Economics has been called the dismal science. It doesn’t seem to have the same respect as other fields of “real” scientific study. Why is that? John Flaherty & Keith Weiner discuss a number of reasons.
In addition, you’ll learn the all-important variable in modern economics, why the net present value calculation obscured the visibility of the real estate bubble leading up to 2008, and the parallel between ‘court economists’ and a Star Wars drug dealer.
- The Great Horse Manure Crisis of 1894
- Time value of money
- Ludwig von Mises
- Star Wars death sticks
- The Austrian School of Economics
- Retrograde motion & Copernicus
- Acting Man
- Principles of Economics by Carl Menger
- Paul Krugman
- Ayn Rand
John Flaherty: Hello, everyone and welcome again to the Gold Exchange podcast. I’m John Flaherty, and I’m here with Keith Weiner, founder and CEO of Monetary Medals. I’m excited for today’s topic, Keith. I want to relay a joke that I heard in grad school. I actually googled it and found that it dates back to the 70s, at least according to Wikipedia. And it goes something like this:
A physicist, a chemist and an economist are all stranded on a desert island with only a closed can of beans between the three of them. As the story goes, the chemist and the physicist immediately set about to scientifically devise a way to open this can, and the Economist simply says, “Assume a can opener.”
I’ve never forgotten that, and I think that might be a good segue to our topic, today. Economics is often called the dismal science. It doesn’t seem to have the same respect as the other fields of “real” scientific study. What’s your take on that, Keith?
Keith Weiner: You know, my first thought just thinking about that is well, that’s classic. Just assume whatever it is that’s convenient to assume in order to make everything else work.
And then I was thinking, you know, kind of reminds me of the field of what would have been sort of physics before Galileo really did his work. And the medievals believed that if you throw a rock, the rock would fly straight until it ran out of force and then basically would turn a corner and fall straight down. You know, I wasn’t there at the time, but I could only imagine that people didn’t have a lot of respect for anybody that was talking about that kind of stuff. Course anybody that went out into the real world could throw a rock or ask some kids to throw a rock while they stood off to the side somewhere and watch the flight of the arc, uh the flight of the Rock. Excuse me, Just give away the punchline. Watch the flight of the rock and they could see that it travels in an arc. There’s no abrupt running out of force on going down. In some ways, I think the field of economics is kind of like that, even today, where the medieval notion of physics was, before Galileo.
John Flaherty: So you know what? When I looked at this topic, the first thing that came to mind was like other fields of science, especially technical ones. You have this whole vocabulary of technical jargon, right? Words like quantitative easing and forward guidance and the Taylor rule.
And so, as you listen to economists spout these different technical terms. You know, it’s easy as a layman to kind of have your eyes gloss over and say, Well, I’m sure glad these guys know you know what they’re talking about. But then here in the real world, we have this boom bust cycle that continues to get worse and worse. And yet, when these people are brought before Congress or TV cameras, they don’t really have, they can’t really explain away how they were wrong. And so what are your thoughts on that? Is that contributing to this label of the dismal science?
Keith Weiner: So much of that is political hacking rather than much of a pretense of economics. And I was going to say when you said “jargon” and then you say quantitative easing, I first thought, that ain’t jargon, that’s euphemism or political slogan in the way it’s designed to obscure what is that they’re doing. And basically, they are increasing the quantity of what they want us to believe is money.
And they do that because they believe, getting back to that medieval analogy. They kind of believe that, if it’s Midsummer’s Eve and you cut some fresh mistletoe and you have Eye of Newt and you say the magic incantations and you increase the quantity of frog’s blood in the stew, then you know he’s gonna fall in love with the girl or whatever it is that that potion is supposed to do.
They believe that they’re making the economy stronger by doing this, but they don’t really want to quite openly admit what they’re doing. And so they use all these terms to obfuscate it to make it unclear. People’s eyes are supposed to glaze over these euphemisms, and, of course, then when they get technical and they start talking about the Fed’s balance sheet and the distinction between M0 versus M2 money supply and, are conditions truly easing or not, and the PCI deflator and on and on and on with all this stuff. And everyone thinks that’s just an argument of statistics.
