WEBVTT NOTE Epistemological Roots of the Present Crises 1 00:00:00.000 --> 00:00:05.640 I want to thank the Mises Institute in a lot of ways for a number of things before we start. 2 00:00:05.640 --> 00:00:12.360 I was asked to write a book by ISI about Austrian economics, and the book will be out. 3 00:00:12.360 --> 00:00:14.680 It's called It Didn't Have to Be This Way. 4 00:00:14.680 --> 00:00:21.320 The book, we're in the last chapter editing the 40 pages that I did on the trade cycle, 5 00:00:21.320 --> 00:00:26.400 which Paul helped me with, and when that's done, the book will be out, so ISI will probably 6 00:00:26.400 --> 00:00:27.400 have it out. 7 00:00:27.400 --> 00:00:34.400 and I'm not on Amazon right now if you want to read about it, but in any event this is one of the chapters from which I've elucidated. 8 00:00:34.400 --> 00:00:42.400 And the strategy in the book is something, an idea I actually got from Joseph Salerno, I have to thank him, because he made a statement here once, 9 00:00:42.400 --> 00:00:51.400 it's interesting how you plant a seed, in which he said, Mises said that the Austrian School had now become mainstream. 10 00:00:51.400 --> 00:01:04.400 And so, the strategy of my book was to present Austrian economics and to use mainstream people and every quote I use, I use the mainstream instead of the Austrians and I parallel it with the Austrians. 11 00:01:04.400 --> 00:01:11.400 Because I got sick and tired of being in economic circles and being told that I was a minority. 12 00:01:11.400 --> 00:01:27.400 And so this paper is part of a strategy that I used, and of course the book, we started in 2007 and I would say doing this book would have been literally impossible without the Mises Institute and the publications that they put out. 13 00:01:27.400 --> 00:01:33.400 I mean the work they've done in publications of these classics is phenomenal. 14 00:01:33.400 --> 00:01:38.280 has really helped me in class, too, because I can use these as textbooks, too, in the classroom. 15 00:01:38.280 --> 00:01:41.520 So I want to really praise the Mises Institute for that. 16 00:01:42.520 --> 00:01:47.120 In doing the book, we started in 2007. 17 00:01:47.120 --> 00:01:51.480 Most of us, and the fellow who talked yesterday, 18 00:01:51.480 --> 00:01:56.240 whose book is downstairs about using Austrian economics as an investment tool, 19 00:01:56.240 --> 00:01:58.600 I gotta tell you, it does work, okay? 20 00:01:58.600 --> 00:02:01.240 And we did know that this mess was coming. 21 00:02:01.240 --> 00:02:07.640 And so we constantly were putting the book off because we were quoting things that were happening. 22 00:02:07.640 --> 00:02:16.300 And one of the things that was happening was all of the literature that came out talking about the problems in the economy. 23 00:02:16.300 --> 00:02:19.800 And they focused on two things, okay, or three things really. 24 00:02:19.800 --> 00:02:21.600 One was government regulation. 25 00:02:21.600 --> 00:02:25.840 The other was the trade cycle, of which Thomas Woods did a magnificent job. 26 00:02:25.840 --> 00:02:28.400 And the other one was epistemological. 27 00:02:28.400 --> 00:02:33.200 And this is the one thing I wanted to cover today, rather than talk about the trade cycle, 28 00:02:33.200 --> 00:02:38.760 is that the tremendous agreement that's coming out, agreeing with the Austrian economist 29 00:02:38.760 --> 00:02:41.120 on epistemology, okay? 30 00:02:41.120 --> 00:02:47.000 And prior to this, we had the movement called positivism, which was bringing physics and 31 00:02:47.000 --> 00:02:50.160 whatever else, and mathematics and economics. 