LewRockwell &#187; Bob Murphy

How To Argue for the Gold Standard

Bob Murphy — Thu, 16 Jun 2011 05:00:00 +0000

Recently by Bob Murphy: The Capitalist in the Hat

With various states debating measures to elevate the monetary status of gold, the gold standard is more politically relevant now than it has been in decades. When the LA Times (to pick just one example) runs an article stating matter-of-factly that "economists" uniformly oppose gold, you know the defenders of the current system are getting nervous.

Precisely because a gold standard is such a hot topic lately, it’s important for people to understand its rationale. In the present article I’ll try to clear up a few misconceptions.

Do All Economists Oppose the Gold Standard?

I realize I am betraying my navete by admitting this, but I was very surprised at the depth of falsehood in the LA Times article mentioned above. Here is the blurb below the title, "Pushing for a Return to the Gold Standard":

The idea to make the precious metal legal tender has gained currency in more than a dozen state capitals, aided by Tea Party support and other efforts to rein in federal power. Economists say the plan would be disastrous.

I suppose the final sentence is technically true, but it’s very misleading. It’s a bit like saying, "Baskin-Robbins offers 31 flavors, but customers buy chocolate." Yes, some economists say a return to the gold standard would be disastrous, and I’d grant that perhaps even a large majority do. But the blurb above makes it sound as if virtually all economists oppose the move, which isn’t true.

The writer, Nathaniel Popper, reinforces this misconception in two other places. He quite clearly tries to pit the rube businessmen and tea-party politicians against the professional economists. First he writes,

The ultimate goal is to return the nation to the gold standard, in which every dollar would be backed by a fixed amount of the precious metal. Economists of all stripes say the plan would be ruinous, but that view is of scant concern to Pitts [a South Carolina state representative].

"Quite frankly, I think that economists from universities are thinking within the confines of their own little world," Pitts said. "They don’t deal with the real issues." (emphasis added)

Just to make sure the reader gets the point, Popper writes later in the article:

The United States and most of the rest of the world operated on a full gold standard until the Great Depression. Economists generally agree that the policy helped cause the depression and earlier severe downturns by limiting the amount of money the government could create, constraining its ability to stimulate the economy.

Scholars say moving to a gold standard now would be likely to slow the economy’s already meager growth.

"At some point someone may be crazy enough to try it, but they won’t stay with it any more than they did in the past," said Allan Meltzer, a Carnegie Mellon University economics professor and a critic of the Fed’s current monetary policy.

Given the lack of support from mainstream economists, activists have turned a few texts written by outsiders into their bibles, such as "Pieces of Eight," an out-of-print book by [constitutional lawyer] Vieira.

In the entire article, Popper doesn’t quote a single economist who is in favor of the gold standard, or even paraphrase his or her views. This might be acceptable, except for the fact that Popper quotes or makes reference to businessmen, politicians, and the lawyer Vieira. (I am not familiar with Vieira’s work, and it should go without saying that I’m not criticizing him.)

Now, it would be easy for me to accuse Popper of lying, but for all I know he was so sure of the stupidity of the gold standard that he didn’t even try to find actual PhD economists currently teaching at colleges (some even at top-20 graduate schools) who would have nice things to say about the gold standard. I personally know at least 20 such people, so believe me, they’re out there if Popper or other journalists actually want to give the case for gold a fighting chance.

As far as books touting the advantages of the gold standard, yes indeed there are volumes written by people with PhDs in economics. A classic text is Ludwig von Mises’s The Theory of Money and Credit, while a newer, much more reader-friendly selection is Murray Rothbard’s What Has Government Done to Our Money? My own book on the Great Depression exploded the myth that the gold standard had something to do with it.

Did Gold Cause the Great Depression?

Before moving on, let me quickly address that particular claim. I’ve written a longer response here, but for now we have to wonder: If the gold standard caused the Great Depression, what else was going on? After all, the gold standard wasn’t implemented in the 1920s. Although there had been plenty of industrial crises or financial panics in the previous hundred years, there had been no prolonged global depression approaching the experience of the 1930s u2014 even as more and more countries joined the growing worldwide market of gold-based economies. So clearly it’s not enough to point to the “golden fetters” of the monetary system to explain what happened in the Great Depression.