And of course, if there was an argument of statistics, then it’s really impossible to make any kind of certainly moral evaluation, but even really tie it to anything that touches on causality. And I just want to say something about causality, because I think ultimately, if you are trying to do science, you have to be thinking about the identity of the objects you’re studying, right?
Every entity that you put, whether it’s under a microscope or you put it into an explosion chamber, or whether you’re throwing it out of a cannon at high velocity or whatever it is, every thing that exists has an identity. It is what it is, and it isn’t what it isn’t. And their actions that are occurring, those actions occur because of causality.
So you know, famously, if you’re studying physics and you have a whole chamber full of a gas, there are equations that describe the behavior of an ideal gas. PV equals NRT, which relates pressure and temperature and so forth and tells you what’s gonna happen if you compress it half its volume or let some gas out or whatever. It could explain all that. That’s what a science should be doing. And all too often, economics, what’s claimed to be economics, isn’t doing that at all.
John Flaherty: So is this a recent phenomenon? Keith, I wonder if you could maybe rewind in history a little bit. Is it the case that the study of economics used to be more of a pure science and has just been infected with the ideas of, say, Keynes or some other prominent figure that sort of changed the game and kind of led the field astray? Can you give us some historical context on the science?
Keith Weiner: Well, first of all, it kind of makes me mindful of the joke, “nostalgia isn’t what it used to be”, but you know this belief that everything was once really grand and golden. And today everything has turned to rubbish.
But I could certainly think of an example, kind of humorous one. I think it was late in the 19th century when you know, somebody was projecting the increase in the number of horses in New York City. And just looking at well, in 1800 we have just so many in 1850 this many they’re projecting by 1920 there’s gonna be so many horses that the entire city will literally be meters deep in horse poop.
And what they’re doing there is like taking a ruler straight edge. And they’re taking a graph of the number of horses that are in the city. And of course, each horse produces a certain volume of poop. You could multiply horses time some constant, and you get how much group has been generated.
And then you say, Well, how wide is each street? How many miles of streets are there and so forth, and then you just do the math and then you project forward and say, Well, if horses are doubling every 20 years or whatever it is, by this time, you know, we’re gonna have 2 m deeper of standing poop. You will never be able to shovel it fast enough.
You know, as I recall, from what I read of this incident, you know all of the intelligentsia or the literati were wringing their hands and crying their crocodile tears over this. Meanwhile, of course it didn’t happen. And if there’s a lesson for economists in all this, it’s that nothing continues on a trend like that forever, especially if there’s aspects of it that are clearly unsustainable. What happens is, some clever entrepreneur comes along and completely changes the rules of the game.
And that’s the thing that defies both the economists, and all too many economists are what I would call court economists. That is, that their express role or their purpose in life is to either attempt to cook up a central plan to be imposed by the state or to post hoc, justify whatever central plan is imposed by the state and then sell it, in the way of propaganda. And so, of course, the state central planners never want or reckon with the crazy entrepreneur that says, “You know, let’s invent an automobile.” It’s going to be a horseless carriage, which is what it was called at the time initially. And of course, that completely takes us off the the trajectory of burying the city in poop. So now today, of course, what do they do is they have the straight line projections of smog due to the automobile. You know the cycle repeats over and over again. And of course, there’s the old saying that people who don’t study history are doomed to repeat it. And there’s an example of it right there.
John Flaherty: So you had mentioned in an earlier episode about the 2008 crisis and you had a front row seat to that with the sale of your business. And then what led to starting this new venture. But I wonder if you could comment on how they didn’t see 2008 coming. I mean, I’ve seen timelines in 2007 where Bernanke is saying, “Yeah, everything’s good, you know, Housing might be a little frothy, but nothing to see here.” And then, two months later, it’s just sort of an iterated version of that, but really no concern. And then, you know, kaboom.
And they have their explanations for why their models didn’t work. But is there any comments you have about as the most recent kind of dramatic example of you know, we’ve got these very smart people at the Fed who are supposed to be in charge of smoothing these things out and preventing these things. Any comments on the science of economics and how it left us, you know, wildly unprepared for the 2008 boom and bust?