32 00:02:50.160 --> 00:02:56.680 I often refer to what we have now as mathonomics, okay, bringing all that in, and the people 33 00:02:56.680 --> 00:03:05.680 The people who fought against positivism were really two groups. There were the Thomists and Fulton J. Sheen in his two books, which I'd recommend to you, 34 00:03:05.680 --> 00:03:10.680 The Philosophy of Science and The Philosophy of Religion. They're very difficult to get a hold of. 35 00:03:10.680 --> 00:03:19.680 He attacks positivism and the Austrians attack on positivism. In other words, this idea of bringing in the mathematics in. 36 00:03:19.680 --> 00:03:23.680 Almost all of these authors, there are three types of authors that I've gone through and 37 00:03:23.680 --> 00:03:29.080 I've read as much as I can of all the books explaining the current meltdown. 38 00:03:29.080 --> 00:03:35.920 There are three basic, the authors fall into three categories and if you, when you started 39 00:03:35.920 --> 00:03:42.760 reading this, you start seeing that what happened was, is modern economics or whatever mainstream 40 00:03:42.760 --> 00:03:49.520 economics, whatever else, couldn't predict it, can't explain it and can't solve it. 41 00:03:49.520 --> 00:03:56.080 And who do I quote? George Soros. Okay? George Soros says that. In fact, Soros goes out in 42 00:03:56.080 --> 00:04:01.160 his book to say the methodology, and I have the quotes here and I'd be glad to send you 43 00:04:01.160 --> 00:04:06.480 the paper if you want with the footnotes. He says the problem with modern economics is 44 00:04:06.480 --> 00:04:12.480 it mixed the physical sciences and the social sciences and they should be separate. George 45 00:04:12.480 --> 00:04:18.480 Soros. Okay? And there were works coming out. He said that, and you notice that even Paul 46 00:04:18.480 --> 00:04:25.460 Paul Krugman said, he says that modern economics, modern macroeconomics, was spectacularly useless 47 00:04:25.460 --> 00:04:29.640 at best and positively harmful at worst, okay? 48 00:04:29.640 --> 00:04:34.840 I mean, they're recognizing, the mainstream people are recognizing that the whole thing 49 00:04:34.840 --> 00:04:37.560 has been a disaster, okay? 50 00:04:37.560 --> 00:04:44.240 So as you go through, and I divided the authors up, and the first group of authors were people 51 00:04:44.240 --> 00:04:49.000 People who wrote books, and I've got a list of them here, who agree with the Austrian 52 00:04:49.000 --> 00:04:56.000 epistemology, they agree that the mathematical thing led to a disaster, but they don't 53 00:04:56.000 --> 00:04:57.740 credit the Austrians. 54 00:04:57.740 --> 00:05:02.720 And that's good, because if someone discovers something independently of you, it reinforces 55 00:05:02.720 --> 00:05:05.480 your idea of the truth. 56 00:05:05.480 --> 00:05:06.480 And it's constant. 57 00:05:06.480 --> 00:05:11.600 For example, Richard Lowenstein, When Genius Failed, The Rise and Fall of Long-Term Capital 58 00:05:11.600 --> 00:05:18.600 Management, Alan Greenspan, of all people, publishes a critique of mathematical economics 59 00:05:18.640 --> 00:05:24.320 in his Age of Turbulence. He obviously didn't follow it, but he published it. Richard Bruchstaber, 60 00:05:24.320 --> 00:05:31.320 a demon of our own design. George Soros, the crash of 2008. He emphasizes the mistake of 61 00:05:34.980 --> 00:05:41.340 confusing the social and physical sciences in almost agreement with Mises and Hayek. Charles 62 00:05:41.340 --> 00:05:46.900 Charles R. Morris, The Trillion Dollar Meltdown, tremendously large section in that book explaining 63 00:05:46.900 --> 00:05:53.420 the failures of mathematical economics and its application to investments, okay? 64 00:05:53.420 --> 00:05:58.900 A wonderful book by Pablo Triano, Lecturing Birds on Flying, Can Mathematical Theories 65 00:05:58.900 --> 00:06:02.340 Destroy Financial Markets, published in 2009. 