MoneyWeek has, in its quarter-century of existence, built up a pretty good record for calling the major economic trends in the economy and society, and explaining what they mean for savers and investors (see this issue, passim). We are the bestselling financial weekly in the country for a reason, after all. But how do we do it? Ours is an age of scientism, so you could be forgiven for thinking that our procedure must be one that follows the tried-and-tested methods of natural science. If our writers were worried about the likelihood of a financial crisis in late 2007, as they were, while the consensus was saying that such things belonged to the past thanks to The Science, presumably that was because they had pored over the economic data, got themselves dusty in the British Library studying the latest economics and social-science papers, solved complex mathematical equations to show that the line now going up was about to hit a maximum and turn back down – or at least something along those lines.
What would the alternative be? Well, as Ayn Rand always used to insist, if we’re going to have a rational conversation and method at all, we’re going to have to take a look at our premises first. There’s no point looking at the data if we’re not first of all sure it is telling us something meaningful. No point looking at a speedometer if it’s not connected to the wheels or if you’re not interested in how fast you’re going. No point reading the social science if the writers of it are wrong-headed to begin with. There’s no point, in short, pretending that you know something when you don’t.
“The pretence of knowledge” was the title of Friedrich Hayek’s acceptance speech for the economics Nobel Prize in 1974. His message has not lost its relevance. He opens his lecture by admitting that his profession has made a mess of things (sound familiar?). The “serious threat of accelerating inflation” that was current at the time he spoke, in December 1974, had been “brought about by policies which the majority of economists recommended and even urged governments to pursue”. The fundamental source of the error, in Hayek’s view, was economists’ propensity to want to “imitate as closely as possible the procedures of the brilliantly successful physical sciences”.
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That may sound reasonable, but actually the method is inappropriate because the study of complex phenomena in the social realm, such as the market, depends “on the action of many individuals” and all the circumstances that will determine the outcome will “hardly ever be fully known or measurable”. In the social sciences, often the factor that is treated as important is the one that is measurable, and the theories deemed admissible only those that refer to what is measurable. In other words, they are like the drunk looking for his keys by the lamp post, not because that’s where he lost them, but because that’s where the light is.
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But we can bring light into the darkness using other methods than those of the physical sciences. One might, as Hayek says, build up “fairly good qualitative knowledge” of social phenomena, the conditions under which they appear, and the factors important in bringing them about or that would have to change to bring about an adjustment, that relies on the “facts of everyday experience”. Knowledge would then rely upon whether we can win general assent to what the facts are and on the “logical correctness of the conclusions drawn from them”. Those words will strike anyone who has read him as a pretty good summary of Ludwig von Mises’s approach in his monumental Human Action. Hayek was highly influenced by Mises. Together they are considered, along with a number of other figures, as the leading lights of the Austrian school of economics.
What is the Austrian school of economics?
This school of thought was founded in 1871 with the publication of Principles of Economics by Carl Menger, who, together with William Stanley Jevons and Leon Walras, were the leading figures in the “marginal revolution” in economics, as Peter Boettke explains at the Library of Economics and Liberty. Menger’s book was an attempt to “rescue theory” from the then-dominant German historical school, which argued that economic science cannot generate universal principles and that research should instead be focused on historical examination. Menger restated the view of classical political economy in “asserting economic laws that transcend time and national boundaries”.
The appropriate unit of analysis in this science, said Menger, is “man and his choices”. Those choices are determined by individual subjective preferences and “the margin on which decisions are made” (we would all prefer to do without diamonds rather than without water, but diamonds are usually more valuable than water because we decide what to value more highly not on the basis of total satisfaction, but at “the margin”, that is, on the basis of whether one additional diamond would give us more satisfaction than one more bucket of water). Hence “marginalism”. Those who held to these theories were dismissed as “the Austrian school” due to the positions the economists held at the University of Vienna, and the term stuck. Later economists taking the same basic approach were also dubbed “Austrians”.
Boettke’s essay goes on to list ten main propositions that define the Austrian school, and it’s as good a summary as you’ll find. Picking out just a few of them here should suffice to show why the teachings of the school have been helpful to MoneyWeek writers. The first proposition in Boetkke’s essay, for example, is that “only individuals choose”. “Man, with his purposes and plans, is the beginning of all economic analysis. Only individuals make choices; collective entities do not choose. The primary task of economic analysis is to make economic phenomena intelligible by basing it on individual purposes and plans; the secondary task of economic analysis is to trace out the unintended consequences of individual choices.”