Keith Weiner: Yeah. You know, one practical technical answer. Probably not that technical. And one a little more theoretical. The practical, technical answer is that they can’t spot a bubble because if you define a bubble as asset prices are higher than they should be, then okay, that begs the question of what do you mean by should?
If you want to try to calculate what an asset is worth, you have to look at the cash flows that’s going to generate in the future. So let’s say I have a piece of property I rent it out for $1000 a year, and so you have a cash flow that says 1000 plus. Now let’s let’s leave out so called inflation for the moment, you have 1000 this year in 1000 next year, and 1000 year after out into perpetuity, the property will generate rent sent to the forever. Which isn’t necessarily true, but let’s just go with that assumption. Let’s assume there’s no inflation and let’s assume that the rent is out in perpetuity. Then you have an infinite series. It’s 1000 plus 1000 plus 1000.
Now it’s not worth infinite money today because each future year has to be discounted because there’s a time value of money. Being that we’re mortal human beings, we value something that we have today versus a promise to pay it in a year. Apart from the risk of whether you’ll get it in a year, there’s still the utility of having it in your hand versus having to wait a year to get it. So the value next year is less than the value this year.
And so it turns out that the best factor to use for discounting those future payments is the interest rate. So if the interest rate of 10% for example, then you have 1000 plus 900 plus 810 plus 720…and a straightforward application of mathematics to say, Well, then that infinite series has a finite sum, and that finite sum is $10,000. 1000 plus 900 plus 810 plus 720…that adds up to 10,000.
So, what that’s saying is that the value of this asset today is $10,000 assuming that the interest rate is 10% assuming that the future payments are certain and that you’re not taking credit risk, other kinds of market risk like that. Um, it’s worth $10,000.
So the problem is what happens if you are the central bank and these are the very same people that we’re asking, why didn’t they see it? And you’re the central bank and you think we’ve got to lower the interest rate because we have to stimulate GDP because unemployment is dropping and so forth, and we don’t have inflation.
So according to all their formulas, they say that they’re supposed to lower the interest rates, you lower the interest rate and you miss the fact that a lower interest rate now you have to recalculate the discounted value of all those future payments. And so at 5% it’s no longer 900 plus 810 plus 720 etcetera. It’s now 950 plus a little over 900 plus a little over 850 so forth, and that is an infinite series that adds up to $20,000. So by cutting interest rate in half, you double the NPV. And so then the asset price doubles.
So anybody who is doing the math and says okay is the asset overpriced? They would look at the interest rate and they would do this discount calculation. And they’d say it isn’t. Even though everybody is wondering, wait a minute. The price of all the real estate in the country doubled. How could that be? Isn’t that a bubble? Anybody doing the NPV calculation would say, No, it’s not a bubble.
It’s missing the fact that the interest rate is the all important variable. I think modern economics does not pay as much attention nearly as much attention to the interest rate and the fact that the interest rate is falling and the consequences of the falling interest rate as it should. And so that’s kind of my practical explanation. They can’t really see the bubble, because from within the interest rate that they administer, it isn’t really technically a bubble.
I mean, that’s assuming that, you know, asset price doesn’t get beyond that, which I don’t think it did leading up to 2008. So that’s the practical reason. The theoretical reason why they don’t see it….I suppose there’s a really simple political retort. And that is these are the court economists whose job it is partly to help design the central plan and partly to act as propagandists to sell the central plan to the people. They’re the last people in the world who want to say, you know, we the government just screwed up or we plan that we’re about to screw up. Our plan includes the fatal flaw in a, but we’re gonna do it anyway. Of course, they’re not going to say that. And so then they’re departing the realm of economics entirely, entering the realm of political hack or partisan shill.
The theoretical reason is that, as Mises explained so thoroughly a century ago when he predicted the collapse of the Soviet Union in 1922. He predicted it on grounds that the central planner doesn’t have and cannot have, cannot ever have…it’s a theoretical…it’s impossible to have enough information to perform economic calculation.
So when you administer a price, and the interest rate is the most important price in the economic world, when you administer the price of something, you don’t really know whether that’s the right price. In fact, you are deliberately self-imposed, blinded to whatever the right price might be. Even if there was a right price for you to administer, there would be no way for you to know it. And the very fact of administering a price would blot out or stamp out any information that would give you a clue as to what the right price might be, and how far off from that theoretical right price your administered price really is.
