Friends Of Liberty

What Thomas Jefferson Thought About Gun Control:

2009-08-25T20:00:00.000-04:00

"Laws that forbid the carrying of arms..disarm only those who are neither inclined nor determined to commit crimes. Such laws make things worse for the assaulted and better for the assailants; they serve rather to encourage than prevent homicides, for an unarmed man may be attacked with greater confidence than an armed one."

- Thomas Jefferson quoting Cesare Beccaria, Criminologist in 1764.

You mean David Patterson is black???

2009-08-25T19:43:00.004-04:00

RACE & POLITICS: NAVIGATING IN A NEW ERA

Honestly, I never knew New York Governor David Paterson was black, until he pulled that tired old "Race Card". I always thought he was just a cross-eyed buffoon.

The solution to the health care crisis is the FREE MARKET!

2009-08-25T19:37:00.002-04:00

Below is an article from the New York Post, Tuesday, August 25, 2009, by Sally Pipes.

What is remarkable about this article is that the solution to our health care crisis lies within it. the answer is simple. It is simpler, easier, more cost-effective, and will give Americans what they need, in the best form. The solution is the FREE MARKET. Read on!

O'S RX: BREAK IT
DEADLY INSURANCE 'FIX'

By SALLY PIPES

Last updated: 3:58 am
August 25, 2009
Posted: 2:59 am
August 25, 2009

PRESIDENT Obama and his allies in Congress seem to have decided that the best way to fix the private health-insurance market is to break it completely.

Polls have prompted them to shift from health-care reform to "health-insurance reform." Combine this with a government-funded, -regulated and an ultimately -controlled "co-op" system, and the nation will arrive by local roads at the same destination that the public rejected via the expressway: an out-of-control health-care system dominated by federal bureaucrats and funded by increasingly high taxes.

The irony is that private insurance works well where it's least regulated. To find the unaffordable disasters, you must head to states such as New York or New Jersey that have pioneered the reforms Obama is peddling for the entire country.

The health-care sector is complex and interwoven. What appears to be government might in fact be run by private insurance companies. Medicare, for example, has long contracted out its day-to-day operations to insurance companies, mostly Blue Cross and Blue Shield.

Most Americans receive the health coverage they cherish through their employer. Chances are, if it's a large employer, it's a self-funded plan, and (as with Medicare) the insurance company is merely administering the program.

It's only smaller employers and people seeking policies in the individual market who actually buy insurance from carriers.

The individual market is where people face the most choices and have the most choice -- except in those states with Obama-style regulations. People are spending their own money and so must confront directly the value of more insurance protection versus other uses of their cash. Not surprisingly, they often opt for less generous coverage with less onerous premiums.

To discover this world of choice, just go to ehealthinsurance.org. Pop in your state, age and gender, and then ponder a myriad of choices to secure protection from catastrophic health expenses, the proper function of insurance.

A 55-year-old man in Allentown, Pa., can choose from 99 plans starting as low as $141 a month for hospital coverage. A zero-deductible HMO plan costs $418 a month. Or he can pick a more flexible PPO, with a higher deductible and pay less monthly out-of-pocket for the premium.

Young people, "the invincibles," often skip insurance, because they have few assets to protect and little fear of getting sick. The congressional Democrats' solution is a tax increase by another name: Force employers to keep paying for them on their parents' expensive plans until age 26.

Yet the market has responded with products targeted at the needs of the young, such as Wellpoint's Tonik, which offers excellent protection, prescription drugs and preventive care for less than $100 a month for the under-30 set.

So if 50-somethings can get a plan at less than $200 a month and youngsters can sign up for less than $100 a month, where's the problem? Why, it's in New York and New Jersey -- precisely the states that have adopted Obama-style reform -- restricting insurers from charging rates based on age and preventing them from saying no due to poor health.

Change the zip code from Pennsylvania to neighboring New Jersey, and choice plummets even as the cost per plan skyrockets. In New York, our 55-year-old has only 12 plans to choose from.

The reason is simple: When people can buy fire insurance after their houses are burning, only those with a fire in the attic apply for insurance. Soon, only those who expect a blaze can afford the high premiums.

Massachusetts enacted such a system in April 2006. A CEO of a major health network reports exactly this problem: Despite the state mandate that everyone buy and keep insurance, his company is experiencing a drastic increase in people who purchase new coverage, run up big bills that are fully covered and then drop the plan.

People are simply gaming the system. Since they can acquire insurance any time, regardless of health, why pay the premium in times of good health?

This is the future of ObamaCare executed by a liberal Congress whose leaders long for a government-dominated system.

The current health-care environment offers all of the components that are touted as true reform -- health co-operatives, health-insurance clearinghouses and tax subsidies for low-income Americans that ensure access to health care. But it doesn't give Washington control of reimbursement rates or health plan design, or the power to force people into insurance plans.

That's what politicians want -- because it's only when they have total control and have totally broken the system that they can recreate it in the image of "Medicare for All."

Sally Pipes is president and CEO of the Pacific Re search Institute.

A response to the article: A WINNING WEEK FOR TERROR

2009-08-25T19:24:00.003-04:00

Below is an article from the New York Post, by Ralph Peters, with my comments inserted, bracketed and in bold, italic red color.

A WINNING WEEK FOR TERROR
WEST'S HUGS FAIL TO STOP THUGS

By RALPH PETERS

Last updated: 3:51 am
August 25, 2009
Posted: 2:59 am
August 25, 2009

LAST week, we learned the answer to the hoary question "What does a Scots man wear under his kilt?" When it comes to terrorism, the answer's "a white flag."

But Scotland's craven release, "on humanitarian grounds," of Abdel Basset Ali al-Megrahi, the mastermind of the bombing that killed 270 passengers aboard a Pan Am flight two decades ago, was merely the noisiest terrorist triumph during a week of shame.

And noisy it was: Libya's Moammar Khadafy staged a huge homecoming party for the terrorist. (Think that would've happened while W was president?) The gleeful Khadafy rubbed the West's snout in our feckless taste for appeasement.

Appeasement was also the watchword back in the United States, where Yale University Press delighted Islamist extremists by removing all illustrations from a scholarly work about the Danish cartoon debacle -- not just the caricatures of Mohammed.

Elsewhere, the casualty count went beyond book illustrations. In Iraq, Islamist terrorists staged massive suicide bombings in Baghdad. Over a hundred Iraqis died, with more than a thousand wounded. The foreign and finance ministries lie in rubble. The government's reeling.

Our president went to the beach.

In Afghanistan, the Taliban crippled the national elections so severely that the eventual "winner" won't have much of a mandate. Despite madcap ballot-box stuffing, the final tally will probably show that less than half of the eligible population voted -- fewer than one in five in the crucial south.

Afghans put more faith in Taliban threats than in government promises. US and Western officials are struggling to paint a smile on the face of the corpse, but the vote was divisive, not unifying. On Sunday, Adm. Mike Mullen, the chairman of the Joint Chiefs, admitted that the Afghan situation is "serious and deteriorating."

That's what happens when, instead of killing our enemies, we try hugs.

[Hugs? By "hugs" does Peters mean talks and negotiations? If so, then why not call it what it is, instead of trying to be cute about it?]

Iran? We all know that its nuclear program is purely for peaceful purposes. That's why, just last week, President Mahmoud Ahmedinejad chose a Revolutionary Guard commander, Ahmad Vahidi, as his new defense minister.

Interpolwants Vahidi for running the 1994 bombing of a Jewish community center in Buenos Aires -- 85 dead, 300 wounded. Soon, he may have his trigger finger on nuclear weapons. But no need for Israel to worry: The Obama administration will negotiate with Tehran.

[Ah, so Peters does indeed mean negotiations by the term "hugs"!]

Returning to America, the establishment media continued to portray imprisoned terrorists as victims, while further chastising the bygone Bush administration for rudeness to mass murderers.

[Rudeness? Does Peters view torture as a form of rudeness? Maybe he's just trying to be cute again. If a captured American soldier were being tortured by terrorists, wouldn't we portray that American soldier as a victim of terrorist torture? By the same token, if we are torturing imprisoned "terrorists", are they not victims of our torture as well? Since we tortured them, the question is answered in the affirmative.]

(Any self-righteous journalist care to spend a night in a cell with one of the butchers whose "rights" have been infringed?) [Is not guilt or innocence determined by trial? We have tortured detainees on the assumption of their guilt before any trial would prove their guilt or innocence. If we, Americans, are far superior culturally and judicially than these people, why then do we stoop below our own level? Peters then assumes that a journalist would be afraid to spend the night in a cell with the detainees. Why be afraid? What would the detainees do to the journalist--eat the flesh off his bones in the middle of the night?]

Then the White House took all major interrogations away from the CIA, further restricting the techniques allowed to stop terrorists. [Torture has not been proven to extract truth from detainees. Often, the truth a detainee reveals is not sufficient in light of what the torturer thinks the truth is, and he dismisses it, then continues the torture. What has been proven is that a torture victim will say anything he believes his torturers want to hear in order to stop the suffering, even lies. Misinformation does not help find and stop other terrorists.]

And now the administration's hard-left Justice Department -- perhaps the most extreme in our country's history -- is on another witch hunt to prosecute CIA patriots who did all they could to keep our citizens safe. [A patriot is one who loves his country and does what is necessary to defend it from harm. Over decades, the CIA has spread terrorism worldwide, and the backlash from it--a term the CIA itself has coined "blowback"--has resulted in the massacre against American citizens on September 11, 2001. How does the CIA's behavior, detrimental to America, apply to the definition of "patriot", which is behavior beneficial to America? It's not hard to see the falsity of this statement.]

Last but not least, a minor legal case bears enormous implications: A 17-year-old female Muslim immigrant to the US, Fathima Rifqa Bary, begged our justice system not to return her to her family.

She fears she'll be the victim of an honor killing.

Smooching with the boys? Naw. Much worse: She converted to Christianity -- still an offense for which, many Muslims believe, Islam (that "religion of peace") prescribes death. Fleeing from her Ohio home to Florida, she's in protective custody, awaiting a judge's verdict on Sept. 3.

Not all of the details are clear, but the big picture is: A legal resident of our country, where religious freedom is constitutionally guaranteed, fears death at the hands of her relatives and her community because she changed her faith.

If she's sent "home" and murdered, will the crime be written off as freedom of religion?

[In a land where the Constitution protects life, liberty, the pursuit of happiness as well as freedom of religion, life trumps liberty as liberty trumps the pursuit of happiness. If a religion's customs include the harming of a citizen's life by another, then life trumps this religion's freedom.]

Coddled by Washington Democrats and Republicans, extremist mullahs here in the United States -- often funded by our "friends" the Saudis -- invoke religious freedom at the drop of a prayer rug. And our elected officials cower.

[Our elected officials are proven nitwits.]

Well, it's high time for Muslim clerics across this country to issue a public statement explicitly denouncing all violence against Muslims who switch faiths. This is America, folks. If a Methodist turns Muslim, fine. But if a Muslim becomes an Evangelical, that, too, must be tolerated. The Koran is not a license to kill in this country.

(And that dating thing? Murder over that's a no-no, too.)

One year ago, terrorists were on the defensive around the world. Then a new US administration condemned our country while "reaching out" to our enemies.

And here we are.

[What is needed is a radical change to our foreign policy, which produces misery around the globe and creates the resentment and anger against us, which is the catalyst for terrorism against America. We need to heed the words of our Founding Fathers--Jefferson, Franklin, etc.--which Ron Paul has repeated over and over again: good neighborliness and free trade with all, yet entangling alliances with none.]

France Has Lost Its Mind

2009-08-12T21:29:00.002-04:00

French pool bars Muslim woman for 'burquini' suit

[my comments are bracketed, italicized and in red]

By MARIA DANILOVA, Associated Press Writer Maria Danilova, Associated Press Writer – 29 mins ago

PARIS – A Muslim woman garbed in a head-to-toe swimsuit — dubbed a "burquini" — may have opened a new chapter in France's tussle between religious practices and its stern secular code.

Officials insisted Wednesday they banned the woman's use of the Islam-friendly suit at a local pool because of France's pool hygiene standards — not out of hostility to overtly Muslim garb.

Under the policy, swimmers are not allowed in pools with baggy clothing, including surfer-style shorts. Only figure-hugging suits are permitted.

Nonetheless the woman, a 35-year-old convert to Islam identified only as Carole, complained of religious discrimination after trying to go swimming in a "burquini," a full-body swimsuit, in the town of Emerainville, southeast of Paris.

She was quoted as telling the daily Le Parisien newspaper that she had bought the burquini after deciding "it would allow me the pleasure of bathing without showing too much of myself, as Islam recommends."

"For me this is nothing but segregation," she said.

The issue of religious attire is a hot topic in France, where head-to-toe burqas or other full-body coverings worn by some Muslim fundamentalists are in official disfavor.

France is home to western Europe's largest Muslim population, estimated at 5 million, and Islam is the nation's second religion after Roman Catholicism.

A 2004 law banning the wearing of Muslim head scarves at public schools sparked fierce debate. That legislation also banned Jewish skullcaps and large Christian crosses in public classrooms.

[Separation of Church and State is not about banning religion and religious items from the public eye, but about preventing the State from interfering in the religious practices of the People. True separation of Church and State would ban the government from banning Muslim head scarves, Jewish skullcaps and Christian crosses.]

French lawmakers recently revived the issue of Muslim dress with a proposal that the burqa and other voluminous Muslim attire be banned.

President Nicolas Sarkozy, a conservative, backs the move, saying such garb makes women prisoners.

[Religious garb does not imprison a woman if she chooses to wear it.]

The "burquini" covers the arms to the wrists and the legs to the ankle and has a hood to cover neck and hair.

An official in charge of swimming pools for the Emerainville region, Daniel Guillaume, said the refusal to allow the local woman to swim in her "burquini" had nothing to do with religion and everything to do with public health standards.

"These clothes are used in public, so they can contain molecules, viruses, et cetera, which will go in the water and could be transmitted to other bathers," Guillaume said in a telephone interview.

[The burquini is not worn in public, so this argument is nonsense.]

"We reminded this woman that one should not bathe all dressed, just as we would tell someone who is a nudist not to bathe all naked," he said.

[Islam, which requires women to cover themselves, is a religion. Nudity is not a religion.]

Guillaume said France's public health standards require all pool-goers to don swimsuits for women and tight, swimming briefs for men — and caps to cover their hair. Bathers also must shower before entering the water.

Guillaume said Carole had tried to file a complaint at a local police station, but her request was turned down as groundless.

Carole told the daily Le Parisien she would protest with the help of anti-discrimination groups.

Emerainville Mayor Alan Kelyor said he could not understand why the woman would want to swim in head-to-toe clothes.

[The Mayor doesn't need to understand why a woman would want to swim in head-to-toe clothing, just that she has the right to do so. ]

"We are going back in civilization," he said by telephone. Women have fought for decades for equal rights with men, he said. "Now we are putting them back in burqas and veils."

[There is a contradiction in the Mayor's statement. First he admits that Carole wanted to swim in head-to-toe clothing, then claimed "we are putting [women] back in burqas and veils." Well, which is it? Either Carole wanted to wear the clothing or she was being put into it by society. Clearly, since Carole chose to wear the clothing, and since the article is about Carole's fight to wear this clothing, no one is putting her into it. It is her decision. Besides, isn't it part and parcel of women's fight for equal rights to wear whatever clothing they choose, even head-to-toe swimwear?]

The suits have a clear market.

Women "jump on the occasion so they can swim with their families. Otherwise, they end up staying on the beach and watching," said Leila Mouhoubia, who runs an online site from France that specializes in the sale of Islamic swimsuits. Sales, she said, are strong.

"I think it's forbidden (in France) because it presents an image of the Muslim woman (and) they have prejudices against Muslims," she said by telephone. "They want women to be undressed."

Mouloud Aounit, head of the anti-racism group known as MRAP, said the decision to ban Carole from the pool appeared fair, since pool authorities were observing regulations. But Aounit lamented that the incident was likely to fuel religious tensions.

"The rules must be the same for everybody, regardless of the color of their skin or their religion," Aounit said. "The concern I have is that this case will again lead to stigmatization of the Muslim population in France."

The all-body suits, worn regularly by some women in Muslim countries, are growing popular in the West. They can be seen on female Muslim lifeguards on Australian beaches, in the United States and various European countries, from the Netherlands to Sweden — which OKed them after two women won discrimination cases last year.

[After years of lamenting from the religious Right that morals have decayed and that there is an overexposure of sex on TV and nudity in public, to complain that a woman is wearing too much clothing is utterly ridiculous, regulatory and antithetical to Sarkozy's phony image that he is a champion of women's rights.]

__________

Associated Press Writers Rod McGuirk in Sydney, Australia, Melissa Eddy in Berlin, Germany, Malin Rising in Stockholm, Sweden, Ian MacDougall in Oslo, Norway, and Toby Sterlin in Amsterdam, the Netherlands contributed to this report.

Great Myths of the Great Depression

2008-12-27T12:32:00.000-05:00

Posted By admin On December 21, 2008 @ 3:27 pm In Articles, Books, Featured, Library | No Comments

Introduction

Many volumes have been written about the Great Depression of 1929-1941 and its impact on the lives of millions of Americans. Historians, economists and politicians have all combed the wreckage searching for the “black box” that will reveal the cause of the calamity. Sadly, all too many of them decide to abandon their search, finding it easier perhaps to circulate a host of false and harmful conclusions about the events of seven decades ago. Consequently, many people today continue to accept critiques of free-market capitalism that are unjustified and support government policies that are economically destructive.

How bad was the Great Depression? Over the four years from 1929 to 1933, production at the nation’s factories, mines and utilities fell by more than half. People’s real disposable incomes dropped 28 percent. Stock prices collapsed to one-tenth of their pre-crash height. The number of unemployed Americans rose from 1.6 million in 1929 to 12.8 million in 1933. One of every four workers was out of a job at the Depression’s nadir, and ugly rumors of revolt simmered for the first time since the Civil War.

“The terror of the Great Crash has been the failure to explain it,” writes economist Alan Reynolds. “People were left with the feeling that massive economic contractions could occur at any moment, without warning, without cause. That fear has been exploited ever since as the major justification for virtually unlimited federal intervention in economic affairs.”[1]

Old myths never die; they just keep showing up in economics and political science textbooks. With only an occasional exception, it is there you will find what may be the 20th century’s greatest myth: Capitalism and the free-market economy were responsible for the Great Depression, and only government intervention brought about America’s economic recovery.

A Modern Fairy Tale

According to this simplistic perspective, an important pillar of capitalism, the stock market, crashed and dragged America into depression. President Herbert Hoover, an advocate of “hands-off,” or laissez-faire, economic policy, refused to use the power of government and conditions worsened as a result. It was up to Hoover’s successor, Franklin Delano Roosevelt, to ride in on the white horse of government intervention and steer the nation toward recovery. The apparent lesson to be drawn is that capitalism cannot be trusted; government needs to take an active role in the economy to save us from inevitable decline.

But those who propagate this version of history might just as well top off their remarks by saying, “And Goldilocks found her way out of the forest, Dorothy made it from Oz back to Kansas, and Little Red Riding Hood won the New York State Lottery.” The popular account of the Depression as outlined above belongs in a book of fairy tales and not in a serious discussion of economic history.

The Great, Great,Great,Great Depression

To properly understand the events of the time, it is factually appropriate to view the Great Depression as not one, but four consecutive downturns rolled into one. These four “phases” are:2

I. Monetary Policy and the Business Cycle

II. The Disintegration of the World Economy

III. The New Deal

IV. The Wagner Act

The first phase covers why the crash of 1929 happened in the first place; the other three show how government intervention worsened it and kept the economy in a stupor for over a decade. Let’s consider each one in turn.

Phase I: The Business Cycle

The Great Depression was not the country’s first depression, though it proved to be the longest. Several others preceded it.

A common thread woven through all of those earlier debacles was disastrous intervention by government, often in the form of political mismanagement of the money and credit supply. None of these depressions, however, lasted more than four years and most of them were over in two. The calamity that began in 1929 lasted at least three times longer than any of the country’s previous depressions because the government compounded its initial errors with a series of additional and harmful interventions.

Central Planners Fail at Monetary Policy

A popular explanation for the stock market collapse of 1929 concerns the practice of borrowing money to buy stock. Many history texts blithely assert that a frenzied speculation in shares was fed by excessive “margin lending.” But Marquette University economist Gene Smiley, in his 2002 book “Rethinking the Great Depression”, explains why this is not a fruitful observation:

There was already a long history of margin lending on stock exchanges, and margin requirements — the share of the purchase price paid in cash — were no lower in the late twenties than in the early twenties or in previous decades. In fact, in the fall of 1928 margin requirements began to rise, and borrowers were required to pay a larger share of the purchase price of the stocks.

The margin lending argument doesn’t hold much water. Mischief with the money and credit supply, however, is another story.

Most monetary economists, particularly those of the “Austrian School,” have observed the close relationship between money supply and economic activity. When government inflates the money and credit supply, interest rates at first fall. Businesses invest this “easy money” in new production projects and a boom takes place in capital goods. As the boom matures, business costs rise, interest rates readjust upward, and profits are squeezed. The easy-money effects thus wear off and the monetary authorities, fearing price inflation, slow the growth of, or even contract, the money supply. In either case, the manipulation is enough to knock out the shaky supports from underneath the economic house of cards.

One prominent interpretation of the Federal Reserve System’s actions prior to 1929 can be found in “America’s Great Depression” by economist Murray Rothbard. Using a broad measure that includes currency, demand and time deposits, and other ingredients, he estimated that the Fed bloated the money supply by more than 60 percent from mid-1921 to mid-1929.3 Rothbard argued that this expansion of money and credit drove interest rates down, pushed the stock market to dizzy heights, and gave birth to the “Roaring Twenties.”

Reckless money and credit growth constituted what economist Benjamin M. Anderson called “the beginning of the New Deal”4 — the name for the better-known but highly interventionist policies that would come later under President Franklin Roosevelt. However, other scholars raise doubts that Fed action was as inflationary as Rothbard believed, pointing to relatively flat commodity and consumer prices in the 1920s as evidence that monetary policy was not so wildly irresponsible.

Substantial cuts in high marginal income tax rates in the Coolidge years certainly helped the economy and may have ameliorated the price effect of Fed policy. Tax reductions spurred investment and real economic growth, which in turn yielded a burst of technological advancement and entrepreneurial discoveries of cheaper ways to produce goods. This explosion in productivity undoubtedly helped to keep prices lower than they would have otherwise been.

Regarding Fed policy, free-market economists who differ on the extent of the Fed’s monetary expansion of the early and mid-1920s are of one view about what happened next: The central bank presided over a dramatic contraction of the money supply that began late in the decade. The federal government’s responses to the resulting recession took a bad situation and made it far, far worse.

The Bottom Drops Out

By 1928, the Federal Reserve was raising interest rates and choking off the money supply. For example, its discount rate (the rate the Fed charges member banks for loans) was increased four times, from 3.5 percent to 6 percent, between January 1928 and August 1929. The central bank took further deflationary action by aggressively selling government securities for months after the stock market crashed. For the next three years, the money supply shrank by 30 percent. As prices then tumbled throughout the economy, the Fed’s higher interest rate policy boosted real (inflation-adjusted) rates dramatically.

The most comprehensive chronicle of the monetary policies of the period can be found in the classic work of Nobel Laureate Milton Friedman and his colleague Anna Schwartz,

“A Monetary History of the United States”, 1867-1960. Friedman and Schwartz argue conclusively that the contraction of the nation’s money supply by one-third between August 1929 and March 1933 was an enormous drag on the economy and largely the result of seismic incompetence by the Fed. The death in October 1928 of Benjamin Strong, a powerful figure who had exerted great influence as head of the Fed’s New York district bank, left the Fed floundering without capable leadership — making bad policy even worse.5

At first, only the “smart” money — the Bernard Baruchs and the Joseph Kennedys who watched things like money supply and other government policies — saw that the party was coming to an end. Baruch actually began selling stocks and buying bonds and gold as early as 1928; Kennedy did likewise, commenting, “only a fool holds out for the top dollar.”6

The masses of investors eventually sensed the change at the Fed and then the stampede began. In a special issue commemorating the 50th anniversary of the stock market collapse, U.S. News & World Report described it this way:

Actually the Great Crash was by no means a one-day affair, despite frequent references to Black Thursday, October 24, and the following week’s Black Tuesday. As early as September 5, stocks were weak in heavy trading, after having moved into new high ground two days earlier. Declines in early October were called a “desirable correction.” The Wall Street Journal, predicting an autumn rally, noted that “some stocks rise, some fall.”

Then, on October 3, stocks suffered their worst pummeling of the year. Margin calls went out; some traders grew apprehensive. But the next day, prices rose again and thereafter seesawed for a fortnight.

The real crunch began on Wednesday, October 23, with what one observer called “a Niagara of liquidation.” Six million shares changed hands. The industrial average fell 21 points. “Tomorrow, the turn will come,” brokers told one another. Prices, they said, had been carried to “unreasonably low” levels.

But the next day, Black Thursday, stocks were dumped in even heavier selling … the ticker fell behind more than 5 hours, and finally stopped grinding out quotations at 7:08 p.m.7

At their peak, stocks in the Dow Jones Industrial Average were selling for 19 times earnings — somewhat high, but hardly what stock market analysts regard as a sign of inordinate speculation. The distortions in the economy promoted by the Fed’s monetary policy had set the country up for a recession, but other impositions to come would soon turn the recession into a full-scale disaster. As stocks took a beating, Congress was playing with fire: On the very morning of Black Thursday, the nation’s newspapers reported that the political forces for higher trade-damaging tariffs were making gains on Capitol Hill.

The stock market crash was only a reflection — not the direct cause — of the destructive government policies that would ultimately produce the Great Depression: The market rose and fell in almost direct synchronization with what the Fed and Congress were doing. And what they did in the 1930s ranks way up there in the annals of history’s greatest follies.

Buddy, Can You Spare $20 Million?

Black Thursday shook Michigan harder than almost any other state. Stocks of auto and mining companies were hammered. Auto production in 1929 reached an all-time high of slightly more than 5 million vehicles, then quickly slumped by 2 million in 1930. By 1932, near the deepest point of the Depression, they had fallen by another 2 million to just 1,331,860 — down an astonishing 75 percent from the 1929 peak.

Thousands of investors everywhere, including many well-known people, were hit hard in the 1929 crash. Among them was Winston Churchill. He had invested heavily in American stocks before the crash. Afterward, only his writing skills and positions in government restored his finances.

Clarence Birdseye, an early developer of packaged frozen foods, had sold his business for $30 million and put all his money into stocks. He was wiped out.

William C. Durant, founder of General Motors, lost more than $40 million in the stock market and wound up a virtual pauper. (GM itself stayed in the black throughout the Depression under the cost-cutting leadership of Alfred P. Sloan.)

Phase II: Disintegration of the World Economy

Though modern myth claims that the free market “self-destructed” in 1929, government policy was the debacle’s principal culprit. If this crash had been like previous ones, the hard times would have ended in two or three years at the most, and likely sooner than that. But unprecedented political bungling instead prolonged the misery for over 10 years.

Unemployment in 1930 averaged a mildly recessionary 8.9 percent, up from 3.2 percent in 1929. It shot up rapidly until peaking out at more than 25 percent in 1933. Until March of 1933, these were the years of President Herbert Hoover — a man often depicted as a champion of noninterventionist, laissez-faire economics.

“The greatest spending administration in all of history”

Did Hoover really subscribe to a “hands-off-the-economy,” free-market philosophy? His opponent in the 1932 election, Franklin Roosevelt, didn’t think so. During the campaign, Roosevelt blasted Hoover for spending and taxing too much, boosting the national debt, choking off trade, and putting millions on the dole. He accused the president of “reckless and extravagant” spending, of thinking “that we ought to center control of everything in Washington as rapidly as possible,” and of presiding over “the greatest spending administration in peacetime in all of history.” Roosevelt’s running mate, John Nance Garner, charged that Hoover was “leading the country down the path of socialism.”8 Contrary to the conventional view about Hoover, Roosevelt and Garner were absolutely right.

The crowning folly of the Hoover administration was the Smoot-Hawley Tariff, passed in June 1930. It came on top of the Fordney-McCumber Tariff of 1922, which had already put American agriculture in a tailspin during the preceding decade. The most protectionist legislation in U.S. history, Smoot-Hawley virtually closed the borders to foreign goods and ignited a vicious international trade war. Professor Barry Poulson describes the scope of the act:

The act raised the rates on the entire range of dutiable commodities; for example, the average rate increased from 20 percent to 34 percent on agricultural products; from 36 percent to 47 percent on wines, spirits, and beverages; from 50 to 60 percent on wool and woolen manufactures. In all, 887 tariffs were sharply increased and the act broadened the list of dutiable commodities to 3,218 items. A crucial part of the Smoot-Hawley Tariff was that many tariffs were for a specific amount of money rather than a percentage of the price. As prices fell by half or more during the Great Depression, the effective rate of these specific tariffs doubled, increasing the protection afforded under the act.9

Smoot-Hawley was as broad as it was deep, affecting a multitude of products. Before its passage, clocks had faced a tariff of 45 percent; the act raised that to 55 percent, plus as much as another $4.50 per clock. Tariffs on corn and butter were roughly doubled. Even sauerkraut was tariffed for the first time. Among the few remaining tariff-free goods, strangely enough, were leeches and skeletons (perhaps as a political sop to the American Medical Association, as one wag wryly remarked).

Tariffs on linseed oil, tungsten, and casein hammered the U.S. paint, steel and paper industries, respectively. More than 800 items used in automobile production were taxed by Smoot-Hawley. Most of the 60,000 people employed in U.S. plants making cheap clothing out of imported wool rags went home jobless after the tariff on wool rags rose by 140 percent.10

Officials in the administration and in Congress believed that raising trade barriers would force Americans to buy more goods made at home, which would solve the nagging unemployment problem. But they ignored an important principle of international commerce: Trade is ultimately a two-way street; if foreigners cannot sell their goods here, then they cannot earn the dollars they need to buy here. Or, to put it another way, government cannot shut off imports without simultaneously shutting off exports.

You Tax Me, I Tax You

Foreign companies and their workers were flattened by Smoot-Hawley’s steep tariff rates and foreign governments soon retaliated with trade barriers of their own. With their ability to sell in the American market severely hampered, they curtailed their purchases of American goods. American agriculture was particularly hard hit. With a stroke of the presidential pen, farmers in this country lost nearly a third of their markets. Farm prices plummeted and tens of thousands of farmers went bankrupt. A bushel of wheat that sold for $1 in 1929 was selling for a mere 30 cents by 1932.

With the collapse of agriculture, rural banks failed in record numbers, dragging down hundreds of thousands of their customers. Nine thousand banks closed their doors in the United States between 1930 and 1933. The stock market, which had regained much of the ground it had lost since the previous October, tumbled 20 points on the day Hoover signed Smoot-Hawley into law, and fell almost without respite for the next two years. (The market’s high, as measured by the Dow Jones Industrial Average, was set on Sept. 3, 1929, at 381. It hit its 1929 low of 198 on Nov. 13, then rebounded to 294 by April 1930. It declined again as the tariff bill made its way toward Hoover’s desk in June and did not bottom out until it reached a mere 41 two years later. It would be a quarter-century before the Dow would climb to 381 again.)

The shrinkage in world trade brought on by the tariff wars helped set the stage for World War?II a few years later. In 1929, the rest of the world owed American citizens $30 billion. Germany’s Weimar Republic was struggling to pay the enormous reparations bill imposed by the disastrous Treaty of Versailles. When tariffs made it nearly impossible for foreign businessmen to sell their goods in American markets, the burden of their debts became massively heavier and emboldened demagogues like Adolf Hitler. “When goods don’t cross frontiers, armies will,” warns an old but painfully true maxim.

Free Markets or Free Lunches?

Smoot-Hawley by itself should lay to rest the myth that Hoover was a free market practitioner, but there is even more to the story of his administration’s interventionist mistakes. Within a month of the stock market crash, he convened conferences of business leaders for the purpose of jawboning them into keeping wages artificially high even though both profits and prices were falling. Consumer prices plunged almost 25 percent between 1929 and 1933 while nominal wages on average decreased only 15 percent — translating into a substantial increase in wages in real terms, a major component of the cost of doing business. As economist Richard Ebeling notes, “The ‘high-wage’ policy of the Hoover administration and the trade unions … succeeded only in pricing workers out of the labor market, generating an increasing circle of unemployment.”11

Hoover dramatically increased government spending for subsidy and relief schemes. In the space of one year alone, from 1930 to 1931, the federal government’s share of GNP soared from 16.4 percent to 21.5 percent.12 Hoover’s agricultural bureaucracy doled out hundreds of millions of dollars to wheat and cotton farmers even as the new tariffs wiped out their markets. His Reconstruction Finance Corporation ladled out billions more in business subsidies. Commenting decades later on Hoover’s administration, Rexford Guy Tugwell, one of the architects of Franklin Roosevelt’s policies of the 1930s, explained, “We didn’t admit it at the time, but practically the whole New Deal was extrapolated from programs that Hoover started.”13

Though Hoover at first did lower taxes for the poorest of Americans, Larry Schweikart and Michael Allen in their sweeping “A Patriot’s History of the United States: From Columbus’s Great Discovery to the War on Terror” stress that he “offered no incentives to the wealthy to invest in new plants to stimulate hiring.” He even taxed bank checks, “which accelerated the decline in the availability of money by penalizing people for writing checks.”14

In September 1931, with the money supply tumbling and the economy reeling from the impact of Smoot-Hawley, the Fed imposed the biggest hike in its discount rate in history. Bank deposits fell 15 percent within four months and sizable, deflationary declines in the nation’s money supply persisted through the first half of 1932.

Compounding the error of high tariffs, huge subsidies and deflationary monetary policy, Congress then passed and Hoover signed the Revenue Act of 1932. The largest tax increase in peacetime history, it doubled the income tax. The top bracket actually more than doubled, soaring from 24 percent to 63 percent. Exemptions were lowered; the earned income credit was abolished; corporate and estate taxes were raised; new gift, gasoline and auto taxes were imposed; and postal rates were sharply hiked.

Can any serious scholar observe the Hoover administration’s massive economic intervention and, with a straight face, pronounce the inevitably deleterious effects as the fault of free markets? Schweikart and Allen survey some of the wreckage:

By 1933, the numbers produced by this comedy of errors were staggering: national unemployment rates reached 25 percent, but within some individual cities, the statistics seemed beyond comprehension. Cleveland reported that 50 percent of its labor force was unemployed; Toledo, 80 percent; and some states even averaged over 40 percent. Because of the dual-edged sword of declining revenues and increasing welfare demands, the burden on the cities pushed many municipalities to the brink. Schools in New York shut down, and teachers in Chicago were owed some $20 million. Private schools, in many cases, failed completely. One government study found that by 1933 some fifteen hundred colleges had gone belly-up, and book sales plummeted. Chicago’s library system did not purchase a single book in a year-long period.15

Phase III: The New Deal

Franklin Delano Roosevelt won the 1932 presidential election in a landslide, collecting 472 electoral votes to just 59 for the incumbent Herbert Hoover. The platform of the Democratic Party, whose ticket Roosevelt headed, declared, “We believe that a party platform is a covenant with the people to be faithfully kept by the party entrusted with power.” It called for a 25 percent reduction in federal spending, a balanced federal budget, a sound gold currency “to be preserved at all hazards,” the removal of government from areas that belonged more appropriately to private enterprise and an end to the “extravagance” of Hoover’s farm programs. This is what candidate Roosevelt promised, but it bears no resemblance to what President Roosevelt actually delivered.

