Why is BFIA a student at the Austrian School of Economics?

James Mackreides claims that during BFIA's 25 years, a heterodox tradition in economics has served as a compass

In its 25 years of operation, BFIA has established a solid reputation for identifying the key economic trends in the economy and society and outlining their implications for investors and savers (see this issue, passim). We are the nation's top-selling financial weekly for a reason. But how do we do it? Given that we live in a scientific age, you might assume that our process must adhere to the tried-and-true methods of natural science. If our writers were concerned about the possibility of a financial crisis in late 2007, as they were, while the general consensus was that such things belonged to the past because of The Science, it was probably because they had studied the most recent economic and social science papers at the British Library, pored over the economic data, and solved complicated mathematical equations to demonstrate that the line that was currently rising was about to reach a maximum and turn back down, or at least something along those lines.

What would be the alternative? Well, as Ayn Rand always insisted, we would need to examine our premises before we could have any kind of rational discussion or approach. If we are not certain that the data is providing us with meaningful information, there is no purpose in examining it. If a speedometer isn't attached to your wheels or you don't care about your speed, there's no use looking at it. If the social science's authors are initially misguided, there is no point in reading it. To put it succinctly, pretending to know something when you don't is pointless.

Friedrich Hayek's acceptance speech for the 1974 Nobel Prize in Economics was titled "The pretence of knowledge." His message is still relevant today. He begins by acknowledging that his line of work has caused chaos (sound familiar?). At the time of his speech in December 1974, there was a "serious threat of accelerating inflation" that was "brought about by policies which the majority of economists recommended and even urged governments to pursue." According to Hayek, economists' inclination to "imitate as closely as possible the procedures of the brilliantly successful physical sciences" was the primary cause of the error.

That may sound reasonable, but the approach is actually inappropriate because studying complex social phenomena, like the market, depends "on the action of many individuals" and all the factors that will determine the result will "hardly ever be fully known or measurable". Measurable factors are frequently considered important in the social sciences, and only theories that make reference to measurable factors are considered admissible. To put it another way, they are similar to the inebriated person searching for his keys near the lamp postnot because that is where he lost them, but rather because that is where the light is.

However, there are other ways besides the physical sciences that we can use to illuminate the dark. According to Hayek, one could develop "fairly good qualitative knowledge" based on the "facts of everyday experience" about social phenomena, the circumstances in which they occur, and the elements that are crucial in causing them or that would need to alter in order to bring about an adjustment. The "logical correctness of the conclusions drawn from them" and our ability to obtain widespread agreement on the facts would then determine our level of knowledge. Anyone who has read him will find those remarks to be a fairly accurate synopsis of Ludwig von Misess's approach in his seminal work Human Action. Mises had a big impact on Hayek. Together with several other individuals, they are regarded as the pioneers of the Austrian school of economics.

What is the economics school of Austria?

According to Peter Boettke at the Library of Economics and Liberty, Carl Menger, William Stanley Jevons, and Leon Walras were the main players in the "marginal revolution" in economics. Menger's Principles of Economics, published in 1871, established this school of thought. Mengers' book was an effort to "rescue theory" from the then-dominant German historical school, which maintained that historical analysis should be the primary focus of research since economic science is unable to produce universal principles. "Asserting economic laws that transcend time and national boundaries" is how Menger rephrased the traditional political economy viewpoint.

Menger stated that "man and his choices" is a suitable unit of analysis in this science. These decisions are based on individual subjective preferences and "the margin on which decisions are made" (we would all prefer to live without diamonds than without water, but diamonds are typically more valuable than water because we determine what to value more highly at "the margin"that is, whether one more diamond would make us happier than one more bucket of waterrather than on total satisfaction). Consequently, "marginalism". Because of the positions the economists held at the University of Vienna, those who adhered to these theories were dismissed as "the Austrian school," and the term stuck. The term "Austrians" was also applied to later economists who adopted the same fundamental methodology.