That may or may not seem obvious, but it is a radical departure from the usual methods of social science. The starting point in Austrian economics is the individual and what he or she does with their mind – something opaque to the methods of natural science, but something we all know something about from introspection, and can build into reliable knowledge by tracing out the logical consequences of what is decided and how we act. Social science rather tries to understand how man is propelled to act by a myriad of social, historical and other forces, which the scientist tries to observe and measure as a physicist would in his laboratory with the aim of changing and controlling it where necessary (you can see why such an approach would be attractive to governments and other world-improvers).
The point here, though, is not to get into an intellectual dispute or to make metaphysical or political claims with which you may disagree, but to show the relevance of the Austrian school to investing, where a key plank of success is discriminating between what you as an individual do have some measure of control over (what you choose to pay in charges for fund management, for example) and what you do not really know or understand and have no control over anyway (whether the stock you are buying will rise or fall in price over the long term, or even survive, for example).
Intelligibility, not prediction
One thing that follows from this (proposition three in Boettke’s essay) is that the goal of Austrian economics – and of investing – is “intelligibility, not prediction”. We can achieve this “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”. You can see the relevance of this to investing by considering the insights of John Kay and Mervyn King in Radical Uncertainty (reviewed in detail by MoneyWeek in 2021). In that book, the authors consider the phenomenon of “superforecasting”, which was all the rage at the time. But Kay and King point out that the future is not so much forecastable (the world is not a game of dice) as “radically uncertain”. It might, as the superforecasters say, be possible, by being open-minded and diligent, to do better than you might think at predicting whether inflation, say, will or will not be 3.5% by the end of the year, 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, MoneyWeek did not predict that inflation would hit a certain rate at a certain time. We did not know. But we did find what was happening intelligible, and hence concluded that the most likely consequence would be a period of prolonged and at least higher-than-usual inflation – again, at a time when The Science was assuring us that any effect would be “transitory”.
This leads us to proposition eight in Boettke’s list, and a key theme for MoneyWeek since its inception, which is that “money is non-neutral”. If government policy distorts the monetary unit, exchange will be distorted as well. Any increase in the money supply, for example, which is not offset by an increase in the demand for money, will lead to an increase in prices. But prices do not adjust instantaneously throughout the economy. Some price adjustments occur faster than others, which means that there are changes in relative prices. Each of these changes affects the pattern of exchange and production. Indeed, another key insight of the Austrian school is that it is artificially low interest rates – government meddling with the price of money – that cause boom-and-bust cycles. It was this kind of reasoning and not a crystal ball or the data that led MoneyWeek to warn of an impending crisis in 2007.
MoneyWeek has spent a great deal of its 25 years arguing along these lines – and warning of the economic and social consequences – and not just as an educational service, but to spell out what it means for investors: that positioning your portfolio to ensure your wealth grows at a rate at least to match and hopefully beat inflation is a key financial goal for all savers and investors, for example, and that some financial instruments and assets are more likely to achieve this goal than others.
It’s only fair to point out that adopting this outlook may not be very exciting. Having a tried-and-tested method for anticipating “what’s going on here” and investing sensibly as a result may well mean you miss out on the big boom in the latest thing and the profits that flow from that. Austrian-school investing is not a get-rich-quick scheme. But it might well protect you from some big mistakes – and avoiding the Big Loss, as our regular columnist Bill Bonner often points out, becomes ever more important to private investors as they get older and run out of time to make up the loss.
The Austrian school will not only protect you from mistakes in investing, but from all kinds of other political and intellectual errors, too. Those who have studied their work will know, for example, why socialism has never worked and never will. They will be sceptical about politicians’ promises to solve economic problems. They might get a clue, too, to the continuing success of MoneyWeek. The Austrian concept of the “disutility of labour” teaches that, all else being equal, individuals tend to prefer to economise on labour than not. By labouring to bring you these insights week in, week out, over the past 25 years, we have greatly reduced the amount of labour our readers need to put in to succeed as savers and investors. You’re welcome!
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