Washington was rife with both fear and optimism as Roosevelt was sworn in on March 4, 1933 — fear that the economy might not recover and optimism that the new and assertive president just might make a difference. Humorist Will Rogers captured the popular feeling toward FDR as he assembled the new administration: “The whole country is with him, just so he does something. If he burned down the Capitol, we would all cheer and say, well, we at least got a fire started anyhow.”16

“Nothing to fear but fear itself”

Roosevelt did indeed make a difference, though probably not the sort of difference for which the country had hoped. He started off on the wrong foot when, in his inaugural address, he blamed the Depression on “unscrupulous money changers.” He said nothing about the role of the Fed’s mismanagement and little about the follies of Congress that had contributed to the problem. As a result of his efforts, the economy would linger in depression for the rest of the decade. Adapting a phrase from 19th century writer Henry David Thoreau, Roosevelt famously declared in his address that, “We have nothing to fear but fear itself.” But as Dr. Hans Sennholz of Grove City College explains, it was FDR’s policies to come that Americans had genuine reason to fear:

In his first 100 days, he swung hard at the profit order. Instead of clearing away the prosperity barriers erected by his predecessor, he built new ones of his own. He struck in every known way at the integrity of the U.S. dollar through quantitative increases and qualitative deterioration. He seized the people’s gold holdings and subsequently devalued the dollar by 40 percent.17

Frustrated and angered that Roosevelt had so quickly and thoroughly abandoned the platform on which he was elected, Director of the Bureau of the Budget Lewis W. Douglas resigned after only one year on the job. At Harvard University in May 1935, Douglas made it plain that America was facing a momentous choice:

Will we choose to subject ourselves — this great country — to the despotism of bureaucracy, controlling our every act, destroying what equality we have attained, reducing us eventually to the condition of impoverished slaves of the state? Or will we cling to the liberties for which man has struggled for more than a thousand years? It is important to understand the magnitude of the issue before us. … If we do not elect to have a tyrannical, oppressive bureaucracy controlling our lives, destroying progress, depressing the standard of living … then should it not be the function of the Federal government under a democracy to limit its activities to those which a democracy may adequately deal, such for example as national defense, maintaining law and order, protecting life and property, preventing dishonesty, and … guarding the public against … vested special interests?18

New Dealing from the Bottom of the Deck

Crisis gripped the banking system when the new president assumed office on March 4, 1933. Roosevelt’s action to close the banks and declare a nationwide “banking holiday” on March 6 (which did not completely end until nine days later) is still hailed as a decisive and necessary action by Roosevelt apologists. Friedman and Schwartz, however, make it plain that this supposed cure was “worse than the disease.” The Smoot-Hawley tariff and the Fed’s unconscionable monetary mischief were primary culprits in producing the conditions that gave Roosevelt his excuse to temporarily deprive depositors of their money, and the bank holiday did nothing to alter those fundamentals. “More than 5,000 banks still in operation when the holiday was declared did not reopen their doors when it ended, and of these, over 2,000 never did thereafter,” report Friedman and Schwartz.19

Economist Jim Powell of the Cato Institute authored a splendid book on the Great Depression in 2003, titled “FDR’s Folly: How Roosevelt and His New Deal Prolonged the Great Depression”. He points out that “Almost all the failed banks were in states with unit banking laws” — laws that prohibited banks from opening branches and thereby diversifying their portfolios and reducing their risks. Powell writes: “Although the United States, with its unit banking laws, had thousands of bank failures, Canada, which permitted branch banking, didn’t have a single failure …”20 Strangely, critics of capitalism who love to blame the market for the Depression never mention that fact.

Congress gave the president the power first to seize the private gold holdings of American citizens and then to fix the price of gold. One morning, as Roosevelt ate eggs in bed, he and Secretary of the Treasury Henry Morgenthau decided to change the ratio between gold and paper dollars. After weighing his options, Roosevelt settled on a 21 cent price hike because “it’s a lucky number.” In his diary, Morgenthau wrote, “If anybody ever knew how we really set the gold price through a combination of lucky numbers, I think they would be frightened.”21 Roosevelt also single-handedly torpedoed the London Economic Conference in 1933, which was convened at the request of other major nations to bring down tariff rates and restore the gold standard.

Washington and its reckless central bank had already made mincemeat of the gold standard by the early 1930s. Roosevelt’s rejection of it removed most of the remaining impediments to limitless currency and credit expansion, for which the nation would pay a high price in later years in the form of a depreciating currency. Sen. Carter Glass put it well when he warned Roosevelt in early 1933: “It’s dishonor, sir. This great government, strong in gold, is breaking its promises to pay gold to widows and orphans to whom it has sold government bonds with a pledge to pay gold coin of the present standard of value. It is breaking its promise to redeem its paper money in gold coin of the present standard of value. It’s dishonor, sir.”22

Though he seized the country’s gold, Roosevelt did return booze to America’s bars and parlor rooms. On his second Sunday in the White House, he remarked at dinner, “I think this would be a good time for beer.”23 That same night, he drafted a message asking Congress to end Prohibition. The House approved a repeal measure on Tuesday, the Senate passed it on Thursday and before the year was out, enough states had ratified it so that the 21st Amendment became part of the Constitution. One observer, commenting on this remarkable turn of events, noted that of two men walking down the street at the start of 1933 — one with a gold coin in his pocket and the other with a bottle of whiskey in his coat — the man with the coin would be an upstanding citizen and the man with the whiskey would be the outlaw. A year later, precisely the reverse was true.

In the first year of the New Deal, Roosevelt proposed spending $10 billion while revenues were only $3 billion. Between 1933 and 1936, government expenditures rose by more than 83 percent. Federal debt skyrocketed by 73 percent.

FDR talked Congress into creating Social Security in 1935 and imposing the nation’s first comprehensive minimum wage law in 1938. While to this day he gets a great deal of credit for these two measures from the general public, many economists have a different perspective. The minimum wage law prices many of the inexperienced, the young, the unskilled and the disadvantaged out of the labor market. (For example, the minimum wage provisions passed as part of another act in 1933 threw an estimated 500,000 blacks out of work).24 And current studies and estimates reveal that Social Security has become such a long-term actuarial nightmare that it will either have to be privatized or the already high taxes needed to keep it afloat will have to be raised to the stratosphere.

Roosevelt secured passage of the Agricultural Adjustment Act, which levied a new tax on agricultural processors and used the revenue to supervise the wholesale destruction of valuable crops and cattle. Federal agents oversaw the ugly spectacle of perfectly good fields of cotton, wheat and corn being plowed under (the mules had to be convinced to trample the crops; they had been trained, of course, to walk between the rows). Healthy cattle, sheep and pigs were slaughtered and buried in mass graves. Secretary of Agriculture Henry Wallace personally gave the order to slaughter 6 million baby pigs before they grew to full size. The administration also paid farmers for the first time for not working at all. Even if the AAA had helped farmers by curtailing supplies and raising prices, it could have done so only by hurting millions of others who had to pay those prices or make do with less to eat.

Blue Eagles, Red Ducks

Perhaps the most radical aspect of the New Deal was the National Industrial Recovery Act, passed in June 1933, which created a massive new bureaucracy called the National Recovery Administration. Under the NRA, most manufacturing industries were suddenly forced into government-mandated cartels. Codes that regulated prices and terms of sale briefly transformed much of the American economy into a fascist-style arrangement, while the NRA was financed by new taxes on the very industries it controlled. Some economists have estimated that the NRA boosted the cost of doing business by an average of 40 percent — not something a depressed economy needed for recovery.

The economic impact of the NRA was immediate and powerful. In the five months leading up to the act’s passage, signs of recovery were evident: factory employment and payrolls had increased by 23 and 35 percent, respectively. Then came the NRA, shortening hours of work, raising wages arbitrarily and imposing other new costs on enterprise. In the six months after the law took effect, industrial production dropped 25 percent. Benjamin M. Anderson writes, “NRA was not a revival measure. It was an antirevival measure. … Through the whole of the NRA period industrial production did not rise as high as it had been in July 1933, before NRA came in.”25

The man Roosevelt picked to direct the NRA effort was General Hugh “Iron Pants” Johnson, a profane, red-faced bully and professed admirer of Italian dictator Benito Mussolini. Thundered Johnson, “May Almighty God have mercy on anyone who attempts to interfere with the Blue Eagle” (the official symbol of the NRA, which one senator derisively referred to as the “Soviet duck”). Those who refused to comply with the NRA Johnson personally threatened with public boycotts and “a punch in the nose.”

There were ultimately more than 500 NRA codes, “ranging from the production of lightning rods to the manufacture of corsets and brassieres, covering more than 2 million employers and 22 million workers.”26 There were codes for the production of hair tonic, dog leashes, and even musical comedies. A New Jersey tailor named Jack Magid was arrested and sent to jail for the “crime” of pressing a suit of clothes for 35 cents rather than the NRA-inspired “Tailor’s Code” of 40 cents.

In “The Roosevelt Myth”, historian John T. Flynn described how the NRA’s partisans sometimes conducted “business”:

The NRA was discovering it could not enforce its rules. Black markets grew up. Only the most violent police methods could procure enforcement. In Sidney Hillman’s garment industry the code authority employed enforcement police. They roamed through the garment district like storm troopers. They could enter a man’s factory, send him out, line up his employees, subject them to minute interrogation, take over his books on the instant. Night work was forbidden. Flying squadrons of these private coat-and-suit police went through the district at night, battering down doors with axes looking for men who were committing the crime of sewing together a pair of pants at night. But without these harsh methods many code authorities said there could be no compliance because the public was not back of it.27

The Alphabet Commissars

Roosevelt next signed into law steep income tax increases on the higher brackets and introduced a 5 percent withholding tax on corporate dividends. He secured another tax increase in 1934. In fact, tax hikes became a favorite policy of Roosevelt for the next 10 years, culminating in a top income tax rate of 90 percent. Sen. Arthur Vandenberg of Michigan, who opposed much of the New Deal, lambasted Roosevelt’s massive tax increases. A sound economy would not be restored, he said, by following the socialist notion that America could “lift the lower one-third up” by pulling “the upper two-thirds down.”28 Vandenberg also condemned “the congressional surrender to alphabet commissars who deeply believe the American people need to be regimented by powerful overlords in order to be saved.”29

Alphabet commissars spent the public’s money like it was so much bilge. They were what influential journalist and social critic Albert Jay Nock had in mind when he described the New Deal as “a nation-wide, State-managed mobilization of inane buffoonery and aimless commotion.”30

Roosevelt’s Civil Works Administration hired actors to give free shows and librarians to catalog archives. It even paid researchers to study the history of the safety pin, hired 100 Washington workers to patrol the streets with balloons to frighten starlings away from public buildings, and put men on the public payroll to chase tumbleweeds on windy days.

The CWA, when it was started in the fall of 1933, was supposed to be a short-lived jobs program. Roosevelt assured Congress in his State of the Union message that any new such program would be abolished within a year. “The federal government,” said the president, “must and shall quit this business of relief. I am not willing that the vitality of our people be further stopped by the giving of cash, of market baskets, of a few bits of weekly work cutting grass, raking leaves, or picking up papers in the public parks.” Harry Hopkins was put in charge of the agency and later said, “I’ve got four million at work but for God’s sake, don’t ask me what they are doing.” The CWA came to an end within a few months but was replaced with another temporary relief program that evolved into the Works Progress Administration, or WPA, by 1935. It is known today as the very government program that gave rise to the new term, “boondoggle,” because it “produced” a lot more than the 77,000 bridges and 116,000 buildings to which its advocates loved to point as evidence of its efficacy.31

With good reason, critics often referred to the WPA as “We Piddle Around.” In Kentucky, WPA workers catalogued 350 different ways to cook spinach. The agency employed 6,000 “actors” though the nation’s actors’ union claimed only 4,500 members. Hundreds of WPA workers were used to collect campaign contributions for Democratic Party candidates. In Tennessee, WPA workers were fired if they refused to donate 2 percent of their wages to the incumbent governor. By 1941, only 59 percent of the WPA budget went to paying workers anything at all; the rest was sucked up in administration and overhead. The editors of The New Republic asked, “Has [Roosevelt] the moral stature to admit now that the WPA was a hasty and grandiose political gesture, that it is a wretched failure and should be abolished?”32 The last of the WPA’s projects was not eliminated until July of 1943.

Roosevelt has been lauded for his “job-creating” acts such as the CWA and the WPA. Many people think that they helped relieve the Depression. What they fail to realize is that it was the rest of Roosevelt’s tinkering that prolonged the Depression and which largely prevented the jobless from finding real jobs in the first place. The stupefying roster of wasteful spending generated by these jobs programs represented a diversion of valuable resources to politically motivated and economically counterproductive purposes.

A brief analogy will illustrate this point. If a thief goes house to house robbing everybody in the neighborhood, then heads off to a nearby shopping mall to spend his ill-gotten loot, it is not assumed that because his spending “stimulated” the stores at the mall he has thereby performed a national service or provided a general economic benefit. Likewise, when the government hires someone to catalog the many ways of cooking spinach, his tax-supported paycheck cannot be counted as a net increase to the economy because the wealth used to pay him was simply diverted, not created. Economists today must still battle this “magical thinking” every time more government spending is proposed — as if money comes not from productive citizens, but rather from the tooth fairy.

“An astonishing rabble of impudent nobodies”

Roosevelt’s haphazard economic interventions garnered credit from people who put high value on the appearance of being in charge and “doing something.” Meanwhile, the great majority of Americans were patient. They wanted very much to give this charismatic polio victim and former New York governor the benefit of the doubt. But Roosevelt always had his critics, and they would grow more numerous as the years groaned on. One of them was the inimitable “Sage of Baltimore,” H. L. Mencken, who rhetorically threw everything but the kitchen sink at the president. Paul Johnson sums up Mencken’s stinging but often-humorous barbs this way:

Mencken excelled himself in attacking the triumphant FDR, whose whiff of fraudulent collectivism filled him with genuine disgust. He was the ‘Fuhrer,’ the ‘Quack,’ surrounded by ‘an astonishing rabble of impudent nobodies,’ ‘a gang of half-educated pedagogues, nonconstitutional lawyers, starry-eyed uplifters and other such sorry wizards.’ His New Deal was a ‘political racket,’ a ‘series of stupendous bogus miracles,’ with its ‘constant appeals to class envy and hatred,’ treating government as ‘a milch-cow with 125 million teats’ and marked by ‘frequent repudiations of categorical pledges.’33

Signs of Life

The American economy was soon relieved of the burden of some of the New Deal’s worst excesses when the Supreme Court outlawed the NRA in 1935 and the AAA in 1936, earning Roosevelt’s eternal wrath and derision. Recognizing much of what Roosevelt did as unconstitutional, the “nine old men” of the Court also threw out other, more minor acts and programs which hindered recovery.

Freed from the worst of the New Deal, the economy showed some signs of life. Unemployment dropped to 18 percent in 1935, 14 percent in 1936, and even lower in 1937. But by 1938, it was back up to nearly 20 percent as the economy slumped again. The stock market crashed nearly 50 percent between August 1937 and March 1938. The “economic stimulus” of Franklin Delano Roosevelt’s New Deal had achieved a real “first”: a depression within a depression!

Phase IV:

The Wagner Act

The stage was set for the 1937-38 collapse with the passage of the National Labor Relations Act in 1935 — better known as the “Wagner Act” and organized labor’s “Magna Carta.” To quote Sennholz again:

This law revolutionized American labor relations. It took labor disputes out of the courts of law and brought them under a newly created Federal agency, the National Labor Relations Board, which became prosecutor, judge, and jury, all in one. Labor union sympathizers on the Board further perverted this law, which already afforded legal immunities and privileges to labor unions. The U.S. thereby abandoned a great achievement of Western civilization, equality under the law.

The Wagner Act, or National Labor Relations Act, was passed in reaction to the Supreme Court’s voidance of NRA and its labor codes. It aimed at crushing all employer resistance to labor unions. Anything an employer might do in self-defense became an “unfair labor practice” punishable by the Board. The law not only obliged employers to deal and bargain with the unions designated as the employees’ representative; later Board decisions also made it unlawful to resist the demands of labor union leaders.34

Armed with these sweeping new powers, labor unions went on a militant organizing frenzy. Threats, boycotts, strikes, seizures of plants and widespread violence pushed productivity down sharply and unemployment up dramatically. Membership in the nation’s labor unions soared: By 1941, there were two and a half times as many Americans in unions as had been the case in 1935. Historian William E. Leuchtenburg, himself no friend of free enterprise, observed, “Property-minded citizens were scared by the seizure of factories, incensed when strikers interfered with the mails, vexed by the intimidation of nonunionists, and alarmed by flying squadrons of workers who marched, or threatened to march, from city to city.”35

An Unfriendly Climate for Business

From the White House on the heels of the Wagner Act came a thunderous barrage of insults against business. Businessmen, Roosevelt fumed, were obstacles on the road to recovery. He blasted them as “economic royalists” and said that businessmen as a class were “stupid.”36 He followed up the insults with a rash of new punitive measures. New strictures on the stock market were imposed. A tax on corporate retained earnings, called the “undistributed profits tax,” was levied. “These soak-the-rich efforts,” writes economist Robert Higgs, “left little doubt that the president and his administration intended to push through Congress everything they could to extract wealth from the high-income earners responsible for making the bulk of the nation’s decisions about private investment.”37

During a period of barely two months during late 1937, the market for steel — a key economic barometer — plummeted from 83 percent of capacity to 35 percent. When that news emblazoned headlines, Roosevelt took an ill-timed nine-day fishing trip. The New York Herald-Tribune implored him to get back to work to stem the tide of the renewed Depression. What was needed, said the newspaper’s editors, was a reversal of the Roosevelt policy “of bitterness and hate, of setting class against class and punishing all who disagreed with him.”38

Columnist Walter Lippmann wrote in March 1938 that “with almost no important exception every measure he [Roosevelt] has been interested in for the past five months has been to reduce or discourage the production of wealth.”39

As pointed out earlier in this essay, Herbert Hoover’s own version of a “New Deal” had hiked the top marginal income tax rate from 24 to 63 percent in 1932. But he was a piker compared to his tax-happy successor. Under Roosevelt, the top rate was raised at first to 79 percent and then later to 90 percent. Economic historian Burton Folsom notes that in 1941 Roosevelt even proposed a whopping 99.5-percent marginal rate on all incomes over $100,000. “Why not?” he said when an advisor questioned the idea.40

After that confiscatory proposal failed, Roosevelt issued an executive order to tax all income over $25,000 at the astonishing rate of 100 percent. He also promoted the lowering of the personal exemption to only $600, a tactic that pushed most American families into paying at least some income tax for the first time. Shortly thereafter, Congress rescinded the executive order, but went along with the reduction of the personal exemption.41

Meanwhile, the Federal Reserve again seesawed its monetary policy in the mid-1930s, first up then down, then up sharply through America’s entry into World War II. Contributing to the economic slide of 1937 was this fact: From the summer of 1936 to the spring of 1937, the Fed doubled reserve requirements on the nation’s banks. Experience has shown time and again that a roller-coaster monetary policy is enough by itself to produce a roller-coaster economy.

Still stinging from his earlier Supreme Court defeats, Roosevelt tried in 1937 to “pack” the Supreme Court with a proposal to allow the president to appoint an additional justice to the Court for every sitting justice who had reached the age of 70 and did not retire. Had this proposal passed, Roosevelt could have appointed six new justices favorable to his views, increasing the members of the Court from 9 to 15. His plan failed in Congress, but the Court later began rubber-stamping his policies after a number of opposing justices retired. Until Congress killed the packing scheme, however, business fears that a Court sympathetic to Roosevelt’s goals would endorse more of the old New Deal prevented investment and confidence from reviving.

Economic historian Robert Higgs draws a close connection between the level of private investment and the course of the American economy in the 1930s. The relentless assaults of the Roosevelt administration — in both word and deed — against business, property, and free enterprise guaranteed that the capital needed to jump-start the economy was either taxed away or forced into hiding. When FDR took America to war in 1941, he eased up on his anti-business agenda, but a great deal of the nation’s capital was diverted into the war effort instead of into plant expansion or consumer goods. Not until both Roosevelt and the war were gone did investors feel confident enough to “set in motion the postwar investment boom that powered the economy’s return to sustained prosperity.”42

This view gains support in these comments from one of the country’s leading investors of the time, Lammot du Pont, offered in 1937:

Uncertainty rules the tax situation, the labor situation, the monetary situation, and practically every legal condition under which industry must operate. Are taxes to go higher, lower or stay where they are? We don’t know. Is labor to be union or non-union? . . . Are we to have inflation or deflation, more government spending or less? … Are new restrictions to be placed on capital, new limits on profits? … It is impossible to even guess at the answers.”43

Many modern historians tend to be reflexively anti-capitalist and distrustful of free markets; they find Roosevelt’s exercise of power, constitutional or not, to be impressive and historically “interesting.” In surveys, a majority consistently rank FDR near the top of the list for presidential greatness, so it is likely they would disdain the notion that the New Deal was responsible for prolonging the Great Depression. But when a nationally representative poll by the American Institute of Public Opinion in the spring of 1939 asked, “Do you think the attitude of the Roosevelt administration toward business is delaying business recovery?” the American people responded “yes” by a margin of more than 2-to-1. The business community felt even more strongly so.44

In his private diary, FDR’s very own Treasury Secretary, Henry Morgenthau, seemed to agree. He wrote: “We have tried spending money. We are spending more than we have ever spent before and it does not work. … We have never made good on our promises. … I say after eight years of this Administration we have just as much unemployment as when we started … and an enormous debt to boot!”45

At the end of the decade and 12 years after the stock market crash of Black Thursday, 10 million Americans were jobless. The unemployment rate was in excess of 17 percent. Roosevelt had pledged in 1932 to end the crisis, but it persisted two presidential terms and countless interventions later.

Whither Free Enterprise?

How was it that FDR was elected four times if his policies were deepening and prolonging an economic catastrophe? Ignorance and a willingness to give the president the benefit of the doubt explain a lot. Roosevelt beat Hoover in 1932 with promises of less government. He instead gave Americans more government, but he did so with fanfare and fireside chats that mesmerized a desperate people. By the time they began to realize that his policies were harmful, World War II came, the people rallied around their commander-in-chief, and there was little desire to change the proverbial horse in the middle of the stream by electing someone new.

Along with the holocaust of World War II came a revival of trade with America’s allies. The war’s destruction of people and resources did not help the U.S. economy, but this renewed trade did. A reinflation of the nation’s money supply counteracted the high costs of the New Deal, but brought with it a problem that plagues us to this day: a dollar that buys less and less in goods and services year after year. Most importantly, the Truman administration that followed Roosevelt was decidedly less eager to berate and bludgeon private investors and as a result, those investors re-entered the economy and fueled a powerful postwar boom. The Great Depression finally ended, but it should linger in our minds today as one of the most colossal and tragic failures of government and public policy in American history.

The genesis of the Great Depression lay in the irresponsible monetary and fiscal policies of the U.S. government in the late 1920s and early 1930s. These policies included a litany of political missteps: central bank mismanagement, trade-crushing tariffs, incentive-sapping taxes, mind-numbing controls on production and competition, senseless destruction of crops and cattle and coercive labor laws, to recount just a few. It was not the free market that produced 12 years of agony; rather, it was political bungling on a grand scale.

Those who can survey the events of the 1920s and 1930s and blame free-market capitalism for the economic calamity have their eyes, ears and minds firmly closed to the facts. Changing the wrong-headed thinking that constitutes much of today’s conventional wisdom about this sordid historical episode is vital to reviving faith in free markets and preserving our liberties.

The nation managed to survive both Hoover’s activism and Roosevelt’s New Deal quackery, and now the American heritage of freedom awaits a rediscovery by a new generation of citizens. This time we have nothing to fear but myths and misconceptions.

- END -

Postscript:

Have We Learned Our Lessons?

Eighty years after the Great Depression began, the literature on this painful episode of American history is undergoing an encouraging metamorphosis. The conventional assessment that so dominated historical writings for decades argued that free markets caused the debacle and that FDR’s New Deal saved the country. Surely, there are plenty of poorly-informed partisans, ideologues and quacks that still make these superficial claims. Serious historians and economists, however, have been busy chipping away at the falsehoods. The essay you have just read cites many recent works worth careful reading in their entirety.

At the very moment this latest edition of “Great Myths of the Great Depression” was about to go to press, Simon & Schuster published a splendid new volume I strongly recommend. Authored by the Foundation for Economic Education’s senior historian and Hillsdale College professor, Dr. Burton W. Folsom, the book is provocatively titled “New Deal or Raw Deal? — How FDR’s Economic Legacy Has Damaged America.” It’s one of the most illuminating works on the subject. It will help mightily to correct the record and educate our fellow citizens about what really happened in the 1930s.

Another great addition to the literature, appearing in 2007, is “The Forgotten Man: A New History of the Great Depression” by Amity Shlaes. The fact that it has been a New York Times bestseller suggests there is a real hunger for the truth about this period of history.

While Americans may be unlearning some of what they thought they knew about the Great Depression, that’s not the same as saying we have learned the important lessons well enough to avoid making the same mistakes again. Indeed, today we are no closer to fixing the primary cause of the business cycle — monetary mischief — than we were 80 years ago.

The financial crisis that gripped America in 2008 ought to be a wake-up call. The fingerprints of government meddling are all over it. From 2001 to 2005, the Federal Reserve revved up the money supply, expanding it at a feverish double-digit rate. The dollar plunged in overseas markets and commodity prices soared. With the banks flush with liquidity from the Fed, interest rates plummeted and risky loans to borrowers of dubious merit ballooned. Politicians threw more fuel on the fire by jawboning banks to lend hundreds of billions of dollars for subprime mortgages.

When the bubble burst, some of the very culprits who promoted the policies that caused it postured as our rescuers while endorsing new interventions, bigger government, more inflation of money and credit and massive taxpayer bailouts of failing firms. Many of them are also calling for higher taxes and tariffs, the very nonsense that took a recession in 1930 and made it a long and deep depression.

The taxpayer bailouts of agencies such as Fannie Mae and Freddie Mac, as well as a growing number of private firms in the early fall of 2008, represent more folly with a monumental price tag. Not only will we and future generations be paying those bills for decades, the very process of throwing good money after bad will pile moral hazard on top of moral hazard, fostering more bad decisions and future bailouts. This is the stuff that undermines both free enterprise and the soundness of the currency. Much more inflation to pay these bills is more than a little likely, sooner or later.

“Government,” observed the renowned Austrian economist Ludwig von Mises, “is the only institution that can take a valuable commodity like paper, and make it worthless by applying ink.” Mises was describing the curse of inflation, the process whereby government expands a nation’s money supply and thereby erodes the value of each monetary unit — dollar, peso, pound, franc or whatever. It often shows up in the form of rising prices, which most people confuse with the inflation itself. The distinction is an important one because, as economist Percy Greaves explained so eloquently, “Changing the definition changes the responsibility.”

Define inflation as rising prices and, like the clueless Jimmy Carter of the 1970s, you’ll think that oil sheiks, credit cards and private businesses are the culprits, and price controls are the answer. Define inflation in the classic fashion as an increase in the supply of money and credit, with rising prices as a consequence, and you then have to ask the revealing question, “Who increases the money supply?” Only one entity can do that legally; all others are called “counterfeiters” and go to jail.

Nobel laureate Milton Friedman argued indisputably that inflation is always and everywhere a monetary matter. Rising prices no more cause inflation than wet streets cause rain.

Before paper money, governments inflated by diminishing the precious-metal content of their coinage. The ancient prophet Isaiah reprimanded the Israelites with these words: “Thy silver has become dross, thy wine mixed with water.” Roman emperors repeatedly melted down the silver denarius and added junk metals until the denarius was less than one percent silver. The Saracens of Spain clipped the edges of their coins so they could mint more until the coins became too small to circulate. Prices rose as a mirror image of the currency’s worth.

Rising prices are not the only consequence of monetary and credit expansion. Inflation also erodes savings and encourages debt. It undermines confidence and deters investment. It destabilizes the economy by fostering booms and busts. If it’s bad enough, it can even wipe out the very government responsible for it in the first place and then lead to even worse afflictions. Hitler and Napoleon both rose to power in part because of the chaos of runaway inflations.

All this raises many issues economists have long debated: Who or what should determine a nation’s supply of money? Why do governments so regularly mismanage it? What is the connection between fiscal and monetary policy? Suffice it to say here that governments inflate because their appetite for revenue exceeds their willingness to tax or their ability to borrow. British economist John Maynard Keynes was an influential charlatan in many ways, but he nailed it when he wrote, “By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens.”

So, you say, inflation is nasty business but it’s just an isolated phenomenon with the worst cases confined to obscure nooks and crannies like Zimbabwe. Not so. The late Frederick Leith-Ross, a famous authority on international finance, observed: “Inflation is like sin; every government denounces it and every government practices it.” Even Americans have witnessed hyperinflations that destroyed two currencies — the ill-fated continental dollar of the Revolutionary War and the doomed Confederate money of the Civil War.

Today’s slow-motion dollar depreciation, with consumer prices rising at persistent but mere single-digit rates, is just a limited version of the same process. Government spends, runs deficits and pays some of its bills through the inflation tax. How long it can go on is a matter of speculation, but trillions in national debt and politicians who make misers of drunken sailors and get elected by promising even more are not factors that should encourage us.

Inflation is very much with us but it must end someday. A currency’s value is not bottomless. Its erosion must cease either because government stops its reckless printing or prints until it wrecks the money. But surely, which way it concludes will depend in large measure on whether its victims come to understand what it is and where it comes from. Meanwhile, our economy looks like a roller coaster because Congresses, Presidents and the agencies they’ve empowered never cease their monetary mischief.

Are you tired of politicians blaming each other, scrambling to cover their behinds and score political points in the midst of a crisis, and piling debts upon debts they audaciously label “stimulus packages”? Why do so many Americans want to trust them with their health care, education, retirement and a host of other aspects of their lives? It’s madness writ large. The antidote is the truth. We must learn the lessons of our follies and resolve to fix them now, not later.

To that end, I invite the reader to join the education process. Support organizations like FEE that are working to inform citizens about the proper role of government and how a free economy operates. Help distribute copies of this essay and other good publications that promote liberty and free enterprise. Demand that your representatives in government balance the budget, conform to the spirit and letter of the Constitution and stop trying to buy your vote with other people’s money.

Everyone has heard the sage observation of philosopher George Santayana: “Those who cannot remember the past are condemned to repeat it.” It’s a warning we should not fail to heed.

Endnotes

1 Alan Reynolds, “What Do We Know About the Great Crash?” National Review, November 9, 1979, p. 1416.

2 Hans F. Sennholz, “The Great Depression,” The Freeman, April 1975, p. 205.

3 Murray Rothbard, America’s Great Depression (Kansas City: Sheed and Ward, Inc., 1975), p. 89.

4 Benjamin M. Anderson, Economics and the Public Welfare: A Financial and Economic History of the United States, 1914-46, 2nd edition (Indianapolis: Liberty Press, 1979), p. 127.

5 Milton Friedman and Anna Jacobson Schwartz, A Monetary History of the United States, 1867-1960 (New York: National Bureau of Economic Research, 1963; ninth paperback printing by Princeton University Press, 1993), pp. 411-415.

6 Lindley H. Clark, Jr., “After the Fall,” The Wall Street Journal, October 26, 1979, p. 18.

7 “Tearful Memories That Just Won’t Fade Away,” U. S. News & World Report, October 29, 1979, pp. 36-37.

8 “FDR’s Disputed Legacy,” Time, February 1, 1982, p. 23.

9 Barry W. Poulson, Economic History of the United States (New York: Macmillan Publishing Co., Inc., 1981), p. 508.

10 Reynolds, p. 1419.

11 Richard M. Ebeling, “Monetary Central Planning and the State-Part XI: The Great Depression and the Crisis of Government Intervention,” Freedom Daily (Fairfax, Virginia: The Future of Freedom Foundation, November 1997), p. 15.

12 Paul Johnson, A History of the American People (New York: HarperCollins Publishers, 1997), p. 740.

13 Ibid., p. 741.

14 Larry Schweikart and Michael Allen, A Patriot’s History of the United States: From Columbus’s Great Discovery to the War on Terror (New York: Sentinel, 2004), p. 553.

15 Ibid., p. 554.

16 “FDR’s Disputed Legacy,” p. 24.

17 Sennholz, p. 210.

18 From The Liberal Tradition: A Free People and a Free Economy by Lewis W. Douglas, as quoted in “Monetary Central Planning and the State, Part XIV: The New Deal and Its Critics,” by Richard M. Ebeling in Freedom Daily, February 1998, p. 12.

19 Friedman and Schwartz, p. 330.

20 Jim Powell, FDR’s Folly: How Roosevelt and His New Deal Prolonged the Great Depression (New York: Crown Forum, 2003), p. 32.

21 John Morton Blum, From the Morgenthau Diaries: Years of Crisis, 1928-1938 (Boston: Houghton Mifflin Company, 1959), p. 70.

22 Anderson, p. 315.

23 “FDR’s Disputed Legacy,” p. 24.

24 Anderson, p. 336.

25 Ibid., pp. 332-334.

26 “FDR’s Disputed Legacy,” p. 30.

27 John T. Flynn, The Roosevelt Myth (Garden City, N.Y.: Garden City Publishing Co., Inc., 1949), p. 45.

28 C. David Tompkins, Senator Arthur H. Vandenberg: The Evolution of a Modern Republican, 1884-1945 (East Lansing, MI: Michigan State University Press, 1970), p. 157.

29 Ibid., p. 121.

30 Albert J. Nock, Our Enemy, the State (online at www.barefootsworld.net/nockoets1.html), Chapter 1, Section IV.

31 Martin Morse Wooster, “Bring Back the WPA? It Also Had A Seamy Side,” Wall Street Journal, September 3, 1986, p. A26.

32 Ibid.

33 Johnson, p. 762.

34 Sennholz, pp. 212-213.

35 William E. Leuchtenburg, Franklin D. Roosevelt and the New Deal, 1932-1940 (New York: Harper and Row, 1963), p. 242.

36 Ibid., pp. 183-184.

37 Robert Higgs, “Regime Uncertainty: Why the Great Depression Lasted So Long and Why Prosperity Resumed After the War,” The Independent Review, Volume I, Number 4: Spring 1997, p. 573.

38 Gary Dean Best, The Critical Press and the New Deal: The Press Versus Presidential Power, 1933-1938 (Westport, Connecticut: Praeger Publishers, 1993), p. 130.

39 Ibid., p. 136.

40 Burton Folsom, “What’s Wrong With The Progressive Income Tax?”, Viewpoint on Public Issues, No. 99-18, May 3, 1999, Mackinac Center for Public Policy, Midland, Michigan.

41 Ibid.

42 Higgs, p. 564.

43 Quoted in Herman E. Krooss, Executive Opinion: What Business Leaders Said and Thought on Economic Issues, 1920s-1960s (Garden City, N.Y.: Doubleday and Co., 1970), p. 200.

44 Higgs, p. 577.

45 Blum, pp. 24-25.

Photo Credits

Cover, Artwork based on a poster created by Works Progress Administration between 1941 and 1943.

Page 1, Library of Congress, Prints and Photographs Division, [LC-USF34-T01-018258-C DLC].

Page 2, Federal Reserve Building, Library of Congress, Prints and Photographs Division, Theodor Horydczak Collection [LC-H814-T-F03-003 DLC].

Page 3, Unemployment, Michigan State Archives.

Page 5, Farm Relief Act, Library of Congress, National Photo Company Collection, [LC-USZ62-111718 DLC].

Page 6, Roosevelt, Library of Congress, Prints and Photographs Division [LC-USZ62-117121 DLC].

Page 7, Roosevelt, Franklin D. Roosevelt Library and Museum.

Page 9, Bridge, Library of Congress, Prints and Photographs Division, Historic American Buildings Survey or Historic American Engineering Record, Reproduction Number [HAER,?TEX,42-VOS.V,4-].

Page 11, Steel Mill, Library of Congress, Prints and Photographs Division, Theodor Horydczak Collection [LC-H814-T-0601 DLC].

Page 12, Supreme Court Building, Library of Congress, Prints & Photographs Division, FSA-OWI Collection, [LC-USF34-005615-E DLC].