66 00:06:02.340 --> 00:06:08.980 Now Triano relies heavily on Nassim Taleb, whose famous book The Black Swan, and of course 67 00:06:08.980 --> 00:06:16.180 Taleb relies very heavily on the Austrians and has quite a section in there on the Austrians, okay? 68 00:06:16.180 --> 00:06:22.620 Gillian Tett writes for the Financial Times, Fool's Gold, published in 2009, 69 00:06:22.620 --> 00:06:26.340 critical, directly critical of the positivistic method. 70 00:06:26.340 --> 00:06:32.500 Scott Patterson, a book called Quantz, published 2010, author gives a blow-by-blow description 71 00:06:32.500 --> 00:06:37.420 of how the use of mathematical, economic modeling in mathematics played a determining role 72 00:06:37.420 --> 00:06:41.740 and The Meltdown, Kevin Dowd and Martin Hutchison. 73 00:06:41.740 --> 00:06:44.900 In this book, I can't recommend more highly, 74 00:06:44.900 --> 00:06:48.800 The Alchemist of Loss, How Modern Finance 75 00:06:48.800 --> 00:06:51.680 and Government Intervention Crashed the Financial System. 76 00:06:51.680 --> 00:06:55.380 Enormous amount, and does not refer to the Austrians at all, 77 00:06:55.380 --> 00:06:59.060 but tremendous critique on mathematical economics 78 00:06:59.060 --> 00:06:59.900 and modeling. 79 00:07:01.820 --> 00:07:05.860 Ragem Rajan, Fault Lines, Rajan mentions Hayek 80 00:07:05.860 --> 00:07:08.580 with regards to the trade cycle. 81 00:07:08.580 --> 00:07:10.540 Now, a lot of them will not mention, 82 00:07:10.540 --> 00:07:12.340 in other words, these authors will mention something 83 00:07:12.340 --> 00:07:15.580 about the trade cycle, but they will be very critical 84 00:07:15.580 --> 00:07:17.120 of the mathematical method. 85 00:07:19.380 --> 00:07:22.100 It's highly critical, the mathematical approach. 86 00:07:22.100 --> 00:07:25.140 None of these authors refer to major Austrian economists, 87 00:07:25.140 --> 00:07:28.460 yet each was as critical of the approach of positivism 88 00:07:28.460 --> 00:07:31.140 as Mises, Hayek, or Rothbard, and they served 89 00:07:31.140 --> 00:07:33.540 to affirm the Austrian case. 90 00:07:33.540 --> 00:07:38.940 The second group, Krugman and Kraut, are familiar with the Austrians but very opposed to us, 91 00:07:38.940 --> 00:07:43.620 but yet they are saying the whole thing has been a disaster. 92 00:07:43.620 --> 00:07:51.900 Now, the authors who refer to the Austrians directly, Nassib Taleb and the Black Swan, 93 00:07:51.900 --> 00:07:54.420 absolutely refers to the Austrians. 94 00:07:54.420 --> 00:08:00.780 Kevin Phillips, Bad Money, Reckless Finance, and Global Crisis of American Capitalism refers 95 00:08:00.780 --> 00:08:05.780 In the first two, what? The Austrians were right in rejecting mathematical economics. 96 00:08:05.780 --> 00:08:10.780 Okay, Justin Fox, The Myth of the Rational Market, published in 2009. 97 00:08:10.780 --> 00:08:16.780 Talib, Phillips, and Fax explicitly mention Austrian criticism of the use of mathematics. 98 00:08:16.780 --> 00:08:23.780 Roubini and Steven, I think it's pronounced Mime, in Crisis Economics, published 2010, 99 00:08:23.780 --> 00:08:28.780 praise the Austrian trade cycle theory and are critical of the use of quantitative methods. 100 00:08:28.780 --> 00:08:38.480 Emanuel Derman, Models Behaving Badly. Derman specifically mentions Hayek's criticism of mixing the methodologies of the human and physical sciences. 101 00:08:38.480 --> 00:08:43.480 Derman, by the way, chief quant for Goldman Sachs, okay? 102 00:08:43.480 --> 00:08:50.480 So what we see is this attack now on positivism, which I think gives an opening for us. 103 00:08:50.480 --> 00:08:53.480 I'll just read you a little thing for humor. 