Cloud Connected - January 2025
Can Austrian Economics Be A Helpful Tool In Investing?
I’m not here to make friends. I’m here to make money. – CM Punk
Many Roads Lead To Rome
One thing I admire about the field of financial markets is the openness to various economic theories. Everyone has their way of looking at markets and the economy and is happy to discuss their views with others.
The same goes for trading strategies. After all, it's about identifying opportunities; every investor and trader must find the approach that suits them best. Just as in the old saying, one could say, "Many roads lead to Rome."
Yet, one could say that you're probably doing well when you have a profound knowledge of economics. I'd heavily stress that argument. In financial markets, many people look for various patterns, correlations, and indicators to enter or exit a position. They'll find correlations that have worked out in the past and use them as tools to assess whether to enter a trade. Economists, on the other hand, often rely too much on their models when it comes to forecasting.
The bottom line here is that they'll take note of any economic theory out there to backtest it and find ways to make money. And here's the catch, as Jason Shapiro from "Crowded Market Report" always sums up, saying, "It's better to be wrong and make money than to be right and lose money."
Regarding Austrian Economics, one might think that it's sound economic theory, but it can help you very little in trading and investing, apart from very long-term investing. Someone recently wrote on X that:
Austrians are good at micro, but terrible at macro.
Within the financial industry, the most well-known Austrians are probably Peter Schiff, who got recognition for predicting the 2008 Global Financial Crisis (GFC), and I'd say Mark Spitznagel (although it's debatable whether he's a true Austrian), who runs a fund that serves as "portfolio protection." So, Austrians are usually known for these things:
They typically have a bearish outlook for the economy.
They are always bullish on precious metals and likely on commodities.
They constantly criticize government spending.
The result is quotes like the one from above. Honestly, one cannot blame people for that, as most of the calls made by some well-known Austrians in the past two decades didn't materialize. After 2008, they called for inflation, which didn't happen, and gold didn't perform either.
Other Economic Theories
Hence, one could say that the criticism of Austrian economics for its bias toward macroeconomic analysis cannot be withdrawn immediately. Many proponents of other economic theories, Keynesians and MMTers, claim to have made better calls than the Austrians. In their view, Austrians don't have a correct view of how the larger economic system works, mainly because they're often criticized for still relying on fixed exchange rates (though this isn't entirely accurate).
Keynesians and MMTers believe that government deficits benefit the economy by creating income for households and businesses. Keynesians think governments should use that tool when the economy slumps, helping to "kickstart" it again.
MMTers, on the other hand, don't consider deficits bad at all and see them as necessary in the current ecosystem to increase growth and productivity. I don't want to discuss the theoretical and political implications here because I'd like to focus on the part essential for macroeconomic analysis.
In the view of MMTers, falling deficits translate directly into lower incomes, which are bearish for markets because there is less money to invest. Their argument is based on bookkeeping examples and claims that government deficits can be seen as equivalent to money printing.
Frankly, following various people within markets, one could conclude that Austrian Economics might be a proper theory for certain conditions but doesn't fit in the current economic and financial system. When you're in the business of making money, then one could even say that people who look at MMT and Keynesian economics have a better track record, as they are usually more bullish on the stock market in the current environment, while many Austrians are always warning about a bubble. To the majority, Austrians are just crazy libertarians who are bearish on the economy and have predicted nine of the last two recessions.
Based on that, one could say that Austrian Economics has its role, but when it comes to macroeconomics related to assessing future market trajectories, it's considered by some to be out of date and not usable. However, I'd like to stress that argument.
Main Part
The Misconception About Austrian Economics
First of all, most people do equate Austrian Economic Theory with libertarianism because many proponents for liberty are often also proponents of Austrian Economics. However, that's a common misconception.
In reality, the application of Austrian Economics doesn't rely on certain political beliefs. It's just a specific framework to analyze the economy from a different viewpoint than the mainstream neoclassical economists, the MMTers, or Keynesians do.