So you don’t know what the right price is, you cannot know what the right price is, you’re preventing yourself from ever knowing what the right price is. And you’re saying the right price of interest is today, near zero interest rates as it was from 2009, for many years until they played it at hiking rates.
So they can’t see the bubble. And they can’t see the consequences of it because they don’t know if they don’t know if they’re off. And if they’re off, they don’t how far off. And so that, of course, blinds them to…Okay, well, what would the consequences be if your interest rate was off? What would that do? Well, that’s not a question that ideologically they’re even inclined to attempt to explore. Because that would lead to all sorts of other uncomfortable truths that they would just assume not admit to.
John Flaherty: So back to our joke about assuming the can opener because they start with this set of assumptions, namely, that they can control the economy by dialing the interest rate lever. When they want things to go up or cool down, they just simply turn a little dial and their outcomes, as they claim they can predict and manipulate benevolently. But sounds to me like there’s nothing really scientific about that. If your underlying assumptions lead you to these perverse outcomes again and again.
Keith Weiner: Let me interject, I was gonna say, It’s honest on so many levels, one of which is their stated premise that, you know things are not hot enough, they can print more money and increase the money supply. And if things get too hot than they will decrease the money supply. If you take a look at a graph, so on their own stated premises, which are all wrong anyway, but even by their own stated terms on their own stated ground, there’s never any un-printing of money. They never actually decrease the quantity of the thing that they call money.
And so if you are honest, you’d have to admit certain things you have to admit to yourself, “Okay, this isn’t even right. Even on the terms I’ve stated it to be” and then you realize “Well, look, I’m just a partisan hack. I’m not an economist at all” Then where would that lead?
You know, it’s like the Star Wars movie. Was that when Obi Wan Kenobi? No, it was I’m sorry. It was a Qui-Gon Jinn in Episode 1. He’s taking young Anakin Skywalker into some sort of bar. Something like that. And this punk is like, “Hey, you wanna buy some death sticks?” and then he does the little Jedi hand wave mind trick thing and says “No, no, you don’t want to sell me death sticks. You want to go home and rethink your whole life.”
And then the guy looks confused, and he’s like, “Yeah, yeah, I don’t want to sell you death sticks. I wanna go home and rethink my whole life.” And then he scurries off. That’s kind of what you’d have to do if you were a court economist.
And then you somehow were forced to confront the fact that even on your own stated terms, none of this works the way you claim that it does, let alone that your stated terms they’re all bogus. You’d have to scurry off like that punk with the death sticks and rethink your whole life. So of course, very few people actually want to do that. Which is why that made such a memorable scene in the movie. There’s nobody that actually does that.
John Flaherty: They’re certainly viewed as Jedis. I mean, your analogy of the court economist is appropriate and that they are operating at the highest levels of government and academia and finance. And so they’re these credentialed people. They have immense power, which ends up impacting the lives of every day folks. And yet when things go horribly wrong, there’s always some explanation other than “the central plan was wrong.”
But again, I want to redirect, Keith, to…we’re talking about this dismal science, right, and all the pitfalls and the bad assumptions that lead to the perverse outcomes. But you actually contend with your study of economics in the new Austrian school that you can actually bring the precision of real scientific thinking to monetary economics. How do we get from A to B, Keith?
Keith Weiner: Well, you have to start at the beginning. Which is tough. And it’s very daunting, especially when you come to a field, and I take a lot of flak, but gonna say it anyway. When it comes to monetary economics…So economics, outside of money, there’s a lot of really well understood things. There’s a lot of economists who can explain to you why imposing tariffs is going to impoverish, you know, a nation. Why trying to set wage floors or price caps or all these things….Adam Smith wrote a lot of this wisdom in 1776 the year of the American Revolution. This is very old, very, very well understood old stuff.
If you have regulations on food trucks, you know you’ll get fewer food trucks and they’ll be of higher price. And if you set all these preconditions for medical research, you’ll get less. Medical research will take longer and longer to find cures for things like cancer. That’s just very well understood.