Page 13, Strikers, Archives of Labor and Urban Affairs, Wayne State University.

Article printed from Foundation for Economic Education: http://fee.org

URL to article: http://fee.org/articles/great-myths-of-the-great-depression/

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[1] Image: http://fee.org/wp-content/uploads/2008/12/greatmythsdepression2008feemcppfinalweb.pdf

News Flash: FDR Didn’t Fix The Economy!

2008-12-27T12:30:00.001-05:00

Posted By Sheldon Richman On December 15, 2008 @ 2:07 pm In TGIF, The Freeman | No Comments

Sheldon Richman ^[1] is the editor of The Freeman and “In brief,” and author of “Fascism” ^[2] in The Concise Encyclopedia of Economics. TGIF appears Fridays. Comments welcome at “Anything Peaceful.” ^[3]

The New Deal did not end the Great Depression. This statement will come as no shock to FEE supporters, but it will to the many people who never encountered it before. Now people are encountering it — in newspaper columns and news-talk shows.

Why, after years of being taught that Franklin Roosevelt’s economic intervention saved the country from disaster, is the general public now being told — by FDR fans, not critics — that this is not the case?

It’s the Rooseveltians’ way of helping President Obama get over any fear he has of deficit spending. Paul Krugman ^[4], the newest Nobel laureate, a Keynesian, and a New York Times columnist, is explicit about this. “[H]ow much guidance does the Roosevelt era really offer for today’s world?” Krugman asks. “The answer is, a lot. But Barack Obama should learn from F.D.R.’s failures as well as from his achievements: the truth is that the New Deal wasn’t as successful in the short run as it was in the long run. And the reason for F.D.R.’s limited short-run success, which almost undid his whole program, was the fact that his economic policies were too cautious.”

By “too cautious” Krugman means that FDR’s deficits were too small. Roosevelt ran deficits (except for one year), but they were about the same size as those run by his predecessor, Herbert Hoover. Roosevelt’s biggest deficit, in 1936, was “only” 4.4 percent of GDP, Jim Powell points out in FDR’s Folly. Both Hoover and Roosevelt were big spenders — FDR doubled spending by 1940 — but they were also big taxers, which kept the deficit from growing. This is confirmed by University of Arizona economist Price Fishback ^[5], who wrote, “Once we take into account the taxation during the 1930’s, we can see that the budget deficits of the 1930’s and one balanced budget were tiny relative to the size of the problem….”

Roosevelt was quite a tax enthusiast. He levied or raised taxes on liquor, tobacco, gasoline, corporate dividends, estates, incomes (top rate 75 percent versus Hoover’s 63), “excess” profits, and undistributed profits. (The last tax was repealed in 1939.) And then there was the payroll tax that came in with Social Security. All in all, the New Deal more than tripled the tax burden from 1933 to 1940: $1.6 billion to $5.3 billion. Serious deficit-spenders don’t raise taxes. But Roosevelt did. Is it any wonder that net investment dropped $3.1 billion during the decade or that unemployment ^[6] was about as high in 1939 as it was in 1932?

Would Bigger Deficits Have Worked?

This raises the question of whether big-time deficit spending would have ended the Depression. Krugman and others think so. But how could it? Deficits are financed either by borrowing or by creating money out of nothing. When the government borrows money, that’s money no one else can borrow and invest. Where’s the gain? Moreover, the money is put to purposes selected by politicians, not entrepreneurs trying to please consumers.

When the government creates money, three things happen. First, the new money lowers interest rates below the level justified by society’s time preference; that produces perverse incentives to invest in longer-term projects far from the consumer-goods level. Second, the money early on changes relative prices (rather than raising prices evenly) because particular economic interests get it sooner than everyone else. Third, prices later rise generally, reducing everyone’s purchasing power. The result is a distorted structure of production and a boom that is unsustainable because it’s based not on real savings but on fiat money. When the inflation stops, the bust follows.

Since the New Deal didn’t end the Depression and a New Deal on steroids wouldn’t have done so, President Obama should pay no heed to Krugman and his Keynesian economic advisers. The way to wake up the economy is reduce the total government burden on producers and consumers by, among other things, slashing spending, taxes, and borrowing.

Article printed from Foundation for Economic Education: http://fee.org

URL to article: http://fee.org/articles/tgif/news-flash-fdr-didnt-fix-the-economy/

URLs in this post:

[1] Sheldon Richman: mailto:srichman@fee.org?subject=

[2] “Fascism”: http://www.econlib.org/library/Enc/Fascism.html

[3] “Anything Peaceful.”: http://www.feeblog.org/

[4] Paul Krugman: http://www.nytimes.com/2008/11/10/opinion/10krugman.html

[5] Price Fishback: http://www.independent.org/newsroom/article.asp?id=2377

[6] unemployment: http://www.econreview.com/events/ur1932b.htm

Bastiat and Bailout Blunders

2008-12-27T12:28:00.000-05:00

Posted By William Anderson On December 24, 2008 @ 9:46 am In Articles, Not So Fast! | 2 Comments

When President George W. Bush promised government aid to General Motors, Ford and Chrysler, no doubt he read the New York Times, which has given economic advice even as its own media empire threatens to collapse financially. Perhaps he read the Washington Post or other mainstream publications that demanded government print more money, fix the balance sheets of bankrupt companies, and go on a spending spree of its own.

Even the thoughtful Stephen Chapman ^[1] of the Chicago Tribune has called for inflation as a way (temporarily) to boost the economy. (One expects such nonsense from Paul Krugman and cheerleaders for the state, but when libertarians join the inflation chorus, we know we a crisis exists.)

Yet, there is someone that President Bush or Krugman and others with political power or influence have not read, although his words are wiser than those of all the modern political pundits put together: Frederic Bastiat. Readers of The Freeman or the FEE webpage likely are familiar with this French statesman who wrote some of the best economic prose of the Nineteenth – or any other – Century. We revisit one of his great works: That Which is Seen and That Which is Not Seen ^[2], completed in 1850, shortly before his death.

Bastiat explains that economic analysis depends not only upon observing those things which are readily visible – domestic auto workers receiving paychecks instead of being laid off – but also those things which do not happen because of the original action, things that in the long run would be more economically (and socially) beneficial. He writes:

In the department of economy, an act, a habit, an institution, a law, gives birth not only to an effect, but to a series of effects. Of these effects, the first only is immediate; it manifests itself simultaneously with its cause - it is seen. The others unfold in succession - they are not seen: it is well for us, if they are foreseen. Between a good and a bad economist this constitutes the whole difference - the one takes account of the visible effect; the other takes account both of the effects which are seen, and also of those which it is necessary to foresee. Now this difference is enormous, for it almost always happens that when the immediate consequence is favourable, the ultimate consequences are fatal, and the converse. Hence it follows that the bad economist pursues a small present good, which will be followed by a great evil to come, while the true economist pursues a great good to come, - at the risk of a small present evil.

Indeed, the “bad” economists have advised short-sighted politicians (Dare I repeat myself?) to do the most visible things. The news cameras will show the autoworkers in Detroit going to work instead of being laid off. When Congress and the incoming presidential administration raise the minimum wage, the news cameras will record the life of a single mother who has received a raise.

The cameras, however, will not record those millions of people elsewhere who lose their jobs because resources are being diverted from productive uses to the political uses of propping up automobile companies that have been a rendition of the “living dead” for many years. The cameras will not record those thousands of single mothers who are thrown out of work because the increase in the minimum wage essentially priced them out of the labor market.

Over time, unfortunately, that which is not seen at first ultimately is seen in its full horror. Nearly 80 years ago, presidents Herbert Hoover and FDR tried to prop up the U.S. economy by forcing up real wages, bailing out failing firms, promoting labor unions (and the violence that inevitably accompanies their activities), and inflating the dollar. What ultimately was seen was a decade of high unemployment which ended in the horror of world warfare.

Instead, of reading Krugman and other “distinguished” economists, perhaps policymakers should discover Bastiat. What he wrote 150 years ago still is more cogent and relevant than the entirety of what the political classes and their media allies are telling us today.

Article printed from Foundation for Economic Education: http://fee.org

URL to article: http://fee.org/articles/bastiat-and-bailout-blunders/

URLs in this post:

[1] Stephen Chapman: http://www.reason.com/news/show/130681.html

[2] That Which is Seen and That Which is Not Seen: http://bastiat.org/en/twisatwins.html

How a Free Society Could Solve Global Warming

2008-12-27T12:25:00.001-05:00

October 1st, 2007 • Related • Filed Under • ShareThis • Print This Post • Email This Post

Gene Callahan is the author of Economics for Real People. He thanks Robert P. Murphy and Sudha Shenoy for their help in preparing this article.

The phrase“global warming” has been around for quite some time, but in the past year it has captured the spotlight as never before. One can’t turn on the radio or open a newspaper without facing ads from “green” corporations, or hearing the latest way to reduce one’s “carbon footprint.” With even prominent Republicans (such as Arnold Schwarzenegger and George W. Bush) on board, it seems all but inevitable that major governments around the world will enact new policies to combat this ostensible threat—and to cripple economic growth in the process.

Thus far the typical libertarian response to the growing clamor has been to challenge the science behind it. Now it really is the scientific consensus that global warming occurred during the twentieth century. What is not so obvious is that (1) humans caused this warming and (2) this warming is necessarily bad.

Although it is interesting to explore the question of whether science has been perverted in the cause of environmentalism, there is a danger for libertarians in pinning their entire case on this strategy. After all, every serious student of science knows that when it comes to empirical claims, we never achieve certainty. For example, even if today one thinks that there are insurmountable problems facing the theory of manmade global warming, one still must accept the possibility that new evidence or theoretical advances could indicate that the environmentalists are perfectly right. Another possibility is that there is some other, similar disaster lurking unsuspected.

For these reasons, I believe it is crucial to accept provisionally, for the sake of argument, the scientific claims behind the case for manmade global warming. In the present article I will demonstrate that it still would not follow that the taxes and other regulations typically proposed by greens are the best way to address the problem. Just as the free market is still the optimal economic arrangement, regardless of how many citizens are angels or devils, so too does the free market outperform government intervention, regardless of the fragility of Earth’s ecosystems.

When trying to determine if the free market is to blame for possibly dangerous carbon emissions, a logical starting point is to list the numerous ways that government policies encourage the very activities that Al Gore and his friends want us to curtail.

The U.S. government has subsidized many activities that burn carbon: it has seized land through eminent domain to build highways, funded rural electrification projects, and fought wars to ensure Americans’ access to oil. After World War II it played a key role in the mass exodus of the middle class from urban centers to the suburbs, chiefly through encouraging mortgage lending.

Every American schoolchild has heard of the bold transcontinental railroad (finished with great ceremony at Promontory Summit, Utah) promoted by the federal government. Historian Burt Folsom explains that due to the construction contracts, the incentive was to lay as much track as possible between points A and B—hardly an approach to economize on carbon emissions from the wood- and coal-burning locomotives. For a more recent example, consider John F. Kennedy’s visionary moon shot. I’m no engineer, but I’ve seen the takeoffs of the Apollo spacecraft and think it’s quite likely that the free market’s use of those resources would have involved far lower CO2 emissions. While myriad government policies have thus encouraged carbon emissions, at the same time the government has restricted activities that would have reduced them. For example, there would probably be far more reliance on nuclear power were it not for the overblown regulations of this energy source. For a different example, imagine the reduction in emissions if the government would merely allow market-clearing pricing for the nation’s major roads, thereby eliminating traffic jams! The pollution from vehicles in major urban areas could be drastically cut overnight if the government set tolls to whatever the market could bear—or better yet, sold bridges and highways to private owners.

Of course, there is no way to determine just what the energy landscape in America would look like if these interventions had not occurred. Yet it is entirely possible that on net, with a freer market economy, in the past we would have burned less fossil fuel and today we would be more energy efficient.

Even if it were true that reliance on the free-enterprise system makes it difficult to curtail activities that contribute to global warming, still the undeniable advantages of unfettered markets would allow humans to deal with climate change more easily. For example, the financial industry, by creating new securities and derivative markets, could crystallize the “dispersed knowledge” that many different experts held in order to coordinate and mobilize mankind’s total response to global warming. For instance, weather futures can serve to spread the risk of bad weather beyond the local area affected. Perhaps there could arise a market betting on the areas most likely to be permanently flooded. That may seem ghoulish, but by betting on their own area, inhabitants could offset the cost of relocating should the flooding occur. Creative entrepreneurs, left free to innovate, will generate a wealth of alternative energy sources. (State intervention, of course, tends to stifle innovations that threaten the continued dominance of currently powerful special interests, such as oil companies—for example, the state of North Carolina recently fined Bob Teixeira for running his car on soybean oil.)

Private insurers have a strong incentive to assess the potential effects of global warming without bias in order to price their policies optimally—if they overestimate the risk, they will lose business to lower-priced rivals; if they are too sanguine about the dangers, they will lose money once the claims start rolling in. Individuals finding their homes or businesses threatened by rising sea levels will find it easier to relocate to the extent that unfettered markets have made them wealthier. Industrial manufacturers, as long as they are held liable for the negative environmental effects of their production processes—a traditional common-law liability from which state policies intended to “promote industry” have often sought to shield manufacturers—will strive to develop technologies that minimize the environmental impact of their activities without sacrificing efficiency. Government interventions and “five-year plans,” even when they are sincere attempts to protect the environment rather than disguised schemes to benefit some powerful lobby, lack the profit incentive and are protected from the competitive pressures that drive private actors to seek an optimal cost-benefit tradeoff.

If the situation truly becomes dire, it will be free-market capitalism that allows humans to develop techniques for sucking massive amounts of carbon out of the atmosphere, and to colonize the oceans and outer space. Beyond these futuristic possibilities, the obvious responses to global warming—such as more houses with AC, sturdier sea walls, and better equipment to evacuate flooded regions—are again only feasible when the free market is unleashed.

It is the poorest people and nations that stand to suffer the most if the worst-case scenario for global warming is realized, and the only reliable way to alleviate their poverty, and thus help protect them from those effects, is the free market.

Can the Market Meet the Threat Head-On?

In the first section I summarized some of the ways governments inadvertently contribute to the very activities that allegedly cause dangerous global warming; in the second I sketched some of the ways that free markets allow humans to better adapt to climate change. However, I haven’t really tackled the problem directly. Am I conceding that with a worldwide problem the market—which is just dandy for one-on-one interactions—can’t match the concerted “will of the people” working through their elected representatives for a common solution?

Of course not. Even when economic transactions generate so-called negative externalities (activities that shower harms on third parties), I still contend that the free market is the best institution for identifying and reducing the problems.

One way negative externalities can be addressed without turning to state coercion is public censure of individuals or groups widely perceived to be flouting core moral principles or trampling the common good, even if their actions are not technically illegal. Large, private companies and prominent, wealthy individuals are generally quite sensitive to public pressure campaigns.

To cite just one recent, significant example, Temple Grandin, a notable advocate for the humane treatment of livestock, asserts that McDonald’s is the world leader in improving slaughterhouse conditions. While many executives at the fast-food giant genuinely may be concerned with the welfare of cattle, pigs, and chickens, undoubtedly a strong element of self-interest is also at work here, as the company realizes that corporate image affects consumers’ buying decisions.

But that self-interest does not negate the laudable outcome of the pressure McDonald’s has applied to its suppliers to meet the stringent standards it has set for animal-handling facilities. Similarly, to the degree that the broad public regards manmade global warming as a serious problem, companies will strive to be seen as “good corporate citizens” that are addressing the matter. And this isn’t ivory-tower speculation on my part—I can see the “green friendly” ads already.

Critics of libertarianism sometimes denigrate it as a political program of “market fundamentalism” that, if put into practice, would reduce all human values to the price they can fetch as mere commodities. But that is a caricature of the social arrangements advocated by any sensible libertarian. The great figures of classical-liberal and libertarian thought have always recognized the vital contributions that nonmarket institutions, such as churches, families, charities, social clubs, communities of scholars and their students, art foundations, conservation groups, neighborhood associations, and youth athletic leagues, make to the healthy functioning of a free society. What libertarians offer as an alternative to statism is not a social order that judges every human interaction solely on a miserly calculation of profit or loss, but a society in which every desirable form of voluntary association is allowed to flourish, free from coercive interference by the state.

Customary Law

Besides the samples listed above, most libertarians recognize private or customary law as another important, nonmarket source of social order. A historical case in point is the Anglo-American common-law tradition in which legal norms evolved spontaneously from the customs of the people to whom it applied, rather than through legislation and state planning deliberately aimed at achieving some “public good.” The many centuries during which the common law sustained civic order in the face of inevitable divergences between individual citizens’ own interests demonstrate that a successful legal order does not inevitably require state sponsorship. The common law has shown itself to be fully capable of dealing with a number of issues that, while not exhibiting the worldwide scope of global warming, are still similar to our present concern in arising from the cumulative effects of many individual actions, each of which, regarded in isolation, appears to be unproblematic and not subject to legal sanction. For instance, the salmon-fishing streams of Scotland are a valuable natural resource, and the communities along them have developed quite successful institutions for ensuring the value of the streams is maintained, including private policing and legal penalties for overfishing and for polluting the water.

The many cases in which voluntary solutions to problems of collective choice have worked pose an empirical embarrassment for those who argue that “public goods” must be provided by the government. Most advocates of compulsory solutions to pollution abatement, for example, would assert that voluntary efforts will be vitiated by “free riding.” If individuals are not forced to contribute their fair share toward addressing these problems, this argument runs, each person rationally will hold back and hope others will pay for the proposed solution, since any free riders would gain the benefits (such as clean air) anyway. Since almost no one likes to be “the sucker,” it follows that the amount of resources devoted to the provision of the public good will fall woefully shy of the total that would be available if each person gave the amount he’d be willing to give if only he could count on everyone else pitching in equally. The sole solution that can be imagined is for the members of a society to create a “social contract” by which they are forced to pay for pollution abatement.

However, Anthony de Jasay notes in his book The State that this argument is severely flawed. If people cannot solve public-goods problems through voluntary cooperation, how can they rely on politicians’ promises to do so? There is no external authority to enforce those promises. There is only public opinion, the same thing that would enforce voluntary solutions. Moreover, government is itself a “public good” in the sense that free riders benefit from the efforts of those who try to get the government to produce public goods such as clean air.

Is Temperature a Public Good?

Another consideration is that the earth’s temperature isn’t such a public good after all. That is, certain people really do have more at stake, particularly if the warming is moderate. For example, if Manhattan became submerged because of rising sea levels, that calamity would not affect every human being equally. The residents of Manhattan and the owners of its skyscrapers would be hurt far more than people living in inland China. Because all the various potential dangers of global warming affect particular people more intensively than others, it is these groups that (in a free market) would have the incentive to reduce CO2 concentrations. For example, if rising sea levels would cause $10 trillion in damage to a comparatively small group of wealthy individuals, that’s a huge “pie” that the wealthy can offer others to motivate them to reduce emissions.

Despite my optimism about the potential to deal with environmental problems through voluntary means, I don’t wish to be misunderstood: If the official global-warming story is true, it presents a serious problem that humanity will find difficult to solve through voluntary means. But this isn’t a strike against voluntarism—of course a difficult problem will be difficult to solve! By the very same token, the government doesn’t do a terrible job at collecting stray dogs, because that’s a very simple task. When it comes to harder assignments, such as stopping terrorism or reducing teen pregnancy, the government’s record is quite a bit worse.

The very features of the official global-warming scenario that hamper purely private solutions would apply equally to government efforts. For example, even if the U.S. government passed draconian measures at home, that alone wouldn’t be enough if China and Indiadon’t follow suit. And just as private companies in a free market may have an incentive to pollute if they can get away with it, so the state, under the influence of special-interest groups and run by leaders always tempted to ignore the public good in favor of increasing their own power and wealth, can have incentives to allow more pollution than is optimal. (It should be clear the “best” amount of pollution is not zero, because even using fire to cook generates some pollutants, and I doubt that anyone but the most misanthropic, fanatical nature worshippers want to reverse all of the last 40,000 years of human progress.)

As in all debates over public versus private choice, it’s inappropriate to measure a realistic free-market response to global warming against an idealized government program. We must try to envision what real people would do if their property rights were respected and compare that scenario with the probable outcome of actual politicians in today’s world being given a blank check in the name of saving the earth.

Government programs don’t ameliorate world poverty or sickness, and no libertarian would deny that these are serious problems. So even if manmade global warming is a real threat, why should we expect governments to get it right on this issue?

Free-Market Education

2008-12-27T09:45:00.000-05:00

Daily Article by Briggs Armstrong | Posted on 12/25/2008 12:00:00 AM

A high-school calculus teacher scored a victory for capitalism and dealt socialized education quite a blow this year. A recent article in USA Today reported that Tom Farber had devised a brilliant, free-market way of funding the tests that he felt were necessary for his students.

Mr. Farber was faced with a dilemma felt by teachers across the country. His supplies budget was cut by the district, which meant that if Farber wanted to give his students the much-needed practice tests that would prepare them for later placement tests, he would have to find funding elsewhere. Many teachers either would have paid for the additional expense out of their own pocket or deprived their students of the requisite practice tests. Farber estimated that, had he paid for the copies out of pocket, it would have cost him almost $200.

Unwilling to shortchange his students or to pay for the copies himself, the visionary teacher found an alternative: he began to sell advertisements on his test papers. According to USA Today, he charged $10 per ad on quizzes, $20 per ad on chapter tests, and $30 per ad on semester finals. Within a few days he had over 75 email requests for ads! Farber has already generated $350 in ad revenue. The article also states that approximately 67% of the ad sales are inspirational messages, paid for by parents. Others are from local businesses.

This free-market solution enables parents to voluntarily provide additional funding in order to help their children. It also allows local businesses to benefit from targeted advertising. Local businesses may also benefit from an improved labor pool due to the improved education students receive from their funding. It is an excellent example of parties participating in voluntary exchange and everyone benefiting: students benefit from the improved education; parents are pleased by improved placement scores; and businesses benefit from a better labor force and more customers. This is capitalism at its finest.

Unfortunately, we live in a time when the knee-jerk reaction is to demand more funding from the government. Mr. Farber has demonstrated that free-market solutions are superior to any that can be provided by government. This also provides a prime example of one of the fundamental flaws with government funding. Government-funded organizations inherently rely on thinking in which decisions are made from the top and imposed on the lower levels. This stifles the ingenuity of the people who have firsthand experience actually doing the work and defers decision making to bureaucrats and committees.

If we are to believe that monopolies are bad because they do not have the best interest of the consumer in mind and have little incentive to improve their product, then why are we to believe that a government monopoly over schooling is good?

It can be reasonably argued that this particular government monopoly is worse than private-sector monopolies, because citizens are forced to pay even if they do not consume the service. To illustrate the point, consider a hypothetical shoe monopoly. If the government declared that shoes are a practical necessity of life in this country, and that there are people unable to afford the best-quality shoes available in the free market, would we then support a "shoe tax" to allow the government to manufacture and distribute shoes free of charge to everyone?

In this scenario, citizens could still purchase shoes from other providers but would be forced to pay their share of the "shoe tax" as well. Since the citizens are already paying for these government shoes (through taxation), the demand for private-sector-produced shoes would be fairly low. Since the demand for privately made shoes would be low, those who desire better shoes would be forced to pay prices that are far higher than those that existed prior to government shoes. The citizens, seeing the high price tag on privately made shoes, would then conclude that they really do need government shoes because only an elite few could afford private shoes.

The success of Farber's experiment shows that, contrary to the common contention, parents would not be forced to shoulder the cost of educating their children alone in the absence of public schools. This is concrete proof that businesses do understand the importance of well-educated students and are willing to provide funding for such a valuable resource. Advertisement revenue is not the only source of funding for schools but it is an important illustration of one of the ways of providing excellent education without extracting funds by force.

$10 $6

Under the current system, everyone is forced to provide funding for schools, regardless of how poor the quality of education provided by those schools. Under a private system, various schools would compete for students and for funding. Both parents and businesspeople would be more willing to devote their resources to the better schools. Students would be the ultimate beneficiaries of such competition.

Many people would agree that the education provided in public schools today is far less than ideal. While there are public schools that provide excellent educations for their students, the costs to taxpayers are too high and the funds are obtained in a highly unethical manner. The lesson to be learned from the success of Farber is that truly private education is plausible and even preferable to the current education provided by the government.

About the Author

Briggs Armstrong

Briggs Armstrong is a student at Auburn University majoring in accounting and minoring in finance. He is a member of the Auburn University Libertarians, the Auburn Economics Club, and the Auburn Philosophy Club. Send him mail.

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Obama's Back Door to Socialism

2008-12-12T18:33:00.000-05:00

The Back Door to Socialism

Daily Article by Chris Brown | Posted on 12/12/2008 12:00:00 AM

Barack Obama plans to initiate public-private partnerships (PPPs) on a grand scale. While the media focuses on Obama's First Dog or his left-handed jump shot, behind the scenes he is planning how to become president of the world. Therefore, it is worth enumerating many of his proposed partnerships so as to expose his actual policies, and then offer an Austro-libertarian analysis of these partnerships. As we will see, a mix of public and private ownership is a socialist arrangement, and a sly tactic employed by those looking for increased power, albeit under a different name: the public-private partnership.

PPPs are essentially contracts between a public agency and a private company where assets, risks, and rewards are shared in providing a good or service to the public. The rationale is typically that private enterprise provides greater efficiency and quality of service, while the government agency furnishes additional capital. They are claimed to (potentially) lead to "happy employees," better educational opportunities, and better public safety. Government agencies reportedly realize cost savings of 20 to 50 percent by using PPPs.

Of course, PPPs, dating back to at least 1652 when the Water Works Company of Boston began providing drinking water to Massachusetts colonists, are nothing new in the United States (or any country), and most government agencies and offices are engaged in using them. From the National Council for Public-Private Partnerships website we read the following:

Public-Private Partnerships [are] used for water/wastewater, transportation, urban development, and delivery of social services, to name only a few areas of application. Today, the average American city works with private partners to perform 23 out of 65 basic municipal services. The use of partnerships is increasing because it provides an effective tool in meeting public needs, improving the quality of services, and [is] more cost effective.

The treatment of so-called "public goods" in neoclassical economics is partly responsible for offering a justification for government intervention in providing for these goods and services. A large part of Obama's economic agenda is to encourage more PPPs —well beyond what neoclassical economists mean by "public goods" (e.g., defense services, streetlights).

Obama claims these partnerships will promote innovation at a local level through federal funding. Before we can engage in an analysis of PPPs, we must provide an overview (lengthy, but I believe worth exposing) of the various partnerships Obama proposes. PPPs will be used in the following ways under an Obama administration:

Deliver real broadband to communities that currently lack it. Encourage PPPs to "get low-income communities and residents connected [through] best practices among those that have deployed citywide free wireless broadband networks and how those lessons learned can be applied in other communities."
Modernize public safety networks and establish a PPP to "facilitate the development of a next generation network for use by public safety agencies on a priority basis."
Award public contracts to companies committed to American workers and end tax breaks for companies that send jobs overseas.
Create a national network of public-private business incubators by "investing $250 million per year to increase the number and size of incubators in disadvantaged communities throughout the country."
Expand PPPs to advance "leading edge technologies" in space and aeronautics research to spur economic growth and innovation.
Provide funding for "Early Learning Challenge Grants" where states will have to, among other requirements, develop strong public-private partnerships.
Establish a Presidential Early Learning Council to expand public/private investments in the "youngest children."
Issue competitive grants to PPPs for evidence-based models to help students graduate.
Mandate public service and require American middle and high school students to perform 50 hours of service a year, and for all college students to perform 100 hours of service a year. At the community level, PPPs will be used so "students can serve more outside the classroom."
Develop and deploy clean coal technology by using the Department of Energy to enter into PPPs to develop five new commercial scale "coal-fired plants with clean carbon capture and sequestration technology."
Expand PPPs between schools and arts organizations by increasing resources for the US Department of Education's Arts Education Model Development and Dissemination Grants.
Improve and expand PPPs to increase cultural and arts exchanges throughout the world and promote "cultural diplomacy."
Interact with the private sector from "electronic health records to the general supply chain."

PPPs: An Economic Analysis

Obama uses PPPs to justify government involvement and intervention, and he typically associates PPPs with innovation, which seems like an oxymoron. Fortunately, the Austrian economist can point out the many likely effects and unintended consequences of government intervention in the form of PPPs, including the (tragic) effects on entrepreneurship. We will discuss a few of these, using as our guide Mises's excellent and insightful book, Bureaucracy. Two topics often associated with entrepreneurship, innovation and risk, are perhaps the most pertinent in our discussion.

Innovation

One of the reasons Obama gives as a justification for these partnerships is to "spur innovation." There are many reasons why this will prove difficult, if not impossible. Private businesses that have a government-granted monopoly from a PPP will have less (or no) competition, decreasing any incentive to increase efficiency and provide better quality services and products at lower prices. With a government guarantee of revenue, either through the company (or government) charging a fee to customers for its services, or through government subsidy, there is less incentive to cut costs.

Innovation is also less likely if the partnership specifies revenue will be obtained in a "cost plus percentage" arrangement where companies will be guaranteed a specified amount of gross profit, regardless of revenue or cost. When the PPP contract guarantees a period of time (typically years), companies may no longer be interested in increasing profits as there is little danger of going out of business during that timeframe. Thus, PPPs have no stringent requirement of meeting the market profit-and-loss test, since they cannot "lose."

Mises pointed out the flaw in trying to use PPPs as a catalyst to innovation:

To say to the entrepreneur of an enterprise with limited profit chances, "Behave as the conscientious bureaucrats do," is tantamount to telling him to shun any reform. Nobody can be at the same time a correct bureaucrat and an innovator. Progress is precisely that which the rules and regulations did not foresee; it is necessarily outside the field of bureaucratic activities.

In addition, progress and innovation may also be trapped by old government regulations, codes, and established ideas. "If it ain't broke, don't fix it," is the motto of the government bureaucrat—and as Mises points out, these are typically old men with established ideas of what works (and what doesn't). In contrast, innovation is more than just making sure a product "ain't broke"—it is about improving an already functional and highly demanded product (think iPhone in the wireless industry, or Google Chrome in web browsers).

In contrast to private businesses, companies in a government partnership that wish to introduce innovations require going through red tape and levels of bureaucracy for approval. If it were not for a government guarantee of monopoly privilege, such a time gap for bureaucratic approval would likely eliminate any first-mover advantage in the market.

Furthermore, investment capital will not necessarily be generated from savings or business operations, but possibly from a shared government budget. Finally, instead of an incentive to earn as much profit as possible, governments often set a limit on the amount of total profit, and tax or remove any profit above the arbitrarily specified amount, thereby discouraging innovation.

Risk

Risk is another aspect that needs to be analyzed in relation to PPPs. Companies that are guaranteed a government contract in some situations may be less likely to take on risk, as risk only disrupts the existing circumstances, and increases the possibility of failure. This is because the company is "safe" (i.e., its revenue is virtually guaranteed) if it does not take any risks. Any risk the company takes may lead to its loss, not the government's.

Companies in a partnership with government will also lose (ultimate) control of their decision-making abilities. For instance, government would be less likely to allow a company to take risks that could affect any government "revenue" originating from the company. Maintaining the status quo is the name of the game. Companies must, in the end, follow the government's wishes and whims, not their own—nor their customers'. The company sees risk not in terms of whether the consumer will buy its product or service, but in terms of whether it is in line with the designs of the bureaucrat. Any risk then becomes focused on pleasing the bureaucrat, at the expense of pleasing the consumer.

On the other hand, risk of failure is essentially reduced to nil for the length of the contract due to government's ability to subsidize losses through taxation or other coercive measures. Obtaining government contracts for smaller companies becomes virtually impossible; and it eliminates any future or start-up companies and investment in that market. Thus, competition and the threat of competition are close to none. We now see that government is truly the enemy—not the oft-viewed, and mistakenly confused, supporter—of the start-up entrepreneur, i.e., the "little guy."

In a PPP, while revenues are guaranteed for the length of the partnership agreement, stability is only limited to the length of the current administration, i.e., to the trust placed in government to keep its agreements and promises. Ironically, by the very act of creating a public-private partnership in an industry, and eliminating or decreasing competition, government reduces that credibility, and other industries are at risk of similar partnership arrangements.

What is left of capitalism in the United States will be uprooted and supplanted with corporatism; any remnants of a free market will have to yield to the coercive measures of government, resulting in monopolies and cartels.

PPPs as a Justification for Bigger Government

When government is able to partner with a private company and grant access to land, labor, or capital that would not have occurred absent government intervention, everyone's property is exposed to the risk of government takeover. A private company may not be able to construct a highway through the private property of others. Government, through powers of eminent domain, is able to seize private property from individuals and construct nearly anything it desires. In other words, government is able to not only extract money from private individuals (taxes) but also to take away their (more tangible) private property.

In addition, public-private partnerships, because of the word "private," are often viewed as more legitimate, and with less hostility, than solely the term "public." Thus PPPs may expand and multiply without real justification, and with little hostility. The (already flawed and misunderstood) meaning of "public goods" then expands beyond the initial neoclassical interpretation to mean anything that could be deemed good for the public.

Murray Rothbard explains how government's violent intervention in one part of the economy results in "calculational chaos," which inevitably spreads to other parts:

[E]ach governmental firm introduces its own island of chaos into the economy; there is no need to wait for socialism for chaos to begin its work. No government enterprise can ever determine prices or costs or allocate factors or funds in a rational, welfare-maximizing manner.

Rothbard states that government cannot be run on a "business basis":

[A]ny government operation injects a point of chaos into the economy; and since all markets are interconnected in the economy, every governmental activity disrupts and distorts pricing, the allocation of factors, consumption/investment ratios, etc. Every government enterprise not only lowers the social utilities of the consumers by forcing the allocation of funds to ends other than those desired by the public; it also lowers the utility of everyone (including, perhaps, the utilities of government officials) by distorting the market and spreading calculational chaos. The greater the extent of government ownership, of course, the more pronounced will this impact become.

Thus, the greater the extent of government ownership, the larger the amount of calculational chaos, and the closer we move toward socialism.

Conclusion: The Power of Ideas

In 1942, Joseph Schumpeter wrote that capitalism would be threatened and condemned by intellectuals, not for its failures, but its successes—and that socialism was inevitable. It seems the public desires the move toward socialism. There are more and more clamors for government intervention in nearly every aspect of an individual's diurnal activities—and as H.L. Mencken said, "Democracy is the theory that the common people know what they want and deserve to get it good and hard." Government propaganda is required to promote such a foolish message. Mises phrased it accurately: "Truth does not need any propaganda; it holds its own."

The danger in public-private partnerships and their promotion by both government bureaucrats and private businesspersons was perhaps best expressed by Rothbard:

What's needed is a corporate spokesman [and government bureaucrat] who embraces the government-business partnership with enthusiasm and joy. … When such a champion emerges, Mr. and Ms. America, keep a sharp eye on your wallets—you are about to be fleeced.

~~$20~~ $18

Nevertheless, there is hope. We live in a world of ideas, where the QWERTY keyboard is truly mightier than the latest military contraption. The rapidity and magnitude of government failure, and the more it is exposed and can be replaced with the idea of free markets—and with greater communications technology than at any other time in history, ideas can spread faster than ever—the faster will be the shift toward free markets, and most likely toward a level of prosperity never before experienced. Obama's public-private partnerships would become extinct and despised, being recognized for what they are: back-door socialism, making a mockery of true partnerships and freedom. Entrepreneurship and innovation would be free to flourish in such an environment.

Chris Brown is a lecturer at the Australian Graduate School of Entrepreneurship. He also centrally plans the Austro-libertarian blog. Comment on the Mises blog.

Is America Going the Way of France?