Thus, to blame the Great Depression on the gold standard is just as nonsensical as blaming it on the "laissez-faire" policies of Herbert Hoover, who (even if we take the caricature of him seriously) was no different from all his predecessors. It would be like explaining a particular airplane crash by citing gravity.

As a final point, let’s not forget that FDR abandoned the gold standard in 1933. The Great Depression thus lingered on – after leaving the allegedly awful gold standard – for at least another 8 years (and I would say 13 years, because I don’t think World War II "fixed" the economy), in what was still the worst economic period in US history. It’s odd that the gold standard could wreak so much havoc in the early 1930s – even though it had never done anything comparable earlier in US history – and then could continue to "cause" the Great Depression, from 8 to 13 years after abandoning it. It starts to make you wonder whether the "economists of all stripes" know what they’re talking about.

"You Can’t Eat Gold!"

One of the most absurd objections to returning to a gold standard is that "You can’t eat gold." I am not making this up; Dave Leonhardt of the New York Times actually said that to Ron Paul when he defended the idea on the Colbert Report.

Dr. Paul didn’t really get a chance to answer (Colbert instead made a funny joke about idolatry), but it would have been delicious had he quickly asked the cynic, "Oh, so you make sandwiches out of Federal Reserve notes?" (We also would have accepted, "Oh, so I take it you are proposing a hamburger standard for the dollar?")

The utter absurdity of the objection – namely that you "can’t eat gold" – is that gold actually is a useful commodity even for nonmonetary purposes. It’s true, you can’t eat gold, but you can wear it, you can fill cavities with it, and you can treat arthritis with it. In contrast, all you can do with fiat paper currency is use it in exchange, and you’d better not keep a large fraction of your wealth in actual paper dollars, since their purchasing power constantly erodes with the passage of time.

Don’t Austrians Favor Market Choice?

Ironically, in addition to ill-informed critiques such as those emanating from the LA Times, the gold standard has critics from the purist libertarian camp. Such critics often ask, "What’s so special about gold? Why do Ron Paul and so many other alleged fans of the free market favor the federal government telling us what the money should be?"

Of course Murray Rothbard – and as far as I know, every living Austrian economist – would prefer that money and banking were returned to the private sector, receiving neither special regulations nor privileges distinguishing them from any other industry. That means banks would be free to issue their own paper notes (backed by gold reserves) if they wanted, but if they issued too many and got caught in a "run," the government wouldn’t declare a "bank holiday" and relieve the irresponsible institution of its contractual obligations.

What Rothbard and his modern followers believe is that gold almost certainly would be the free choice of individuals all over the world, if they were allowed to settle on a money without government legal-tender laws and other interventions stacking the deck.

In the meantime, given that there is a Federal Reserve (and other central banks), many Austrians (though here the agreement is not universal) believe that restoring the convertibility of the dollar to a fixed weight of gold would be a move in the right direction, even though it would still not be perfect.

The purpose of repegging the dollar to gold would be to remove what is euphemistically called "monetary policy" (a more sinister description would be "legalized counterfeiting") from politics and special-interest corruption as much as possible. People laud the current Fed as being "independent," but of course that is absurd. The Fed as it currently operates is clearly a cartelization device that shoves new money into the pockets of rich bankers, and that allows the government to finance massive deficits much more cheaply than would otherwise be possible.

"So You Want the Government to Set Prices?"

Related to the above criticism, some purists also ask, "Why don’t you favor a market-driven price for the dollar and for gold? Just let supply and demand determine prices, not some rigid number picked out of a hat by the politicians."

This objection sounds plausible at first, but it too misses the mark. If the Fed were to say, "We are now announcing a new policy objective of maintaining the price of gold at $2,000 per ounce, from now until the end of time, and we will begin accumulating stockpiles of gold to reassure investors that we will be able to maintain the target," this would not be analogous to the federal government saying, "We are establishing a minimum price of labor at $7.25 per hour."

Under a genuine gold standard, when the Fed "sets" the dollar price of gold it isn’t threatening people with fines or jail time if they want to trade gold at a different price. Rather, the Fed (or the government in general, if there were no central bank) would adjust the quantity of dollars in existence to maintain the target. If the forces of supply and demand were such that the market price of gold had drifted upward to, say, $2,025 per ounce, then the Fed (assuming a $2,000 target) would need to sell off some of its gold holdings,[1] which would (1) flood the market with more gold and (2) shrink the amount of dollars in the financial system. This contractionary policy would push down the price of gold toward the peg of $2,000.