But monetary economics as a science is kind of like physics before Galileo and before Copernicus. It’s at the point where you know, the medieval is used to believe that everything went around the earth. The sun revolved around the earth. All the other planets revolved around the earth, and they were staring at a problem that was called retrograde motion.
When you look through a telescope at the other planets and you’re assuming that these other things are revolving around the Earth, it’s inexplicable why these planets would seem to go forward in their orbit for a while and then reverse and go backwards for a bit kind of do a loop de loop and then continue on in the orbit and then do it again. There’s no explanation for what would make a planet reverse in its orbit on do loop like that. As we know today, of course, the whole thing was an artifact of the assumption that things were going around the Earth, which they had other reasons, theological reasons to believe that, the geocentric view of Ptolemy.
And in monetary economics, today is a lot like that. There are reasons why people want to believe what they believe. It’s the want to believe, the wanting to believe something…that is not science. So when you said the precision of science, I would substitute, or at least add another word to that which is discipline. It’s a discipline of thought, discipline of mind and how you approach things.
Any time you find yourself wanting a certain conclusion, just, you know, use that as your own internal, like red flag or reset button. Say wait a minute, shake your head and, you know, go take a sip of water or just go take a walk around the block and come back and say, Wait, that’s not science. That’s not valid. I can’t want to have a conclusion and then try to, post hoc, justify or rationalize that conclusion. You’re just going about it wrong.
So you have to start and say, what am I actually observing? And then start to think from there about what are the natures of the entities. What is the identity of this object that I’m staring at? What makes it so? And then what is the causality? How does this act on this?
For a great example of that, I think Carl Menger, the founder of the Austrian School of Economics, has a very Aristotelian approach. And I think Aristotle should really be credited as the father of logic. And ultimately, without logic, there’s no such thing as science. In his approach and saying, okay, suppose a man who is a farmer of wheat brings some wheat to the market to trade and who’s looking at this idea of is there such a thing as a right price of wheat?
But, you know, he says, Okay, so suppose this guy brings the wheat to the market, and encounters another guy who also has wheat. Will there be an exchange? Will the one guy trade his wheat for the other guy’s wheat? And if there was a right price, they both had the right price, and in theory there’d be no reason not to. But Menger is very clear. That obviously there won’t be. So he begins to observe the nature of the entity which is now called Acting Man from Mises. Acting Man, we’re economizing. What was this term? The economizing man? Something like that.
The economizing actor, economizing individual, has some goals in mind because, of course, he’s a human being. Human beings have a certain need for food. Within food, it’s a variety. We don’t want to just eat bread. We wanna also eat meat. And so this guy bringing wheat to market is keenly interested in finding somebody who brought meat to market. Then there’s going to be a trade. And so he begins to observe later, causality based on the identity of this actor, this economizing individual, you can observe the causality the laws by which he operates. And one of the first laws is the marginal utility of each good is always diminishing.
In other words, the value that you put on…if you have 100 units of wheat. And you’re the farmer of wheat. Of course you have. Basically, you’re overflowing in the stuff. You have 100 units of wheat. The value that you put on the 101st unit is very low. It could be basically zero. You don’t value it. And so your desire to acquire any more wheat is zero or even negative.
But to anyone else, who doesn’t have any wheat, the value they put on the first unit of wheat is much, much higher. And so, you know, he goes through whole discussions of the stuff. But the point being that you’re beginning to do a science. Because instead of just extrapolating a trend like horses in the City of New York and therefore horse poop piling up in the streets, or instead of just trying to justify government policy and central planning and just selling the propaganda of it, you’re saying “Okay, what is the nature of this person? What is the nature of value, how people value goods, and coming up with this law that says the utility of a good at the margin is diminishing?”
And then you can go into what is the marginal use of wheat and so forth. For anybody is interested in this stuff, I highly recommend Principles of Economics by Menger. But the point being, that’s how you begin a scientific approach as compared to the guy with a straight edge approach or as compared to a propagandist for the regime approach.
John Flaherty: So, Keith, is there any way or any path that you see for the current schools of economics, as taught in Western democracies, to start to open their mind to these principles? Or is there too many incentives that are going to keep us here? And what, if anything, is going to turn the tide to get economics back into a science that can be more respected and adhering to the principles that he started to outline here?