2008-12-11T19:16:00.000-05:00

Going the Way of France (1790)

Daily Article by Cyd Malone | Posted on 12/11/2008 12:00:00 AM

French assignat, 1795

First printed in 1896 and as unfortunately pertinent today as it was then, Dr. Andrew Dickson White's Fiat Money Inflation in France chronicles the national suicide of an imposing empire that choked to death on one of mankind's more foolish delusions — the stubborn belief that money does grow on trees. Dr. White's style makes the book an easy read, even during the frightening parts that sound as if lifted directly from today's newspapers.

Weighing in at a light sixty-eight pages, the book nonetheless packs a wallop. It is well-researched and — most surprising for a history book — full of laugh-out-loud moments. One-hundred-plus years have done nothing to diminish the effect of Dr. White's prose.[1] Only in the author's method of referring to the numbers involved — numbers that then seemed so fantastic yet are commonplace today — does the book show any signs of dating. This leads you to read, for example, "twenty eight hundred millions" instead of $2.8 billion — billions likely being beyond the thought process of the people of his time.

Not beyond ours, though; we're up to a trillion.

File Under "Idea, Not a Good One"

The issue of paper will show that gold is not necessary.

–Mirabeau, French politician (1790)

Wisdom comes and goes; lessons are learned hard then hardly remembered. Mankind's endless stupidity on the subject of paper money surely ranks up there in the realm of the sublime. We are forever like Charlie Brown, trying and trying to kick Lucy's football. Generation follows generation, each refusing to learn one of life's more important lessons — nobody must be allowed license to counterfeit. Fiat Money Inflation in France uses as its lesson plan the tragedy of France in the 1790s and Dr. White moves the tale along at a steady clip.

His prose is pointed but polite, and makes no bones about giving credit where credit is due. On the plus side of the ledger, he notes that France was not plunged into a decade-long economic pit by wild-eyed fools, but rather by calm, well-educated ones. The smartest guys in the room whose ideas brought about the tragedy "were universally recognized as among the most skillful and honest financiers in Europe" (p. 47).

Because France in 1789 was in an economic downturn, the idea that the difficulties were due to a lack of money — and that more of it would be nice — caught the imagination of many people. France boasted its own Bernankes, Paulsons, and Greenspans, and when not misthinking, they were off making the rounds of Parisian salons, talking peoples' ears off about how fiat money, despite its disastrous history, could work if only done better — and better is what they intended.

"France was not plunged into a decade-long economic pit by wild-eyed fools, but rather by calm, well-educated ones."

Fiat money, declared the experts, was a means of "securing resources without paying interest" (p. 2). The idea promised that from nothing there would be something — or, as Keynes would later put it, from stone there shall be bread. Nobody was thinking this one through.

Soon the doctrine wormed into the ears of the French politicians who, upon having it explained to them that the plan called for them to print money whenever they wanted, were quickly convinced the whole thing was a splendid idea.

France in 1790 was on a gold standard, with the livre being the unit of measure, but the government would now issue paper money, too. It was to be backed not by gold but by church land stolen specifically for the purpose, and under the authority of The Will of the People. While France had just experienced a harsh lesson in paper money not too long before the coming madness — with John Law's 1720 paper-money schemes — members of the French central government insisted that John Law's paper notes did in fact bring prosperity, "and the ruin they caused resulted from their over-issue, and that such an over-issue is possible only under a despotism" (p. 4).

"We don't live under a despotism!" everyone agreed, and promptly voted to issue $400 million livres' worth of paper money, backed by the stolen church land and paying interest to the holder at three percent annually. Not five months later, $800 million more were printed, the notes not bearing any interest at all. With the currency now nice and elastic (before it all collapsed in 1796), the French politicians were madly printing money in secret, running the printing-press workers at a very un-French-like fourteen hours per day.[2] In less than six years, the French politicians printed over $45 billion in irredeemable paper — and that was when $45 billion was a lot of money.

Those few goldbugs who always doubted the soundness of fiat money — paper currency without a metal anchor — have in large measure been vindicated. But why were the rest of us so blinded by money illusion?

Niall Ferguson (2008)

It is where Dr. White outlines the effects of all this inflation on France that the book reads like today's paper. Prices rose as the value of the currency endlessly fell; savings dwindled while debt loads rose; a spirit of gambling took hold, and bribery flourished. I just Googled those terms plus "America," and we're four for four.

Dr. White created the book from a series of lectures given during his time at Cornell University and the University of Michigan. Judging by how the book reads, he must have been quite the speaker. Describing Mirabeau's impassioned 1790 speech in support of paper, he writes of its oratorical beauty, of how it was frequently interrupted by applause, yet how listening to the opinion of a man who never studied the subject he's yammering about (Mirabeau knew nothing of economics) "was like summoning a prize fighter to mend a watch" (p. 18).

And that went for the rest of the French Assembly, too, bursting with plans to "fix" the economy but full of "men who had never shown any ability to make or increase fortunes for themselves (yet) abounded in brilliant plans for creating and increasing wealth for the country at large" (p. 17). They soon would fall back to the politician's more natural road to wealth, as their newly found power to dispense endlessly available money made them obvious candidates to bribe for legislative favors. Dr. White tries to see the bright side by writing "it is some comfort to know that nearly all concerned were guillotined for it" (p. 30).

What is best about the book is that it is, at its base, a plea for the poor — an appeal to grant them the protection afforded by gold. Dr. White shows a progressive mind in his concern for the less fortunate, always the ultimate victim of inflation, which "creates on the ruins of the prosperity of all men of meager means a class of debauched speculators, the most injurious class that a nation can harbor" (p. 5).

Don't we know it.

No, Virginia, Money Does Not Grow On Trees

On whom did this vast depreciation mainly fall at last? Men of small means.

–Andrew Dickson White (1896)

Using the French monetary collapse of 1796 as a lesson to teach a greater point — to warn against fiat currency — the book is unabashedly supportive of a gold standard. At the time of its publication in 1896 this position was not only respected; it was mainstream — proponents of paper money were the kooks. Now the shoe is firmly on the other foot: polite people do not talk about a gold standard. Maybe they should start.

The purpose of a gold standard — what makes it so indispensable to a system of economic justice — is that it takes the power to create money and credit at will out of the politicians' hands — in fact, out of anyone's hands. No man, no matter how virtuous and saintly, can long resist the call of the money machine; and the political world, where virtue and saints are always in meager supply, is a particularly dangerous place for it to reside.

The removal of the gold standard from our lives, Robert Samuelson recently noted, has "created an entirely new situation…inflation would no longer control itself." With Nixon's repudiation of the US dollar's remaining link to gold in 1971, we've all taken a time machine back to 1790s France, and so far it's been a less-than-excellent adventure.[3]

"Polite people do not talk about a gold standard. Maybe they should start."

We have substituted for the steady, disinterested hand of gold the arbitrary, rapacious vagaries of the politician; yet we wonder why prices do nothing but float upward, year after year, until grandma is eating cat food. Whenever and wherever paper money has been introduced, from France in the 1790s to America in 2008, a steadily debased currency and a steadily debased economy have followed, as "there is a natural law of rapidly increasing emissions and depreciation" (p. 21).

Inflation as a deliberate policy is fit for nobody but street junkies; it is a method of short-term, artificial pleasure at the certain cost of long-term pain. But "long term" is a misleading, soothing term meant to calm nerves. The "long term" always inevitably morphs into "right now," and towards the foolish he's a vicious bastard. A glance at America's money-supply growth since 1971 — and since the Federal Reserve's creation in 1913, for that matter — gives notice that many have been fools.

The French of the late 1790s, like so many people in so many times, believed in "the doctrine that all currency…derives its efficiency from the stamp it bears" (p. 22), and therefore we can print as much of that currency as we please. Dr. White identifies that flawed doctrine as the root cause of the disaster.

In France during 1790 to 1796 the economic dislocations gained steam as the currency dove towards zero, leading politicians to pass a desperate intervention, followed in time by another even more desperate; and soon Marat, one of the most powerful men in French politics, was openly calling for the people to murder the shopkeepers and plunder their inventory. (That was his economic stimulus package.) The price inflation rent the fabric of French civilization; just the attempt alone to enforce price controls had the guillotines chopping steadily.

As much as the French of the 1790s, we too wished to be "delivered by this grand means from all uncertainty and from all ruinous results of the credit system" (p. 8), and now, also like the 1790s French, we have discovered that where "commerce was dead; betting took its place" (p. 27). We too sat at dinner parties and prattled on about how our hedge fund — the one we told you all to invest in — is up 46% year to date; and now we find ourselves staring at an empty 401(k) with the same dumbfounded "what happened?" look on our face.

What is amazing about America circa 2008 is not the citizens' money illusion — history has seen that aplenty — but the utter lack of resistance to it. From near to far, from MTV to CNBC to cocktail parties, the doctrine of fiat money is so pervasive that the thought of life without it is beyond our comprehension. Maybe it shouldn't be.

~~$15~~ $10

Niall Ferguson recently asked why the West was so "blinded by money illusion." He asks the question as if we're over the illusion, as if we now see paper money for what it is. We don't. We, like the French of 1795, still blame "every cause except the right one" for our troubles.

On a Paris morning in February 1796, with great melancholy all the apparatus for printing paper money was "solemnly broken and burned" in that city's Place Vendome (p. 53). It took the French six years to figure it out; it's taken us 37 and counting.

Dr. White's excellent book can move us a step closer to "solemnly" breaking and burning the root of our problem. Even if it doesn't, Fiat Money Inflation in France is still a great read.

Cyd Malone lives and works in New York City. Comment on the blog.

Notes

[1] Case in point: "All that saved thousands of laborers in France from starvation was that they were drafted off into the army and sent to be killed on foreign battlefields."

[2] Being French, they of course went on strike.

[3] My mother-in-law now lives with me. Her savings have been depleted by the dollar’s steady debasement. Thank you, Mr. Greenspan. You’re the best.

Obama's Idea of Change: Four More Years of Government Stupidity

2008-11-30T12:53:00.002-05:00

Ignorance of Money and the Rejection of Austrian Economics

by William L. Anderson
by William L. Anderson

As the traditional Thanksgiving Day shopping weekend is upon us, we hear the usual canards of hope – hope that consumers will "stimulate" the economy, or we read from people like Karl Rove that President-elect Barack Obama’s "economic team" is "first-rate," and will have the "answers" for the economy. Paul Krugman, who already had advocated trillion-dollar deficits as a way to bring the economy into recovery, says that this new government can "fix the financial system" by even more regulation, thus avoiding the next recession (if we ever recover from this one).

The spate of bad advice and outright ignorance of what actually is happening will continue into the Obama presidency, which has promised "green jobs" as a means of bringing the economy back into balance. (What Obama means is that his administration plans to destroy the relatively-healthy energy industries and replace them with unreliable substitutes like wind power and corn-based ethanol, thus destroying millions of jobs in order to create a few thousand "new" ones.) Moreover, the vaunted "economic team" so lavishly praised by the former Bush political officer Rove so far has offered nothing but more Keynesian "solutions" of massive debt and inflation.

Instead of simply attacking the newest Keynesian nonsense, however, I will note that the eternal default position on economic crises – the Keynesian one – arises because academic economists foolishly have rejected Austrian Economics and the wise counsel it provides. This hardly is an accident or a problem that can be "solved" by being more aggressive in promoting the Austrian position. Instead, the failure of economists to embrace Austrianism comes both from ignorance about the economy in general and the fact that Austrian "solutions" do not provide a central role for economists to be seen as heroes or "fixers" of the economy.

Robert Murphy, in a recent "open letter" to the famed Nobel-winning economist Gary Becker, writes the following:

Mainstream economists often have a hard time grasping the Austrian theory of the business cycle because it relies on a theory of the complex capital structure in a modern economy. Most mainstream economists, in contrast, usually think of the "capital stock" encapsulated by a single value, K. Relying on the framework of the Solow growth model, mainstream economists usually interpret the Austrian theory as one of "overinvestment" during the boom.

As Murphy continues, it is clear that modern neoclassical economists are clueless in general about capital:

In order to even comprehend the Austrian claim, the mainstream economist needs to discard the simplistic homogeneous notion of the capital stock, and seek a richer framework that reflects the time structure of production. In a modern economy, if we picked a random consumer good off the store shelf, it would probably have a "life history" going back many years, and involving thousands of workers handling resources originating in dozens of countries. (Leonard Read's wonderful essay "I, Pencil" is apposite.)

Indeed, if one were to ask a typical economist how an economy grows, he or she might reply: "Aggregate demand has been increased." (The so-called Supply-Siders might say that "aggregate supply has increased," but neither statement really makes any sense. There really is no such thing as "aggregate demand" or "aggregate supply"; they are figments of economists’ imaginations.) For now, it seems that economists, no matter if they are of the "free market" variety or if they are disciples of Keynes and Krugman, all are calling for the government to become involved in schemes to "jump start" the economy. The blind are leading the blind.

Furthermore, as Murphy points out in his "open letter," even accomplished economic thinkers like Becker seem incapable of understanding the basic Austrian notion of "malinvestment," instead mistakenly calling it "overinvestment." (Krugman refers to it as the "Hangover Theory," but presents a caricature not only of the theory itself, but also in his portrayal of Austrian economists as people who revel in the economic misery of others.)

Murphy and others of the Austrian School are correct in pointing out that typical academic economists really don’t understand capital very well, and their few attempts at formulating a theory of capital have been failures. Yet, I believe that the mainstream failure of capital theory is due to the greater failure of economists to understand that simple good: money.

About 30 years ago, I read The Biggest Con by Irwin Schiff, and I have not forgotten his opening statement that money in the United States had "disappeared." I was taken aback when first reading those words, but as I read his book and then read the Austrian economists, I realized that Schiff was right: money has disappeared in this country, and has been gone for a long time. In fact, almost all modern economists have grown up in a time when fiat "money" has been the norm. Few economists (and I include myself) ever have seen real money in circulation. The closest thing that most of us have seen was the silver (or part-silver) coinage that existed in the United States until 1965, but was replaced by government tokens.

Thus, few, if any, of us have experience in dealing with what historically has been termed "money," and that situation only adds to the overall ignorance that economists have of this subject. Furthermore, because of the artificial division of economics into "microeconomics" and "macroeconomics," economists who choose the more-popular "micro" fields have almost no contact at all with monetary theory, save a class or two from graduate school in which a near-pure quantity theory prevails.

Economists can speak of "money supply" or "price levels," but very few understand the very nature of the money economy and what happens when governments predictably abuse their monopolies of "money creation." Even the "free market" economists often stumble over the issue of money, even when they "specialize" in it, as did Milton Friedman.

This state of affairs was made clear to me in an exchange of articles by Joseph Salerno and Richard Timberlake in The Freeman nearly a decade ago. Salerno argued the Austrian position while Timberlake followed the Monetarist view. Timberlake, for example, could not understand Salerno’s contention that the 1920s was an era of Federal Reserve-induced inflation in this country because the consumer price index fell slightly during that decade. Timberlake’s reasoning was that if the government index was falling, then the 1920s had to be a time of deflation, not inflation.

Yet, Salerno and Timberlake were arguing past each other because each man was defining money in very different terms. Salerno was defining money as a good used for exchange that had all the properties of any individual good, and if the amount of money in circulation increases, the marginal utility of money falls, with inflation being the decrease of the value of money relative to the goods it is used to purchase.

Timberlake, on the other hand, defined money in the more typical neoclassical fashion of being a quantity variable monopolized by government and manipulated by the central bank as a means of influencing economic activity. The difference between the two points is crucial not only in understanding the current economic crisis, but also in understanding Austrian Capital Theory and the Austrian Theory of the Business Cycle. If one cannot understand money and capital, then one cannot understand the whole issue of malinvestments and what causes the boom and bust cycle.

The consequences of this ignorance are not esoteric. This is not a parlor discussion among economists on how many spirits of George Stigler can dance on the head of a pin. Instead, it is about understanding how this current crisis came to being, what to do about it, and, just as important, what not to do.

The upshot is that economists are creating crude models of imaginary "aggregate demand and aggregate supply," throwing in government spending and expansion of fiat currency, and calling it a "solution." However, one applies these "solutions" the same way that one pours gasoline on a house fire to extinguish the flames. The Keynesian "solution" is a disaster which is made worse because most academically-trained economists are ignorant of the causes of the problem and, thus, are not intellectually equipped to recommend the needed steps to put the economy back into balance.

Austrian economists and the intellectual tools they bring to the table are needed more than ever, yet the response of the economics profession has been to be even more aggressive in denouncing Austrians as "quacks" and "charlatans" and making sure that they are excluded from any academic and political discussions about this crisis. However, if one wishes to see just how superior the Austrian position has been, the best proof is to watch clips of Peter Schiff (Irwin’s son), who is a well-known investor and fund manager, debate mainstream economists and other "financial experts" by using the Austrian analysis against their viewpoints. Schiff clearly understands the nature of the crisis and how to stop the bleeding and cure the "patient"; the others blindly stumble about, citing the "expertise" of economic theories that lead to nowhere.

For years, economists from the University of Chicago and others influenced by them have claimed that Austrian Economics is rejected by the mainstream because it "fails the market test." Their logic goes like this: (a) Mainstream economists accept good theory and reject bad theory; (b) Austrian Economics is rejected by the mainstream; (c) Therefore, Austrian Economics is bad economics.

This is circular reasoning, not economic logic. The Chicago economists never deal with the actual Austrian arguments or if they attempt to do so, they usually get them wrong. In my view, the reason they get them wrong is because most economists do not have a clue as to understanding money. The consequences for this ignorance are serious. We have a financial and economic crisis that is going to turn into a major depression because the economic mainstream is intellectually incapable of understanding causes and solutions, and when the Austrians speak up, the other economists close their ears, start screaming, and continue to lead everyone else down the same path of destruction.

November 29, 2008

William L. Anderson, Ph.D. [send him mail], teaches economics at Frostburg State University in Maryland, and is an adjunct scholar of the Ludwig von Mises Institute.He also is a consultant with American Economic Services.

William Anderson Archives

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How Obama Will Continue to Ruin the Economy

2008-11-21T21:34:00.000-05:00

Jobarama: Obama's "Investment"

Daily Article by Chris Brown | Posted on 11/14/2008

With all of the talk of how charismatic Barack Obama is, or of his oratory ability—and especially given his recent presidential victory—it is time to engage in a deeper economic critique of Obama's actual policies. Once we see the true effects of his policies and the incentives they create, we will see that his leadership skills and abilities make him more of a threat to freedom than if he were less articulate.

In this article we will start with a small part of Obama's program to "create" jobs, with the aim of tackling poverty. We find the following claim on Obama's website:

Barack Obama will expand access to jobs. Obama and Biden will invest $1 billion over five years in transitional jobs and career pathway programs that implement proven methods of helping low-income Americans succeed in the workforce.

First, there is the use of the word "investment"—in true government Orwellian fashion—as a euphemism for government spending. Investment signifies an accumulation of savings through lower present consumption, which will then be used to achieve (potential) profitable returns in the future. Obama does not have $1 billion of his own money (even including campaign contributions) that he will be investing. Isn't it bizarre how the more money politicians say they are "investing," the more excited people get? Do people not realize that it is their money politicians are referring to? It is as if a thief approached you and, instead of demanding half of your money, said, "Since I really do care about you and your future, give me 90% of your money." Wouldn't it be better if Obama could say, "We are going to invest $10 and creates thousands of new jobs"? Talk about a return on investment.

Second, there is no non-arbitrary way to determine whether a government program makes a profit or a loss. Indeed, government typically does not "talk" in those terms. If a private company is making losses for whatever reason, it must change and innovate in order to make a profit or it will continually make losses and go out of business. But with the government, if a program is labeled as failing, it receives more money—just think of FEMA, the current bank crisis, or, no doubt, Obama's future jobs program.

In contrast, when private companies fail it is not a proof of market failure; on the contrary, it is proof the market is working. It is eliminating failure; in sharp contrast, the government promotes failure: if you want more of something, subsidize it. Government's solution to government failure is consistent with Mises's theory of intervention: government meddling seems to require more government involvement (and more money). And there is nothing as permanent as a temporary government program.

Continuing, we read the following from Obama's program:

Obama and Biden will create a transitional jobs program to place people with extreme difficulties getting and keeping good jobs into temporary, subsidized wage-paying jobs to gain necessary job skills before applying for unsubsidized jobs in the private and public sectors.

Those who are being coerced into subsidizing these jobs should expect more and continued taxation. Obama claims these jobs will be provided by both the private and public sectors. We can assume that politicians want to ensure and, more likely, reassure their voters, that this program is working. After all, it's a $1 billion investment, right? Well, if private companies aren't hiring these workers, obviously, what will probably happen will be more government (public) jobs. As for incentives, if someone is guaranteed a "subsidized wage-paying job," albeit a government one, then they will be less likely to search for an unsubsidized, less-secure job. The obvious effect of this would be fewer private-sector, productive, wealth-creating jobs, and more public-sector, unproductive, waste-creating jobs.

Government investment through taxation means taxpayers must lower their current levels of consumption and investment. As Murray Rothbard points out,

When capital investment takes place in the free market, it deprives no one of consumption goods; for those save who voluntarily choose investment over some present consumption. No one is required to sacrifice present consumption who does not wish to do so. As a result, the standard of living of everyone rises continually and smoothly as investment increases. But a Soviet or other system of compulsory investment lowers the standard of living of almost everyone, certainly in the near future.

Standards of living will decrease as there will be a shift from private production and exchange to political demagoguery, as well as taxes levied on the more efficient to subsidize the less efficient, but privileged, group. As with most government programs, this creates a caste conflict where one man or group benefits at the expense of another man or group. Thus we see government as the true originator of conflict in a society; whereas the market creates mutual harmony, the government engages in exploitation to achieve its ends.

While Austrian economists do not necessarily promote economic growth, it is recognized that true growth can only come through an increase in savings and investment by individuals in the free market, determined by how much they want to consume in the future compared to the present. On the other hand, government "investment" leads to either malinvestment or does not turn out to be an investment at all. An increase in government spending leads to an increase in (government) consumption and a decrease in (private) saving and investment. Thus we see Obama's jobs program will distort the market by shifting workers and resources from the private sector to the public sector, toward government ends rather than consumers'.

~~$60~~ $50

Jobs cannot be created by government fiat. While it is true that neither governments nor entrepreneurs have any way of perfectly forecasting the innovations that will take place in the future, there is, however, one enormous and fundamental difference: entrepreneurs are putting themselves at risk—not taxpayers. An entrepreneur can only originate funds from consumers and investors, i.e., individuals with an interest in the entrepreneur's success who anticipate a profit. Government, however, can extract funds by taxation and obtain them seemingly at whim. Therefore, the profit-and-loss test functions as a market mechanism to properly allocate funds. Without the requirement of obtaining goods through voluntary exchange, government can neither calculate nor allocate funds rationally.

Without a free price system and profit-and-loss criteria, says Rothbard,

[T]he government can only blunder along, blindly "investing" without being able to invest properly in the right fields, the right products, or the right places. A beautiful subway will be built, but no wheels will be available for the trains; a giant dam, but no copper for transmission lines, etc. These sudden surpluses and shortages, so characteristic of government planning, are the result of massive malinvestment by the government.

Obama's jobs program will lower the standard of living of nearly everyone in the near future. The solution to any of Obama's policies would be to eliminate all current and future government "investments."

Chris Brown is a lecturer at the Australian Graduate School of Entrepreneurship at Swinburne University. He also centrally plans the Austro-libertarian blog. Send him mail. Comment on the blog.

A Recipe for the Next Great Depression

2008-11-11T17:00:00.002-05:00

by Thomas J. DiLorenzo

Along with the ascendancy of the Democratic Party to control of the executive and legislative branches of government has come the repetition of the tired, old mantra of an alleged need for a "new New Deal." God help us. The original New Deal unequivocally made the Great Depression much worse, and much longer-lasting, than it would otherwise have been.

One of the most readable expositions of why the New Deal was an economic debacle is Jim Powell’s book, FDR’s Folly. It summarizes more than a half century of economic research on the actual effects of the New Deal and presents the results in a very readable, conversational style that is suitable to a general reading audience. And every bit of it is being studiously ignored by the powers that be in Washington. After his voluminous survey of the ill effects of New Deal interventionism Powell concludes with "lessons for today." Every one of these lessons is not only being ignored by Washington policymakers, but the policy proposals coming out of Washington are ominously structured to do exactly the opposite of what Powell suggests.

Lesson Number One is that "the basic problem with central banks is that like socialist economic planners, they can never have more than a fraction of the vast knowledge needed to make a society work, knowledge that is dispersed in the minds of millions of people. In addition, when central bankers make mistakes – as they inevitably will, since they’re human beings – these mistakes harm not just the economy in a city or a region but the entire country. The Fed’s response to the current economic crisis, which it created by creating the housing bubble, has been to declare more and more central planning powers for itself."

Lesson Number Two is that "deposit insurance must be priced to reflect the risks of the banks that buy it. Having the federal government provide deposit insurance inevitably introduced political pressures to offer deposit insurance at the same price for all banks, which meant subsidized banks engaged in risky practices and contributed to the instability of the banking system." The federal government recently expanded the coverage of federal deposit insurance, thereby guaranteeing more excessively risky lending in the future.

Lesson Number Three is, "Especially because taxes are the biggest burden millions of people face today, it’s crucial to cut taxes. Tax cuts mean expanding economic liberty . . ." President-elect Obama is promising punitive taxes on the most productive people in America – higher income families and investors and savers, combined with government handouts that he mislabels as "tax cuts" for people who don’t even pay income taxes.

Lesson Number Four is "efforts to ‘soak the rich’ will backfire, because the investments of the rich are needed to create jobs." If Obama’s campaign and, indeed, his entire political career, has been about anything it has been about soaking the rich and "redistributing" income and wealth through the tax system.

Lesson Number Five is "public works and other ‘jobs’ programs must be avoided because they increase the cost and burden of government, making it more difficult for the private sector to function." All of Washington is foaming at the mouth over the prospect of more pork-barrel spending, laughingly labeled "stimulus package."

Lesson Number Six is that "especially during a recession or depression, the government must not enact laws preventing prices from adjusting to circumstances. Prices are vital signals that help people decide what to produce and consume." The government has been doing exactly the opposite. Stopping prices from adjusting to realistic levels is the whole intent of the Fed’s policies as well as the Wall Street Plutocrat Bailout Bill.

Lesson Number Seven is that "government must not enact laws preventing wages from adjusting to circumstances . . . . Labor union monopolies have been major obstacles to adjusting wages." One of the first orders of business for the Obama administration will be to strengthen labor union monopolies by passing a law that prohibits secret ballot voting in union certification elections.

Lesson Number Eight is, "only if investors feel private property is secure will they be willing to make long-term financial commitments needed to spur recovery and boost employment." The government has been busy charging businesses that have simply gone bankrupt with crimes, promising more of the same, placing price controls on executive pay, increasing the taxation of investment with higher capital gains taxes, and generally demonizing the entire American capitalist system as a means of shifting the blame for the economic crisis that its own stupid policies have created.

In other words, everything going on in Washington today is a recipe for another Great Depression.

November 11, 2008

Thomas J. DiLorenzo [send him mail] is professor of economics at Loyola College in Maryland and the author of The Real Lincoln; Lincoln Unmasked: What You’re Not Supposed To Know about Dishonest AbeandHow Capitalism Saved America. His latest book, Hamilton’s Curse: How Jefferson’s Archenemy Betrayed the American Revolution – And What It Means for America Today, will be published on October 21.

Thomas DiLorenzo Archives at LRC

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Why Obama Will Be Worse Than Bush

2008-11-09T12:48:00.003-05:00

by William Norman Grigg

My reaction isn’t dictated merely by the conclusion that Obama is uniquely unsuitable to the office he will acquire next January.

I'm of the view that all presidents should be simultaneously inaugurated and impeached, and that there should be a streamlined procedure to expedite their conviction and removal from office upon each president's first documented violation of his constitutional oath.

This would be more than merely a convenient time-saving measure; it is entirely justified in light of the alacrity with which presidents become enemies of the Constitution. Nearly all newly installed presidents reveal themselves to be perjurers before the echo of their insipid inaugural addresses dies down. Indeed, in our degenerate socialist democracy it's impossible for a politician to become a "serious" presidential contender without promising, in extravagant detail, the crime wave he intends to preside over once enthroned.

But since there's no acceptable procedure for impeaching a candidate before he obtains public office, we would have to settle for a system in which presidents entered the office under the burden of impeachment and haunted by the prospect of immediate removal.

Granted, this would result in an executive turnover akin to that experienced by Argentina following its financial collapse earlier this decade, when that country went through five presidents in roughly a year. Governmental paralysis would ensue, with legislation lingering unsigned, executive appointments left unmade, and "rogue" nations left un-bombed.

Some would describe the resulting state of affairs as a crisis. I'd describe it as a miraculous improvement on the status quo.

In an interview with the redoubtable Lew Rockwell, former Federal Judge Andrew Napolitano – one of the few jurists in our history to display actual respect for the Constitution – yielded to what he called the human virtue of hope by opining that it's possible Barack Obama (we pause to observe a moment of chastened reverence) will prove to be a friend to constitutionally protected individual liberties once he assumes office.

Judge Napolitano correctly points out that Obama, whose absence during critical votes has been a consistent trait of his legislative career, made a point of being present to vote in favor of renewing the PATRIOT [sic] Act and the revised FISA law that supposedly authorized unconstitutional electronic surveillance. (Not mentioned in that interview, but relevant to this discussion, is Obama's explicit disavowal of any intention to pursue investigations or criminal prosecutions of Bush administration figures implicated in torture and other abuses once he is in office.)

However, Napolitano suggested that those votes reflected a cynical, election-year design on Obama's part to neutralize criticism that he was in some sense "soft on terrorism." So the best case to be made here is that Obama was willing to abet the assault on individual liberties in order to win election so as to be able to undo the damage he helped inflict on the Constitution. This would mean, in principle, that he is willing to impose tangible injury on innocent people in exchange for power while piously insisting on the purity of his intentions.

So we'd be seeing a familiar routine: A politician compromises his professed principles, insisting this is necessary in order to obtain the power he needs to act on those discarded principles.

Judge Napolitano did make a substantive point when he observed that the Democratic Party, unlike the GOP, has a civil liberties constituency, even if its influence is negligible. But whether or not Obama sympathizes with that element of his coalition and harbors a desire to rectify atrocities committed by the Bu'ushists in the realm of civil liberties, the hyper-activist role he prescribes for the State will inevitably mean that his reign will be even worse for individual liberty than that of his predecessor.

During the era of Bush the Lesser, conservatives who claimed to oppose big, intrusive government at home embraced unlimited government for the purpose of conducting imperial warfare abroad. As the history of previous empires demonstrates, pretending that such an arrangement is possible is an exercise in puerile self-deception: War is the definitive big government program, and – to quote James Madison yet again – "No nation can preserve its freedom in the midst of continual warfare."

The same principle applies with even greater acuity to the enhancement of government power for domestic purposes. It is impossible to mobilize government power on behalf of wealth redistribution without commissioning widespread and wholesale violation of individual rights – beginning, obviously, with the fundamental right to own and dispose of one's wealth and property.

Governments that get really serious about this sort of thing tend to kill all productive activity outright; often the only significant industry that remains is the manufacture of corpses out of once-living, breathing, productive human beings.

Barack Obama, a one-time professor of constitutional law, has famously criticized the Constitution for defining liberty in terms of "negative" liberties – meaning protections against various forms of state action. This is a hoary truism often invoked in theories of Constitutional law that were rooted in Marxism and nurtured by the federal government's post-New Deal demand for legal apologists and executors.

Obama, speaking as a state legislator in a recently discovered and inadequately publicized 2001 radio interview, observed that the civil rights revolution of the 1960s sought to overcome this "negative" concept of liberties, but was too wedded to the idea of pursuing its social revolution through the courts.

As he pointed out, "[T]he Supreme Court never ventured into the issues of redistribution of wealth, and the more basic issues of political and economic justice in this society.... [O]ne of the, I think, tragedies of the civil rights movement was, because the civil rights movement became so court-focused, I think there was a tendency to lose track of the community organizing and activities on the ground that are able to put together the actual coalitions of power through which to bring about redistributive change. And in some ways we still suffer from that." (Emphasis added.)

Here in one paragraph Obama at once reveals his core ideological commitments and answers the much-asked question, "What does a 'community organizer' actually do?" From Obama's own words (soon to be printed in double-column, red-letter text on gilt-edged, leather-bound paper, according to his more devoted followers) we learn that a community organizer is someone who assembles "coalitions of power" in the interest of "redistributive change."

This is an elaborate way of saying that a "community organizer" is what less sophisticated people would call a Communist agitator.

Obama, who reads a teleprompter with panache and knows how to pose for a photo, often finds himself foundering when asked to extemporize.

He does have a certain facile glibness of the kind often mistaken for wit, as we saw when he dismissed charges that he is a socialist by "confessing" to sharing his brownies in kindergarten.

This was actually a moment of self-aggrandizing compound dishonesty worthy of Bill Clinton: In one stroke – a carefully rehearsed "spontaneous" one-liner – Obama offered a non-denial of his intentions while at once lying about the nature of socialism and adding another line to his auto-hagiography (a work constantly in progress):

And the Child Obama, seeing that the multitudes in his kindergarten were an hungered, did say:
Behold, my bosom abounds in compassion for you.
Therewith He did take of his brownies and – offering thanks unto the Almighty State for its wisdom in erecting tax-subsidized child care through the great bounty of its divinely plundered wealth – did break them and offer them to the others,
saying: Take, and eat; And the other children did eat, and gave thanks to Obama the Blessed for his divine generosity,
foreshadowing the day when He, the Embodiment of Change and Hope, would have the power to compel those heedless of the requirements of social justice to surrender their brownies for redistribution to those more worthy.
And the Child Obama did wax mighty in the Spirit of Alinsky, and great wonders were wrought by his hand.

At the risk of committing heresy, I have to point out something His Holiness sought to conceal: Socialism isn't about sharing one's own brownies, but rather about the forcible collectivization of brownies by seizing them from others at gunpoint – and then the ever-escalating use of lethal violence to regiment society once the inevitable shortage of brownies (or bread, or any other good subject to distribution through political rather than economic means) develops.

All State efforts to redistribute wealth and regiment the economy are, in principle and generally in practice, warfare against the rights of the governed. Obama's most impassioned supporters, some of whom have sung arias lamenting the criminal foreign aggression carried out by the Bush Regime, are already chanting hymns of praise in anticipation of the Holy One's war against the American bourgeoisie.

Prominent among those psalmists is Norman Solomon, who wrote a splendid book indicting the corrupt entente between the Establishment media and the presidential warmaking apparatus (War Made Easy: How Presidents and Pundits Keep Spinning Us to Death). Solomon insists that Obama's victory is nothing less than a mandate for war on Americans who stubbornly insist on the sanctity of their personal wealth.

"Two days before he lost the election, John McCain summarized what had become the central message of his campaign: `Redistribute the wealth, spread the wealth around – we can't do that,'" recalls Solomon. "Oh, yes we can. The 2008 presidential campaign became something of a referendum on `spreading the wealth.'"

Solomon complained – inaccurately, alas – that the Republican presidential campaign "recycled attacks on the principles of the New Deal. Like Franklin Roosevelt when he first ran for president in 1932, Barack Obama put forward economic prescriptions that were hardly radical. Yet, in the next few years, Obama's administration could accomplish great things – reminiscent of the New Deal...."

Assuming that he's familiar with the relevant history, Solomon is actually assuming that Obama's campaign was a work of deliberate deception, as FDR's initial presidential bid certainly was. As I've noted before, the 1932 Democratic platform actually criticized Herbert Hoover from the right, condemning his profligacy, demanding a balanced budget, endorsing a sound currency backed by precious metals and the expansion of free trade. FDR's first running mate actually accused Hoover of shepherding the United States into socialism.

Once in power, of course, FDR pivoted sharply to the left, filling the executive branch with squalid Bolsheviks and building a corporate socialist state along the lines prescribed by Italian technocrat Giovanni Gentile, a key adviser to a disavowed disciple of Lenin named Benito Mussolini. FDR ran as a conservative, and governed as an aspiring totalitarian.

