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The Pretence Of Knowledge

29 July 2010 2 Comments

The following article was written by Monty Pelerin from economicnoise.com

Friedrich Hayek

The “Pretence of Knowledge” was the title of economist Friedrich Hayek’s 1974 Nobel speech. In his first few sentences, he described the then-prevailing economic condition in words appropriate to today:

… [this economic condition] has been brought about by policies which the majority of economists recommended and even urged governments to pursue. We have indeed at the moment little cause for pride: as a profession we have made a mess of things.

Hayek’s words in 1974 were not meant to describe today’s condition, although they were extremely prescient. His hope was that the limits of knowledge would be recognized by the economics profession so that we would never reach our current situation.

Hayek’s call was for professional humility at a time when Keynesians arrogantly believed they could manage the economy and the business cycle. His was a caution about how little we really know about the economy and can ever know about it:

.. in the study of such complex phenomena as the market, which depend on the actions of many individuals, all the circumstances which will determine the outcome of a process, … will hardly ever be fully known or measurable.

Hayek described the role of economics as follows:

The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.

Two decades earlier Hayek had dedicated his The Road to Serfdom to the socialists of all parties in hopes that they would see the error of their ways. This warning was ignored by the political class as his Nobel speech was subsequently ignored by most economists.

Fast Forward To Today

Last week the Chairman of the Federal Reserve, Ben Bernanke, testified before Congress. He described the condition of the economy as “unusually uncertain.” That phrase, fogged up enough to make Alan Greenspan proud, was inconsistent with Mr. Bernanke’s prior “pretence of knowledge.” Peeling back the Fedspeak, Mr. Bernanke essentially admitted that he was baffled by the economy and had no idea what might happen next.

For anyone who has looked at Mr. Bernanke’s (the Fed’s) forecasting record, this quasi-admission should not surprise. Mr. Bernanke has not foreseen anything with reasonable accuracy. As Mish pointed out:

Ben Bernanke was pretty certain there would not be a recession, that housing was not in a bubble, that the unemployment rate would peak at 8.5%, that paying interest on reserves would enable the Fed to hold short-term rates above 2%.

Bernanke was wrong on every count. At least now he admits he is guessing.

Most economists have ignored Hayek’s caution for humility. Bernanke’s doubts in his recent testimony are both new and troublesome. It suggests that he does not know what to do next. He has tried everything that he “knows” in dosages never before imagined. Despite his actions, monetary and fiscal actions have not moved the economy. This is not the way the world is supposed to work, at least according to the (increasingly disrespected) prevailing macro-economics.

Mr. Bernanke and others of his generation and training have absorbed what Mark Twain described as dangerous knowledge:

It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.

In modern days, Twain’s aphorism was formalized by Thomas Kuhn. Kuhn wrote The Structure of Scientific Revolution which dealt with the difficulty of changing scientific paradigms.We are at the point where increasing numbers of people question the value of the existing economic paradigm. Bernanke’s testimony may be the start of his Thomas Kuhn moment.

A long battle between the defenders of the old paradigm and the rise of a new one is about to take place. Bernanke, most professional economists and politicians will do everything they can to protect the status quo. Crises often shorten the period of acceptance for something new. That was the case in the 1930s when we accepted the false paradigm of Keynesianism. Desperation caused hundreds of years of economics to be thrown overboard for an unproven theory.

Two years into the crisis with unemployment still rising (using the broader measures) and stimulus almost exhausted, the economy is dead man walking. Negative GDP numbers are likely to appear once the stimulus ends. While government may have some bullets left, they fired their missiles and howitzer shells and are left with small arms. Somewhere Mr. Hayek must be smiling and thinking: “I told you so more than fifty years ago.”

The incorrect paradigm that has guided government policies for about 70 years is spent. Economies around the world have been crippled as a result of its incorrect prescriptions —  increased taxation, spending, debt and regulation. Even the highly socialistic Western Europe economies appear to be recognizing the error in such stimulus policies. In the Financial Times Jean Claude Trichet, Bernanke’s counterpart, has recently been highly critical of U.S. economic policy.

To be fair to Mr. Bernanke, it is not his fault. As Hayek explained, no one is capable of doing what cannot be done. Mr. Bernanke’s sin was to pretend otherwise, not his failure to do the impossible. Of course, to not pretend would have made Mr. Bernanke ineligible for government employment. Whether he truly believed he was capable of managing the economy or he just tried to maintain the crucial statist political myth is not knowable. My guess is that Bernanke was motivated primarily by his sincerity to the false Keynesian paradigm but was also recognized the necessity of maintaining the myth.

Critics will judge Mr. Bernanke harshly. They will argue that prior Fed chairmen did better jobs. That conclusion is false, although arguing it is as subjective as judging a beauty contest and as useful as last week’s newspaper. The reality is that other Fed chairman had options not afforded Mr. Bernanke. Because they preceded him, they worked with an economy less damaged than Bernanke inherited. It was their decades of false paradigm prescriptions that so damaged the current economy.

A free-market economy is a self-correcting mechanism despite all the protestations of Keynes, his followers, government economists and politicians. Benign neglect is all that is required to enable an economic recovery when an economy is free and flexible. Prior Fed chairman did not practice benign neglect. Like the physicians of yore, economists believed their form of bloodletting cured the economy. This myth was especially convenient for politicians who could claim credit while buying votes at the same time.

Cumulative abuses heaped on the economy weakened its resilience. We are at the point where the patient is so weak that additional bloodletting is likely to cause death. It was Mr. Bernanke’s misfortune to rise to the job at the wrong time. While this may buttress the case that he was no worse than his predecessors, it certainly doesn’t excuse his judgment.

For any thinking economist, not blinded by the false Keynesian paradigm, it was obvious where this economy was going at least ten years ago. Bernanke’s decision to accept the job when he did was equivalent to knowing history and accepting the captaincy on the maiden voyage of the Titanic. Should we be surprised that Bernanke is unable to forecast with any accuracy? Or are we to presume that his ego was so big that he believed he could navigate the ship through the icebergs?

Hayek’s final book, written in 1991, had the title of The Fatal Conceit. Although not directed specifically at economists, the phrase is an accurate description for much of the economics profession for the past 70 years.

Our economy is broken and on the verge of collapse. Send thanks to most any economist that has served in government over this period or taught at an Ivy League school.

Written by Monty Pelerin – read more of his writing at www.economicnoise.com

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