Boettke's essay provides an excellent summary of the ten key ideas that characterize the Austrian school. Just a few of them should be enough to demonstrate why BFIA writers have benefited from the school's teachings. For instance, the first claim made in Boetkkes' essay is that "only individuals choose." "All economic analysis begins with man and his goals and intentions. Collective entities don't make decisions; only individuals do. Economic analysis's main goal is to make economic phenomena understandable by basing it on personal goals and plans; its secondary goal is to identify the unforeseen effects of personal decisions. A "

That may or may not seem apparent, but it represents a significant shift from social science's typical approaches. Austrian economics begins with the individual and their mental processes, which are opaque to the methods of natural science but that we can all understand through introspection and develop into trustworthy knowledge by following the logical ramifications of our decisions and actions. Instead, social science seeks to comprehend how a variety of social, historical, and other factors influence human behavior. The scientist attempts to measure and observe these factors as a physicist would in a lab, with the goal of modifying and controlling them as needed (you can see why such an approach would be attractive to governments and other world-improvers).

The goal here is to demonstrate the applicability of the Austrian school to investing, where a key component of success is distinguishing between what you as an individual do have some control over (what you choose to pay in fees for fund management, for example) and what you do not truly know or understand and have no control over in any way (whether the stock you are buying will rise or fall in price over the long term, or even survive, for example).

Comprehensibility rather than forecasting.

This leads to the conclusion that "intelligibility, not prediction" is the aim of Austrian economics and investing (proposition three in Boettkes' essay). This is possible "because we are what we study, or because we possess knowledge from within, whereas the natural sciences cannot pursue a goal of intelligibility because they rely on knowledge from without." The insights of John Kay and Mervyn King in Radical Uncertainty (reviewed in detail by BFIA in 2021) demonstrate the relevance of this to investing. The phenomenon of "superforecasting," which was popular at the time, is examined by the writers of that book. However, Kay and King note that the future is "radically uncertain" rather than "predictable" because the world is not a dice game. As the superforecasters say, it might be possible to do better than you might think at predicting whether inflation, for example, will or won't be 3.5 percent by the end of the year by being diligent and open-minded, but this is at best a proxy for what we really want to know, which is "what is going on here"? During the Covid pandemic, BFIA failed to predict that inflation would reach a specific rate at a specific time. We had no idea. Even though The Science was telling us that any impact would be "transitory," we did find what was happening to be understandable and came to the conclusion that the most likely outcome would be a period of prolonged and at least higher-than-usual inflation once more.

The idea that "money is non-neutral" is the eighth item on Boettke's list and has been central to BFIA since its founding. Exchange will be distorted if the monetary unit is distorted by government policy. Prices will rise in response to any increase in the money supply, for instance, if there is no corresponding rise in the demand for money. However, prices do not change instantly across the board. Relative prices fluctuate because some price adjustments happen more quickly than others. Every one of these modifications has an impact on the production and exchange patterns. In fact, another important finding of the Austrian school is that boom-and-bust cycles are caused by government interference with the price of money through artificially low interest rates. In 2007, BFIA warned of an impending crisis based on this type of reasoning rather than data or a crystal ball.

For the majority of its 25 years, BFIA has argued along these lines and warned of the economic and social repercussions. It has done this not only as an educational service but also to explain what it means for investors, such as that positioning your portfolio to ensure that your wealth grows at a rate at least to match and hopefully beat inflation is a key financial goal for all savers and investors, and that some financial instruments and assets are more likely to achieve this goal than others.

It is reasonable to note that adopting this perspective might not be particularly thrilling. You might lose out on the big boom in the newest thing and the profits that come with it if you don't have a tried-and-true strategy for predicting "whats going on here" and making wise investments as a result. Investing in the Austrian style is not a quick way to become wealthy. However, as our regular columnist Bill Bonner frequently notes, avoiding the Big Loss becomes increasingly crucial for private investors as they age and run out of time to make up the loss. It may also shield you from some significant mistakes.

The Austrian school will shield you from a variety of other political and intellectual blunders in addition to investment mistakes. For instance, anyone who has studied their work will understand why socialism has never worked and never will. Politicians' pledges to address economic issues will be met with skepticism. They may also learn something about BFIA's ongoing success. According to the Austrian theory of the "disutility of labor," people would rather save labor than not, all other things being equal. Over the past 25 years, we have worked tirelessly to provide you with these insights, which has significantly decreased the amount of work our readers must do in order to be successful investors and savers. Thank you so much!