Obama campaigned as an unabashed European-style socialist and, if he is given the means, will rule like a post-colonial African dictator.

I say the latter not because of Obama's attenuated African ancestry, but rather because of his preferred style of mobilizing public support – the grotesque Leni Riefenstahl-meets-Tony Robbins public spectacles that portend the advent of an Americanized version of Africa's "Big Man" theory of government.

Given Obama's youth, the bottomless devotion of his followers, the depth of our impending economic disaster, the eagerness of the mass media to help the Holy One "make history," the well-earned political disintegration of the Republican Party, and the totalitarian powers of the office Obama inherits, he may very well become America's second president-for-life, following the course set by FDR before he died and went to hell.

Can Obama rule by decree? Thanks to Bush's example, his answer would be: Yes, I can!

Can he and his followers overturn the 22nd Amendment? Yes, they can!

Can they succeed in creating an egalitarian paradise through forcible redistribution of wealth from the productive to the parasitical?

No – they can't.

But that won't stop them from trying, even if they have to destroy what remains of our liberties in the process.

November 8, 2008

William Norman Grigg [send him mail] writes the Pro Libertate blog.

Proof of Free Market Superiority Over Government Funded Waste

2008-11-09T12:46:00.000-05:00

The Myth of the Robber Barons

by Burton W. Folsom, Jr.

This article is adapted from a lecture Professor Folsom gave at the History and Liberty seminar at FEE in June. For readers who are interested in finding out more about these lost lessons of history we recommend Professor Folsom's popular book, The Myth of the Robber Barons, now in its fifth edition.

In the ongoing war of ideas in American history, those who advocate government action as an engine of economic development have been encouraged by a general and all-too-human tendency to avoid thinking deeply. Because we have a long history of government intervention in the economy, the assumption—both among those who design government programs and among the constituencies that support them—has usually been that government action accomplishes its objectives. Even people who have reservations about bureaucratic inefficiency reason that we wouldn't have turned to government so many times in the past if government hadn't accomplished something.

Three Assumptions About Capitalism

This shallow conclusion dovetails with another set of assumptions: First, that the free market, with its economic uncertainty, competitive stress, and constant potential for failure, needs the steadying hand of government regulation; second, that businessmen tend to be unscrupulous, reflecting the classic cliché image of the “robber baron,” eager to seize any opportunity to steal from the public; and third, that because government can mobilize a wide array of forces across the political and business landscape, government programs therefore can move the economy more effectively than can the varied and often conflicting efforts of private enterprise.

But the closer we look at public-sector economic initiatives, the more difficult it becomes to defend government as a wellspring of progress. Indeed, an honest examination of our economic history—going back long before the twentieth century—reveals that, more often than not, when government programs and individual enterprise have gone head to head, the private sector has achieved more progress at less cost with greater benefit to consumers and the economy at large.

Competition Versus Subsidy in the Steamship Industry

America's early experience with the steamship industry provides an illustrative case. By the 1840s,the technology of steam-powered water transport had reached the point where it became practical to build large ocean-going vessels, and steamships began plying the route between New York City and Liverpool, England. An enterprising fellow named Edward K. Collins approached the U.S. Congress with a plan to develop a steamship fleet that could compete with Britain's Cunard Company. Since the Cunard operation was subsidized by the British government, Collins asked Congress to provide him with a grant of $3 million to underwrite the construction of five vessels and a yearly supplement of $385,000 so he could strive to best Cunard's fare of $200 per passenger and its rates for carrying freight and mail.

Playing skillfully on congressional fears about British domination of the transatlantic trade, and promising that his ships could serve as the basis of a merchant marine fleet in the event of war, Collins got his money. He then proceeded to build four very large and luxurious ships, instead of the five smaller vessels provided for in the agreement, and he took far longer than anticipated to get his fleet into operation.

Collins ran his ships on the same schedule as Cunard, sailing every two weeks, and he often did beat Cunard's crossing time by one day, though at considerably higher operating costs. But while he had promised Congress that his yearly subsidy could eventually be phased out, he was soon lobbying for annual increases to about $500,000, $600,000, $700,000, and then to more than $800,000 per year.

Cornelius Vanderbilt, who had made his mark as an operator of river steamboats, approached Congress with a proposal for an “Atlantic ferry,” promising to match Collins's two-week sailing schedule at half the cost of Collins's subsidy. Congress debated Vanderbilt's proposal. But it doubted his ability. Having made a commitment to Collins—and by now a considerable investment as well—Congress turned Vanderbilt down.

Vanderbilt was undeterred. He went into operation without a subsidy, using privately financed ships, set up a self-insurance arrangement by which he was able to save on payments to outside insurers, and ran his ships at slower speeds to save fuel. He also reduced the fare, and he invented a new, cheaper passenger class, by which people could travel below decks, in what was called steerage, for as little as $30. Vanderbilt's “sardine class” made it possible for many immigrants to come to America.

After a year, Vanderbilt's operation was flourishing, and Collins, in serious trouble from competition with Vanderbilt, went to Congress to ask that his subsidy be raised, yet again, to more than $850,000. Collins managed to persuade the congressmen to conclude that since they started with Collins, it would be disloyal to take his money away now.

But Collins recognized that each time he went back to Congress for more money, the vote was closer. He decided that if he couldn't beat Vanderbilt on price, he would concentrate on beating his crossing time, demonstrating that the Collins line clearly offered the most efficient way to get from Liverpool to New York City. This strategy had its dangers. Long beset with maintenance problems because their engines were too large for their hulls, Collins's ships began to feel the strain of this high-speed policy. Two of the ships—half his fleet—sank, killing almost 500 passengers, and Collins faced the humiliation of going back to Congress to beg for an emergency $1 million appropriation to construct a replacement vessel.

Again Congress funded him. But the new ship, The Adriatic, was so hastily and poorly constructed that it had to be sold at auction after its first voyage—at a $900,000 loss. When Collins went back to Congress for still more money to build yet another ship, he was finally turned down.

It is interesting to look at the reaction in Congress after being embarrassed again and again by the subsidies to Collins. Senator Judah Benjamin of Louisiana said, “I believe [the Collins line] has been our most miserably managed.” Senator Robert Hunter of Virginia went even further. “The whole system was wrong,” he said. “It ought to have been left, like any other trade, to competition.” Senator John Thompson of Kentucky insisted, “Give neither this line nor any other line a subsidy. Let the Collins line die. I want a tabula rasa . . . a new beginning.”

Collins had his subsidy stripped and had to compete head to head—unsupported—with Vanderbilt. Within a year, Collins went bankrupt, and Vanderbilt was the dominant force on the seas from the American side.

Competition Versus Subsidy in the Railroad Industry

It would be comforting to report that the United States learned its lesson about the effects of federal subsidies from the Collins/Vanderbilt experience. Unfortunately, less than a decade later, would-be railroad builders were coming to Congress begging for money to span the nation with transcontinental lines. Congress subsidized three transcontinental rail-roads: the Union Pacific, the Central Pacific, and later the Northern Pacific.

These companies, which were provided with money and land by the government, had no incentive to build their lines efficiently, along straight routes with even grades and proper materials. Eventually they went bankrupt. The Union Pacific and the Central Pacific did so only after eating up 44 million acres of free land and $61 million in cash loans. Large sections of the lines they did complete soon had to be rebuilt and sometimes even relocated due to shoddy construction.

The privately funded Great Northern, which, by contrast, operated on a shoestring budget, was a success. Unlike his competitors, James J. Hill built the Great Northern for durability and efficiency. “What we want,” he said, “is the best possible line, shortest distance, lowest grades, and least curvature that we can build.” That meant he personally supervised the surveying and construction. “I find that it pays to be where the money is being spent,” he noted. He believed that building a functional and durable product actually saved money. For example, he usually imported high-quality Bessemer rails, even though they cost more than those made in America. He was thinking about the future, and quality building cut costs in the long run. When Hill constructed the solid granite Stone Arch Bridge—2,100 feet long, 28 feet wide, and 82 feet high across the Mississippi River—it became the Minneapolis landmark for decades. Yet today Hill is regarded as just another member among the ranks of the greedy, amoral “get-rich-quick” capitalists.

After the transcontinental railroad episode, Congress increasingly began to take the position that American business success would be based on entrepreneurship, not subsidy, relying on those whom I call market entrepreneurs rather than political entrepreneurs. If you look at industries after the Civil War—particularly steel, oil, and chemicals—you find that time and again American market entrepreneurs stepped in and defeated competition from Europe, without subsidies.

Andrew Carnegie and the Steel Industry

When Andrew Carnegie founded Carnegie Steel in 1872, the biggest steel producer in the world was England and the going price of steel rails was about $56 per ton. Carnegie was an eager innovator. He adopted the revolutionary Bessemer process and introduced new accounting methods to make his operations more efficient, applied a merit-pay system to reward his workers, and implemented many employee-suggested ideas. Carnegie Steel became so efficient that by 1900 the company could produce steel rails at $11.50 per ton, and its rail output surpassed that of all the steel mills in England combined. Other U.S. firms followed Carnegie's lead, and America became the dominant steel producer of the world.

John D. Rockefeller and the Oil Industry

Our story would not be complete without recalling the success of John D. Rockefeller. By the 1890s, Standard Oil had a 60 percent market share of all the oil sold in the world. Rockefeller sold the oil at eight cents a gallon—that would be around $1.60 today. Eight cents a gallon! Nobody in the world could do it that cheaply. Kerosene was so inexpensive that people could light their homes for less than one cent an hour.

Rockefeller, the first billionaire in U.S. history, made a fraction of a cent on each gallon of oil his company sold. He had the foresight to say that his goal was to make it for six cents, sell it for eight cents, and use the two cents for research and development. Rockefeller realized that finding new uses for oil was the key to success. (Other companies would take a barrel of oil out of the ground, heat it to get the kerosene, and dump the excess as waste into rivers.) Eventually Standard Oil discovered and produced scores of byproducts, including candle wax, soap, petroleum jelly, tars, and lubricating oils.

Because of this resourcefulness, Rockefeller might well be called the first environmentalist. (He also could be credited with species preservation: the whaling industry declined precipitously as kerosene displaced whale oil in lighting.)

But all this did not make him popular. Competitors did not like him, and public opposition mounted. Standard Oil had already begun to lose market share to competitors because it failed to invest in the Texas oil fields in 1900. But despite this declining market share, successful antitrust litigation resulted in the company's being split into 34 companies.

Time and again, experience has shown that while private enterprise, carried on in an environment of open competition, delivers the best products and services at the best price, government intervention stifles initiative, subsidizes inefficiency, and raises costs. But if we have difficulty learning from history, it is often because our true economic history is largely hidden from us. We would be hard pressed to find anything about Vanderbilt's success or Collins's government-backed failure in the steamship business by examining the conventional history textbooks or taking a history course at most colleges or universities. The information simply isn't included.

The Greatest Generation?

I want to end on a positive note. The success of the market entrepreneurs of the post-Civil War era depended on their ability to serve consumers. When they started their enterprises, the United States was a second-rate power; during their lifetimes they spurred American industry to world dominance. Their accomplishments in transportation, steel, oil, and chemicals led to the unparalleled economic progress of the late 1800s, contributed to American prosperity, and prepared the way for future innovation.

Along with our Founding Fathers and the World War II generation, this remarkable group of entreprenurs, has a rightful claim to being America's greatest generation.

"Spontaneous Order" or How A Free Society Works

2008-11-05T16:38:00.001-05:00

The Freeman: Ideas on Liberty - July 1999

Vol. 49 No. 7

View as PDF

Features:

Spontaneous Order

By Nigel Ashford

Nigel Ashford is senior lecturer in politics at the University of Staffordshire in England and coauthor of A Dictionary of Conservative and Libertarian Thought (Routledge, 1991). This article is adapted from his paper “Principles for a Free Society,” a primer for former communist countries. Reprinted by permission of the Jarl Hjalmarson Foundation of Stockholm.

“Many human institutions are the result of human action, but not of human design.”
—Adam Ferguson

Order has been a central preoccupation of political thinkers and philosophers throughout the ages. It is widely understood today as a state of harmony between people, or social peace. In the premodern era, however, the concept was understood as the maintenance of a stable, hierarchical order that was pre-ordained by God or nature or both. Order can also be seen as the existence of regularity and predictability in human affairs, the absence of chaos. Although no longer associated with a rigid society ranked by privilege and power, the idea of order is still highly valued. This is because it allows people with different interests and values to live together in society without resorting to discord, conflict, or civil war. This is the modern idea of spontaneous order.

The first thinker to articulate this modern concept of spontaneous order was Bernard de Mandeville, in a book called The Fable of the Bees (1714). This work discussed the paradox that “private vices” such as individual self-interest could lead to “public benefits” from which the whole community benefited. He observed that the sum of individuals acting from separate motives produced a commercial society that was no part of any one person’s intention. This idea that the evolution of human institutions allowed individuals to serve others, even though their motive might be self-interest, was at the core of the Scottish Enlightenment that grew up around Adam Smith, David Hume, and Adam Ferguson. They sought to apply this idea to a whole range of human institutions, including commerce, law, language, human morality, and even mores and customs. Far from a narrow theory of economics, Smith’s Theory of Moral Sentiments (1759) argued that morals evolved slowly. The principles that enabled humanity to flourish and prosper were eventually accepted by the community. They stood the test of time.

Smith, Hume, and Ferguson were fascinated at how these values and institutions grew up to greatly benefit mankind despite their being the product of no single mind. Adam Ferguson’s observation that human action produced a form of social order superior to that conceived by human design was to echo in the thoughts of an Austrian thinker, F. A. Hayek, two centuries later. Hayek took on the ancient idea that institutions were divided between those that are “natural” and those that are “artificial.” A third group existed, Hayek said, and these were social institutions. As these are regular and orderly, people suppose that they have been invented by humanity and can therefore be altered or restructured at will. Hayek pointed out that this notion was mistaken because the human mind and society had evolved together. Tearing down the institutions that kept society together and building anew, as socialists advocated, would destroy the order that made society work.

Order Without Commands

Spontaneous order keeps the wheels of society turning without the need to issue commands from the center. A free society is orderly not because people are told what to do but because the evolving traditions and inherited institutions of human society allow individuals to pursue their own ends and by so doing, meet the needs of others. People’s behavior follows certain patterns because they have been accepted by society initially as they allowed the groups that adopted them to prosper. It is no accident, said Hayek, that the sharpest differences in material welfare can be seen throughout the Third World where the city meets the countryside and complex rule-guided societies meet intimate communities in which the rules are different.
The rules that allow a complex social order like a city or the global economy to function are not orders in the sense that term is usually understood. Rules that prevent individuals’ injuring others or engaging in theft or fraud or breaking promises in fact give people a great deal of latitude in their behavior. They tell people how to do things, but they do not tell them what they should do.

The moral framework for human society is not set in stone, but rather is constantly changing as new rules are discovered that allow the social order to function better. The problem is that we do not know in advance which rules will work and which will not. Our existing laws and customs show us what has worked to get us to the stage society has reached, but innovation and trial and error are required if we are to continue to discover new, effective rules of which we are currently ignorant. Social institutions that keep society orderly—customs, traditions, and values—are like tools. They contain the knowledge of generations before us about how to behave and will be modified by the rising generation and then passed on to the next. Groups that adopt these rules benefit from having done so, without necessarily knowing why. The institutions that transmit information about the rules are the product of human action, but not necessarily the result of human design.
There are three categories of social rules, according to Hayek. The first consists of those that we design ourselves, such as parliamentary legislation. The second, which has been called “tacit knowledge,” consists of things like a sense of fair play or injustice that we all understand but cannot put into words. Finally, there is a third group of rules of beneficial behavior that we can observe and write down, but our attempts at codification only approximate the principles. The Anglo-Saxon system of common law is an example of this third type of rule; it evolved through and was gradually refined over centuries by different cases and judgments, and it is open to modification in the future. We learn from these rules and contribute to them even though we often cannot fully explain them. It is the second and third categories that have the power to create a complex order that uses more knowledge than can ever be known by a single human mind.

Why We Need Freedom

Complex social orders require freedom because the information and knowledge that make them work can never be amassed by a central authority. Attempting to use the first category of rules—legislation—to change the second and third categories will fail because the sum total of human knowledge has allowed people in society to live with one another and brought us to the levels of prosperity and population that we now enjoy. This was seen in the old socialist states of the Soviet empire, in which government attacked and undermined traditional morality, justice, and fair play while relying on the economies of the West to keep living standards from falling below subsistence levels. Freedom is critical to the process of achieving spontaneous order in society because we do not know in advance which rules will work, because liberty is essential to the trial-and-error process, and because the creative powers of man can only be expressed in a society in which power and knowledge are widely dispersed. To impose a pre-designed pattern on society would make society cease to function as a creative force. Progress cannot be commanded.

Essential to the progress of an orderly society is the distribution of power among its citizens, as opposed to the concentration of power in the hands of the state. This allows society to experiment in the rules and mores that govern people’s behavior. The process of trial and error limits the impact of mistakes to a small segment of society. Rules that work will be observed, imitated, and absorbed into the social framework. Risk-taking and rule-breaking are virtually impossible in small, intimate rural societies, yet these activities are essential to maintaining the large populations that live in the vast impersonal societies of modern life.

The Role of Incentives

Life in a free society can be hard because it forces individuals to adjust to the needs of others. The free society works because it coordinates conflicting desires by creating incentives for people to satisfy their own wants by satisfying those of others. This is the opposite of a state in which one can only achieve one’s aims at the expense of others. As if by an invisible hand, Adam Smith suggested, we are moved to serve the needs of others while pursuing our own self-interest.

This complex order that harmonizes and synchronizes the conflicting desires of people who are different from one another can be confusing at first. But it is essential to look beyond that initial confusion if we are to see how a free society works. When Alexis de Tocqueville first disembarked in New York in 1831, he heard what he described as “a confused hum.” That great chronicler of American society wrote, “No sooner do you set foot upon American ground than you are stunned by a kind of tumult; a confused clamor is heard on every side, and a thousand simultaneous voices demand the satisfaction of their social wants.” Simply trying to work out how society works by watching it and listening to it tells us little. It would be like trying to understand how a clock works by telling the time. It is how people must interact with one another that allows the clockwork of society to keep ticking.

The hum of commerce eases the path of social cooperation in a free society, in part because it offers man opportunities that are simply not available when acting alone or in a state of war of all against all. Incentives allow us to cooperate with others even though our views on political issues or our religious beliefs may radically differ. When people supply goods and services or buy them from others, they may not know with whom they deal. Protestant, Catholic, Jew, and Muslim all benefit from the commercial activity of a free society without altering their fundamental beliefs. Their security and prosperity are interdependent and in free societies far surpass those of nations where conflict marks differences of faith. These differences are resolved peaceably and profitably in a free society, because the benefits of these values have been passed down through society and have become part of the moral framework. The absence of this mechanism for transmitting moral values is one of the reasons that religious strife and social discord mark societies that have never known freedom.

The Law

One key institution that makes the coordination of a free society possible is the law. In a free society, law is not the same as the arbitrary government decrees of totalitarian and autocratic societies or the legislation of Western congresses and parliaments. It is, as we have seen, a code that has evolved not at the hands of politicians but in the decisions of judges. Tocqueville in Democracy in America (1840) described how laws keep order in a free society. He observed that “the spirit of the law which is produced in the schools and courts of justice, gradually penetrates beyond their walls into the bosom of society, where it descends to the lowest classes, so that at last the whole people contract the habits and tastes of the judicial magistrate.” The law is respected in a free society not by the use of force (although governments do reserve the right to use force to protect freedom), but because it is based on rules that have grown up and been tested in real life, and because the values and the spirit of the law are closely connected to the moral values of the civilization.
Over-government undermines that respect by imposing controls on society that do not conform to people’s inherited sense of right and wrong. Freedom creates order in society. The institutions of a free society give people an interest in keeping the peace, better than any police state or concentration camp.

©2007 Foundation for Economic Education. All Rights Reserved.
http://www.fee.org/publications/the-freeman/article.asp?aid=4571

The Next President's First 5 Tasks

2008-11-03T18:50:00.001-05:00

An article in Time magazine online listed 5 important first things that the next President (whoever he may be) must take care of . Here is the link

The Next President's First Five Things To Do

I believe this list is too vague, and mostly wrong. Here are 5 better suggestions:

Return to a Gold Standard. By making sure the dollar is backed by precious metals such as gold and silver, the dollar will once again be worth something, and inflation will be completely eliminated.
Change to a non-interventionist domestic policy. Get the government completely out of the economy. Instead of hurtling headlong into a completely socialist economy, let's take our current mixed economy and for the first time in our history let's have a completely free market. Resources will be most efficiently allocated, and society will prosper tremendously. This means abandoning the economic myths and fallacies of John Maynard Keyens which have all but destroyed America from the inside, and adopting an Austrian Economic philosophy.
Change to a non-interventionist foreign policy. Wise were the words of our Founding Fathers, who believed that sticking our noses in everybody's business would be a bad idea, create resentment, and cause terrorism against us. Minding our own business, stopping "Foreign Aid" which only puts money in the hands of brutal dictators, returning our troops home from the over 137 countries which we occupy will stop giving the world a reason to hate America. No nation-building, no shoving democracy down everyone's throat (when we ourselves don't even have it anymore), no empire-building, no more being the world's biggest bully by pretending to be Globo-Cop.
With a solid change to a foreign policy of peace, trade with all and non-interventionism, terrorism will all but cease to exist. Without any terrorist threat, we will no longer need to live in an Orwellian Surveillance and Police State.
Re-establish our Constitution as the Supreme Law of the Land. Recognize it not as a living breathing document which is subject to change, but as a document of universal values chiseled into stone, never to be changed, and always protecting the citizenry from government gone wild. This will shrink the government down to what it was originally intended to be--a small government that protects private property and contracts, and one that is subject to the citizenry. In other words, We the People are the BOSS, and the government is our servant, not the other way around.

How the Government Caused the Financial Crisis

2008-10-28T19:49:00.000-04:00

In Praise of Bankruptcy

Daily Article by Henry Thompson | Posted on 10/28/2008

[An MP3 audio version of this article, read by Dr. Floy Lilley, is available here.]

In one word, the market approach to the financial problem is bankruptcy. Firms go bankrupt when they do not have enough revenue to pay their bills. Banks make money by borrowing from lenders at a low interest rate and lending to borrowers at a higher interest rate. If banks make bad loans and borrowers quit repaying, banks go bankrupt.

Insurance firms help people avoid risk, collecting premiums to pay those who suffer bad luck. If the premiums collected by an insurance firm are less than what it has to pay, it goes bankrupt. AIG sold insurance policies to stockholders that banks and other firms would not go bankrupt and could not pay the policies when that happened.

Bankruptcy is a normal part of economic life, covered by laws that guarantee stockholders will be compensated as much as possible. More efficient firms move in to take over what is left of bankrupt firms, buying what can be put to productive use. There is no crime in bankruptcy and, if handled quickly, little economic harm. When the largest US energy company Enron went bankrupt a few years ago, there was not even a ripple in the energy markets, much less the economy. Bankruptcy is not criminal and should not be a surprise, but it can be unnerving if large, well-known firms go bankrupt.

Banks and insurance firms are careful when lending or selling policies because they want to ensure their revenue will pay their bills. Government involvement, however, provides a cushion for failure and allows banks and insurance firms to be careless. This carelessness occurred with the government-sponsored mortgage bank, the Federal National Mortgage Association.

Fannie Mae provides backing to mortgage banks, more or less encouraging them to make bad loans. Fannie Mae makes subsidized loans to mortgage companies when they are short of cash. Freddie Mac is a government mortgage bank that sells mortgages without the usual worry of making a profit, given its taxpayer backing. The government has taken over these two losing mortgage banks, and losses will be paid by taxpayers.

The government provides subsidized mortgage insurance in case home buyers cannot pay. This insurance lets commercial mortgage banks relax and make loans to people who might not be able to pay. Government support for people wanting to buy a house elevated demand for houses and pushed up prices. Rising prices made home buyers confident they could buy a house they could not afford and sell it soon for a profit, counting on a "greater fool" to come along. Realistically, people should only buy a house when they plan to live in it and can actually pay for it. Greater fools do not always come along.

The result of government meddling in the mortgage market is that people have bought houses they cannot afford. When prices quit going up, people were left owing more on their house than it was worth in the market. With their subsidized mortgage insurance and little penalty, people defaulted on their mortgages. The mortgage banks are left without income. This mortgage mess is the root cause of the present financial crisis.

One part of the evolving financial bailout is the government using taxpayer money to help people who have not been able to pay their mortgage. The government is taxing those who have paid their mortgages and transferring the money to those who have not. It is not a good idea to reward inefficiency.

The government is also giving money to select financial and insurance firms, rewarding their poor performance with taxpayer money. Better advice is, "Don't throw good money after bad." The failed firms should go bankrupt.

Another part of the bailout plan is that the Treasury will actually buy houses with defaulted mortgages that the failing banks are holding — the overpriced mortgages that people quit paying. The Treasury has become a realty speculator, hoping to sell these overpriced houses sometime in the future for an even higher price. It is much more likely that taxpayers will pay the losses. The bailout money will purchase 6% of the houses in the United States — not such a large amount and only a very small part of the total real-estate market. The bailout money, as large as it is, will have little effect on the aggregate housing market.

As another part of the bailout, the Federal Reserve will make short-term loans to troubled banks and insurance companies to meet their payroll or other bills. The Fed's job is to make loans to banks and buy or sell bonds to control the money supply. Certainly the bankrupt firms will be first in line to borrow such short-term funds. These loans are likely to go unpaid and be written off at taxpayer expense. It is easy for the Fed to make loans since it is in charge of the money supply.

In the bailout, the Treasury also plans to buy a stake in the failed firms, using taxpayer money to become part owner of second-rate mortgage banks and insurance firms — your tax dollars at work.

The underlying goal of the financial bailout is not to keep the economy "healthy" but to keep a few Wall Street firms, mortgage banks, and insurance firms in business. Never mind that most mortgage and insurance firms in the country are profitable; the government wants to support the inefficient, large, high-profile firms. If these firms were allowed to go bankrupt, the economy would recover quickly. Other firms, not necessarily with an address on Wall Street, would step in and buy them out. Wall Street is much less important now than in the past, due to national and global financial competition.

$25 $20

Profit motives in business are clear, but governments have no profit motive and are able to collect taxes, print money, and borrow against future taxpayer money to pay their bills. Mortgage and other financial-market firms will wait to see what the government agencies do in the market and then generally do the opposite, playing against taxpayer money. The rules are changing with more government involvement, but competition will continue. The situation would be like the government making delivery of packages less than 5 pounds illegal except by the US Post Office.

The present financial problems would disappear quickly if the government let the markets operate and let inefficient firms go bankrupt. The irony is that the government is stepping in to solve the problems it created. The solution might "work," but the underlying disincentives in the mortgage and insurance markets will persist. Increased government meddling in the financial markets will only make the financial problems linger.

Henry Thompson teaches economics at Auburn University. Comment on the blog.

Government Intervention Is Responsible for the Crisis

2008-10-23T19:46:00.000-04:00

The Myth that Laissez Faire Is Responsible for Our Present Crisis

Daily Article by George Reisman | Posted on 10/23/2008

The news media are in the process of creating a great new historical myth. This is the myth that our present financial crisis is the result of economic freedom and laissez-faire capitalism.
The attempt to place the blame on laissez faire is readily confirmed by a Google search under the terms "crisis + laissez faire." On the first page of the results that come up, or in the web entries to which those results refer, statements of the following kind appear:

"The mortgage crisis is laissez-faire gone wrong."
"Sarkozy [Nicolas Sarkozy, the President of France] said 'laissez-faire' economics, 'self-regulation' and the view that 'the all-powerful market' always knows best are finished."
"'America's laissez-faire ideology, as practiced during the subprime crisis, was as simplistic as it was dangerous,' chipped in Peer Steinbrück, the German finance minister."
"Paulson brings laissez-faire approach on financial crisis…."
"It's au revoir to the days of laissez faire."[1]

Recent articles in The New York Times provide further confirmation. Thus, one article declares, "The United States has a culture that celebrates laissez-faire capitalism as the economic ideal…."[2] Another article tells us, "For 30 years, the nation's political system has been tilted in favor of business deregulation and against new rules."[3] In a third article, a pair of reporters assert, "Since 1997, Mr. Brown [the British Prime Minister] has been a powerful voice behind the Labor Party's embrace of an American-style economic philosophy that was light on regulation. The laissez-faire approach encouraged the country's banks to expand internationally and chase returns in areas far afield of their core mission of attracting deposits."[4] Thus even Great Britain is described as having a "laissez-faire approach."

The mentality displayed in these statements is so completely and utterly at odds with the actual meaning of laissez faire that it would be capable of describing the economic policy of the old Soviet Union as one of laissez faire in its last decades. By its logic, that is how it would have to describe the policy of Brezhnev and his successors of allowing workers on collective farms to cultivate plots of land of up to one acre in size on their own account and sell the produce in farmers' markets in Soviet cities. According to the logic of the media, that too would be "laissez faire" — at least compared to the time of Stalin.

Laissez-faire capitalism has a definite meaning, which is totally ignored, contradicted, and downright defiled by such statements as those quoted above. Laissez-faire capitalism is a politico-economic system based on private ownership of the means of production and in which the powers of the state are limited to the protection of the individual's rights against the initiation of physical force. This protection applies to the initiation of physical force by other private individuals, by foreign governments, and, most importantly, by the individual's own government. This last is accomplished by such means as a written constitution, a system of division of powers and checks and balances, an explicit bill of rights, and eternal vigilance on the part of a citizenry with the right to keep and bear arms. Under laissez-faire capitalism, the state consists essentially just of a police force, law courts, and a national defense establishment, which deter and combat those who initiate the use of physical force. And nothing more.

The utter absurdity of statements claiming that the present political-economic environment of the United States in some sense represents laissez-faire capitalism becomes as glaringly obvious as anything can be when one keeps in mind the extremely limited role of government under laissez-faire and then considers the following facts about the present-day United States:

Government spending in the United States currently equals more than forty percent of national income, i.e., the sum of all wages and salaries and profits and interest earned in the country. This is without counting any of the massive off-budget spending such as that on account of the government enterprises Fannie Mae and Freddie Mac. Nor does it count any of the recent spending on assorted "bailouts." What this means is that substantially more than forty dollars of every one hundred dollars of output are appropriated by the government against the will of the individual citizens who produce that output. The money and the goods involved are turned over to the government only because the individual citizens wish to stay out of jail. Their freedom to dispose of their own incomes and output is thus violated on a colossal scale. In contrast, under laissez-faire capitalism, government spending would be on such a modest scale that a mere revenue tariff might be sufficient to support it. The corporate and individual income taxes, inheritance and capital gains taxes, and social security and Medicare taxes would not exist.
There are presently fifteen federal cabinet departments, nine of which exist for the very purpose of respectively interfering with housing, transportation, healthcare, education, energy, mining, agriculture, labor, and commerce, and virtually all of which nowadays routinely ride roughshod over one or more important aspects of the economic freedom of the individual. Under laissez-faire capitalism, eleven of the fifteen cabinet departments would cease to exist and only the departments of justice, defense, state, and treasury would remain. Within those departments, moreover, further reductions would be made, such as the abolition of the IRS in the Treasury Department and the Antitrust Division in the Department of Justice.
The economic interference of today's cabinet departments is reinforced and amplified by more than one hundred federal agencies and commissions, the most well known of which include, besides the IRS, the FRB and FDIC, the FBI and CIA, the EPA, FDA, SEC, CFTC, NLRB, FTC, FCC, FERC, FEMA, FAA, CAA, INS, OHSA, CPSC, NHTSA, EEOC, BATF, DEA, NIH, and NASA. Under laissez-faire capitalism, all such agencies and commissions would be done away with, with the exception of the FBI, which would be reduced to the legitimate functions of counterespionage and combating crimes against person or property that take place across state lines.
To complete this catalog of government interference and its trampling of any vestige of laissez faire, as of the end of 2007, the last full year for which data are available, the Federal Register contained fully seventy-three thousand pages of detailed government regulations. This is an increase of more than ten thousand pages since 1978, the very years during which our system, according to one of The New York Times articles quoted above, has been "tilted in favor of business deregulation and against new rules." Under laissez-faire capitalism, there would be no Federal Register. The activities of the remaining government departments and their subdivisions would be controlled exclusively by duly enacted legislation, not the rule-making of unelected government officials.
And, of course, to all of this must be added the further massive apparatus of laws, departments, agencies, and regulations at the state and local level. Under laissez-faire capitalism, these too for the most part would be completely abolished and what remained would reflect the same kind of radical reductions in the size and scope of government activity as those carried out on the federal level.

What this brief account has shown is that the politico-economic system of the United States today is so far removed from laissez-faire capitalism that it is closer to the system of a police state. The ability of the media to ignore all of the massive government interference that exists today and to characterize our present economic system as one of laissez faire and economic freedom marks it as, if not profoundly dishonest, then as nothing less than delusional.

Government Intervention Actually Responsible for the Crisis

Beyond all this is the further fact that the actual responsibility for our financial crisis lies precisely with massive government intervention, above all the intervention of the Federal Reserve System in attempting to create capital out of thin air, in the belief that the mere creation of money and its being made available in the loan market is a substitute for capital created by producing and saving. This is a policy it has pursued since its founding, but with exceptional vigor since 2001, in its efforts to overcome the collapse of the stock market bubble whose creation it had previously inspired.

The Federal Reserve and other portions of the government pursue the policy of money and credit creation in everything they do that encourages and protects private banks in the attempt to cheat reality by making it appear that one can keep one's money and lend it out too, both at the same time. This duplicity occurs when individuals or business firms deposit cash in banks, which they can continue to use to make purchases and pay bills by means of writing checks rather than using currency. To the extent that the banks are then enabled and encouraged to lend out the funds that have been deposited in this way (usually by the creation of new and additional checking deposits rather than the lending of currency), they are engaged in the creation of new and additional money. The depositors continue to have their money and borrowers now have the bulk of the funds deposited. In recent years, the Federal Reserve has so encouraged this process, that checking deposits have been created equal to fifty times the actual cash reserves of the banks, a situation more than ripe for implosion.
All of this new and additional money entering the loan market is fundamentally fictitious capital, in that it does not represent new and additional capital goods in the economic system, but rather a mere transfer of parts of the existing supply of capital goods into different hands, for use in different, less efficient, and often flagrantly wasteful ways. The present housing crisis is perhaps the most glaring example of this in all of history.

"Laissez-faire capitalism has a definite meaning, which is totally ignored, contradicted, and downright defiled by such statements…"

Perhaps as much as a trillion-and-a-half dollars or more of new and additional checkbook-money capital was channeled into the housing market as the result of the artificially low interest rates caused by the presence of an even larger overall amount of new and additional money in the loan market. Because of the long-term nature of its financing, housing is especially susceptible to the effect of lower interest rates, which can serve sharply to reduce monthly mortgage payments and in this way correspondingly increase the demand for housing and for the mortgage loans needed to finance it.

Over a period of years, the result was a huge increase in the production and purchase of new homes, rapidly rising home prices, and a further spiraling increase in the production and purchase of new homes in the expectation of a continuing rise in their prices.

To gauge the scale of its responsibility, in the period of time just since 2001, the Federal Reserve caused an increase in the supply of checkbook-money capital of more than 70 percent of the cumulative total amount it had created in the whole of the previous 88 years of its existence — that is, almost 2 trillion dollars.[5] This was the increase in the amount by which the checking deposits of the banks exceeded the banks' reserves of actual money, that is, the money they have available to pay depositors who want cash. The Federal Reserve caused this increase in illusory capital by means of creating whatever new and additional bank reserves were necessary to achieve a federal funds interest rate — that is, the rate of interest paid by banks on the lending and borrowing of reserves — that was far below the rate of interest dictated by the market. For the three years 2001–2004, the Federal Reserve drove the federal funds rate below 2 percent and, from July of 2003 to June of 2004, drove it even further down to approximately 1 percent.

