very same comment was going to come through our solar system like 61 years and three months later and everybody's like yeah right and then it came true. Everybody was amazed it was almost like a magic trick and ever since people have been trying to achieve similar magic tricks but all scientifically based and so into this framework neoclassicals proceed along the lines of prediction. I've got a graph up here that shows a textbook example of the business cycle where an economy is growing over time. This is production over time. Business cycles appear in the economy. You see booms followed by busts or expansions followed by contractions. They're roughly of the same size. The time periods are roughly similar and expansions always follow contractions and in their view if you have certain policies you might be able to limit the downside or hasten the upside and so you have Mr. Bernanke with this model having undertaken all of these policies to hasten the recovery and yet events are not playing out as that textbook would say. That's because the business cycle does not follow a regular reoccurring pattern like Haley's comment that events change, circumstances change, reactions to policy maneuvers change over time so that the actual economy over time might look something more like this. So there's no regularity built into that system where you can anticipate an economy expanding then you can anticipate it contracting for a while and then about given an average time that contraction will be reversed into an expansion and you can take average numbers and work everything out so that you can be fairly confident in making your predictions about changes and that's just not the way things are. This is more of the reality where you can have sharp increases in economic production followed by a minor dip followed by another major climb followed by a plateau and then a series of down drafts in the economy where the economy is collapsing with minor upticks and then further collapse. You can't depend upon a regularity of a comet like system in an economy that can where anything virtually can happen. Austrians reject forecasting and prediction scientific prediction in favor of qualitative prediction. We recognize that there are no constant relations for people. This is a point where we were driving home the first couple of days in various lectures. You were probably wondering does that really matter? Well here is where it matters. Here is precisely where it matters. Ludwig von Mises declared that men are not rocks and he was directly attacking this physics based notion of mainstream economics. Men don't have ascertainable inevitable regularity especially men. Praxeological prediction with which we do have apodictic certainty is of a qualitative nature and of a nuanced nature. We say for example Ceteris Paribus all other things held constant. A decrease in the demand for a good will lead to a decrease in the price of that same good. We don't say how much of a decrease in demand. We don't say how much of a decrease in price. We don't say how much of a decrease in the quantity demanded or how long all that's going to take. Those are things to which we cannot be certain which require some guesswork if necessary. In terms of quantitative issues like how much is price going to fall, how much is quantity demanded going to change, how long will all that take ultimately to take effect. We don't have pure science to deal with that. We have to use understanding in the German that's Verstehen. That's the only appropriate method which is essentially you're taking your understanding of economic theory. You're taking your knowledge of history and then you're making some guesswork. You simply cannot predict the timing and magnitude of events with regularity. You might get it once or twice on specific things. The S&P 500 is going to fall 50%. If everybody picked a number here, one of us would be right. It's not much of a model to go on, is it though? Statistics are things from the past. It cannot simply be projected scientifically into the future. Let me give Amisa's own words on all this. This is from the Ultimate Foundations. Economics can predict the effects to be expected from resorting to definite measures of economic policies. It can answer the question whether a definite policy is able to attain the ends aimed at and if the answer is in the negative, what its real effects will be. But of course this prediction can be only qualitative. It cannot be quantitative as there are no constant relations between the factors and the effects concerned. The practical value of economics is to be seen in this neatly circumscribed power of predicting the outcome of definite measures. In fact, Austrians view the notion of scientific forecasting or prediction as a science at the level of a science as self-contradictory. For example, let me tell you that I can absolutely forecast a slowly rising stock market for the next six months and then an economic crash in the stock market. Now if that were true and scientific then I would, what would I do? I'd sell out before that crash came. And actually if my forecast were scientifically valid and people would buy my services, then everybody would sell five months and 29 days after I made that projection. Or would they? Would some of them just stay in, take the crash? What would you do? Sell when? Well, you got markets going to go up for six months and then crash. Yes. But if you were selling out the day before then I would sell the day before that. Right? Got all these people out there that I've just told this information to and then I have to sell now. I'd better sell quicker than that. Well basically what would happen is that people would start selling early at some point and the bust in the stock market would start occurring. Well certainly the growth in the market would slow down or stop and the bust would ultimately come quicker than my