On the other hand, nobody would be so foolish as to sell his gold for less than $2,000 per ounce, if the Fed (or the Treasury) had a standing invitation for anyone to trade in an ounce of gold in exchange for $2,000 in Federal Reserve notes. Why sell your gold to another private citizen for (say) $1,950 an ounce, when the US government stands prepared to buy unlimited quantities of gold at a fixed price of $2,000 per ounce?

Finally, a critic could (and actually did, on my blog) ask how this arrangement differs from the current one? After all, right now Bernanke "sets" interest rates, but not through literal price controls. Instead, the Fed adjusts the quantity of reserves in the banking sector such that the "market-determined" federal funds rate is close enough to the Fed’s target for this interest rate. So isn’t this basically the same thing as the gold standard, with a different "good" serving as the monetary commodity?

There are two problems with this sophisticated objection. First, in the current system the Fed has a moving federal-funds target. At best, then, it would be analogous only if the Federal Open Market Committee said after each meeting, "We are now setting the target price of gold at such-and-such dollars. However, if unemployment begins rising and core CPI is under 2 percent, we will begin raising the target price of gold in $10 increments over the next few meetings." That system would be nothing like the classical gold standard.

Yet the deeper problem with the analogy is that on a classical gold standard, the government is (imperfectly) mimicking what would happen if the money were actually gold, with people walking around with gold coins in their pockets, and merchants quoting prices not in dollars but in grains or ounces of gold. The classical gold standard, by fixing the dollar as convertible into a definite and constant weight of gold, doesn’t introduce another price: the dollar is supposed to be a claim-ticket to gold. This isn’t really "price fixing," any more than defining a foot as 12 inches is "central planning."

In contrast, what would be the free-market analog of the Fed’s current strategy of targeting short-term interest rates? The only thing I can think of is if the money commodity in a community weren’t something tangible like gold, silver, or tobacco, but rather overnight bonds issued by banks. Yet what is a bond but a promise to deliver money? So how could the money itself be a short-term bond? At this point I am dropping the analogy, lest I become permanently cross-eyed.

Conclusion

As the Fed’s debasement of the currency reaches literally unprecedented levels, more and more regular Americans are waking up to the merits of commodity money. Yet this isn’t some populist fad; there is a whole tradition of excellent academic scholarship touting the virtues of the gold standard. If he returns to the subject, I hope critics like the LA Times’s Popper will give gold a fairer hearing.

Notes

[1] The operation would be automatic if the system were set up along the lines of the classical gold standard. People all over the world would have the guarantee that they could always turn over $2,000 in Federal Reserve notes in exchange for a physical ounce of gold. If the market price of gold ever went above $2,000, therefore, speculators could earn arbitrage profits by buying from Uncle Sam at $2,000 and reselling gold in the market for more.

Reprinted from Mises.org.

The Capitalist in the Hat

Bob Murphy — Tue, 19 Apr 2011 05:00:00 +0000

Recently by Bob Murphy: Everybody Knows Bernanke Is aJoke

An amusing story on NPR recently explained the origin of a new collection of Dr. Seuss stories.

The tale involves an entrepreneurial dentist with a passion for Seuss and a knack for exploiting price spreads. Explaining profits that are fat? We here at Mises know a lot about that!

Is There a Doctor in the Magazine?

We can excerpt from the NPR transcript to see the entrepreneurial component of the story:

Every now and then a treasure-trove of seemingly "lost" literature is discovered. The latest such find is a collection of stories by Theodor Geisel, better known as Dr. Seuss. Seuss scholars and collectors have known about these stories for a while, but fans will have the chance to read them in a new book to be released by Random House next fall. …

These are not half-written stories found in a dusty attic after the death of the author. These are stories that have already been published. Dr. Charles Cohen, a Massachusetts dentist with a passion for all things Dr. Seuss, simply managed to collect them all in one place.

"They came out in the ’50s in magazines," Cohen explains. "And then when the next month’s magazine would come in, people would throw away the old one. And those stories were forgotten. And literally it’s been 60 years for some of these stories and very few people have seen them."