104 00:08:53.480 --> 00:08:58.440 Where I taught economics at Walsh College before, we had what was called the mad dean, 105 00:08:58.440 --> 00:09:04.640 okay, and he was very critical of us, and he said, you have to teach something called 106 00:09:04.640 --> 00:09:08.280 financial engineering, which is heavy math and economics, and I asked him, I said, what 107 00:09:08.280 --> 00:09:09.280 is it? 108 00:09:09.280 --> 00:09:14.400 He said, well, he says, you can take this dodgy debt and through some kind of statistical 109 00:09:14.400 --> 00:09:18.960 methods transform it into the triple A bonds, 2005. 110 00:09:18.960 --> 00:09:22.000 Even though he claimed to have a doctorate in economics, I knew he had a problem when 111 00:09:22.000 --> 00:09:28.000 And he told me that Adam Smith wrote The Theory of Moral Sentiments after he wrote The Wealth of Nations because he felt guilty. 112 00:09:31.000 --> 00:09:34.000 Actually, Smith's books on morals came first. 113 00:09:34.000 --> 00:09:42.000 When one entered his office, it was like coming into the workshop of a renaissance alchemist where beakers were overflowing with gases and various chemicals were cooking. 114 00:09:42.000 --> 00:09:48.000 He'd be sitting there with his mathematical formulas, somewhat reminiscent of the search for the philosopher's stone. 115 00:09:48.000 --> 00:09:52.460 The stone was a substance that was supposed to turn base metals into gold. There he'd 116 00:09:52.460 --> 00:09:57.840 be, mothering various incantations as cognitive leadership, mezzanine financing and subordinated 117 00:09:57.840 --> 00:10:02.520 debt and he would criticize our economics as not having rigor. When I told him I thought 118 00:10:02.520 --> 00:10:06.680 his method would simply cheat a lot of little old ladies out of their money, 2005, he became 119 00:10:06.680 --> 00:10:10.800 very incensed, told me he had letters from companies who would not hire our graduates 120 00:10:10.800 --> 00:10:15.920 because they were not sufficiently trained in this type of alchemy. This 2005, today 121 00:10:15.920 --> 00:10:21.960 Those companies are all bankrupt, leaving a lot of retirement funds holding an empty bag, 122 00:10:21.960 --> 00:10:26.520 the ladies have been cheated out of their money, and the entire world economy is suffering 123 00:10:26.520 --> 00:10:28.840 from a multi-trillion dollar problem. 124 00:10:28.840 --> 00:10:33.160 The Dean disappeared into the sunset, leaving for parts west was his beakers of smoking 125 00:10:33.160 --> 00:10:38.240 chemicals, formulas, PowerPoint presentations, rigor and robustness, seeking the philosopher's 126 00:10:38.240 --> 00:10:39.600 stone. 127 00:10:39.600 --> 00:10:43.360 Warren Buffett said it best, beware of geeks with formulas. 128 00:10:43.360 --> 00:10:51.360 Indeed, a follower of Beckett, an advocate who considered the human element in investing, 129 00:10:51.360 --> 00:10:56.680 Robert Heigstrom, warned in 2000, ongoing research has shown that overall our use of 130 00:10:56.680 --> 00:11:02.680 mental models is seriously flawed. We construct incomplete presentations of phenomena we are 131 00:11:02.680 --> 00:11:07.320 trying to explain. Even when they are accurate, we don't use them properly. We tend to forget 132 00:11:07.320 --> 00:11:12.140 details about models, particularly when the time has passed. Finally, we have a distressing 133 00:11:12.140 --> 00:11:17.140 and tendency to create mental models based on superstition and unwarranted beliefs. 134 00:11:17.140 --> 00:11:23.100 And it's interesting, I quote some of the people on the moral problem, and then the paper 135 00:11:23.100 --> 00:11:28.940 goes into the allure of science, the allure of this positivism, probably starting with 136 00:11:28.940 --> 00:11:31.460 Sputnik. 137 00:11:31.460 --> 00:11:35.660 What happened is everything had to be thrown out, all the human sciences had to be thrown 138 00:11:35.660 --> 00:11:41.940 out and we had the whole idea of science was launching satellites. 