The Federal Reserve also made it possible for banks to operate with a far lower percentage of reserves than ever before. Whereas in a free market, banks would hold gold reserves equal to their checking deposits — or at the very least to a substantial proportion of their checking deposits[6] — the Federal Reserve in recent years contrived to make it possible for them to operate with irredeemable fiat-money reserves of less than 2 percent.

The Federal Reserve drove down the federal funds rate and brought about the vast increase in the supply of illusory capital for the purpose of driving down all market interest rates. The additional illusory capital could find borrowers only at lower interest rates. The Federal Reserve's goal was to bring about interest rates so low that they could not compensate even for the rise in prices. It deliberately sought to achieve a negative real rate of interest on capital, that is, a rate below the rate at which prices rise. This means that a lender, after receiving the interest due him for a year, has less purchasing power than he had the year before, when he had only his principal.

In doing this, the Federal Reserve's ultimate purpose was to stimulate both investment and consumer spending. It wanted the cost of obtaining capital to be minimal so that it would be invested on the greatest possible scale and for people to regard the holding of money as a losing proposition, which would stimulate them to spend it faster. More spending, ever more spending was its concern, in the belief that that is what is required to avoid large-scale unemployment.

As matters have turned out, the Federal Reserve got its wish for a negative real rate of interest, but to an extent far beyond what it wished. It wished for a negative real rate of return of perhaps 1 to 2 percent. What it achieved in the housing market was a negative real rate of return measured by the loss of a major portion of the capital invested. In the words of The New York Times, "In the year since the crisis began, the world's financial institutions have written down around $500 billion worth of mortgage-backed securities. Unless something is done to stem the rapid decline of housing values, these institutions are likely to write down an additional $1 trillion to $1.5 trillion."[7]

This vast loss of capital in the housing debacle is what is responsible for the inability of banks to make loans to many businesses to which they normally could and would lend. The reason they cannot now do so is that the funds and the real wealth that have been lost no longer exist and thus cannot be lent to anyone. The Federal Reserve's policy of credit expansion based on the creation of new and additional checkbook money has thus served to give capital to unworthy borrowers who never should have had it in the first place and to deprive other, far more credit worthy borrowers of the capital they need to stay in businesses. Its policy has been one of redistribution and destruction.

The capital it has caused to be malinvested and lost in housing is capital that is now unavailable for such firms as Wickes Furniture, Linens 'N Things, Levitz Furniture, Mervyns, and innumerable others, who have had to go bankrupt because they could not obtain the loans they needed to stay in business. And, of course, among the foremost victims have been major banks themselves. The losses they have suffered have wiped out their capital and put them out of business. And the list of casualties will certainly grow.

Any discussion of the housing debacle would be incomplete if it did not include mention of the systematic consumption of home equity encouraged for several years by the media and an ignorant economics profession. Consistent with the teachings of Keynesianism that consumer spending is the foundation of prosperity, they regarded the rise in home prices as a powerful means for stimulating such spending. In increasing homeowners' equity, they held, it enabled homeowners to borrow money to finance additional consumption and thus keep the economy operating at a high level. As matters have turned out, such consumption has served to saddle many homeowners with mortgages that are now greater than the value of their homes, which would not have been the case had those mortgages not been enlarged to finance additional consumption. This consumption is the cause of a further loss of capital over and above the capital lost in malinvestment.

A discussion of the housing debacle would also not be complete if it did not mention the role of government guarantees of many mortgage loans. If the government guarantees the principal and interest on a loan, there is no reason why a lender should care about the qualifications of a borrower. He will not lose by making the loan, however bad it may turn out to be.

A substantial number of mortgage loans carried such guarantees. For example, a New York Times article describes the Department of Housing and Urban Development as "an agency that greased the mortgage wheel for first-time buyers by insuring billions of dollars in loans." The article describes how HUD progressively reduced its lending standards: "families no longer had to prove they had five years of stable income; three years sufficed… lenders were allowed to hire their own appraisers rather than rely on a government-selected panel … lenders no longer had to interview most government-insured borrowers face to face or maintain physical branch offices," because the government's approval for granting mortgage insurance had become automatic.

The Times' article goes on to describe how "Lenders," such as Countrywide Financial, which was among the largest and most prominent, "sprang up to serve those whose poor credit history made them ineligible for lower-interest 'prime' loans." It notes the fact that "Countrywide signed a government pledge to use 'proactive creative efforts' to extend homeownership to minorities and low-income Americans."[8] "Proactive creative efforts" is a good description of what lenders did in offering such bizarre types of mortgages as those requiring the payment of "interest only," and then allowing the avoidance even of the payment of interest by adding it to the amount of outstanding principal. (Such mortgages suited the needs of homebuyers whose reason for buying was to be able to sell as soon as home prices rose sufficiently further.)

Just as vast numbers of houses were purchased based on an unfounded belief in an endless rise in their prices, so too vast numbers of complex financial derivatives were sold based on an unfounded belief that the Federal Reserve System actually had the power it claimed to have of making depressions impossible — a power which the media and most of the economics profession repeatedly affirmed.

Derivatives have received such a bad press that it is necessary to point out that the insurance policy on a home is a derivative. And many of the derivatives that were sold and which are now creating problems of insolvency and bankruptcy, namely, "credit default swaps (CDSs)," were insurance policies in one form or another. Their flaw was that unlike ordinary homeowners' insurance, they did not have a sufficient list of exclusions.

Homeowners' policies make exclusions for such things as damage caused by war and, in many cases, depending on the special risks of the local area, earthquakes and hurricanes. In the same way, the more complex derivatives should have made an exclusion for losses resulting from financial collapse brought on by Federal Reserve–sponsored massive credit expansion. (If it is impossible actually to write such an exclusion, because many of the losses may occur before the nature of the cause becomes evident, then such derivatives should not be written and the market will no longer write them because of the unacceptable risks they entail.) But decades of brainwashing by the government, the media, and the educational system had convinced almost everyone that such collapse was no longer possible.

Belief in the impossibility of depressions played the same role in the creation and sale of "collateralized debt obligations (CDOs)." Here disparate home mortgages were bundled together and securities were issued against them. In many cases, large buyers bundled together collections of such securities and issued further securities against those securities. As more and more homeowners have defaulted on their loans, the result has been that no one is able directly to judge the value of these securities. To do so, it will be necessary to disentangle them down to the level of the underlying individual mortgages. Such tangles of securities could never have been sold in a market not overwhelmed by the propaganda that depressions are impossible under the government's management of the financial system.

Finally, a discussion of the housing debacle would not be complete if it did not include mention of forms of virtual extortion that served to encourage loans to unworthy borrowers. Thus, the online encyclopedia Wikipedia writes,

The Community Reinvestment Act [CRA] … is a United States federal law designed to encourage commercial banks and savings associations to meet the needs of borrowers in all segments of their communities, including low- and moderate-income neighborhoods … CRA regulations give community groups the right to comment or protest about banks' non-compliance with CRA. Such comments could help or hinder banks' planned expansions.

The meaning of these words is that the Community Reinvestment Act gives the power to "community groups," to determine in an important respect the financial success or failure of a bank. Only if they are satisfied that the bank is making sufficient loans to borrowers to whom it would otherwise choose not to lend, will it be permitted to succeed. The most prominent such community group is ACORN.

Part and parcel of the environment that has made an act such as the CRA possible, is threats of slander against banks for being "racist" if they choose not to make loans to people who are poor credit risks and also happen to belong to this or that minority group. The threats of slander go hand in glove with intimidation from various government agencies that exercise discretionary power over the banks and are in a position to harm them if they do not comply with the agencies' wishes. The same points apply to mortgage lenders other than banks.

What this extensive analysis of the actual causes of our financial crisis has shown is that it is government intervention, not a free market or laissez-faire capitalism, that is responsible in every essential respect.

The Laissez-Faire Myth and the Marxism of the Media

The myth that laissez faire exists in the present-day United States and is responsible for our current economic crisis is promulgated by people who know practically nothing whatever of sound, rational economic theory or the actual nature of laissez-faire capitalism. They espouse it despite, or rather because of, their education at the leading colleges and universities of the country. When it comes to matters of economics, their education has steeped them entirely in the thoroughly wrong and pernicious doctrines of Marx and Keynes. In claiming to see the existence of laissez faire in the midst of such massive government interference as to constitute the very opposite of laissez faire, they are attempting to rewrite reality in order to make it conform with their Marxist preconceptions and view of the world.

"Decades of brainwashing by the government, the media, and the educational system … convinced almost everyone that such collapse was no longer possible."

They absorb the doctrines of Marx more in history, philosophy, sociology, and literature classes than in economics classes. The economics classes, while usually not Marxist themselves, offer only highly insufficient rebuttal of the Marxist doctrines and devote almost all of their time to espousing Keynesianism and other, less-well-known anticapitalistic doctrines, such as the doctrine of pure and perfect competition.
Very few of the professors and their students have read so much as a single page of the writings of Ludwig von Mises, who is the preeminent theorist of capitalism and knowledge of whose writings is essential to its understanding. Almost all of them are thus essentially ignorant of sound economics.

When I refer to the educational system and the media as Marxist, I do not intend to imply that its members favor any kind of forcible overthrow of the United States government or are necessarily even advocates of socialism. What I mean is that they are Marxists insofar as they accept Marx's views concerning the nature and operation of laissez-faire capitalism.

They accept the Marxian doctrine that in the absence of government intervention, the self-interest, the profit motive — the "unbridled greed" — of businessmen and capitalists would serve to drive wage rates to minimum subsistence while it extended the hours of work to the maximum humanly endurable, imposed horrifying working conditions, and drove small children to work in factories and mines. They point to the miserably low standard of living and terrible conditions of wage earners in the early years of capitalism, especially in Great Britain, and believe that that proves their case. They go on to argue that only government intervention in the form of pro-union and minimum-wage legislation, maximum-hours laws, the legal prohibition of child labor, and government mandates concerning working conditions, served to improve the wage earner's lot. They believe that repeal of this legislation would bring about a return to the miserable economic conditions of the early 19th century.

They view the profits and interest of businessmen and capitalists as unearned, undeserved gains, wrung from wage earners — the alleged true producers — by the equivalent of physical force, and hence regard the wage earners as being in the position of virtual slaves ("wage slaves") and the capitalist "exploiters" as being in the position of virtual slave owners. Closely connected with this, they regard taxing the businessmen and capitalists and using the proceeds for the benefit of wage earners, in such forms as social security, socialized medicine, public education, and public housing, as a policy that serves merely to return to the wage earners some portion of the loot allegedly stolen from them in the process of "exploitation."

In full agreement with Marx and his doctrine that under laissez-faire capitalism the capitalists expropriate all of the wage earner's production above what is necessary for minimum subsistence, they assume that the government's intervention harms no one but the immoral businessmen and capitalists, never the wage earners. Thus not only the taxes to pay for social programs but also the higher wages imposed by pro-union and minimum-wage legislation are assumed simply to come out of profits, with no negative effect whatever on wage earners, such as unemployment. Likewise for the effect of government-imposed shorter hours, improved working conditions, and the abolition of child labor: the resulting higher costs are assumed simply to come out of the capitalists' "surplus value," never out of the standard of living of wage earners themselves.

This is the mindset of the whole of the left and in particular of the members of the educational system and media. It is a view of the profit motive and the pursuit of material self-interest as inherently lethal if not forcibly countered and rigidly controlled by government intervention. As stated, it is a view that sees the role of businessmen and capitalists as comparable to that of slave owners, despite the fact that businessmen and capitalists do not and cannot employ guns, whips, or chains to find and keep their workers but only the offer of better wages and conditions than those workers can find elsewhere.

Not surprisingly, the educational system and media share the view of Marx that laissez-faire capitalism is an "anarchy of production," in which the businessmen and capitalists run about like chickens without heads. In their view, rationality, order, and planning emanate from the government, not from the participants in the market.

As I say, this, and more like it, is the intellectual framework of the great majority of today's professors and of several generations of their predecessors. It is equally the intellectual framework of their students, who have dutifully absorbed their misguided teachings and some of whom have gone on to become the reporters and editors of such publications as The New York Times, The Washington Post, Newsweek, Time, and the overwhelming majority of all other newspapers and news magazines. It is the intellectual framework of their students who are now the commentators and editors of practically all of the major television networks, such as CBS, NBC, ABC, and CNN.[9] And it is this intellectual framework within which the media now attempts to understand and report on our financial crisis.

In their view, laissez-faire capitalism and economic freedom are a formula for injustice and chaos, while government is the voice and agent of justice and rationality in economic affairs. So firmly do they hold this belief, that when they see what they think is evidence of large-scale injustice and chaos in the economic system, such as has existed in the present financial crisis, they automatically presume that it is the result of the pursuit of self-interest and the economic freedom that makes that pursuit possible. Given this fundamental attitude, the principle that guides contemporary journalists so-called is that their job is to find the businessmen and capitalists who are responsible for the evil and the government officials who set them free to commit it, and, finally, to identify and support the policies of government intervention and control that will allegedly eliminate the evil and prevent its recurrence in the future.

Their fear and hatred of economic freedom and laissez-faire capitalism, and their need to be able to denounce it as the cause of all economic evil, is so great that they pretend to themselves and to their audiences that it exists in today's world, in which it clearly does not exist even remotely. By making the claim that laissez faire exists and is what is responsible for the problem, they are able to turn the full force of their hatred for actual economic freedom and laissez-faire capitalism against each and every sliver of economic freedom that somehow manages to exist and which they decide to target. That sliver, they project, is part and parcel of the starvation of the workers in the inhuman exploitation of labor that, in their ignorance, they take for granted is imposed by capitalists under laissez faire. Their brainwashed audience — as much the product of the contemporary educational system as they themselves — then quickly follows suit and obliges their efforts to arouse hatred.

The result is summed up in words such as these, which appeared in one of the same New York Times articles I quoted earlier:

"We now have a collective anger, disgust, over our whole financial system and it's obvious we're going to get a regulatory backlash…" [with] a spillover effect to other industries because voters have the perception that "big companies are animals and they need to be put in their cages."[10]

In this way the enemies of capitalism and economic freedom are able to proceed in their campaign of economic destruction and devastation. They use the accusation of "laissez faire" as a kind of ratchet for increasing the government's power. For example, in the early 1930s they accused President Hoover of following a policy of laissez faire, even as he intervened in the economic system to prevent the fall in wage rates that was essential to stop a reduced demand for labor from resulting in mass unemployment. On the basis of the mass unemployment that then resulted from Hoover's intervention, which they succeeded in portraying as "laissez faire," they deceived the country into supporting the further massive interventions of the New Deal.

$95 $80

"The enemies of capitalism and economic freedom … use the accusation of 'laissez faire' as a kind of ratchet for increasing the government's power."

Today, they continue to play the same game. Always it is laissez faire that they denounce, and whose alleged failures they claim need to be overcome with yet more government regulations and controls. Today, the massive interventions not only of the New Deal, but also of the Fair Deal, the New Frontier, the Great Society, and of all the administrations since, have been added to the very major interventions that existed even in the 1920s and to which Hoover very substantially added. And yet we still allegedly have laissez faire. It seems that so long as anyone manages to move or even breathe without being under the control of the government, laissez faire allegedly continues to exist, which serves to make necessary yet still more government controls.

The logical stopping point of this process is that one day everyone will end up being shackled to a wall, or at the very least being compelled to do something comparable to living in a zip code that matches his social security number. Then the government will know who everyone is, where he is, and that he can do nothing whatever without its approval and permission. And then the world will be safe from anyone attempting to do anything that benefits him and thereby allegedly harms others. At that point, the world will enjoy all the prosperity that comes from total paralysis.

George Reisman, Ph.D. is the author of Capitalism: A Treatise on Economics. (A PDF replica of the complete book can be downloaded to the reader's hard drive simply by clicking on the book’s title, immediately preceding, and then saving the file when it appears on the screen.) He is Pepperdine University Professor Emeritus of Economics. His web site is www.capitalism.net. His blog is at www.georgereisman.com/blog/. Comment on the Mises blog.
Copyright © 2008 by George Reisman. All rights reserved.

Notes

[1] See http://www.volunteertv.com/international/headlines/29762874.html.
[2] Steve Lohr, "Intervention Is Bold, but Has a Basis in History," October 14, 2008, p. A14.
[3] Jackie Calmes, "Both Sides of the Aisle See More Regulation," October 14, 2008, p. A15.
[4] Landon Thomas Jr. and Julia Werdigier, "Britain Takes a Different Route to Rescue Its Banks," October 9, 2007, p. B7.
[5] I arrive at these figures by calculating total checking deposits in January of 2001 and in August of 2008 as the sum of those contained in M1, the "sweep" accounts compiled by the Federal Reserve Bank of St. Louis, and money market mutual fund deposits, both retail and institutional. From these respective totals I subtract total bank reserves as of the same dates. I then subtract the result for 2001 from that for 2008 and divide the difference by the sum calculated for 2001.
[6] If the creation of checkbook money in excess of currency holdings is in fact an attempt at cheating, as I described it earlier, then it follows that a free market would actually require a 100 percent reserve.
[7] Joe Nocera, "Shouldn't We Rescue Housing?" October 18, 2008, p. B1.
[8] David Streitfeld and Gretchen Morgenson, "The Reckoning, Building Flawed American Dreams," October 19, 2008, p. A26.
[9] For a comprehensive refutation of all aspects of this intellectual framework, see George Reisman, Capitalism: A Treatise on Economics (Ottawa, Illinois: Jameson Books, 1996), chapters 11, 14, and passim.
[10] Jackie Calmes, loc. cit.

Thanks to the Government, We're Headed Toward Socialism!

2008-10-22T18:43:00.000-04:00

A Move towards Market Socialism

Daily Article by D.W. MacKenzie | Posted on 10/16/2008

"They want people to play market as children play war, railroad, or school. They do not comprehend how such childish play differs from the real thing it tries to imitate." – Ludwig von Mises

The recent financial crisis has renewed interest in old issues. The Bush administration has announced plans to buy $85 billion in preferred stock in what are (for the time being) private financial institutions, like Bank of America, J.P. Morgan, Wells Fargo, and Morgan Stanley. The total commitment by the Treasury is set at $250 billion. While this move by the Treasury Department into the financial industry is unique in American history, it has precedents elsewhere, and has been debated many times.
Karl Marx proposed "centralization of credit in the banks of the state, by means of a national bank with state capital and an exclusive monopoly." Years later, so-called "market socialists" like Oscar Lange, Abba Lerner, and H.D. Dickinson proposed state control over credit and financial capital. While these market socialists accepted trade and the use of money with consumer goods, markets for capital goods would be simulated and markets for financial capital would be wholly replaced by central planning. Capital investment would therefore be determined by state officials, rather than by competition for funds in financial markets. Lange was particularly clear about how the state would determine the overall rate and pattern of capital investment. State officials would set the overall rate of capital accumulation, instead of interest rates. State officials would also determine the pattern of investment, instead of profit-seeking capitalists and entrepreneurs.
Ludwig von Mises and Friedrich Hayek defended capitalism from its Marxian and market-socialist enemies. Mises attributed special significance to financial markets and private financial institutions. After all, it is financial markets that determine the rate and pattern of future capital investment in capitalism.[1] Since socialism is defined by communal control of capital, this system requires state control of investment and finance. Socialism therefore means replacing private dividends with social dividends and interest rates with edicts. All private speculation and credit must be prohibited if capital is truly to become communal property. Capitalism works because it eliminates inept managers of production automatically through bankruptcy, while extending greater industrial control to competent capitalists.
The elimination of markets for capital goods and financial capital introduces arbitrary and political forces into the determination of capital investment. In capitalism, money prices direct capital investment. Socialist officials necessarily lack money prices relating to capital goods because the markets that form these prices are incompatible with socialist aims and ideals. Socialist officials will not determine investment by rational calculations in terms of money, but will be guided by political expediency.
The collapse of the Soviet Union was seen by many people as a final verdict on socialism as an economic system. Whatever one might have thought about socialist ideals, the system was itself seen as unworkable. Yet, in only fifteen years, we have come to a point where a Lange-type system is close to being implemented. Of course, the federal government already holds strong regulatory powers over financial institutions. The regulation of American finance introduces an element of politics in financial markets. However, federal regulation of financial markets puts the voting public in the position of an active stakeholder in financial markets. With limited government and laissez faire, voters are passive stakeholders in financial markets. To put it simply, regulation changes the role but not the position of voters and interest groups in these markets.
The purchase of preferred stock by the federal government alters the position of the general citizenry regarding financial institutions. If implemented, this plan will move voting citizens from the position of active stakeholders to that of actual shareholders. It is not yet clear if the federal government will be an active or silent partner in the aforementioned financial institutions.[2] But, given the historical record, it seems highly unlikely that the federal government would gain a $250 billion interest in these institutions without asserting some influence over their operations. It appears likely that the American public will become active shareholders in some of the largest and most important financial institutions.
The Bush buyout plan is being implemented "to restore confidence in the battered banking system." The Bush approach is not, however, the only way. The Bank of East Asia has also faced difficulties. When depositors began to withdraw money en masse, Hong Kong tycoon Li Ka-Shing began buying up shares. This move by Li Ka-Shing helped restore depositor confidence, and rightly so. The Bank of East Asia is well capitalized and has minimal stakes in Lehman and AIG. Of course, Li Ka-Shing made this move for personal profit, but this did help stabilize the financial situation in the Far East. The Hong Kong approach stands in stark contrast to the Bush administration's new policy. Hong Kong is standing by its capitalist institutions by allowing private investors to deal with the current crisis, as well they should. Free-market capitalism transformed Hong Kong from a poverty-stricken victim of the Second World War to its current prosperous condition.
The Bush administration is going beyond its well-established record of intervention by implementing partial socialization of numerous financial firms. It does seem that we are at the crossroads. Will we move in the direction of Lange's market socialism, or will we opt for greater freedom and prosperity?

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"They want to abolish private control of the means of production, market exchange, market prices, and competition. But at the same time they want to organize the socialist utopia in such a way that people could act as if these things were still present." – Ludwig von Mises

The prospects for avoiding further losses of economic freedom seem poor. Presidential candidate Barack Obama has declared that the current financial crisis is the result of deregulation that has "shredded" necessary regulatory controls. While Obama's belief in recent deregulation of financial markets is factually incorrect, his call for greater regulation might actually be preferable to the Bush administration's plan for partial socialization of banking and finance.
The overall record of private capital markets is one of unprecedented economic success. Financial capitalism has raised living standards to previously unimagined heights. Government regulation of financial markets has caused problems and setbacks. In fact, our current crisis is due largely to the strictures of the Community Reinvestment Act and Federal Reserve interest-rate policy. But regulation has not reversed the general trend towards greater prosperity.
The track record of state-controlled capital investment through state-owned banking and financial institutions is equally clear, but opposite in its results. Socialized investment has failed so consistently that one must wonders why the Bush administration would claim that its buyout of banks will restore public confidence. Why would anyone have confidence in the federal government's ability to direct matters of finance and investment? One need only look at the federal deficit and the burden of unfunded entitlements like Social Security to gauge the ineptitude of federal financial management. We are at the crossroads, and, unfortunately, our future course is being charted by George W. Bush and Henry Paulson.

D.W. MacKenzie teaches economics at the Coast Guard Academy. The views expressed in this paper do not represent the official views of the Coast Guard. Comment on the blog.

Bibliography

Dickinson, H.D. The Economics of Socialism (1939).
Hayek, F.A. Collectivist Economic Planning (1935).
Lange, O.R. On the Economic Theory of Socialism (1938).
Lerner, A.P. The Economics of Control (1944).
MacKenzie, D.W. "Social Dividends, Bureaucratic Rules, and Entrepreneurial Discretion." Under final revision for The Eastern Economic Journal.
Marx, Karl. The Communist Manifesto (1848).
Mises, Ludwig von. Socialism, an Economic and Sociological Analysis (1922).
—— Human Action (1949).
Solomon, et al., "US to Buy Stakes in Nation's Largest Banks," The Wall Street Journal A1 (October 14, 2008).

Notes

[1] For example, see Mises 1922, p. 121; 1949, p. 257.
[2] Preferred stock generally does not come with the usual voting rights for stockholders. However, some preferred shares allow voting a few key issues, and preferred shares may be convertible into common shares.

The Gov't Caused the Financial Mess, NOT the Free Market!

2008-10-21T09:56:00.000-04:00

The Founding Father of Crony Capitalism

Daily Article by Thomas J. DiLorenzo | Posted on 10/21/2008

As soon as the federal government announced its trillion-dollar bailout (for starters) of Wall Street plutocrats, defenders of the bailout pulled out what they apparently believed was their secret weapon: the myth of Alexander Hamilton as the alleged inventor of American capitalism. Hamilton, they said, would approve of the bailout. Case closed. How could anyone dispute "the architect of the American economy"?

Forbes.com immediately published an article entitled "Alexander Hamilton versus Ron Paul" to make the point that libertarian critiques of the bailout should be dismissed, since Hamilton was such a great statesman compared to Congressman Paul and his supporters. The Wall Street Journal Online published a piece by business historian John Steele Gordon in which he argued that our real problem is that central banking is not centralized enough; called for a financial-market dictator/regulator; supported the bailout; and, most importantly, blamed the current economic crisis on … Thomas Jefferson! Jefferson opposed America's first central bank, Hamilton's bank of the United States, and was a hard-money advocate. It is this kind of libertarian, free-market thinking, said Gordon, that is the cause of the current crisis.

What all this frantic Hamilton idolatry demonstrates is how the myth of Alexander Hamilton is the ideological cornerstone of the American system of crony capitalism financed by a huge public debt and legalized counterfeiting through central banking. It is this system that is the real cause of the current economic crisis — contrary to the false proclamations issued by Forbes.com and the Wall Street Journal.

We live in "Hamilton's republic," as the writer Michael Lind has proudly stated. Americans may like to quote Jefferson, George Will once wrote, but we live in Hamilton's country. This is true, but it is not the blessing that people like Lind, Will, and others proclaim. Just the opposite is true, as I argue in my new book, Hamilton's Curse: How Jefferson's Archenemy Betrayed the American Revolution — And What It Means for America Today.

The Real Hamilton

Hamilton was the intellectual leader of the group of men at the time of the founding who wanted to import the system of British mercantilism and imperialistic government to America. As long as they were on the paying side of British mercantilism and imperialism, they opposed it and even fought a revolution against it. But being on the collecting side was altogether different. It's good to be the king, as Mel Brooks might say.

It was Hamilton who coined the phrase "The American System" to describe his economic policy of corporate welfare, protectionist tariffs, central banking, and a large public debt, even though his political descendants, the Whig Party of Henry Clay, popularized the slogan. He was not well schooled in the economics of his day, as is argued by such writers as John Steele Gordon. Unlike Jefferson, who had read, understood, and supported the free-market economic ideas of Adam Smith, David Ricardo, John Baptiste Say (whom Jefferson invited to join the faculty of the University of Virginia), Richard Cantillon, and Turgot (a bust of whom still sits in the entrance to Monticello), Hamilton either ignored or was completely unaware of these ideas. Instead, he repeated the mercantilist myths and superstitions that had been concocted by apologists for the British mercantilist state, such as Sir James Steuart.

Hamilton championed the cause of a large public debt — which he called "a public blessing" — not to establish the credit of the US government or to finance any particular public works projects but for the Machiavellian idea of tying the interests of the more affluent to the state: being government bondholders, they would, he believed, then support all of his grandiose plans for heavy taxation and a government much larger than what was called for in the Constitution. He was right. They, along with Wall Street investment bankers who have marketed the government's bonds, have always provided effective political support for bigger government and higher taxes. That is why Wall Street investment bankers were first in line for a bailout, administered by one of their fellow investment bankers, Treasury Secretary Paulson.

Hamilton argued for a large standing army not because he feared an invasion by France or England, but because he understood that the European monarchs had used such armies to intimidate their own citizens when it came to tax collection. Evidence of this is the fact that Hamilton personally led some 15,000 conscripts into Western Pennsylvania (with George Washington) to attempt to quell the famous Whiskey Rebellion. He was eventually put in charge of the entire expedition, and rounded up two dozen tax protesters, every one of whom he wanted to hang. They were all pardoned by George Washington, however, to Hamilton's everlasting regret.

In a publication entitled "A History of Central Banking in America" the Fed proudly labels Hamilton as its founding father, boasting that he even spoke just like a contemporary Fed chairman. The First Bank of the United States, which was opposed by Jefferson and Madison, created 72 percent inflation in its first five years of operation, as Murray Rothbard wrote in A History of Money and Banking in the United States. It was not rechartered in 1811, but was resurrected by Congress in 1817, after which it created America's first boom-and-bust cycle, which led to the Panic of 1819, the title of another of Rothbard's great works on American economic history.

After years of generating political corruption and economic instability, Hamilton's bank finally came to an end by the early 1840s, thanks to President Andrew Jackson. This led to the twenty-year "free banking" era. Hamiltonian central banking was resurrected once again in the 1860s with the National Currency Acts. This is an important reason why some historians have labeled the postwar decades as a period of "Hamiltonian hegemony."

When Anna Schwartz, Michael Bordo, and Peter Rappaport evaluated this precursor to the Fed in an academic publication, they concluded that it was characterized by "monetary and cyclical instability, four banking panics, frequent stock market crashes, and other financial disturbances" (see their paper in Claudia Goldin, ed., Strategic Factors in Nineteenth-Century Economic Growth). Naturally, the government's response to all of this economic panic and instability caused by centralized banking was to create an even more centralized banking system with the Federal Reserve Act.

Hamilton is perhaps best known among economists for his Report on Manufactures. In his 1905 biography of Hamilton, William Graham Sumner wrote that Hamilton's report advocated "the old system of mercantilism of the English school, turned around and adjusted to the situation of the United States." Thomas Jefferson also wrote that Hamilton's "schemes" for protectionism, corporate welfare, and central banking were "the means by which the corrupt British system of government could be introduced into the United States." They were right.

Hamilton's reputation as having had great expertise in economics and finance has been greatly exaggerated, wrote Sumner, who also wrote that Hamilton's economic thinking was marred by "confusion and contradiction" and that Hamilton was "befogged in the mists of mercantilism." Unfortunately for us, all of Hamilton's bad ideas "proved a welcome arsenal to the politicians" who succeeded him, noted Sumner.

At the constitutional convention Hamilton proposed a permanent president who would appoint all the governors of the states and would have veto power over all state legislation. His opponents correctly interpreted this as advocating a monarchy and, worse yet, a monarchy based on mercantilism. The reason for consolidating all political power first in the central government, and then in the hands of one man, the permanent president, was so that an American mercantilist empire could be centrally planned and controlled without any dissenters, such as tax protestors or free traders who resided in the various states. Hamilton (and his political heirs) understood that forced national uniformity is the only way in which such a central-planning scheme could work. The socialists of the 20th century understood this as well.

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Hamiltonian mercantilism is essentially the economic and political system that Americans have lived under for several generations now: a king-like president who rules through "executive orders" and disregards any and all constitutional constraints on his powers; state governments that are mere puppets of the central government; corporate welfare run amok, especially in light of the most recent outrage, the Wall Street Plutocrat Bailout Bill; a $10 trillion national debt ($70 trillion if one counts the government's unfunded liabilities); a perpetual boom-and-bust cycle caused by the Wizard of Oz–like central planners at the Fed; constant military aggression around the world that only seems to benefit defense contractors and other beneficiaries of the warfare state; and more than half of the population bribed with subsidies of every kind imaginable to support the never-ending growth of the state. This is Hamilton's curse on America — a curse that must be exorcized if there is to be any hope of resurrecting American freedom and prosperity.

Thomas DiLorenzo is professor of economics at Loyola College in Maryland and a member of the senior faculty of the Mises Institute. He is the author of The Real Lincoln, Lincoln Unmasked, How Capitalism Saved America, and, more recently, Hamilton's Curse. Comment on the blog.

Financial Crisis Solution: Gov't Should Do NOTHING!

2008-10-16T19:22:00.000-04:00

Good and Bad Credit

Daily Article by Frank Shostak | Posted on 10/16/2008

Did Chairman Bernanke learn the correct lesson from the Great Depression?

On Wednesday October 8 the Federal Reserve, European Central Bank, and four other central banks lowered interest rates in an emergency coordinated bid to ease the economic effects of the financial crisis.

The Fed, ECB, Bank of England, Bank of Canada, and Sweden's Riksbank each cut their benchmark rates by half a percentage point. Furthermore, China's central bank lowered its key one-year lending rate by 0.27 percentage points. According to a joint statement by the central banks,

The recent intensification of the financial crisis has augmented the downside risks to growth and thus has diminished further the upside risks to price stability. Some easing of global monetary conditions is therefore warranted.

The Fed's decision brought its benchmark rate to 1.5%. The ECB's main rate is now 3.75%; Canada's fell to 2.5%; the U.K.'s rate dropped to 4.5%; and Sweden's rate declined to 4.25%. China cut interest rates for the second time in three weeks, reducing the main rate to 6.93%. One day earlier the Reserve Bank of Australia had lowered its policy rate — the cash rate — by 1% to 6%.

Only a day earlier Federal Reserve Chairman Bernanke announced that the US central bank is ready to intervene in the commercial paper market. The Fed will now buy commercial paper issued by corporations — meaning the US central bank will make direct loans to corporations.

It seems that Bernanke is ready to push trillions of dollars to keep the monetary system alive.

Bernanke is of the view that a major reason for the Great Depression of 1930s was the failure of the US central bank to act swiftly to revive the paralyzed credit market. By "swift action," Bernanke means massive monetary pumping.

The Fed chairman continuously reminds us that at least he has learned the lesson of the Great Depression and will make sure that the error that the Fed made then will not be repeated again.

At the conference to honor Milton Friedman's ninetieth birthday, Bernanke apologized to Friedman on behalf of the Fed for not pumping enough money to prevent the Great Depression:

Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again.

(Milton Friedman and Anna Schwartz wrote that the key factor behind the Great Depression was the failure by the Fed to pump large doses of money.)

Central-bank policy makers have said that the key for economic growth is a smooth flow of credit. For them (in particular, for Bernanke) it is credit that provides the foundation for economic growth and raises individuals' living standards. From this perspective, it makes a lot of sense for the central bank to make sure that credit flows again.

Following the teachings of Friedman and Keynes, it is an almost-unanimous view among experts that if lenders are unwilling to lend, then it is the duty of the government and the central bank to keep the flow of lending going.

For instance, if in the commercial-paper market lenders are not there, then the Fed should step in and replace these lenders. The important thing, it is held, is that various businesses that rely on the commercial-paper market to keep their daily operations going should be able to secure the necessary funding.

Will the increase in money pumping by central banks unfreeze credit markets? Experts believe that this will do the trick. If the current dosage of pumping won't work, then the central bank must continue to push more money until credit markets start moving again, so it is believed.

It is true that credit is the key for economic growth. However, one must make a distinction between good credit and bad credit. It is good credit that makes real economic growth possible and thus improves people's lives and well-being. False credit, however, is an agent of economic destruction and leads to economic impoverishment.

Good Credit versus Bad Credit

There are two kinds of credit: that which would be offered in a market economy with sound money and banking (good credit); and that which is made possible only through a system of central banking, artificially low interest rates, and fractional reserves (bad credit).

Banks cannot expand good credit as such. All that they can do in reality is to facilitate the transfer of a given pool of savings from savers (lenders) to borrowers. To understand why, we must first understand how good credit comes to be and the function it serves.

Consider the case of a baker who bakes ten loaves of bread. Out of his stock of real wealth (ten loaves of bread), the baker consumes two loaves and saves eight. He lends his eight remaining loaves to the shoemaker in return for a pair of shoes in one week's time. Note that credit here is the transfer of "real stuff," i.e., eight saved loaves of bread from the baker to the shoemaker in exchange for a future pair of shoes.