predictions, the prediction that I made. And so if we did have a scientifically valid way of making predictions it would change the course of events and undermine the model that I was using. So it's sort of a self-contradiction and this is something that Mises recognized. This is something that Oscar Morgan Stern recognized as well as Hayek. Although Hayek was at some points reluctant to say that scientific prediction in this sense was impossible. But he sure knew that it was highly unlikely. So with the mainstream we have an empirical approach. Prediction is the whole key to everything. It's a statistical approach and it's an approach based on Homo economicus where man is a rock and he acts as if he's a machine. And this is really embarrassing for the mainstream economists in academia, government and Wall Street because they have had such an abysmal record making predictions about the business cycle. In fact there's not even a suggestion that they are approaching the scientific ideal of prediction in the physical sciences. They've had one thing they can do is that they can make fairly accurate short-term projections of microeconomic markets. So for example a mainstream economist can build a model and test and retest and back test this model that would predict the sales of an American cigarette company in South America for the next month. Put all the variables in, put all the data in and then put all the new data for let's say July and then make the projection for August. They have a pretty good track record of being able to do that. But in terms of the overall business cycle their record is a real embarrassment. The Austrian perspective is theoretical. We use economic theory to make it possible for us to understand past events, current events and to analyze various policy measures, various proposed policy measures. It's based on a cause-and-effect approach and one where man is not a rock. However this is embarrassing for the Austrians as well. Mises established the Austrian Institute for Business Cycle Research which was actually designed and funded to collect data and distribute economic statistics in much the same way as American institutions were doing. Claiming that this data would help firms make better decisions with regard to the business cycle. Hayek was the first director of this Institute even though he didn't think forecasting was possible. And Morgan Stern, the second director of the Institute after Hayek left for the London School, also believed even more strongly that forecasting was impossible and yet they were running an outfit basically designed to provide the statistics for such forecasts. What I'm going to do in here at this point is to look at a couple of important economic cycles in history and show how the Austrians and how the mainstream economists did in terms of predicting it. I'm not going to cover the tech bubble, the Japanese bubble and the housing bubble but if you go to that page the predicting articles page you'll see articles where that's all analyzed and Austrians are compared to neoclassicals and what their predictions were and how they made them. First is a great depression. Ludwig von Mises knew throughout the 1920s that the world economy was in monetary disorder and especially was worried about the monetary policy as conducted by central banks. He wrote and published three separate monographs on this subject dealing with these problems in 1923 and 1928 and 1931. Primarily he was attacking the ideas of John Maynard Keynes and Irving Fisher. In particular the 1928 book refuted Irving Fisher who was the leading American economist at the time and his stable dollar plan. The stable dollar plan would use an index number of commodities prices to keep the purchasing power of the dollar stable and everybody thought that that was perfectly sensical except Ludwig von Mises. The Fisher plan had not been explicitly adopted by the Federal Reserve but they were considered to be using the plan implicitly in other words changing monetary policy in order to keep an index of commodity prices stable and level. In any case Fisher approved of monetary policy by the Fed during the 1920s. In 1928 one year before the crash Mises wrote quote anyone who approves of this index standard because he wants to see purchasing power stabilized will find himself in serious error. He then concluded that quote because of the imperfection of the index number these calculations would necessarily lead in time to errors of very considerable proportions. The evidence suggests that Mises was convinced of a looming worldwide monetary financial and economic collapse would necessarily collapse as a result of central banks trying to fix the value of their currencies rather than allowing them to freely fluctuate along the eyes lines of a true or classical gold standard system and his student Hayek and several of his Austrian colleagues were of the same mind. Not only did Fisher fail to predict the crash and depression his predictions were consistently wrong and completely at odds with the course of actual events. Just two days after reaching the peak of the bull market of the 1920s Fisher reassured investors that he foresaw no problem with the stock market quote there may be a recession in stock prices but not anything in the nature of a crash. Dividend returns on stocks are moving higher this is not due to receding prices of stocks and will not be hastened by any anticipated crash the possibility which I fail to see. Even after stocks started to fall in value Fisher stated on October 15 that stocks had reached quote a permanently high plateau and that he expected quote to see the stock market a good deal higher than it is today within a few months and that in any case he did quote not feel that there will be soon if ever be a 50 or 60 point break or drop below present levels. Then on October 22nd Fisher was quoted as saying that he believed quote the