Keith Weiner: That’s a fascinating question. My first knee jerk reaction to that is there’s an old saying that science advances one funeral at a time. And by that, what is meant is that usually the old practitioner is in the sixties or seventies has a great deal of prestige. Professor emeritus, Nobel Prize, high government position, position at an investment bank making hundreds of millions of dollars a year. All those things, that person has not only no incentive to learn a new way.
As Upton Sinclair pointed out, it’s something like, “It’s impossible to teach a man something that his salary depends on him not knowing.”
So you’re never going to….I’ll just pick on Paul Krugman for obvious reasons. Hopefully, obvious reasons. You know, Nobel Prize, all this stuff, very prestigious position, and he’s got a basically blank check at The New York Times to write, you know, whatever it is he chooses to expectorate onto a piece of paper and they’ll print it. Somebody in his position just is not interested in a new idea.
But the young Turks who haven’t committed to that yet, haven’t made their name based on that yet, haven’t had success yet may be receptive to something better. And then, in that case, you really have to make sure that the argument you’re presenting them is better. If it just comes across as partisan bickering from the other side of the aisle, I witnessed a debate between Stephen Moore, who was on the Wall Street Journal editorial board. I’m not sure if he was the head of that board or not. And an economist who writes for The Wall Street Journal. He’s on TV a lot. Obviously, the more conservative side of things debated Paul Krugman at Freedom Fest in Las Vegas some years ago.
All of Stephen Moore’s arguments were arguments for why red states are better than blue states. Why all the time Obama was president…why Bush was a better president than Obama. And if that’s all you’re doing, then it’s clear that you’ve jumped down into the same mud wrestling pit as the other guy.
So Krugman’s clearly a partisan hack for the Democrats. If you just jump down, tear off your tuxedo jacket, rip off your bow tie and you get into the mud, start grappling with him, kicking mud in his face. You’re really no better, and you’re gonna persuade exactly nobody that you know your position is right. And of course, his position wasn’t right. He was trying to equate Bush with free markets and capitalism, which, you know you can’t square that circle, so you have to make sure that you are making a clear argument about an idea and not a partisan in favor just of the other side.
And if you make a clear idea and you make your argument compelling… And so just to take back to Menger’s premise for a minute and you say that if two wheat farmers both brought wheat to the market, when they see each other, they will not do a trade of one wheat for the other. That’s inarguable.
Whatever else one might argue about, one is not going to argue that those two guys are going to take their wheat out and trade and then go through the motions of trading coins and giving change. And they both have the same wheat at the end and the same amount of coins in their purse at the end. That’s inarguable.
And if you go on and build an economic science, premise by premise, argument by argument like that, you should create an unassailable position, and then anybody….So Ayn Rand said that as long as there’s a free market for ideas, this does not apply if you’re in the Soviet Union and it’s illegal to say certain things or else they arrest you at night and disappear you to a gulag where they torture you to death. If that’s the case, then all bets are off.
But as long as you have a free market for ideas, then ultimately the true ideas are going to win in the end, not necessarily instantly, because they have the advantage of corresponding with reality and the opposing ideas are untrue and therefore contradict reality. So it’s a very daunting task because you’re trying to come to, I started to say earlier, the field of economics, and I get flack for saying this, that there’s particularly monetary economics, there’s some gems there in what economists have said before.
But they’re like diamonds in the rough, buried in a whole heap of of dung. And you have to come and kind of build that field up from almost from zero. So it’s very daunting. It’s very intimidating. In a certain sense, you’re not really welcome in any school. I consider myself to be much closer to the Austrians. I consider myself to be of the Austrian School and certainly not the Monetarists or the Keynesians. But you have to carefully and methodically build that.
And if you do that, then in the end, the young minds – that have not yet been corrupted by getting access to real power and real prestige – will be sold. If you make a rigorous argument and you’re honest and in promoting it, you don’t try to sell it. You don’t try to browbeat people. You don’t try to pressure them to join your tribe and all those other things that we see going on partisan politics Then then I think it’s just possible.