139 00:11:41.940 --> 00:11:48.280 Edmond Standen, who writes on the allure of science at the time, talked about science 140 00:11:48.280 --> 00:11:51.100 as a sacred cow. 141 00:11:51.100 --> 00:11:54.240 Now then I go into the consistent warnings. 142 00:11:54.240 --> 00:11:58.560 There have been consistent warnings about this use of this type of methodology starting 143 00:11:58.560 --> 00:11:59.560 with Aristotle. 144 00:11:59.560 --> 00:12:07.580 You start with the Nicomachean Ethics Criticism, Edmund Burke, English Statesman. 145 00:12:07.580 --> 00:12:12.300 You can't use this stuff in running societies, okay? 146 00:12:12.300 --> 00:12:19.460 Jean-Baptiste Say, Alfred Marshall, I've got quotes in my paper from all of them. 147 00:12:19.460 --> 00:12:25.540 He said, pardon the mathematics, Gershwisser, one of our guys, is critical. 148 00:12:25.540 --> 00:12:31.060 Albert Einstein, he said, we must not forget Einstein's warning that pure mathematical 149 00:12:31.060 --> 00:12:35.540 construction can give us no knowledge whatsoever of the world of experience. 150 00:12:35.540 --> 00:12:39.540 All knowledge about reality begins with experience and terminates in it. 151 00:12:39.540 --> 00:12:44.540 Rabki, of course, was very critical of the mechanistic method. 152 00:12:44.540 --> 00:12:47.540 And of all people, guess who said this? 153 00:12:47.540 --> 00:12:53.540 The only function of economic forecasting is to make astrology respectable. 154 00:12:53.540 --> 00:12:56.540 John Kenneth Galbraith. 155 00:12:56.540 --> 00:12:58.540 Milton Friedman. 156 00:12:58.540 --> 00:13:02.540 Of course, I couldn't get the quote from Friedman, but I got it from a good book called 157 00:13:02.540 --> 00:13:07.180 Friedman called the Chicago School of Economics and he said, he claims that Friedman never 158 00:13:07.180 --> 00:13:12.260 thought much of sophisticated model building, although Friedman, I don't quite agree with 159 00:13:12.260 --> 00:13:14.740 his epistemology at all. 160 00:13:14.740 --> 00:13:19.260 Now I just want to read you one quote and I'll ask you who said this, one of the saddest 161 00:13:19.260 --> 00:13:23.860 days of my life was when my grandson, and he's a particularly brilliant grandson, went 162 00:13:23.860 --> 00:13:24.860 to college. 163 00:13:24.860 --> 00:13:28.980 He was good at mathematics and after he had been at college for a year or two I asked 164 00:13:28.980 --> 00:13:30.900 him what he wanted to do when he grew up. 165 00:13:30.900 --> 00:13:33.780 He said, I want to be a financial engineer. 166 00:13:33.780 --> 00:13:35.220 My heart sank. 167 00:13:35.220 --> 00:13:38.220 Why was he going to waste his time in this profession? 168 00:13:38.220 --> 00:13:41.140 A year or so ago, my daughter had seen something in the paper, 169 00:13:41.140 --> 00:13:44.380 some disparaging remarks I made about financial engineering. 170 00:13:44.380 --> 00:13:46.700 She sent it to my godson, grandson, 171 00:13:46.700 --> 00:13:48.660 who normally didn't communicate with me very much. 172 00:13:48.660 --> 00:13:50.220 He sent me an email. 173 00:13:50.220 --> 00:13:51.460 Grandpa, don't blame it on us. 174 00:13:51.460 --> 00:13:54.380 We're just following orders we're getting from our bosses. 175 00:13:54.380 --> 00:13:56.580 The only thing I could do is send them back an email. 176 00:13:56.580 --> 00:13:59.180 I will not accept the Nuremberg excuse. 177 00:13:59.180 --> 00:14:06.340 There was so much opaqueness and so many complications and misunderstandings involved in very complex 178 00:14:06.340 --> 00:14:10.300 financial engineering by people who, in my opinion, did not know financial markets. They 179 00:14:10.300 --> 00:14:17.300 knew mathematics. They thought financial markets obeyed mathematical laws. They found out differently. 