breaks of the last few days have driven stocks down to hard rock. I believe that we will have a ragged market for a few weeks and then the beginning of a mild bull movement that will gain momentum next year. Two days later on October 24th Fisher was quoted as saying quote if it is true that 15 billion in stock quotation losses have been suffered in the present break I have no hesitation in saying values are too low and yet once again the next day the New York Times reported the worst stock crash ever with nearly 13 million shares swamping the market. Less than a week later on October 28th and 29th the Dow Jones industrial average plummeted with an almost 70 point break and a two day loss of almost 25 percent. Stock market lost one third of its value during October 1929 and on November 3rd Fisher was quoted as saying that stock prices were absurdly low. However stocks had much further to fall and in the two years following his predictions the Dow Jones industrial average lost 95% of its value. Not a very good record. He later actually admitted that Mises was right and that the problem was in the imperfection of index numbers. However it never changed his mindset and even coming to this conclusion that the index numbers were imperfect it still could not penetrate Fisher's ego because he had recommended that monetary injections to prevent any decrease in the price level and he never lost faith in scientific management of the economy or his devotion to the idea of a stable dollar. As a matter of fact he wrote a book about all this published in 1932 which the economy was in awful shape. He said as this book goes to press in September of 1932 recovery seems to be in sight. In the course of about two months stocks have gone up in price and commodities have risen five and a half percent. European stock prices were the first to rise and European buyers were among the first to make themselves felt in the American market. Fisher attributed this success to inflationary measures undertaken by the Fed that were of quote deliberate human effort more than a mere pendulum reaction. So he was favoring deliberate human effort that's his policies rather than the mere pendulum action which is Mises's idea of allowing the economy to find its own level. Unfortunately not only was his prediction wrong the world was really only at the end of the beginning of the Great Depression. The human effort that he thought was the tonic of recovery was actually the toxin of lingering depression. The second example I want to look at is the stagflation of the 1970s where the Americans went from a very prosperous economy in the 1960s maybe overly so to a decade long slump of high unemployment and high inflation and lower returns on the stock market. During the late 1960s and early 1970s Henry Haslett who was an editorial writer for Newsweek magazine and other magazines prominent magazines was constantly writing and critiquing U.S. monetary and financial policy. He specifically was worried about too much spending and too much inflation and he said that this would undermine our economy in the long run and undermine the value of the dollar. Murray Rothbard was also writing at this time in fact he wrote his little pamphlet on the causes and cure of the business cycle which was published in 1969 and Mises's last interview occurred around this time he was an elderly man and this was his last really public interview and he brought attention to the issues of monetary policy and the likely problems that will result in the near future so they didn't make any really hard specific you know the market is going to crash next year type of prediction or the value of the dollar is going to somehow slump within six months but they were all very much aware about what was going on the problems that they saw and the effects that those problems of too much spending and too much inflation would cause. As far as the mainstream of economists is concerned everything was great. Academic economist Arthur Oaken was a prominent member of President Johnson's Council of Economic Advisors right before the crash he described the economic expansion as quote unparalleled unprecedented and uninterrupted. Oaken believed the economy was on a new dramatic departure from the past. The persistence of prosperity has been the outstanding fact of American economic history of the 1960s. The absence of recession for nearly nine years marks a discreet and dramatic departure from the traditional performance of the American economy. After declaring the business cycle dead in late 1969 he went on to demonstrate that research on the business cycle was now a thing of the past and that a new approach to the economy had replaced it. In fact he even took the dangerous step of ridiculing those who stubbornly stuck to the old economics where business cycles were viewed as the inevitable feature of the market economy and that recession could even be placed as a positive role of clearing up previous excesses. He confidently declared the death of the business cycle as proof par excellence that economic controversies could be solved. How was the business cycle killed according to Oaken? He found that the slayer was not new theories or policy tools but simply a more confident and scientifically rigorous implementation of existing tools that resulted in the efficient scientific management of our economy. So he's talking about Keynesian economics using fiscal stimulus, monetary stimulus to keep the economy perfectly balanced and moving forward. He opposed the much older fiscal religion of limiting the size of government and keeping its budget in balance that was based mainly on what he viewed as myth and superstition. The activist strategy was the key that unlocked the door of the sustained expansion of the 1960s. It was unfortunate for Oaken that the publication of his book was not delayed further because an economic recession began in the