[Throughout today, residents of Greece - mired in a recession dating back to the Olympic boom in 2004 - will vote a second time in as many months. One of the central issues being debated is whether or not Greece should exit the Euro, a government managed monetary exchange mechanism. Below is a recent interview with economist Mark Thornton, who among other things, has written extensively on the boom-bust cycle and central planning.]
Tim: What originally drew you to the Austrian school of economics?
Mark: It was the Austrian Theory of the Business Cycle.
Tim: What is the Austrian Theory of the Business Cycle?
Mark: The ABC Theory is a specific version of Richard Cantillon’s analysis of changes in the supply of money in an economy. In the modern era central banks control the money supply and make changes in the money supply in order to influence interest rates. When they influence interest rates away from what the market would dictate, they undermine the decisions of entrepreneurs and investors in a systematic, economy wide fashion. For example, lower than market rates encourage more investment in longer term, more “roundabout” capital. In fact we refer to these distortions as “Cantillon Effects.” It also encourages more consumption and less savings. This “stimulates” the economy, but in the long run it is obviously a recipe for disaster.
Tim: What motivated you to write about the connection between Skyscrapers and Business Cycles?
Mark: I read about the “skyscraper curse” in 1999. The curse is the correlation between record setting skyscrapers and economic crisis. I immediately saw the ABC Theory at work. The record setting skyscrapers were an identifiable marker for the central bank’s distortion of the economy’s capital structure. It is how we can see Cantillon Effects in action. My paper (pdf) shows the theoretical connection that explains the correlation.
Tim: You mention them several times in your paper, what are Cantillon effects? Are they applicable to our hyper-globalized, robo-algorithmic, New Economy 2.0 world?
Mark: Cantillon Effects are changes in the structure of production that occur because changes in the supply of money. An increase in the supply brings about a different distribution of money amongst the population. This in turn brings about a different allocation of these funds across consumer goods and producer goods. This change in the pattern of spending changes the relative prices of goods which in turn encourages entrepreneurs to produce more of some goods and less of others. It therefore alters the structure of production. For example, if we doubled the money supply and gave all the new money to Marion Barry. Hypothetically this would increase the price of cocaine and limousines and reduce the relative prices of most other goods. Entrepreneurs would respond to the higher prices by planting more coca bushes and building more limousine factories.
Tim: While you mentioned a number of past limitations, do you think the predictive power of the original Skyscraper Index published by Andrew Lawrence will last through this century?
Mark: I think it is clearly at work today. However, I do think we will see an end to central banking by the end of the century.
Tim: You published this paper in 2005, just before the real-estate bubble popped in the US, Europe and before the Burj Khalifa in Dubai was even completed. Since that time a lot has happened including massive capital misallocation at every latitude and perpetual bailouts, including one for Dubai by the president of neighboring Abu Dhabi, now the namesake of the eponymous skyscraper. Many other construction money pits dot the global landscape including most notably Greece, Ireland and the on-again-off-again Moscow International Business Center. Do you think that this index is still a good predictor of real-estate bubbles?
Mark: Yes, I do think it is still a good predictor, but I admit that it is easy to see that it could send false signals.
Tim: You mentioned the ‘Super Bowl indicator,’ the ‘January effect’ and a number of other arbitrarily conceived metrics that are more coincidental than organic predictors of economic growth or stagnation. Aside from perhaps the yield curve and the Skyscraper Index, is there any particular indicator or metric that you think might help analysts read the tea leaves?
Mark: Fundamental analysis and technical analysis can help an Austrian business cycle analyst see the business cycle more clearly, but they too can be fooled without a good theory to work with.
Tim: You noted in Table 1 that there was, as of 2005, a 1,509 foot skyscraper being planned for completion in Shanghai by 2012 and suggested that this could presage a recession in China. In September 2007 the World Financial Tower topped out just under 1,600 feet. This occurred a month before the DJIA peaked at 14,164 — a peak that has thus far not been repeated. A number of indicators including labor shortage currently suggest that China is now faced with stagnation and perhaps negative real growth (when adjusted for inflation). Do you think the latest Shanghai Tower under construction – which is planned to top out at 2,073 feet in 2014 – is another indicator of an unsustainable boom?
Mark: Absolutely. The skyscraper building in China, India, and the Middle East is all a “warning” of trouble as well as a “signal” of regional crisis. The skyscraper index also works at the regional, national, or local level to a certain degree. The new record setting skyscraper in Europe [Shard London Bridge] was an accurate signal of economic crisis in Europe. The imbalances in the Chinese economy go far beyond those attainable in a real market economy.
Tim: Two weeks ago the People’s Bank of China lowered interest rates for the first time in nearly four years. Do you think this will help their long-term growth? What is the right interest rate?
Mark: No. The problems in China seem immense. They have prolonged their economic growth with smoke and mirrors on a massive scale. At this point I would guess that if they got a miracle that it would still not be enough. The rate determined by the market produces harmony between savers and investors and generates balance throughout the economy. Left undisturbed from government interference, market determined interest rates result in a stable economy and one that is likely to experience strong growth over time.