180 00:14:17.300 --> 00:14:21.220 You know, they all said these events could only happen once every hundred years, but 181 00:14:21.220 --> 00:14:26.460 we have had once every hundred years now. What's happening every year or two? Who said 182 00:14:26.460 --> 00:14:34.460 Paul Volcker. It's astounding that people who are not on our side are coming to our conclusion. 183 00:14:34.460 --> 00:14:39.460 I think it's a tremendous opening for the Austrians. I mean, it's like the line broke. 184 00:14:39.460 --> 00:14:45.460 We can ride right through and say, hey, you guys are saying it. Ipse Dixit, he himself said it. 185 00:14:45.460 --> 00:14:54.460 Jane Jacobs, her book is very critical of the mathematical method. Her stuff was published in the 1980s. 186 00:14:54.460 --> 00:14:57.900 The Economy of Cities and Cities and the Wealth of Nations 187 00:14:57.900 --> 00:15:02.100 Very critical of their positivistic approach. And of all people, 188 00:15:02.100 --> 00:15:06.180 okay, you can guess who said this, 189 00:15:06.180 --> 00:15:10.780 two larger proportion of recent quotes mathematical economics are mere concoctions 190 00:15:10.780 --> 00:15:15.020 as imprecise as the initial assumptions they rest on, which allow the author to 191 00:15:15.020 --> 00:15:18.100 lose sight of complexities and interdependencies of the real world 192 00:15:18.100 --> 00:15:21.180 in a maze of pretentious and unhelpful symbols. 193 00:15:21.180 --> 00:15:30.140 John Maynard Keynes, okay, and you can go through and it's very interesting and 194 00:15:30.140 --> 00:15:34.780 then I quote Mises and I sum it up and I said after quoting all these people at 195 00:15:34.780 --> 00:15:38.300 the end I said how are these guys different than what Mises said when he 196 00:15:38.300 --> 00:15:42.580 wrote the epistemological foundations of economics, the ultimate foundations, it 197 00:15:42.580 --> 00:15:47.180 wasn't any different, I mean I'll quote Mises, I know I don't have much 198 00:15:47.180 --> 00:15:50.820 time, but it's diluted by the idea that the sciences of human action must ape 199 00:15:50.820 --> 00:15:53.580 They shift the technique of the natural sciences. 200 00:15:53.580 --> 00:15:56.980 Hosts of authors are intent upon the quantification of economics. 201 00:15:56.980 --> 00:16:02.420 They think that economics are to imitate chemistry, which progress from a qualitative to a quantitative 202 00:16:02.420 --> 00:16:03.420 state. 203 00:16:03.420 --> 00:16:06.980 Their motto is the positivistic maximum sciences measurement. 204 00:16:06.980 --> 00:16:12.260 They try to compute mathematical relations among the various of these data and thus determine 205 00:16:12.260 --> 00:16:16.740 what they call by analogy with the natural sciences correlations and functions. 206 00:16:16.740 --> 00:16:22.100 They fail to realize that in the field of human action, statistics is always history, 207 00:16:22.100 --> 00:16:27.740 and that the alleged correlations and functions do not describe anything else than what happened 208 00:16:27.740 --> 00:16:32.540 at a definite instant in time in the definite geographical areas, the outcome of the actions 209 00:16:32.540 --> 00:16:34.140 of definite people. 210 00:16:34.140 --> 00:16:39.100 As a method of economic analysis, economics is a child's play with figures that do not 211 00:16:39.100 --> 00:16:42.740 contribute anything to the elucidation of the problems of economic reality. 212 00:16:42.740 --> 00:16:48.740 Ludwig von Mises, and that's in the Ultimate Foundation of Economic Science, okay? 213 00:16:48.740 --> 00:16:57.740 I'd like to go on. I'll just say one thing. The rest of my paper is a call for the reconstruction of economics based upon the human action. 214 00:16:57.740 --> 00:17:03.740 And I go back to Aristotle, say Thomas, and build it right up and say, look, we are in the mainstream. 215 00:17:03.740 --> 00:17:07.740 They are out to lunch. Thank you very much. 216 00:17:07.740 --> 00:17:09.740 Thank you very much.