following month. Civilian unemployment increased from well below four percent to just over six percent by the end of 1970. The rate then retreated to six to five percent only to skyrocket to nine percent by mid-1975, the highest rate since the Great Depression. The unemployment rate remained above normal levels for the next two decades, including ten double-digit months during 1982. The experiment of the new economists had resulted in higher price inflation, as would be expected, as we would expect. From the beginning of 1946 to the beginning of 1965, the consumer price index increased by 71 percent, but then increased by 20 percent by the end of the decade, 1970. In 1965, when the experiment began in earnest to the end of 1980, the CPI increased by a whopping 176 percent. The experiment had tripled the rate of inflation experienced by the American consumer. So what they thought was a reworking of economic policy to scientifically manage the economy and to create a new era only created great economic havoc in the American economy. We ended up going off the gold standard, we ended up imposing comprehensive wage and price controls, and the stock market in real terms over the decade of stagflation lost 50 percent of its value. That's what he was bragging about, about being able to accomplish. So I want to finish up by looking at the question of how to spot an economic bubble. Jed, you better turn off the broadcasting feature at this point. The necessary conditions are things that you can pretty much figure out on your own. This would include the first thing would be low interest rates, low real interest rates, adjusting the interest rate for perceived inflation. So that's one thing that we would look for. We'd look for strong money supply growth, growth in the money supply and exceeding the trend level of money supply growth. All types of lending would also be above trend growth. And you'd also want to look at specifically where that new money is going into the economy. Is it going into mortgages? Is it going into commercial lending? What part is consumer lending playing and things of that nature? This is art, not science. Fourth, the unemployment rate should be near or moving towards its natural rate. What the mainstream account is called a natural rate of unemployment. So if unemployment gets to or below say five percent, that is also an indicator. And the savings rate should also be low. It should be below trend at least, below average. There are other things to look for. Not quite as easy to see. The first group are things that you can find if you Google FRED, Federal Reserve, Economic, whatever, data. You'll go to the St. Louis database on economic statistics. These other things look for is things that are not going to be as easy to see. But labor will be getting sucked away from some areas of the economy to more capital intensive or financially oriented jobs, technology, higher order goods, real estate, things of that nature. So that burger flippers become house flippers and cab drivers become day traders. You should also look for markets with no errors, where everybody appears to be a genius, even though you know a guy who's making money and he's an idiot. And then you're also going to be looking for unusually high levels of speculative behavior, where people who had their money in the bank, you know, all these years and now all of a sudden they're putting it into internet startups. Don't have any revenue to show. They just have an idea. Things to listen for. The most common one is some version of it's too good to be true. My brother called me. He had a new job selling mortgages over the phone. He said, Mark, I can refinance these people their mortgage. They get a lower rate. They have a lower payment and they can cash out $50,000. He says, it's almost too good to be true. I said, it is too good to be true. Another thing to listen for is new era thinking, where things that normally didn't make sense are now considered sensical, because this is a new era. Another version of that is this time it's different. Well, it's true. Every time is different. So it's hard to refute that. So you have to do some legwork to make sure that it's really not that much different. It's just a different industry where the bubbles popping up. That makes things tough. I mean, it's usually technology and some combination of technology and real estate, but it can be anywhere. We're also, there's various versions of we've killed off the business cycle, or the business cycle is a thing of the past, or we've harnessed the business cycle. And then there are personality changes that occur that you can actually witness if you're close to the bubble somehow. People exhibit euphoria, where they're really not concerned about anything day to day in their lives, or what's going around them, making so much money, they don't care. They just don't care. And they don't even really have to do anything. Okay, pervasive luxury. Austrians don't condemn people spending a lot of money or luxury goods, fancy stuff. But in the old days, luxury was a word used to describe excessive, ostentatious consumption. Like, I don't believe you're spending that much money on a pen. Or where did you get the money to have Elton John play at your birthday party? It's that kind of thing. And it's true of the wealthy people who are in the bubble. And it's also true of everybody else. So Joe Sixpack, you know, when he buys his second bass boat, and has never won any money catching bass, look out. And then there are more basic things people tend to, during the booms, they tend to dress sloppier. They tend to gain weight. They tend to smoke more drink more and use more drugs. And during the correction or the recession, the exact opposite is true. People dress better. Women use more makeup. They lose weight. They spend much less money on smoking, drinking. They stop taking certain drugs altogether, certain