Tim: In discussing the boom leading up to the Great Depression you noted that Robert Lucas “claimed that it defied explanation” and that there were a number of contributing factors controlled vis-a-vis the Federal Reserve. This included a “significant increase in the money stock” prior to the Crash and “a significant decline in the supply of money after the crash.” What role do you think the Fed played in the Depression?
Mark: The Fed was young and dumb. They were following the advice from economist Irving Fisher. Fisher was the father of modern macroeconomics which means he was a crackpot with no fundamental understanding of who the economy works or the role of money in the economy. The Fed and Fisher (along with other central banks) caused the depression (pdf), although Hoover and Roosevelt made it “great.”
Tim: What role do you think the Fed plays in the boom-bust cycle? Is there a way for central planners to achieve their stated goals at controlling and soothing such cycles?
Mark: The Fed plays the key role in generating the business cycle. The leverage provided by fractional reserve banking also plays a key role. Central planners can banish the business cycle be getting rid of central banking and fractional reserve banking and replacing it with market determined money and banking.
Tim: Several years ago, John Paul Koning wrote a series of articles (Part 1 & Part 2) describing and illustrating how the decades old $35 gold peg was ultimately broken. You also mentioned that a number of factors contributed to the stagflation of the ’70s including the abandonment of the gold standard because the Bretton Woods system (BWS) ended. Why did this occur?
Mark: The dollar was the BWS’s reserve currency which meant that the US could print up purchasing power. Other members of the BWS eventually realized that we would continue to abuse this privilege and so they started to buy the government’s gold with dollars and we reneged on our promise to back the dollar with gold. That just shows you how despicable central banking is. We cheated the members of the BWS, then reneged on our promise, continue to build a massive debt and to devalue the dollar and we are still one of the most trustworthy central bank.
Tim: Can a commodity-based standard realistically play a mediating role in our modern financial world? Is there much of a difference between a managed peg and a floating-peg managed by market forces?
Mark: Absolutely. It already does to a certain extent. However, I believe a market standard can completely replace the current government mess just as I believe that the market can completely replace the Post Office.
Tim: During his original confirmation hearing, Ben Bernanke stated in October 2005 that there was “no housing bubble to go bust.” And that he shared similar sanguine views as then Fed-chairman, Alan Greenspan. Do you think Fed monetary policy contributed to either the mid-2000′s housing bubble and/or the 2008-2009 financial crisis?
Mark: I wrote in 2004 that the Fed was responsible for the housing bubble and the bust that was yet to come. My skyscraper crisis signal in the summer of 2007 showed that bust would indeed much worse than almost anyone else thought.
Tim: Is there anything that a chairman can do differently going forward?
Mark: The chairman can start today by letting interest rates float and achieve their own levels.
Tim: While describing the expansion of the monetary supply you mention the self-adjusting market process and how the entire capital structure is changed during this boom period. Are there any specific industries or asset classes that are immune to such speculation? Are there any long-term effects of prolonged expansion?
Mark: There is little immunity to the business cycle because the imbalances ultimately cause pain for just about everyone. However lets take a look at the self-adjusting market process for a minute. As the crisis causes the economy to collapse all prices have a tendency to fall. Stock prices, capital goods and land tend to fall significantly, wages then to fall by less in percentage terms, and the price of consumer goods by even less. This leads to profit opportunities for entrepreneurs to buy and combine capital and labor to produce consumer goods. Mainstream economists have apoplithorismosphobia, or fear that deflation will spiral out of control. In reality deflation is like a shock absorber.
Tim: You mention that skyscrapers are considered art forms, yet their construction is always a business “that must pay heed to [monetary] incentives and constraints.” Is this true for all construction projects including the Egyptian Pyramids or perhaps the Ryugyong Hotel in North Korea? Are ‘face-projects‘ immune to the laws of economics?
Mark: Such projects are not immune from the laws of economics. They are simply consumption by the rulers that undermine the standard of living of the people.
Tim: What is your outlook on the Eurozone as a whole? Can it last, or will it break apart along a North-South divide?
Mark: The Eurozone is trying to put off the inevitable. They are stalling in hopes that the problem will somehow solve itself. The skyscraper signal for Europe only confirms this. The Euro has a design flaw that is explain in Philipp Bagus’s book. Even if all of these problems could be “papered over” it would still leave all sorts of structural, institutional, and governmental problems in Europe that will continue to contain the standard of living. What will happen and when is a matter for the Europeans to decide, but they cannot wish their problems to go away.
Tim: What other areas of research are you currently pursuing?
Mark: I am continuing my research on Cantillon and continue to find fascinating things about the father of economic theory. My new translation of his book is now available for free in electronic form. I also continue to write about prohibition and the war on drugs. I remain fascinated with the economic issues of the American Civil War and the writings of Frederic Bastiat. I am also preparing some new courses for the Mises Academy including a special webinar on the Skyscraper Index.
Tim: Thanks for your time. Readers may also enjoy the Jeff Tucker-Mark Thornton interview from 2010 as well as Mark’s past interview with AEN. You may also be interested in a number of Mark’s other writings predicting the real-estate boom-bust: 1 2 3 4