The Difference To Other Schools Of Thought
It's the framework under which Austrians look at the world that differs from many schools of thought. Instead of relying on economic statistics and putting inputs into econometric models to get estimations out of the model, Austrians concentrate on the main driver of all markets: individuals acting within the market economy.
The Core Principle Of Austrian Economics: Human Action
Instead of looking at macroeconomic aggregates, Austrians start on the micro-level to analyze the market. The core principle is their a priori, logical reasoning. Just like "2 + 2 = 4," the starting point of the analysis is that "humans act to achieve desired ends." If one buys a good for price x, it's because their expected value is >x.
According to Austrian Economics, economic laws can be deduced from a priori truths. This is in contrast to mainstream economic thinking, which analyzes vast amounts of empirical data to test whether a theory is valid. In my view (the Austrian view), such methods are insufficient because human action is too complex to be seen as mechanistic. People have subjective preferences that can easily change over time.
Ludwig von Mises, arguably the most famous Austrian economist apart from Hayek (who was once his disciple), even went so far as to claim that economics was just a branch within the field of "Catallactics," the study of exchanges. His strongest criticism is that economics must not be seen as a science akin to the natural sciences, where one can derive theorems from experiments (or statistical analysis) but from economic theory.
The Law Of Diminishing Marginal Utility
The most "mainstream" view of Austrian Economics is probably Carl Menger's law of "diminishing marginal utility." Menger is seen as the founding father of Austrian Economics, and all his successors have based their economic thinking on his framework. Yet, despite being used in mainstream microeconomics, I want to add that the microeconomic model isn't necessarily based on Menger but on Jevons and Walras, who formulated similar, equation-based theories simultaneously, aiming to "make economics more scientific."
Fundamentally, Menger's reasoning differs significantly from that of Walras and Jevons. As a former journalist, Menger relied on verbal logic and qualitative analysis to develop his theory, arguing that value is inherently subjective and depends on individual preferences and circumstances. In contrast, Walras and Jevons adopted mathematical approaches to model their ideas, introducing general equilibrium frameworks and formalizing the principle of diminishing marginal utility.
While all three contributed to the marginalist revolution, Menger focused on explaining real-world processes, particularly how individual valuations lead to price formation in markets, whereas Walras and Jevons emphasized abstract models of economic equilibrium.
Economic Realism & Market Dynamics
Unlike the other schools, which look at economies through the lens of statistical abstractions and aggregates, Austrians look at the economy through the lens of the actors. Because of the complexity of human actions, mathematical models can never depict the real world closely enough and, therefore, in themselves, produce sound economic reasoning.
The argument is that economic reality should be examined to derive economic theorems. Instead of reviewing just numbers, exploring how a business operates, how consumers make decisions, and how these decisions form the market is helpful. Mathematical models cannot capture this decision-making process because they assume homogeneity in economic agents.
In my view, this is one of the most essential parts of Austrian economic analysis. It's always better to understand why people make economic decisions by doing a qualitative analysis rather than quantifying how much things change.
One could argue that this merely underscores the claim that Austrian economists are "bad at macro," but I'd deny that as well. There's a difference between macroeconomics and looking at the world through a macroeconomic lens (through aggregates). We Austrians just stress that the economy evolves bottom-up instead of top-down, through millions and millions making decisions.
What sets Austrians apart from basic microeconomic analysis is that they don't believe that markets are in equilibrium. The Austrian view is that markets are constantly changing, and decisions lead the market to move away from or toward an equilibrium. The argument is that traders and entrepreneurs profit by spotting or anticipating the market moving from disequilibria to equilibria or vice versa. In our framework, government interventions are crucial here because they influence human decision-making and distort the natural flux of markets.
Austrian Economics & Asset Prices
After hearing about how Austrians view the economic landscape, the question is how this can help analyze financial markets. The fundamental critique I've mentioned hasn't been refuted so far: Austrian economics doesn't help analyze financial markets and macroeconomics because it focuses on the micro level. Yet, I'm ready to explain why I think Austrian economic analysis can be a helpful tool for investors to understand what’s going on in the macroeconomy.