illegal drugs, I'm not afraid to. So that all reverses itself. And so those are the tidbits of how to spot an economic bubble. With that, I'll take questions. On the back. Yes, the inversion of the yield curve is a good indicator. It's basically when short term rates rise above long term rates, it's an indication of a desperation for short term funding. When short term funding, people realize that a lot of things out there could go bad real quick. And so borrowers have to offer penalty rates in order to get those funds. And so it's an indication of a quick change of the fundamentals and is one of the things I look for on a primary basis. And I'm gonna have to put that in my list. Yes, sir. Well, yeah, I think the question has to do with the cost of production and prices rising. I'm not sure if we can actually directly measure that. But another thing that I use that I've forgotten to mention, it's one of the primary ones that I look at is a spike in the price of oil. A spike in the price of oil almost always comes at the end of the boom. And then the onset of the crisis or their correction, you see a sharp downdraft in the price of oil because of its primary role in the production of all goods and services. Well, you know, I don't disagree with that. I think that the Austrian way of doing things gives you the most information possible that is good information, that it's in some sense, if you've got a good Austrian economist doing it, you can use that information with certainty. Whereas other inputs into your decision making might be useful. I mean, you might be able to use empirical methods, certainly people do, to enhance entrepreneurial decision making. But the Austrian economist stops at that point and says, you know, we can know this with a high degree of certainty, with regard to either policy goals for government, or entrepreneurs goals for profit. And after that, then you're getting into the area, a gray area where you're getting more precise. And but you're also introducing a greater latitude for error. Yes, sir, back. Is gold itself in a bubble? Well, it could be in a bubble, but it's not in a boom. It's not in the boom bust issue, because it's as a product. It's it's not doesn't have these the same characteristics of a structure production. If you're looking at the gold mining industry, then you could possibly view it in a boom bust cycle. But I would say that the price of gold itself is in and is in a bubble itself. But it's not strictly speaking in and of itself a capital structure production type issue. socio economics. Yes, I have heard of that. Robert prector, you're speaking of. Yeah. Yeah. Have I heard of socio economic socio economics? Yeah, that's the work that centered on the work of Robert prector, who himself is kind of an Austrian economist. But he's using his understanding of Austrian economics and then creating an entirely different model. That model is one based on psychology. And so there's kind of an overlap on the Venn diagram level of the two. Austrian's view, the economy as being affected by changes in real economic variables. This these changes then can change psychology. I just mentioned, for example, euphoria and depression. And so we're we're one step from him. We're looking at changing real variables and markets in the economy with monetary policy and credit policy, which then changes psychology. Prector is in the business of trying to measure psychology and track that with technical models. The efficient market hypothesis. Well, you know, when I think about that model, I think of management and how management changes its preferred model every six or seven years. And I think that's basically what's going on in mainstream macroeconomics is that they change that model every so often because it's found to be inaccurate. The predictions don't hold up. They hold up for a few years and then something happens and everything has to be rethought, which they're basically doing right now because the efficient market hypothesis failed. And it failed, I think, badly. How would I recommend protecting ourselves from the coming bust? You know, I've been so surprised at the number of unprecedented maneuvers by this administration, this Congress, and the Federal Reserve in particular, that it's quite baffling if you're actually following the stuff and reading about this stuff and writing about this stuff since late 2007 and tracking all the different modifications that they've made in order to keep this thing going. That I really have no idea of how to anticipate the magnitude or the timing of what that bust is going to be. And so I guess I'm left with the idea of you better hunker down pretty good in terms of your savings, in terms of having gold, of having little or no debt exposed to very little, in terms of markets staying very balanced financially and try to anticipate those things that will benefit so that overall you're balanced with respect to the dollar and which could rally at some point, and certainly would in a collapse of the world economy. But if you own inflation protected assets like gold and silver, then that's in a sense a shock absorber to any kind of economic fallout. And so, you know, I think we have to start, Americans have to start looking at the crisis as having a very increased potential of reaching levels that we have never seen in our lifetimes in the United States that haven't really occurred except in the depths of the Great Depression when there were riots, when there were marches, when there were tax revolts, you know, things of that nature, but which other people from other countries have seen in more recent times. And so you have to be aware that those kind of things are possible so that you're not mentally and psychologically frozen if they actually appear. And so that's what I would in general consider. And we just ran out of time, but I'll hang around for a few minutes. Thank you.