Also, observe that the amount of real savings determines the amount of available credit. If the baker had saved only four loaves of bread, the amount of credit would have only been four loaves instead of eight.

Note that the saved loaves of bread provide support to the shoemaker, i.e., they sustain him while he is busy making shoes. This means that credit, by sustaining the shoemaker, gives rise to the production of shoes and therefore to the formation of more real wealth. This is a path to real economic growth.

Money and Credit

The introduction of money does not alter the essence of what credit is. Instead of lending his eight loaves of bread to the shoemaker, the baker can now exchange his saved eight loaves of bread for eight dollars and then lend those dollars to the shoemaker. With eight dollars, the shoemaker can secure either eight loaves of bread (or other goods) to support him while he is engaged in the making of shoes. The baker is supplying the shoemaker with the facility to access the pool of real savings, which among other things includes eight loaves of bread that the baker has produced. Note that without real savings, the lending of money is an exercise in futility.

Observe that money fulfills the role of a medium of exchange. Hence, when the baker exchanges his eight loaves for eight dollars, he retains his real savings by means of the eight dollars. The money in his possession will enable him, when he deems it necessary, to reclaim his eight loaves of bread or to secure any other goods and services. There is one provision here: that the flow of production of goods continues; without the existence of goods, the money in the baker's possession will be useless.

The existence of banks does not alter the essence of credit. Instead of the baker lending his money directly to the shoemaker, the baker lends his money to the bank, which in turn lends it to the shoemaker.

In the process, the baker earns interest for his loan while the bank earns a commission for facilitating the transfer of money between the baker and the shoemaker. The benefit that the shoemaker receives is that he can now secure real resources in order to be able to engage in his making of shoes.

Despite the apparent complexity that the banking system introduces, the act of credit remains the transfer of saved real stuff from lender to borrower. Without the increase in the pool of real savings, banks cannot create more credit. At the heart of the expansion of good credit by the banking system is an expansion of real savings.

Now, when the baker lends his eight dollars, we must remember that he has exchanged for these dollars eight saved loaves of bread. In other words, he has exchanged something for eight dollars. So when a bank lends those eight dollars to the shoemaker, the bank lends fully "backed-up" dollars so to speak.

False Credit Is an Agent of Economic Destruction

Trouble emerges however if, instead of lending fully backed-up money, a bank engages in fractional-reserve banking, the issuing of empty money, backed up by nothing.

When unbacked money is created, it masquerades as genuine money that is supposedly supported by real stuff. In reality, however, nothing has been saved. So when such money is issued, it cannot help the shoemaker, since the pieces of empty paper cannot support him in producing shoes — what he needs instead is bread. But, since the printed money masquerades as proper money, it can be used to "steal" bread from some other activities and thereby weaken those activities.

This is what the diversion of real wealth by means of money "out of thin air" is all about. If the extra eight loaves of bread aren't produced and saved, it is not possible to have more shoes without hurting some other activities — activities that are much higher on the priority lists of consumers as far as life and well-being are concerned. This in turn also means that unbacked credit cannot be an agent of economic growth.

Rather than facilitating the transfer of savings across the economy to wealth-generating activities, when banks issue unbacked credit they are in fact setting in motion a weakening of the process of wealth formation. It has to be realized that banks cannot relentlessly pursue unbacked lending without the existence of the central bank, which, by means of monetary pumping, makes sure that the expansion of unbacked credit doesn't cause banks to bankrupt each other.

We can thus conclude that, as long as the increase in lending is fully backed up by real savings, it must be regarded as good news, since it promotes the formation of real wealth. False credit, which is generated "out of thin air," is bad news: credit which is unbacked by real savings is an agent of economic destruction.

Fed and Treasury Actions Only Make Things Worse

Neither the Fed nor the Treasury is a wealth generator: they cannot generate real savings. This in turn means that all the pumping that the Fed has been doing recently cannot increase lending unless the pool of real savings is expanding. On the contrary, the more money the Fed and other central banks are pushing, the more they are diluting the pool of real savings.

Yet most commentators are of the view that, given the present fragile state of the financial system, the central bank and the government must intervene to prevent the collapse. But how can the government and the central bank help in this regard? How can the central bank or the government generate more real savings?

The only thing that the government and the central bank can do is to redistribute the real savings from other people and give it to banks. Now, if the pool of real savings is still expanding this can "work" — and lending might flow again — but the overall pool of real savings will weaken as a result of the transfer of real savings from the nonbanking sector to the banking sector. If, however, the pool of real savings is falling, then it will not be possible to increase the flow of lending.

Why Doing Nothing Is the Best Policy to Revive the Economy

Given the growing likelihood that the pool of real savings is in serious trouble, does this mean that the flow of credit will remain frozen? What can be done to unfreeze the flow is to allow the interest rate to find its own level.

With a weakening real economy, lenders will be willing to lend only at the interest rate that allows for higher risk and for the fact that less real savings is available, all other things being equal. At a much higher interest rate, the so-called financial crisis and the shortage of credit will vanish.

The problem then is not with the credit market as such but with the fact that the central banks are pushing massive amounts of money and trying to force interest rates artificially lower. This of course makes it even less attractive for lenders to enter the credit market. Hence the shortage (i.e., the credit crunch) is the result of the central bank not allowing interest rates to reflect the levels that are in line with the facts of reality.

Why then are authorities resisting market forces and allowing the crunch to persist?

Because if interest rates were allowed to be higher, many bubble activities would become unprofitable, and would cease.

Most of those in a position to influence policy are of the view that this would lead to a serious economic slump and therefore should not be allowed. Supporting bubble activities with easy money further impoverishes wealth generators and delays the prospects of a meaningful economic recovery. The pumping by the Fed will distort the interest-rate structure further and worsen the credit crunch. The best policy is for the Fed to do nothing as soon as possible. By doing nothing, the Fed will enable wealth generators to accumulate real savings. The policy of doing nothing will force various activities that add too little or nothing to the pool of real savings to disappear. This will make make the generation of wealth much more rewarding.

As time goes by, the expanding pool of real savings will work towards the lowering of interest rates. This in turn will provide a base for the further expansion of various wealth-generating activities. Therefore, the sooner the Fed stops tampering, the sooner an economic recovery will emerge.

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The Lesson They Refuse to Learn

If the pool of real savings is still growing, then doing nothing (and allowing the interest rate to reflect reality) will allow the recession to be short lived and economic recovery to emerge as fast as possible. (At a higher interest rate, various bubble activities will go belly up. As a result, more real savings will become available to wealth generators. This in turn will work towards the lowering of interest rates.)

We suggest that decades of reckless monetary policies by the Fed have severely depleted the pool of real savings. More of these same loose policies cannot make the current situation better. On the contrary, such policies only further delay the economic recovery.

By impoverishing wealth generators, the current policies of the government and the Fed run the risk of converting a short recession into a prolonged and severe slump.

Frank Shostak is an adjunct scholar of the Mises Institute and a frequent contributor to Mises.org. He is chief economist of M.F. Global. Comment on the blog.

Henry Hazlitt on the Bailout

2008-10-15T12:10:00.000-04:00

Daily Article by Scott A. Kjar | Posted on 10/15/2008

Treasury Secretary Henry Paulson needs to change his reading list. Instead of reading the balance sheets and income statements of the failing banking industry, he needs to read Henry Hazlitt's classic book Economics in One Lesson. It will cost Paulson far less than the $700 billion that he is spending on the bailout, and he might just learn a little economics in the process.

Hazlitt delivers his "one lesson" in chapter 1, and proceeds to spend the rest of the book giving examples. His lesson, based on the work of Frédéric Bastiat, is that "the art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups."

For example, in chapter 2, Hazlitt delivers the well-known "broken window fallacy" in which a hoodlum breaks a shopkeeper's window with a rock. The common folk see it as a tragedy, but an astute Washington bureaucrat could argue that it creates new jobs for glaziers. As Hazlitt points out, though, any resources that the shopkeeper spends on the new window would have been used elsewhere, perhaps for a new suit. So while the glazier gets new business, the tailor loses the same amount of business. There is no net benefit; in fact there is a net loss. Absent the hoodlum, the shopkeeper would have had both a window and a new suit; given the hoodlum, the shopkeeper has a window but no suit. Even though the damage was to the window, it is the suit that is lost to the shopkeeper and, hence, to society.

In chapter 6, entitled "Credit Diverts Production," Hazlitt discusses government lending policies, such as additional credit to farmers or business owners. However, he points out, the recipients of such programs are rarely the more-productive farmers and business owners. After all, the more-productive people are able to borrow their money from private lenders. It is only the less-productive individuals and firms, unable to get funds on the free market, that must turn to government.

For example, suppose that there is a farm for sale. A private lender would normally be willing to lend money to farmer A who has proven his abilities in the past, rather than to farmer B, who has demonstrated a lower level of productivity than has A. However, because government taxes citizens or borrows money itself in capital markets, private lenders have fewer funds available to lend to A. Instead, government lends the money to B on the grounds that B is underprivileged, in need of a hand, or some other politically based argument. The more productive borrower, A, loses out on the scarce land while the less productive borrower, B, gains the resources. Because the less-productive individual acquires the scarce resource, there will be less total production, and the entire society is worse off.

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Read by Jeff Riggenbach

Further, Hazlitt states, the government takes bigger risks with taxpayers' money than private lenders take with their own money. Private lenders who make bad loans will go bankrupt and be forced out of business. But when the government gets involved, it lends funds for riskier ventures since the bureaucrats who approve the loan face no personal recriminations — much less loss of profit — for error.

In other words, private lenders would take Action A while government lenders would take Action B, and Action B is the less-productive path. After all, there is no need for government to take Action A: it can be handled quite well in the free market.

So it is with the current rash of bailouts. Whatever the final price tag — $500 billion, $750 billion, $1 trillion, more — the fact is that government gets its money either from taxes, borrowing, or the printing press. It is hard to raise taxes by $1 trillion on short notice, and since there is a small hurdle that slows the government's ability to print the money,[1] we know that government will issue bonds. In other words, government will borrow the money from private capital markets.

As Hazlitt points out, though, the private capital markets (those that aren't bankrupt and standing in line for a bailout) would otherwise lend their funds to more-productive ventures. If private capital wants to lend directly to the failing banks, it is already capable of doing so. The fact that such private capital is not lending to the banks is a clear indication that the government's current bailout is contrary to free-market principles.

The argument that the government is somehow pumping new capital into the market is absurd. Government is actually borrowing the money from the capital markets that it is in turn injecting into the capital markets. There is no additional source of funding; there is only a diversion of funds from more-productive outlets to less-productive outlets, with government acting as the middleman.

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Treasury Secretary Henry Paulson needs to read this book.

So when Henry Paulson argues that it is necessary to pump money into credit markets to prevent them from freezing up, he doesn't bother to realize that the money he pumps into the credit markets is coming directly out of the very same credit markets. He is doing little more than rearranging the deck chairs on the Titanic; shuffling the money from one set of financial intermediaries to another does not increase either liquidity or solvency. It merely delays the problem for a few brief moments.

Even the failing banks pay lip service to their fiduciary responsibility, but any privately funded firm that took money from more-productive people to give it to less-productive people would soon go out of business. Only the government can violate Hazlitt's logic and survive, because only government can socialize its losses through the tax system.

Scott A. Kjar teaches economics at Baldwin-Wallace College. Comment on the blog.

Note

[1] The government issues bonds to private borrowers and then the Fed creates the new money to buy them, rather than the government directly printing the new money. It's a very small hurdle.

Article: Financial Crisis and Recession

2008-10-06T19:48:00.000-04:00

Daily Article by Jesus Huerta de Soto | Posted on 10/6/2008

The severe financial crisis and resulting worldwide economic recession we have been forecasting for years are finally unleashing their fury. In fact, the reckless policy of artificial credit expansion that central banks (led by the American Federal Reserve) have permitted and orchestrated over the last fifteen years could not have ended in any other way.

The expansionary cycle that has now come to a close was set in motion when the American economy emerged from its last recession in 1992 and the Federal Reserve embarked on a major artificial expansion of credit and investment, an expansion unbacked by a parallel increase in voluntary household saving. For many years, the money supply in the form of banknotes and deposits (M3) has grown at an average rate of over ten percent per year (which means that every six or seven years the total volume of money circulating in the world has doubled). The media of exchange originating from this severe fiduciary inflation have been placed on the market by the banking system as newly created loans granted at extremely low (and even negative in real terms) interest rates. The above fueled a speculative bubble in the shape of a substantial rise in the prices of capital goods, real-estate assets, and the securities that represent them and are exchanged on the stock market, where indexes soared.

Curiously, as in the "roaring" years prior to the Great Depression of 1929, the shock of monetary growth has not significantly influenced the prices of the subset of goods and services at the final-consumer level of the production structure (approximately only one third of all goods). The decade just past, like the 1920s, has seen a remarkable increase in productivity as a result of the introduction on a massive scale of new technologies and significant entrepreneurial innovations which, were it not for the "money and credit binge," would have given rise to a healthy and sustained reduction in the unit price of the goods and services all citizens consume. Moreover, the full incorporation of the economies of China and India into the globalized market has gradually raised the real productivity of consumer goods and services even further. The absence of a healthy "deflation" in the prices of consumer goods in a period of such considerable growth in productivity as that of recent years provides the main evidence that the monetary shock has seriously disturbed the economic process.

Economic theory teaches us that, unfortunately, artificial credit expansion and the (fiduciary) inflation of media of exchange offer no shortcut to stable and sustained economic development, no way of avoiding the necessary sacrifice and discipline behind all voluntary saving. (In fact, particularly in the United States, voluntary saving has not only failed to increase, but in some years has even fallen to a negative rate.)

Indeed, the artificial expansion of credit and money is never more than a short-term solution, and often not even that. In fact, today there is no doubt about the recessionary consequence that the monetary shock always has in the long run: newly created loans (of money citizens have not first saved) immediately provide entrepreneurs with purchasing power they use in overly ambitious investment projects (in recent years, especially in the building sector and real-estate development). In other words, entrepreneurs act as if citizens had increased their saving, when they have not actually done so.

Widespread discoordination in the economic system results: the financial bubble ("irrational exuberance") exerts a harmful effect on the real economy, and sooner or later the process reverses in the form of an economic recession, which marks the beginning of the painful and necessary readjustment. This readjustment invariably requires the reconversion of the entire real productive structure, which inflation has distorted.

The specific triggers of the end of the euphoric monetary "binge" and the beginning of the recessionary "hangover" are many, and they can vary from one cycle to another. In the current circumstances, the most obvious triggers have been the rise in the price of raw materials, particularly oil, the subprime mortgage crisis in the United States, and finally, the failure of important banking institutions when it became clear in the market that the value of their debts exceeded that of their assets (mortgage loans granted).

At present, numerous self-interested voices are demanding further reductions in interest rates and new injections of money, which permit those who desire it to complete their investment projects without suffering losses.

Nevertheless, this "flight into the future" would only temporarily postpone problems at the cost of making them far more serious later. The crisis has hit because the profits of capital-goods companies (especially in the building sector and in real-estate development) have disappeared due to the entrepreneurial errors provoked by cheap credit, and because the prices of consumer goods have begun to rise faster than those of capital goods.

At this point, an inevitable, painful readjustment begins, and in addition to a drop in production and an increase in unemployment, we are now seeing a very harmful rise in the prices of consumer goods (stagflation).

The most rigorous economic analysis and the coolest, most balanced interpretation of recent economic and financial events lead inexorably to the conclusion that central banks (which are in fact monetary central-planning agencies) cannot possibly succeed in finding the most advantageous monetary policy at every moment. This is exactly what became clear in the case of the failed attempts to plan the former Soviet economy from above.

To put it another way, the theorem of the economic impossibility of socialism, which the Austrian economists Ludwig von Mises and Friedrich A. Hayek discovered, is fully applicable to central banks in general, and to the Federal Reserve and (at one time) Alan Greenspan and (currently) Ben Bernanke in particular. According to this theorem, it is impossible to organize society, in terms of economics, based on coercive commands issued by a planning agency, since such a body can never obtain the information it needs to infuse its commands with a coordinating nature. Indeed, nothing is more dangerous than to indulge in the "fatal conceit" — to use Hayek's useful expression — of believing oneself omniscient or at least wise and powerful enough to be able to keep the most suitable monetary policy fine-tuned at all times. Hence, rather than soften the most violent ups and downs of the economic cycle, the Federal Reserve and, to a lesser extent, the European Central Bank, have most likely been their main architects and the culprits in their worsening.

Therefore, the dilemma facing Ben Bernanke and his Federal Reserve Board, as well as the other central banks (beginning with the European Central Bank), is not at all comfortable. For years they have shirked their fiduciary responsibility, and now they find themselves in a blind alley. They can either allow the recessionary process to begin now, and with it the healthy and painful readjustment, or they can procrastinate with a "hair of the dog" cure. With the latter, the chances of even more severe stagflation in the not-too-distant future increase exponentially. (This was precisely the error committed following the stock market crash of 1987, an error that led to the inflation at the end of the 1980s and concluded with the sharp recession of 1990-1992.)

Furthermore, the reintroduction of a cheap-credit policy at this stage could only hinder the necessary liquidation of unprofitable investments and company reconversion. It could even wind up prolonging the recession indefinitely, as occurred in the Japanese economy, which, after all possible interventions were tried, ceased to respond to any stimulus involving credit expansion or Keynesian methods.

It is in this context of "financial schizophrenia" that we must interpret the latest "shots in the dark" fired by the monetary authorities (who have two totally contradictory responsibilities: both to control inflation and to inject all the liquidity necessary into the financial system to prevent its collapse). Thus, one day the Fed rescues AIG, Bear Stearns, Fannie Mae, and Freddie Mac, and the next it allows Lehman Brothers to fail, under the amply justified pretext of "teaching a lesson" and refusing to fuel moral hazard. Finally, in light of the way events were unfolding, the US government announced a $700 billion plan to purchase illiquid (i.e., worthless) assets from the banking system. If the plan is financed by taxes (and not more inflation), it will mean a heavy tax burden on households, precisely when they are least able to bear it.

In comparison, the economies of the European Union are in a somewhat less poor state (if we do not consider the expansionary effect of the policy of deliberately depreciating the dollar, and the relatively greater European rigidities, particularly in the labor market, which tend to make recessions in Europe longer and more painful). The expansionary policy of the European Central Bank, though not free of grave errors, has been somewhat less irresponsible than that of the Federal Reserve. Furthermore, meeting the requirements for admission to the euro currency bloc (convergence) involved a healthful and significant rehabilitation of the chief European economies. Only a few countries on the periphery, like Ireland and especially Spain, engaged in considerable credit expansion from the time they initiated their processes of convergence.

The case of Spain is paradigmatic. The Spanish economy underwent an economic boom that was due, in part, to real causes (liberalizing structural reforms which originated with José María Aznar's administration). Nevertheless, the boom was also largely fueled by an artificial expansion of money and credit, which grew at a rate nearly three times the corresponding rates in France and Germany.

Spanish economic agents essentially interpreted the decrease in interest rates which resulted from the convergence process in the easy-money terms traditional in Spain: a greater availability of easy money and mass requests for loans from Spanish banks (mainly to finance real-estate speculation), loans which these banks have granted by creating the money ex nihilo while European central bankers looked on unperturbed. When faced with the rise in prices, the European Central Bank has remained faithful to its mandate and has decided not to lower interest rates despite the difficulties of those members of the Monetary Union which, like Spain, are now discovering that much of their investment in real estate was in error and are heading for a lengthy and painful reorganization of their real economy.

$50 $45

"The reckless policy of artificial credit expansion could not have ended in any other way."

Under these circumstances, the most appropriate policy would be to liberalize the economy at all levels (especially in the labor market) to permit the rapid reallocation of productive factors (particularly labor) to profitable sectors. Likewise, it is essential to reduce public spending and taxes, in order to increase the available income of heavily indebted economic agents who need to repay their loans as soon as possible.

Economic agents in general and companies in particular can only rehabilitate their finances by cutting costs (especially labor costs) and paying off loans. Essential to this aim are a very flexible labor market and a much more austere public sector. These factors are fundamental if the market is to reveal as quickly as possible the real value of the investment goods produced in error and thus lay the foundation for a healthy, sustained economic recovery in a future that, for the good of all, we hope is not too distant.

Jesús Huerta de Soto, professor of economics at Rey Juan Carlos University in Madrid, is Spain's leading Austrian economist. As an author, translator, publisher, and teacher, he also ranks among the world's most active ambassadors for classical liberalism. He is the author of Money, Bank Credit, and Economic Cycles. Comment on the blog.

Economic Depressions: Their Cause and Cure

2008-10-02T19:57:00.000-04:00

Daily Article by Murray N. Rothbard | Posted on 10/2/2008

[This essay was originally published as a minibook by the Constitutional Alliance of Lansing, Michigan, 1969.]

We live in a world of euphemism. Undertakers have become "morticians," press agents are now "public relations counsellors" and janitors have all been transformed into "superintendents." In every walk of life, plain facts have been wrapped in cloudy camouflage.

No less has this been true of economics. In the old days, we used to suffer nearly periodic economic crises, the sudden onset of which was called a "panic," and the lingering trough period after the panic was called "depression."

The most famous depression in modern times, of course, was the one that began in a typical financial panic in 1929 and lasted until the advent of World War II. After the disaster of 1929, economists and politicians resolved that this must never happen again. The easiest way of succeeding at this resolve was, simply to define "depressions" out of existence. From that point on, America was to suffer no further depressions. For when the next sharp depression came along, in 1937–38, the economists simply refused to use the dread name, and came up with a new, much softer-sounding word: "recession." From that point on, we have been through quite a few recessions, but not a single depression.

But pretty soon the word "recession" also became too harsh for the delicate sensibilities of the American public. It now seems that we had our last recession in 1957–58. For since then, we have only had "downturns," or, even better, "slowdowns," or "sidewise movements." So be of good cheer; from now on, depressions and even recessions have been outlawed by the semantic fiat of economists; from now on, the worst that can possibly happen to us are "slowdowns." Such are the wonders of the "New Economics."

For 30 years, our nation's economists have adopted the view of the business cycle held by the late British economist, John Maynard Keynes, who created the Keynesian, or the "New," Economics in his book, The General Theory of Employment, Interest, and Money, published in 1936. Beneath their diagrams, mathematics, and inchoate jargon, the attitude of Keynesians toward booms and bust is simplicity, even naivete, itself. If there is inflation, then the cause is supposed to be "excessive spending" on the part of the public; the alleged cure is for the government, the self-appointed stabilizer and regulator of the nation's economy, to step in and force people to spend less, "sopping up their excess purchasing power" through increased taxation. If there is a recession, on the other hand, this has been caused by insufficient private spending, and the cure now is for the government to increase its own spending, preferably through deficits, thereby adding to the nation's aggregate spending stream.

The idea that increased government spending or easy money is "good for business" and that budget cuts or harder money is "bad" permeates even the most conservative newspapers and magazines. These journals will also take for granted that it is the sacred task of the federal government to steer the economic system on the narrow road between the abysses of depression on the one hand and inflation on the other, for the free-market economy is supposed to be ever liable to succumb to one of these evils.

All current schools of economists have the same attitude. Note, for example, the viewpoint of Dr. Paul W. McCracken, the incoming chairman of President Nixon's Council of Economic Advisers. In an interview with the New York Times shortly after taking office [January 24, 1969], Dr. McCracken asserted that one of the major economic problems facing the new Administration is "how you cool down this inflationary economy without at the same time tripping off unacceptably high levels of unemployment. In other words, if the only thing we want to do is cool off the inflation, it could be done. But our social tolerances on unemployment are narrow." And again: "I think we have to feel our way along here. We don't really have much experience in trying to cool an economy in orderly fashion. We slammed on the brakes in 1957, but, of course, we got substantial slack in the economy."

Note the fundamental attitude of Dr. McCracken toward the economy — remarkable only in that it is shared by almost all economists of the present day. The economy is treated as a potentially workable, but always troublesome and recalcitrant patient, with a continual tendency to hive off into greater inflation or unemployment. The function of the government is to be the wise old manager and physician, ever watchful, ever tinkering to keep the economic patient in good working order. In any case, here the economic patient is clearly supposed to be the subject, and the government as "physician" the master.

It was not so long ago that this kind of attitude and policy was called "socialism"; but we live in a world of euphemism, and now we call it by far less harsh labels, such as "moderation" or "enlightened free enterprise." We live and learn.

What, then, are the causes of periodic depressions? Must we always remain agnostic about the causes of booms and busts? Is it really true that business cycles are rooted deep within the free-market economy, and that therefore some form of government planning is needed if we wish to keep the economy within some kind of stable bounds? Do booms and then busts just simply happen, or does one phase of the cycle flow logically from the other?

The currently fashionable attitude toward the business cycle stems, actually, from Karl Marx. Marx saw that, before the Industrial Revolution in approximately the late eighteenth century, there were no regularly recurring booms and depressions. There would be a sudden economic crisis whenever some king made war or confiscated the property of his subject; but there was no sign of the peculiarly modern phenomena of general and fairly regular swings in business fortunes, of expansions and contractions. Since these cycles also appeared on the scene at about the same time as modern industry, Marx concluded that business cycles were an inherent feature of the capitalist market economy. All the various current schools of economic thought, regardless of their other differences and the different causes that they attribute to the cycle, agree on this vital point: That these business cycles originate somewhere deep within the free-market economy. The market economy is to blame. Karl Marx believed that the periodic depressions would get worse and worse, until the masses would be moved to revolt and destroy the system, while the modern economists believe that the government can successfully stabilize depressions and the cycle. But all parties agree that the fault lies deep within the market economy and that if anything can save the day, it must be some form of massive government intervention.

There are, however, some critical problems in the assumption that the market economy is the culprit. For "general economic theory" teaches us that supply and demand always tend to be in equilibrium in the market and that therefore prices of products as well as of the factors that contribute to production are always tending toward some equilibrium point. Even though changes of data, which are always taking place, prevent equilibrium from ever being reached, there is nothing in the general theory of the market system that would account for regular and recurring boom-and-bust phases of the business cycle. Modern economists "solve" this problem by simply keeping their general price and market theory and their business cycle theory in separate, tightly-sealed compartments, with never the twain meeting, much less integrated with each other. Economists, unfortunately, have forgotten that there is only one economy and therefore only one integrated economic theory. Neither economic life nor the structure of theory can or should be in watertight compartments; our knowledge of the economy is either one integrated whole or it is nothing. Yet most economists are content to apply totally separate and, indeed, mutually exclusive, theories for general price analysis and for business cycles. They cannot be genuine economic scientists so long as they are content to keep operating in this primitive way.

But there are still graver problems with the currently fashionable approach. Economists also do not see one particularly critical problem because they do not bother to square their business cycle and general price theories: the peculiar breakdown of the entrepreneurial function at times of economic crisis and depression. In the market economy, one of the most vital functions of the businessman is to be an "entrepreneur," a man who invests in productive methods, who buys equipment and hires labor to produce something which he is not sure will reap him any return. In short, the entrepreneurial function is the function of forecasting the uncertain future. Before embarking on any investment or line of production, the entrepreneur, or "enterpriser," must estimate present and future costs and future revenues and therefore estimate whether and how much profits he will earn from the investment. If he forecasts well and significantly better than his business competitors, he will reap profits from his investment. The better his forecasting, the higher the profits he will earn. If, on the other hand, he is a poor forecaster and overestimates the demand for his product, he will suffer losses and pretty soon be forced out of the business.

The market economy, then, is a profit-and-loss economy, in which the acumen and ability of business entrepreneurs is gauged by the profits and losses they reap. The market economy, moreover, contains a built-in mechanism, a kind of natural selection, that ensures the survival and the flourishing of the superior forecaster and the weeding-out of the inferior ones. For the more profits reaped by the better forecasters, the greater become their business responsibilities, and the more they will have available to invest in the productive system. On the other hand, a few years of making losses will drive the poorer forecasters and entrepreneurs out of business altogether and push them into the ranks of salaried employees.

If, then, the market economy has a built-in natural selection mechanism for good entrepreneurs, this means that, generally, we would expect not many business firms to be making losses. And, in fact, if we look around at the economy on an average day or year, we will find that losses are not very widespread. But, in that case, the odd fact that needs explaining is this: How is it that, periodically, in times of the onset of recessions and especially in steep depressions, the business world suddenly experiences a massive cluster of severe losses? A moment arrives when business firms, previously highly astute entrepreneurs in their ability to make profits and avoid losses, suddenly and dismayingly find themselves, almost all of them, suffering severe and unaccountable losses? How come? Here is a momentous fact that any theory of depressions must explain. An explanation such as "underconsumption" — a drop in total consumer spending — is not sufficient, for one thing, because what needs to be explained is why businessmen, able to forecast all manner of previous economic changes and developments, proved themselves totally and catastrophically unable to forecast this alleged drop in consumer demand. Why this sudden failure in forecasting ability?

An adequate theory of depressions, then, must account for the tendency of the economy to move through successive booms and busts, showing no sign of settling into any sort of smoothly moving, or quietly progressive, approximation of an equilibrium situation. In particular, a theory of depression must account for the mammoth cluster of errors which appears swiftly and suddenly at a moment of economic crisis, and lingers through the depression period until recovery. And there is a third universal fact that a theory of the cycle must account for. Invariably, the booms and busts are much more intense and severe in the "capital goods industries" — the industries making machines and equipment, the ones producing industrial raw materials or constructing industrial plants — than in the industries making consumers' goods. Here is another fact of business cycle life that must be explained — and obviously can't be explained by such theories of depression as the popular underconsumption doctrine: That consumers aren't spending enough on consumer goods. For if insufficient spending is the culprit, then how is it that retail sales are the last and the least to fall in any depression, and that depression really hits such industries as machine tools, capital equipment, construction, and raw materials? Conversely, it is these industries that really take off in the inflationary boom phases of the business cycle, and not those businesses serving the consumer. An adequate theory of the business cycle, then, must also explain the far greater intensity of booms and busts in the non-consumer goods, or "producers' goods," industries.

Fortunately, a correct theory of depression and of the business cycle does exist, even though it is universally neglected in present-day economics. It, too, has a long tradition in economic thought. This theory began with the eighteenth century Scottish philosopher and economist David Hume, and with the eminent early nineteenth century English classical economist David Ricardo. Essentially, these theorists saw that another crucial institution had developed in the mid-eighteenth century, alongside the industrial system. This was the institution of banking, with its capacity to expand credit and the money supply (first, in the form of paper money, or bank notes, and later in the form of demand deposits, or checking accounts, that are instantly redeemable in cash at the banks). It was the operations of these commercial banks which, these economists saw, held the key to the mysterious recurrent cycles of expansion and contraction, of boom and bust, that had puzzled observers since the mid-eighteenth century.

The Ricardian analysis of the business cycle went something as follows: The natural moneys emerging as such on the world free market are useful commodities, generally gold and silver. If money were confined simply to these commodities, then the economy would work in the aggregate as it does in particular markets: A smooth adjustment of supply and demand, and therefore no cycles of boom and bust. But the injection of bank credit adds another crucial and disruptive element. For the banks expand credit and therefore bank money in the form of notes or deposits which are theoretically redeemable on demand in gold, but in practice clearly are not. For example, if a bank has 1000 ounces of gold in its vaults, and it issues instantly redeemable warehouse receipts for 2500 ounces of gold, then it clearly has issued 1500 ounces more than it can possibly redeem. But so long as there is no concerted "run" on the bank to cash in these receipts, its warehouse-receipts function on the market as equivalent to gold, and therefore the bank has been able to expand the money supply of the country by 1500 gold ounces.

The banks, then, happily begin to expand credit, for the more they expand credit the greater will be their profits. This results in the expansion of the money supply within a country, say England. As the supply of paper and bank money in England increases, the money incomes and expenditures of Englishmen rise, and the increased money bids up prices of English goods. The result is inflation and a boom within the country. But this inflationary boom, while it proceeds on its merry way, sows the seeds of its own demise. For as English money supply and incomes increase, Englishmen proceed to purchase more goods from abroad. Furthermore, as English prices go up, English goods begin to lose their competitiveness with the products of other countries which have not inflated, or have been inflating to a lesser degree. Englishmen begin to buy less at home and more abroad, while foreigners buy less in England and more at home; the result is a deficit in the English balance of payments, with English exports falling sharply behind imports. But if imports exceed exports, this means that money must flow out of England to foreign countries. And what money will this be? Surely not English bank notes or deposits, for Frenchmen or Germans or Italians have little or no interest in keeping their funds locked up in English banks. These foreigners will therefore take their bank notes and deposits and present them to the English banks for redemption in gold — and gold will be the type of money that will tend to flow persistently out of the country as the English inflation proceeds on its way. But this means that English bank credit money will be, more and more, pyramiding on top of a dwindling gold base in the English bank vaults. As the boom proceeds, our hypothetical bank will expand its warehouse receipts issued from, say 2500 ounces to 4000 ounces, while its gold base dwindles to, say, 800. As this process intensifies, the banks will eventually become frightened. For the banks, after all, are obligated to redeem their liabilities in cash, and their cash is flowing out rapidly as their liabilities pile up. Hence, the banks will eventually lose their nerve, stop their credit expansion, and in order to save themselves, contract their bank loans outstanding. Often, this retreat is precipitated by bankrupting runs on the banks touched off by the public, who had also been getting increasingly nervous about the ever more shaky condition of the nation's banks.

The bank contraction reverses the economic picture; contraction and bust follow boom. The banks pull in their horns, and businesses suffer as the pressure mounts for debt repayment and contraction. The fall in the supply of bank money, in turn, leads to a general fall in English prices. As money supply and incomes fall, and English prices collapse, English goods become relatively more attractive in terms of foreign products, and the balance of payments reverses itself, with exports exceeding imports. As gold flows into the country, and as bank money contracts on top of an expanding gold base, the condition of the banks becomes much sounder.

This, then, is the meaning of the depression phase of the business cycle. Note that it is a phase that comes out of, and inevitably comes out of, the preceding expansionary boom. It is the preceding inflation that makes the depression phase necessary. We can see, for example, that the depression is the process by which the market economy adjusts, throws off the excesses and distortions of the previous inflationary boom, and reestablishes a sound economic condition. The depression is the unpleasant but necessary reaction to the distortions and excesses of the previous boom.

Why, then, does the next cycle begin? Why do business cycles tend to be recurrent and continuous? Because when the banks have pretty well recovered, and are in a sounder condition, they are then in a confident position to proceed to their natural path of bank credit expansion, and the next boom proceeds on its way, sowing the seeds for the next inevitable bust.

But if banking is the cause of the business cycle, aren't the banks also a part of the private market economy, and can't we therefore say that the free market is still the culprit, if only in the banking segment of that free market? The answer is No, for the banks, for one thing, would never be able to expand credit in concert were it not for the intervention and encouragement of government. For if banks were truly competitive, any expansion of credit by one bank would quickly pile up the debts of that bank in its competitors, and its competitors would quickly call upon the expanding bank for redemption in cash. In short, a bank's rivals will call upon it for redemption in gold or cash in the same way as do foreigners, except that the process is much faster and would nip any incipient inflation in the bud before it got started. Banks can only expand comfortably in unison when a Central Bank exists, essentially a governmental bank, enjoying a monopoly of government business, and a privileged position imposed by government over the entire banking system. It is only when central banking got established that the banks were able to expand for any length of time and the familiar business cycle got underway in the modern world.

The central bank acquires its control over the banking system by such governmental measures as: Making its own liabilities legal tender for all debts and receivable in taxes; granting the central bank monopoly of the issue of bank notes, as contrasted to deposits (in England the Bank of England, the governmentally established central bank, had a legal monopoly of bank notes in the London area); or through the outright forcing of banks to use the central bank as their client for keeping their reserves of cash (as in the United States and its Federal Reserve System). Not that the banks complain about this intervention; for it is the establishment of central banking that makes long-term bank credit expansion possible, since the expansion of Central Bank notes provides added cash reserves for the entire banking system and permits all the commercial banks to expand their credit together. Central banking works like a cozy compulsory bank cartel to expand the banks' liabilities; and the banks are now able to expand on a larger base of cash in the form of central bank notes as well as gold.