The Role of Money, The Cantillon Effect And Price Determination
While most macroeconomic models in the Neo-Keynesian macroeconomic mainstream don't even consider money, Austrians point out that money plays a crucial role within financial markets and shapes asset prices. In that sense, some overlap with MMT, which also looks at money and the flows.
The difference is that while MMT merely makes some sort of bookkeeping analysis to underscore their argument, Austrians look deeper. Further, their assessment isn't based on aggregates (while MMT looks at aggregates) but on individual decision-making.
Austrians see interest rates as a signal for the economy. If interest rates are low, the financial sector signals to producers that there's plenty of liquidity just waiting to be used for specific projects. On the contrary, when interest rates rise, the market seeks liquidity and rewards those who provide it more.
As money isn't fixed in our system but created either through the central bank’s interest rate policy or banks lending money into existence (at least to a certain degree), new units of currency entering the system have different effects on various groups of people.
As a result, Austrians see money creation as not net-neutral, meaning that some people benefit from money creation while others suffer from it. It creates disequilibria and benefits people and businesses who get hold of the new money at the expense of late recipients. That is in line with what Richard Cantillon observed in the 18th Century when he looked at the consequences of new gold entering the market.
As value is subjective, prices cannot be objective. Price is just a reflection of people's decisions (their acting) to buy or sell a particular product. Hence, Austrians argue that there's no real "intrinsic value" or "fair price" for goods, services, or financial assets.
It's just a reflection of an equilibrium of enough people willing to sell and buy. If something is scarce, people tend to hold onto it for longer and sell it more expensively than something that can easily be replicated and increased in quantity. Supply and demand are the driving forces of price determination.
Applying The Austrian Method To Trading And Investing
I think that Austrian economic analysis is helpful to assess the future trajectory of interest rates and the macroeconomy. If we recall that most people within finance mostly know Austrian Economics just because they once saw some bearish guy on TV talking about it, they'll think that using it is useless if you aim to make money.
Yet, there's a reason why these people on TV talk about markets the way they do. It's not that Peter Schiff doesn't believe that his words will eventually become true. They very well might become true, but how he presents them to the audience makes it seem as if the oversimplification "when A occurs, B will happen" is always falling short.
If one adopts Austrian economic thinking, one will quickly discover why events don't necessarily play out the way Schiff and others think they will, which is that they assume linearity. But basically, that's what an Austrian economist should tell you by the way we look at markets: that there is no linearity because the more people make decisions, the more multilinear the aftermath becomes.
The Long-Term Focus
Regarding long-term investing, I'd say that Austrian economics helps us understand how markets unfold over a more extended period. Therefore, it's no wonder why so many call for a higher allocation to commodities or precious metals in a portfolio.
The clear answer is that the best way to preserve wealth over decades is to invest in scarce assets in a system where the money supply needs to increase to keep the system from collapsing. It's the very long-term where linear thinking seems to have the most benefits, although people who implemented this would have lost a lot of gains in the stock market. And while people could see that as a weakness of Austrian economics (because of high opportunity costs), that's where I think the method becomes valuable.
The Short-Term Focus
The shorter your trading horizon, the harder it is to act based on a particular economic theory. Prices result from supply and demand, which happens to be similar to the conditions a day ago. That doesn't mean today's price is a function of yesterday's price. It just means that conditions are similar to the day before, especially in a world where many financial actors receive all the essential information within seconds on their Terminals or social media.
Once one understands that markets move because people make decisions based on new economic data and news or certain narratives that emerge and they try to jump on, price discovery within markets makes a lot of sense under an Austrian lens.
Here, I think I can underscore the differences between scientific Austrian analysis and the use of Austrian economic analysis to assess the trajectory of financial markets. An Austrian academic might tell you that NFPs, GDP, or inflation numbers are meaningless because they do not reflect the economic reality. And who am I to say they don't have a point?
