Austrian School

How does the Austrian School differ from mainstream economics?

 

Austrian Economics

Founded in 1871 by Carl Menger with the publication of Principles of Economics, the Austrian School advanced the marginalist revolution in economic analysis. Named after its early representatives from Vienna, the school has since spread its influence globally, opposing mainstream economics by rejecting large aggregates and mathematical models in favor of methodological individualism.

The Austrian School is mostly known for its emphasis on subjective theory of value and their business cycle theory. But they also made other important contributions, like the formulation of the economic calculation problem, theory of capital, theory of money or theory of entrepreneurship. F. A. Hayek was honored by the Nobel Memorial Prize in Economic Sciences for developing an Austrian business cycle theory.

After the financial crisis of 2008 Austrian School gained some recognition among economists and central bankers. That is because of their business cycle, which explains how credit boom drives the business cycle. According to their business cycle theory, periods of booms are caused by the manipulation of interest rates and money supply. Those manipulations are causing malinvestments in the economy which lead to bust. The period of exacerbated boom is necessarily unstable and according to Austrian economists it must come to an end.

Those malinvestments usually take the form of long-term investments. Those sectors in which there are the most malinvestments, grow the most in the present and suffer the most during the bust. For example, according to Austrian business cycle theory during the boom period there should be a lot of malinvestments in real estate and durable production goods, which should cause a boom in the construction industry or technology companies, which will later suffer losses and share prices of those companies will fall.

The Austrian School also believes that monetary policy and fractional reserve banking (creating deposits by the banking sector) destabilizes both real and financial sectors. The real sector is destabilized by promoting malinvestments and the financial sector is destabilized due to insufficient reserves and balance sheets suffering losses due to financing malinvestments.

Austrians usually don’t make quantitative predictions, but focus on getting fundamentals right. For example, if the government would close down the economy and give every citizen a welfare check, it would cause inflation due to fall in supply and rise in demand. But the average Austrian economist would not try to predict the exact inflation number.

 

Austrian School and Gold

Austrian economists advocate the gold standard. They oppose fiat money, as prone to inflation, arguing that contemporary paper currencies did not spontaneously emerge in the free market. Instead, gold and silver were used as money in the free market. The supply of gold cannot be increased by political will, therefore the gold standard is the best protection against inflation. In other words, Austrian economics says that gold was chosen as money by the free market and the monetary system based on fiat money is inherently unstable.

The Austrian School preaches that fiat money is unstable, since central bankers or politicians can manipulate and inflate currency as they see fit. Because of this, the value of fiat currency necessarily falls in time, and sometimes we see periods of quickly rising prices.

This is why gold is a safe-haven and a bet against the U.S. dollar. Gold used to be money for thousands for years, whereas our fiat money experiment has been here only since 1971. Thus, when this faith decreases, especially in the U.S. dollar, the price of the unofficial world currency, gold, rises.

However, investors should remember that the Austrian School neither predicts the price of gold, nor claims that the price of gold is manipulated or should always be rising. Nobody knows when the current monetary system will crash – it may actually take decades or centuries, and there is no guarantee that gold would become the basis of a new monetary system.