So now we see, at last, that the business cycle is brought about, not by any mysterious failings of the free market economy, but quite the opposite: By systematic intervention by government in the market process. Government intervention brings about bank expansion and inflation, and, when the inflation comes to an end, the subsequent depression-adjustment comes into play.

The Ricardian theory of the business cycle grasped the essentials of a correct cycle theory: The recurrent nature of the phases of the cycle, depression as adjustment intervention in the market rather than from the free-market economy. But two problems were as yet unexplained: Why the sudden cluster of business error, the sudden failure of the entrepreneurial function, and why the vastly greater fluctuations in the producers' goods than in the consumers' goods industries? The Ricardian theory only explained movements in the price level, in general business; there was no hint of explanation of the vastly different reactions in the capital and consumers' goods industries.

The correct and fully developed theory of the business cycle was finally discovered and set forth by the Austrian economist Ludwig von Mises, when he was a professor at the University of Vienna. Mises developed hints of his solution to the vital problem of the business cycle in his monumental Theory of Money and Credit, published in 1912, and still, nearly 60 years later, the best book on the theory of money and banking. Mises developed his cycle theory during the 1920s, and it was brought to the English-speaking world by Mises's leading follower, Friedrich A. von Hayek, who came from Vienna to teach at the London School of Economics in the early 1930s, and who published, in German and in English, two books which applied and elaborated the Mises cycle theory: Monetary Theory and the Trade Cycle, and Prices and Production. Since Mises and Hayek were Austrians, and also since they were in the tradition of the great nineteenth-century Austrian economists, this theory has become known in the literature as the "Austrian" (or the "monetary over-investment") theory of the business cycle.

Building on the Ricardians, on general "Austrian" theory, and on his own creative genius, Mises developed the following theory of the business cycle:

Without bank credit expansion, supply and demand tend to be equilibrated through the free price system, and no cumulative booms or busts can then develop. But then government through its central bank stimulates bank credit expansion by expanding central bank liabilities and therefore the cash reserves of all the nation's commercial banks. The banks then proceed to expand credit and hence the nation's money supply in the form of check deposits. As the Ricardians saw, this expansion of bank money drives up the prices of goods and hence causes inflation. But, Mises showed, it does something else, and something even more sinister. Bank credit expansion, by pouring new loan funds into the business world, artificially lowers the rate of interest in the economy below its free market level.

On the free and unhampered market, the interest rate is determined purely by the "time-preferences" of all the individuals that make up the market economy. For the essence of a loan is that a "present good" (money which can be used at present) is being exchanged for a "future good" (an IOU which can only be used at some point in the future). Since people always prefer money right now to the present prospect of getting the same amount of money some time in the future, the present good always commands a premium in the market over the future. This premium is the interest rate, and its height will vary according to the degree to which people prefer the present to the future, i.e., the degree of their time-preferences.

People's time-preferences also determine the extent to which people will save and invest, as compared to how much they will consume. If people's time-preferences should fall, i.e., if their degree of preference for present over future falls, then people will tend to consume less now and save and invest more; at the same time, and for the same reason, the rate of interest, the rate of time-discount, will also fall. Economic growth comes about largely as the result of falling rates of time-preference, which lead to an increase in the proportion of saving and investment to consumption, and also to a falling rate of interest.

But what happens when the rate of interest falls, not because of lower time-preferences and higher savings, but from government interference that promotes the expansion of bank credit? In other words, if the rate of interest falls artificially, due to intervention, rather than naturally, as a result of changes in the valuations and preferences of the consuming public?

What happens is trouble. For businessmen, seeing the rate of interest fall, react as they always would and must to such a change of market signals: They invest more in capital and producers' goods. Investments, particularly in lengthy and time-consuming projects, which previously looked unprofitable now seem profitable, because of the fall of the interest charge. In short, businessmen react as they would react if savings had genuinely increased: They expand their investment in durable equipment, in capital goods, in industrial raw material, in construction as compared to their direct production of consumer goods.

Businesses, in short, happily borrow the newly expanded bank money that is coming to them at cheaper rates; they use the money to invest in capital goods, and eventually this money gets paid out in higher rents to land, and higher wages to workers in the capital goods industries. The increased business demand bids up labor costs, but businesses think they can pay these higher costs because they have been fooled by the government-and-bank intervention in the loan market and its decisively important tampering with the interest-rate signal of the marketplace.

The problem comes as soon as the workers and landlords — largely the former, since most gross business income is paid out in wages — begin to spend the new bank money that they have received in the form of higher wages. For the time-preferences of the public have not really gotten lower; the public doesn't want to save more than it has. So the workers set about to consume most of their new income, in short to reestablish the old consumer/saving proportions. This means that they redirect the spending back to the consumer goods industries, and they don't save and invest enough to buy the newly-produced machines, capital equipment, industrial raw materials, etc. This all reveals itself as a sudden sharp and continuing depression in the producers' goods industries. Once the consumers reestablished their desired consumption/investment proportions, it is thus revealed that business had invested too much in capital goods and had underinvested in consumer goods. Business had been seduced by the governmental tampering and artificial lowering of the rate of interest, and acted as if more savings were available to invest than were really there. As soon as the new bank money filtered through the system and the consumers reestablished their old proportions, it became clear that there were not enough savings to buy all the producers' goods, and that business had misinvested the limited savings available. Business had overinvested in capital goods and underinvested in consumer products.

The inflationary boom thus leads to distortions of the pricing and production system. Prices of labor and raw materials in the capital goods industries had been bid up during the boom too high to be profitable once the consumers reassert their old consumption/investment preferences. The "depression" is then seen as the necessary and healthy phase by which the market economy sloughs off and liquidates the unsound, uneconomic investments of the boom, and reestablishes those proportions between consumption and investment that are truly desired by the consumers. The depression is the painful but necessary process by which the free market sloughs off the excesses and errors of the boom and reestablishes the market economy in its function of efficient service to the mass of consumers. Since prices of factors of production have been bid too high in the boom, this means that prices of labor and goods in these capital goods industries must be allowed to fall until proper market relations are resumed.

Since the workers receive the increased money in the form of higher wages fairly rapidly, how is it that booms can go on for years without having their unsound investments revealed, their errors due to tampering with market signals become evident, and the depression-adjustment process begins its work? The answer is that booms would be very short lived if the bank credit expansion and subsequent pushing of the rate of interest below the free market level were a one-shot affair. But the point is that the credit expansion is not one-shot; it proceeds on and on, never giving consumers the chance to reestablish their preferred proportions of consumption and saving, never allowing the rise in costs in the capital goods industries to catch up to the inflationary rise in prices. Like the repeated doping of a horse, the boom is kept on its way and ahead of its inevitable comeuppance, by repeated doses of the stimulant of bank credit. It is only when bank credit expansion must finally stop, either because the banks are getting into a shaky condition or because the public begins to balk at the continuing inflation, that retribution finally catches up with the boom. As soon as credit expansion stops, then the piper must be paid, and the inevitable readjustments liquidate the unsound over-investments of the boom, with the reassertion of a greater proportionate emphasis on consumers' goods production.

Thus, the Misesian theory of the business cycle accounts for all of our puzzles: The repeated and recurrent nature of the cycle, the massive cluster of entrepreneurial error, the far greater intensity of the boom and bust in the producers' goods industries.

Mises, then, pinpoints the blame for the cycle on inflationary bank credit expansion propelled by the intervention of government and its central bank. What does Mises say should be done, say by government, once the depression arrives? What is the governmental role in the cure of depression? In the first place, government must cease inflating as soon as possible. It is true that this will, inevitably, bring the inflationary boom abruptly to an end, and commence the inevitable recession or depression. But the longer the government waits for this, the worse the necessary readjustments will have to be. The sooner the depression-readjustment is gotten over with, the better. This means, also, that the government must never try to prop up unsound business situations; it must never bail out or lend money to business firms in trouble. Doing this will simply prolong the agony and convert a sharp and quick depression phase into a lingering and chronic disease. The government must never try to prop up wage rates or prices of producers' goods; doing so will prolong and delay indefinitely the completion of the depression-adjustment process; it will cause indefinite and prolonged depression and mass unemployment in the vital capital goods industries. The government must not try to inflate again, in order to get out of the depression. For even if this reinflation succeeds, it will only sow greater trouble later on. The government must do nothing to encourage consumption, and it must not increase its own expenditures, for this will further increase the social consumption/investment ratio. In fact, cutting the government budget will improve the ratio. What the economy needs is not more consumption spending but more saving, in order to validate some of the excessive investments of the boom.

Thus, what the government should do, according to the Misesian analysis of the depression, is absolutely nothing. It should, from the point of view of economic health and ending the depression as quickly as possible, maintain a strict hands off, "laissez-faire" policy. Anything it does will delay and obstruct the adjustment process of the market; the less it does, the more rapidly will the market adjustment process do its work, and sound economic recovery ensue.

The Misesian prescription is thus the exact opposite of the Keynesian: It is for the government to keep absolute hands off the economy and to confine itself to stopping its own inflation and to cutting its own budget.

It has today been completely forgotten, even among economists, that the Misesian explanation and analysis of the depression gained great headway precisely during the Great Depression of the 1930s — the very depression that is always held up to advocates of the free market economy as the greatest single and catastrophic failure of laissez-faire capitalism. It was no such thing. 1929 was made inevitable by the vast bank credit expansion throughout the Western world during the 1920s: A policy deliberately adopted by the Western governments, and most importantly by the Federal Reserve System in the United States. It was made possible by the failure of the Western world to return to a genuine gold standard after World War I, and thus allowing more room for inflationary policies by government. Everyone now thinks of President Coolidge as a believer in laissez-faire and an unhampered market economy; he was not, and tragically, nowhere less so than in the field of money and credit. Unfortunately, the sins and errors of the Coolidge intervention were laid to the door of a non-existent free market economy.

If Coolidge made 1929 inevitable, it was President Hoover who prolonged and deepened the depression, transforming it from a typically sharp but swiftly-disappearing depression into a lingering and near-fatal malady, a malady "cured" only by the holocaust of World War II. Hoover, not Franklin Roosevelt, was the founder of the policy of the "New Deal": essentially the massive use of the State to do exactly what Misesian theory would most warn against — to prop up wage rates above their free-market levels, prop up prices, inflate credit, and lend money to shaky business positions. Roosevelt only advanced, to a greater degree, what Hoover had pioneered. The result for the first time in American history, was a nearly perpetual depression and nearly permanent mass unemployment. The Coolidge crisis had become the unprecedentedly prolonged Hoover-Roosevelt depression.

Ludwig von Mises had predicted the depression during the heyday of the great boom of the 1920s — a time, just like today, when economists and politicians, armed with a "new economics" of perpetual inflation, and with new "tools" provided by the Federal Reserve System, proclaimed a perpetual "New Era" of permanent prosperity guaranteed by our wise economic doctors in Washington. Ludwig von Mises, alone armed with a correct theory of the business cycle, was one of the very few economists to predict the Great Depression, and hence the economic world was forced to listen to him with respect. F. A. Hayek spread the word in England, and the younger English economists were all, in the early 1930s, beginning to adopt the Misesian cycle theory for their analysis of the depression — and also to adopt, of course, the strictly free-market policy prescription that flowed with this theory. Unfortunately, economists have now adopted the historical notion of Lord Keynes: That no "classical economists" had a theory of the business cycle until Keynes came along in 1936. There was a theory of the depression; it was the classical economic tradition; its prescription was strict hard money and laissez-faire; and it was rapidly being adopted, in England and even in the United States, as the accepted theory of the business cycle. (A particular irony is that the major "Austrian" proponent in the United States in the early and mid-1930s was none other than Professor Alvin Hansen, very soon to make his mark as the outstanding Keynesian disciple in this country.)

What swamped the growing acceptance of Misesian cycle theory was simply the "Keynesian Revolution" — the amazing sweep that Keynesian theory made of the economic world shortly after the publication of the General Theory in 1936. It is not that Misesian theory was refuted successfully; it was just forgotten in the rush to climb on the suddenly fashionable Keynesian bandwagon. Some of the leading adherents of the Mises theory — who clearly knew better — succumbed to the newly established winds of doctrine, and won leading American university posts as a consequence.

$35 $29

But now the once arch-Keynesian London Economist has recently proclaimed that "Keynes is Dead." After over a decade of facing trenchant theoretical critiques and refutation by stubborn economic facts, the Keynesians are now in general and massive retreat. Once again, the money supply and bank credit are being grudgingly acknowledged to play a leading role in the cycle. The time is ripe — for a rediscovery, a renaissance, of the Mises theory of the business cycle. It can come none too soon; if it ever does, the whole concept of a Council of Economic Advisors would be swept away, and we would see a massive retreat of government from the economic sphere. But for all this to happen, the world of economics, and the public at large, must be made aware of the existence of an explanation of the business cycle that has lain neglected on the shelf for all too many tragic years.

Murray N. Rothbard (1926–1995) was dean of the Austrian School. See his archive. Comment on the blog.

This essay was originally published as a minibook by the Constitutional Alliance of Lansing, Michigan, 1969.

The Government's $700 Billion Screw Up

2008-09-29T12:10:00.002-04:00

The Rescue Package Will Delay Recovery
Daily Article by Frank Shostak Posted on 9/29/2008

In his testimony to the Congress on September 24, Fed Chairman Bernanke urged the legislators to quickly approve the bailout of the financial sector with a package of $700 billion. Bernanke echoed Treasury Secretary Paulson's view that the bailout expense, while hefty, is needed to remove from banks' balance sheets the mortgage-linked assets, which are paralyzing the flow of credit.

I think it's extraordinarily important to understand that as we have seen many previous examples in different countries and in different times that choking up of credit is like taking the lifeblood away from the economy.

Most experts came out in strong support for the package. Without the rescue package, many large institutions that are "too big to fail" could go belly up. Many believe that the consequences of all this could be very severe to the real economy.

It is true that the financial system must be rescued; it must be rescued from the institutions holding bad debt that are currently draining capital while waiting for a bailout and adding little in return. It is they that are preventing wealth-generating activities in the financial sector and the other parts of the economy from expanding real wealth.

The Essence of Economic Adjustment

Conventional thinking presents economic adjustment — also labeled as "economic recession" — as something terrible, even the end of the world. In fact, economic adjustment is not menacing or terrible; from an economic point of view, it is nothing more than a time when scarce resources are reallocated in accordance with consumers' priorities.

Allowing the market to do the allocation always leads to better results. Even the founder of the Soviet Union, Vladimir Lenin, understood this when he introduced the market mechanism for a brief period in March 1921 to restore the supply of goods and prevent economic catastrophe. Yet for some strange reason, most experts these days cling to the view that the market cannot be trusted in difficult times like these.

If central bankers and government bureaucrats can fix things in difficult times, why not in good times too? Why not have a fully controlled economy and all the problems will be fixed forever? The collapse of the Soviet Union's centralized system is the best testimony one can have that controls don't work. A better way to fix economic problems is to allow entrepreneurs the freedom to allocate resources in accordance with society's priorities.

In this sense, the best rescue plan is to allow the market mechanism to operate freely. Allowing the market to do the job will result in some activities disappearing all together while some other activities will in fact be expanded.

Take, for instance, a company that has six profitable activities and four losing activities. The management of the company concludes that the four losing activities must go. To keep them alive is a threat to the survival of the company; these activities rob scarce funding from profitable activities.

Once the losing activities are shut down, the released funding can now be employed to strengthen the winning activities. The management can also decide to use some of the released funding to acquire some other profitable activities.

This is precisely what the government rescue package prevents from happening. The government package is not going to rescue the economy, but it will rescue activities that the economy cannot afford and that consumers do not want. It will sustain waste and promote inefficiency, draining resources from growth and efficiency. Remember: government is not a wealth generator; it can only take resources from A and give them to B.

Can the Rescue Package Prevent Economic Disruptions?

Some supporters of the package are of the view that the package is necessary in order to prevent economic disruptions. They mean by this that various phony activities should be kept alive by wealth generators for a little bit longer until a proper system is established. By "proper," they mean more controls.

For a while, the government's package can appear to be working; this is because there is still enough real savings to support both profitable and unprofitable activities. If, however, savings and capital are shrinking, nothing is going to help, and the real economy will follow up with further declines.

Hence the rescue package cannot prevent so-called economic disruptions. If anything, government intervention would make these disruptions much worse. Again, a better alternative is to let the market do the job. The market's ability to make swift adjustments without much drama was vividly illustrated only a few weeks ago when the very large investment bank, Lehman Brothers, was allowed to go belly up. The world did not come to an end. Instead, this was a healthy development. A money loser was eliminated from the market. This freed up resources to promote growth.

One could have made the case that when Lehman was on the brink it was too big to fail — assets of $639 billion and employing over 26,000 people. Yet in a few days the market, once allowed to do the job, reallocated the good pieces of Lehman to various buyers and the bad parts have vanished. It was poetry.

Likewise Merrill Lynch, which was bought by the Bank of America, will see the good parts of it reinforced while the useless parts are likely to be removed.

On September 18, 2008, Washington Mutual, the largest US saving and loan bank, was forced into liquidation. The bank had $307 billion in assets and $188 billion in deposits. What prompted the closure are heavy losses on its $227 billion book of real-estate loans, of which a large portion was in subprime mortgages.

The bank lost $6.3 billion in the nine months ending June 30. Against this background, and coupled with customers withdrawing $16.7 billion over the past ten days, government regulators decided to close the bank.

Observe that this was the largest US banking failure. Note that the closure of the bank didn't result in the end of the world. JP Morgan Chase bought some of the good assets of Washington Mutual for $1.9 billion.

On this, Jeffrey Tucker made the following observation,

But as wonderful as the daily shifts and movements are, what really inspires are the massive acts of creative destruction such as when old-line firms like Lehman and Merrill melt before our eyes, their good assets transferred to more competent hands.… This is the kind of shock and awe we should all celebrate. It is contrary to the wish of all the principal players and it accords with the will of society as a whole and the dictate of the market that waste not last and last. No matter how large, how entrenched, how exalted the institution, it is always vulnerable to being blown away by market forces — no more or less so than the lemonade stand down the street.

Most commentators have accepted that the root problem of the current financial crisis is the lack of proper control over mortgage lending. But the out-of-proportion explosion in the mortgage lending didn't occur out of the blue. Without the aggressive lowering of interest rates by the Fed, mortgage lending couldn't have exploded. The Fed lowered the federal-funds rate target from 6% in January 2001 to 1% by June 2003. The 1% was kept until June 2004.

The loose monetary stance prepared the ground for various false activities that wouldn't have been around without the loose stance. If authorities had kept strong controls over mortgage lending, while at the same time creating money out of thin air, the excesses would have popped up in some other sector. The banks would have ended up having plenty of bad non-mortgage-related assets.

The Fed's loose policies are the crux of the problem. So rather than blaming the symptoms, what is required is to let the market work and close all the loopholes that allow the creation of money and credit out of thin air.

Can Making Banks' Balance Sheets Look Good "Fix" the Economy?

Recall that Treasurer Paulson and the Fed chairman are of the view that once banks' bad assets are removed, the banks are likely to move ahead and start lending. We suggest that making the balance sheet look pretty is not going to alter the essence of the problem, which is the poor state of capital and savings to support such high lending activities.

The essence of a sound credit market is not lending money as such but lending the real stuff that people require by means of money. Without the real stuff — the preceding savings and subsequent productivity to fund the lending — no lending is possible.

Decades of nonproductive consumption (consumption that is not backed up by production) that emerged on the back of loose monetary and fiscal policies have severely damaged the store of wealth that serves as the foundation for credit markets. If this is the case, it will be futile to try to boost lending by pushing more money into the banking system. More money cannot generate real wealth. If it could, world poverty would have been eliminated a long time ago.

When the market is allowed to take charge, the relationship between savings, lending, and productivity will be brought into proper perspective. At last we will know which activities are genuine and which are phony.

Does the Fall in Stock Prices Cause an Economic Slump?

The proponents of government intervention maintain that one cannot allow the market to take charge since this will cause a drop in stock prices, which will be bad for the economy. Within the confines of this way of thinking, it is not surprising that Bernanke and Paulson panicked on September 18, once a large money-market mutual fund — the Reserve Primary Fund — was on the brink.

They argue that were it not for the Fed's injecting $105 billion and the subsequent announcement of the rescue package, the stock market would have had a massive fall. They also believe that the massive monetary injection prevented a run on money-market mutual funds and prevented a major disaster.

They further believe that if people had taken the money out of their money-market mutual funds, banks wouldn't be able to secure money to fund credit cards and various consumer and business loans. This in turn would have paralyzed the economy.

So let us think about this. Say that people take their money from the money-market mutual funds. What happens then? They will have placed it somewhere else, mostly likely with commercial banks. Hence money wouldn't disappear and banks could continue to fund activities as before.

If large money-market funds were to go under, some of their assets would be sold and the shareholders would suffer losses; this however, cannot provide justification for the Fed to pump money and to introduce a rescue package. Monetary expansion and a rescue package do not undo the bad investment decisions of the money-market-mutual-fund managers. Why should people who didn't risk investments in the fund pick up the tab?

A fall in asset prices, including stocks, and a run on financial institutions are just symptoms and not the cause of anything. The key factor behind the current difficulty in the credit markets is the lagged effect coming from the Fed's tighter stance between June 2004 and August 2007, when the federal-funds-rate target was raised from 1% to 5.25%.

The tighter stance started to undermine various bubble activities that had emerged from the previous loose stance. A tighter stance slowed the diversion of real savings from wealth generators towards bubble activities. Without an adequate supply of real funding, these activities started to crumble. Obviously, then, banks that have been providing support to these activities by providing loans have ended up holding a large amount of bad assets.

As a result, bank stock prices started to come under pressure. With a time lag, bubbles in the various other parts of the economy are also likely to come under pressure, and this again is going to hurt financial stocks. So the fall in economic activity is not the result of a fall in stock prices, but rather comes on account of the tighter Fed stance that throttled the supply of real savings to non-wealth-generating activities.

Would the stock market have come under pressure if the Fed had kept the interest rate at 1% for an indefinite period of time? A prolonged loose stance would have given rise to a much greater amount of nonproductive bubble activities. As a result, the pace of real wealth generation would have continued to slow, and consequently the growth momentum of profits would have come under pressure. In response to this, commercial banks would have become more cautious in their expansion of credit out of thin air.

All this in turn would have undermined the existence of bubble activities. Bubble activities cannot stand on their own feet; once the rate of growth of the money supply slows down, the pace of the diversion of real savings towards false activities follows suit. As a result, the survival of these activities is threatened.

From this we can infer that a fall in non-wealth-generating activities — also labeled an economic slump — is not due to a fall in the stock market as such but to the previous loose monetary policy that has weakened the pool of real savings.

The central-bank policies aimed at preventing a fall in the stock market cannot prevent a fall in the real economy. In fact, the real economy has already been damaged by the previous loose monetary stance. All that the fall in the stock market does is inform us about the true state of economic conditions. The fall in the price of stocks just puts things in a proper perspective. The fall in the stock price is just an acknowledgment of reality.

Conclusion

Only a few weeks ago, we saw that the liquidation of a large bank such as Lehman Brothers and the sale of Merrill Lynch did not cause massive disruptions. In fact, the adjustment was swift and almost invisible. The reason for the smooth adjustment is that the market was allowed to do its job. If government and Fed bureaucrats had tried to intervene with bailouts, the whole process would have taken much longer and would have been very costly in terms of real resources.

--------------------
Frank Shostak is an adjunct scholar of the Mises Institute and a frequent contributor to Mises.org. He is chief economist of M.F. Global. Comment on the blog.
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Star Trek and Collectivism: The Case of the Borg, By Steven Yates

2008-07-28T18:11:00.004-04:00

The Freeman: Ideas on Liberty - April 1997
Vol. 47 No. 4
Features:
Star Trek and Collectivism: The Case of the Borg
By Steven Yates

Does the American flag belong in church?

2008-07-28T17:00:00.001-04:00

Does the American flag belong in church?
Our allegiance belongs to God, not state power.
By Becky Akers

America vs Canada

2008-07-28T16:44:00.000-04:00

War Plan Red: America's 1920's Plan to Attack Canada, and Canada's 1921 Plan for a Pre-emptive Attack Against America.

ANWR Drilling Would Provide Quick Relief, by Robert P. Murphy

2008-07-28T10:53:00.002-04:00

Daily Article by Robert P. Murphy | Posted on 7/28/2008

In a previous article, I showed that the proposals to curb "excessive" speculation in oil futures markets were based on ignorance of how the market coordinates production and consumption over time. In the present article, I will explore the issue of opening up the Arctic National Wilderness Refuge (ANWR) to oil drilling. We'll see once again that even friends of the market often don't fully understand its power to fix problems.

The Standard Argument Over ANWR

With record oil prices, many on the Right (as defined with today's labels) have understandably called for the federal government to remove its restrictions on oil exploration and drilling in ANWR (located in Alaska) as well as other federal lands and offshore water areas.[1] They point out that these federal restrictions, in conjunction with local environmental activism, have resulted in the absurd situation where 94 percent of federal land, and 97 percent of federal offshore waters, are not being leased by energy companies. The US government itself estimates that its own prohibitions currently render 18 billion barrels in the outer continental shelf (OCS) and 19 billion barrels located under federal lands off limits. Note that these are very conservative estimates, because nobody has gone out and extensively explored the areas where it is illegal to extract oil!

Of course, calls to open up domestic areas for drilling horrify environmentalists and others on the Left, who liken the move to giving a junkie one more fix rather than dealing with his addiction. One of their strongest arguments is that ANWR drilling isn't a real solution for today's crisis, since

The Energy Information Administration (EIA) estimates that it will require 8 to 10 years after opening ANWR before oil is produced from any new leases. Furthermore, it would be 20 years after opening ANWR before oil production reached its peak of only 780,000 barrels per day.

Faced with this response, the people on the Right have typically come back with a few zingers. First, they point out that the critics of drilling have provided alternative proposals (development of renewable energy, conservation measures such as raising CAFE standards, etc.) that would also take years to kick in. They also frequently mention that this ten-year lag would have been over by now, if President Clinton hadn't vetoed the attempt to open up ANWR back in 1995.

More Oil in the Future Means More Oil Now

Yet there is an even stronger argument for opening up ANWR: because of its impact on oil prices in the future, relaxing federal prohibitions would cause current oil producers to change their pumping decisions right now. Even though the additional barrels from ANWR wouldn't physically hit the market for years, current knowledge of this fact will alter current behavior, leading to rapid relief at the pump.

Though compelling, this argument is subtle and has only recently gained attention. I myself didn't bat an eye when experts in the industry told me (last year at a briefing) that opening ANWR wasn't a near-term solution. It wasn't until a colleague passed along an unpublished paper by Coats and Pecquet that I considered the impact of future supply increases on current production decisions.

Once I heard the argument, it was obvious and I couldn't believe I had missed it. I began using it wherever I could, and was very glad to see that the respected Martin Feldstein made the case in the Wall Street Journal. Hopefully, proponents of ANWR drilling will now feel confident to repeat the claim. In the remaining space, I'll spell out the argument as simply as possible, because, admittedly, at first it sounds too good to be true.

Prices Guide Production

Imagine that you are sitting on a huge oil deposit, which has (let us suppose) one billion barrels that can be brought to the surface for $20 each, so long as you don't pump more than one million barrels per day. (If you want to pump at a higher rate, you have to spend more money per barrel, and you might reduce the total number of barrels you can extract from the deposit.) So the question is, how fast should you pump?

You might at first think that you should pump at the maximum extraction rate, without raising your marginal costs — i.e., that you should pump at one million bbls/day. But this clearly is wrong, if you expect oil prices to keep rising. Why sell 365 million barrels in 2008 at an average of $150 each, when you could postpone production for a year and then sell those same million barrels for, say, $200 each?

In light of this consideration, maybe you think you should just hold your barrels off the market forever. By letting them sit in the ground, the market value of your asset rises over time, as the market price of oil rises.

But that isn't necessarily the right thing to do, either. What if oil prices rise an average of only 10 percent per year over the next two decades? Do you really want to put all your eggs (oil) in one basket, by leaving them sitting underground? Especially if your deposit is located in the Middle East, you might feel more comfortable selling off some of the oil now, and then using the revenue to buy stocks and bonds, not to mention a few surface-to-air missile silos. (And of course, you could be wrong in your forecasts; maybe oil prices will tank in two years.)

My point here isn't to come up with the "optimal" extraction plan for an oil producer; since I'm not in the business, there are undoubtedly considerations I would overlook. But what I will say is that the expected price of oil in the future plays a very important role in these decisions. As always, a liquid futures market allows oil producers (and consumers) to make much more confident plans, because they can lock in prices for future transactions. For example, the oil producer doesn't have to simply guess that he can postpone production today, in order to sell next year at $150 per barrel; he can sell futures contracts to make sure of it (assuming he can find a buyer at that price).

Now what happens if we are at an initial equilibrium, and then all of a sudden the US government relaxes the prohibitions on ANWR drilling? If oil traders really believe the policy shift is permanent, and that up to a million extra barrels will be hitting the market in a decade, then this will obviously reduce the expected world price of oil starting at that time. Consequently, any oil producers who had previously settled on a production rate with "excess capacity" — i.e., where they could have produced and sold more barrels today, but decided not to for reasons of profit — will re-evaluate their decision.

Without specifics we have no idea how much the new information will change their output plans, but surely they will pump more in the present than they had previously decided.

If we step back and survey the big picture, what would happen is that the market in a sense would be transferring some of those future ANWR barrels to the present. It's true, the market doesn't have recourse to time machines. But physical barrels of oil that would have otherwise sat underground in 2008, 2009, and so on, will now be brought to the surface and sold, because they have been displaced by the barrels currently buried in Alaska that will be brought to the surface and sold in 2018, 2019, and so on.

If this seems too theoretical and farfetched, consider this: In May, the Saudis officially rebuffed President Bush's request for them to increase their output. Yet one month later, they reversed their position. What changed in the interim?

Obviously I don't know for sure what motivates oil barons, but the political mood in the United States shifted in between those two announcements. All of a sudden, opening up ANWR and offshore areas for drilling was "on the table." The mere possibility of an extra million or more competing barrels per day may have been enough to reverse the Saudis' stance.

Conclusion

Market prices help coordinate actions over space and time. To the extent that it is physically possible, the market will exploit the availability of new future supplies in order to provide immediate relief. The time lag involved should be no deterrent to opening up ANWR (and other prohibited areas) for oil development.

Beyond that, the ideal solution would be to completely privatize federal lands, so that the decision of whether or not to drill would no longer be a political one.

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Speculators Are in Obama's Sights

2008-07-19T21:40:00.000-04:00

The Freeman: Ideas on Liberty - August 1999
Vol. 49 No. 8

Columns:

Conservation and Speculation
By Dwight R. Lee

Dwight Lee is Ramsey Professor at the Terry College of Business, University of Georgia, and an adjunct fellow at the Center for Study of American Business at Washington University.

I often ask my students, “How many of you are in favor of conservation?” Except for those who are asleep, every hand goes up. I then ask, “How many of you are in favor of speculators?” and almost no one raises his hand. The students see conservation as a noble activity that prevents people from squandering resources now to insure that adequate quantities will be available in the future. On the other hand, they see speculation as the greedy hoarding of valuable resources now in order to gouge those who will need those resources later. I attempt to explain that if they are serious about conservation, they should also applaud speculation. The speculation that results from private property and the desire for profits is the most powerful force for beneficial conservation.

The Right Amount of Conservation

Without private property rights there could be no speculation for personal profit and no meaningful conservation. As discussed last month, animal species that are not privately owned are the ones at risk of extinction. Without private property no one has an incentive to conserve a resource, since no one can benefit from doing so. But if I own a resource and believe its value is going to be greater in the future (after considering the cost of holding it—including the opportunity cost of forgoing interest), I will conserve it for future use or sale. Similarly, even if I don’t own a resource, but I believe its value is going to increase, I will buy it at today’s price in order to conserve (hoard) it and then sell it at the expected higher price later.

But why should we depend on private property and greed to conserve valuable resources? Why not have the government determine how much of a resource should be conserved and then limit its current use accordingly? Relying on government to enforce conservation would be foolish even if the right amount of conservation were known. If government has enough power to allocate a resource over time, it has enough power to allocate its use to competing alternatives at each point in time. This much power guarantees waste, as special-interest influence replaces the cooperation of market exchange in determining how and where resources are used.

But even if the public interest, rather than special interests, motivated government decisions (dream on), the authorities could never determine the right amount of conservation as accurately as speculators subject to the discipline of the marketplace. There can be too much as well as too little conservation. Just as we don’t want to use resources today that will be worth a lot more in the future, neither do we want to sacrifice consumption today to conserve resources that will be worth less in the future.

Speculators Do It Better

Even if government authorities were not subject to special-interest influence, they would have less motivation to conserve wisely than speculators do. If bureaucrats make wasteful decisions, their salaries aren’t reduced. Indeed, their failures often result in larger budgets, supposedly so they can do a better job. In sharp contrast, speculators make money only if they conserve wisely—purchasing resources (holding them off the market) when they are less valuable and selling them (making them available) when they are more valuable. If speculators don’t conserve enough they pass up profitable opportunities to buy low and sell high, and if they conserve too much they lose money by buying high and selling low. As opposed to bureaucrats, who can survive despite their mistakes, the speculator who consistently makes mistakes is soon relieved of the money necessary to continue speculating.

Speculators can also act much more quickly than any government agency. For example, at the first indication that next year’s Brazilian coffee crop will be devastated by a frost, speculators will immediately purchase raw coffee beans to store them until next year. Consumers will still see plenty of ground coffee in the stores, but suddenly the prices will be higher. What consumers don’t see is that coffee prices will be lower next year than they otherwise would have been because they are higher today, and that their reduced consumption today will be more than compensated by their greater consumption later. The complaint will be that greedy speculators have unnecessarily driven up prices. Interestingly, the universal complaint against speculators that they cause current prices to be too high is really a complaint that they conserve too much.

Don’t Complain Out Loud

I find it fascinating that people who believe that speculators are responsible for prices being too high complain about it out loud. The last thing you should do if you are convinced that speculators are harming the public by driving up the prices of important resources is to let others know. If you are correct, you can make yourself a fortune by keeping quiet, while providing a valuable public service at the same time. If the public is being harmed by speculative buying, it is because coffee is being taken off the market now when it is worth more than it will be later. If this is so, you would be right to criticize speculators for harmful price increases.

But this is a problem you can help correct. Simply call your broker and sell coffee short. Selling short means borrowing a quantity of coffee (from a speculator) and selling it at the currently high price. When the price falls later, you can buy the quantity borrowed, repay the speculator, and pocket the difference between the two prices. (You will have sold high and bought low.) If you were correct about market conditions, you will have made the coffee available to consumers now and made a profit. Why you should keep your criticism of speculators secret is obvious. If others believe you, they will sell coffee short themselves, which will drive down the current price and increase the future price, thereby reducing your profit opportunities.

Too Important to Leave to the “Experts”

Why don’t we hear fewer people complaining about speculators and see more people selling short? The answer has to be that most people find complaining easier than understanding what they are complaining about. But the objective here is not to criticize. The important point is that anyone who believes he has better information on the future value of resources or commodities than is reflected in market prices can both profit personally and benefit society by acting on that information—if he is right. So when conservation is left to speculators, far more relevant information from far more people with far more at stake is acted on than if conservation is left to government.

Conservation is important, much too important to leave to government “experts.” There is no better way of achieving sensible conservation than through the concern for the future that is motivated by private property, market exchange, and speculators putting their own money on the line.

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http://www.fee.org/Publications/the-Freeman/article.asp?aid=4692

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