Yet, I would add that these and other data are shaping the decision-making of people active within markets. I'd also say that the way to analyze inflation the wrong way, namely via looking at singular price developments, can be helpful for short-term price movements and, hence, unsustainable price increases/decreases. It's the way to interpret the data to assess further actions of buyers and sellers within financial markets, where Austrian economic analysis really could give one an edge.
Strategic Investment Practices
Indeed, as with all approaches in financial markets, the Austrian approach doesn't guarantee infinite profits. However, it can help identify potential opportunities to profit from the movement of markets toward or away from equilibria.
For example, when long-term bonds rise because of an unexpectedly low CPI, one might look at the other data to see whether the euphoria regarding falling interest rates is warranted. In an environment where the central bank has reached the terminal rate, and inflation is falling, people's experience is that as soon as inflation falls, cuts will be on the way, so it's reasonable for them to bet on it.
Yet, if—as in the current environment—GDP nowcasts are still signaling a strong economy and employment data still looks good, then continuing these trends will lead to rapid erasure of the price increases that bonds received from the fall in CPI. Suppose one scans social media and sees everyone telling you that the economic downturn is right around the corner, albeit the available numbers don't reflect that. In that case, one might have spotted a certain disequilibrium.
When the yield curve suggests that traders shifted their expectations for interest rate cuts sharply lower because of the low CPI print, this could signal potential mispricing and that continuously strong growth and good employment numbers will lead to people exiting the long-bond trade. That would push bond prices lower and back towards equilibrium. It's not that the thesis will always be true because new data can turn out worse than expected. Still, I think my example gives a profound idea of how one can include Austrian economics in his market analysis.
Another example is that fundamentals do not always play a role when it comes to price. How often did you hear that stocks are vastly overvalued but still keep rising? I bet you've read that a lot of times. The reason behind that is relatively simple: stock prices are also driven by people's perceptions and beliefs. Sometimes, one can read news about a specific invention that changes everything. As information spreads out slowly across all people, it will take time until this (let it even be unwarranted) expectation feeds into the price.
It's not the valuation that hinders the price from rising. It's the increasing euphoria and FOMO that pushes the price higher. People will react to the information they receive and act accordingly. This brings me to the final important tool to observe when assessing future price trajectories: sentiment.
Prices will have limited upside when sentiment is extremely optimistic, and they will have limited downside when people are overly pessimistic. When everyone has already bought an asset, no other buyer can push the price higher, and vice versa. This also leads to people liquidating their positions and driving the price up or down, depending on whether sentiment is extremely pessimistic or optimistic.
I'm not a big fan of technical analysis on its own, but I have to say that it can help to spot potential entry points. Therefore, I'd argue that one should not dismiss it as a whole. However, I think it shouldn't be used to assess the price trajectory, although you will find people who do that and do exceptionally well.
Conclusion
I hope that I could shed some light on the reasoning of Austrian economists, how they look at markets, and how one can use the theory within financial markets, investing, and trading. Albeit one could easily dismiss it because it looks as if one must be a perma-bull on gold and a perma-bear on stocks and bonds, if one scratches beneath the surface of the theory, one can discover that Austrian Economics can give a unique perspective on the market and helps to be a helpful tool to spot price dislocations one can profit from.
That doesn't mean that one must be a proponent of Austrian Economics to make money. Many people will tell you that the opposite is true. I'm here to tell you that none of both sides is correct and that Austrian Economics is nothing but a tool where sound economics can help you as a guide to understand the real world better and to find arbitrage within markets where people's decisions seem to have pushed prices out of equilibrium.
Have a great weekend!
Fabian Wintersberger
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All my posts and opinions are purely personal and do not represent the views of any individuals, institutions, or organizations I may be or have been affiliated with, whether professionally or personally. They do not constitute investment advice, and my perspective may change over time in response to evolving facts. IT IS STRONGLY RECOMMENDED TO SEEK INDEPENDENT ADVICE AND CONDUCT YOUR OWN RESEARCH BEFORE MAKING INVESTMENT DECISIONS.