While doing research on the children’s book author, Cohen began tracking down original copies of the stories. But he needed a way to support his habit.

"I would find some of these magazines that these appeared in and I would purchase them on eBay for $2 or $5 from people who didn’t know they had these Dr. Seuss stories in them," he says. "And then I would list them on eBay and explain what they were. So a $5 magazine would bring in $200 or $400, and that was a great markup for me."

Naturally, the NPR story goes on to explain the significance of the collection. If anything, we are led to believe that Cohen’s eBay profits were a necessary evil in order to produce the end result.

Yet I want to focus just on the eBay transactions themselves. Even if nothing else had come of this – so that there was no new collection of Dr. Seuss stories, and we never heard an NPR story about it – Cohen’s actions provided a socially useful service, which was reflected in the profits he earned.

Entrepreneurs: the Driving Force of the Market

In his masterpiece Human Action, Ludwig von Mises wrote:

The driving force of the market process is provided neither by the consumers nor by the owners of the means of production – land, capital goods, and labor – but by the promoting and speculating entrepreneurs. These are people intent upon profiting by taking advantage of differences in prices. Quicker of apprehension and farther-sighted than other men, they look around for sources of profit. They buy where and when they deem prices too low, and they sell where and when they deem prices too high. … Profit-seeking speculation is the driving force of the market as it is the driving force of production. (pp. 328-329, Third Edition)

Among all the various schools of economic thought, the Austrians place the most emphasis on the importance of entrepreneurship. Indeed, it is no exaggeration to say that one could get a PhD in economics from a top university without ever hearing the term "entrepreneur" discussed in the classroom.

The Social Function of Entrepreneurship

Most people recognize the contributions of bold pioneers like Henry Ford or Bill Gates, but Mises recognized that even mundane operations, where lesser-known entrepreneurs "buy low and sell high," adjust the market to better satisfy consumers.

In Mises’s analogy, consumers "vote" with their money, and every dollar constitutes a separate vote. Entrepreneurs enter the market for labor and other resources in order to bid on these inputs and produce finished goods and services for the consumers – hoping to "win their votes." The importance of various possible items is indicated (however imperfectly) by how much money consumers are willing to spend on them.

For example, because consumers are willing to spend some of their money on retail vegetables, the grocery stores are able to spend money on wholesale vegetables, and so on up the chain of production, until we reach the farmers who are willing to devote some of their scarce land to growing vegetables.

At the same time, however, smokers are willing to spend some of their money on cigarettes. This is why the market process ensures that some arable farmland is devoted to tobacco. Mises made clear that the profitability of a good wasn’t a sign of its morality, but rather an indication that at least some consumers valued it more than other potential goods they could have purchased instead.

Mises was clear that those who condemned "capitalism" for producing cigarettes instead of (say) baby formula were really condemning the buying habits of their fellow citizens. If smokers quit and used the money instead to donate baby formula to poor mothers, then capitalism would cater to those preferences just as efficiently.

The Capitalist in the Hat

We can now understand how Dr. Cohen provided a service when he found obscure Dr. Seuss stories in forgotten magazines. Someone putting up such a magazine on eBay for $2 or $5 obviously didn’t realize its significance. Had Cohen not spotted the offer, it might have been purchased by somebody else who didn’t know about the Dr. Seuss story either.

Enter Cohen, with his superior knowledge. He had earlier discovered many magazines that contained Dr. Seuss stories, and so he could recognize the particular volumes when he spotted them on eBay. By purchasing them (at a low price) and then relisting them for a much higher price – and advertising the fact that they contained unknown Dr. Seuss stories – Cohen "created wealth" in a very meaningful sense.

Specifically, Cohen bought magazines that people were willing to sell for only $5, and he in turn sold them to people who were willing to pay up to $400 for them. Each side of the trade was voluntary; everybody thought he or she benefited when each transaction was consummated. The magazines were transferred out of the possession of the people who didn’t realize what they contained, and into the hands of people who did (because Cohen told them).

In an economically relevant sense, Cohen created those extra copies of original Dr. Seuss stories, just as surely as an artist can create a figurine out of a block of wood with a knife. It’s true, he could have simply emailed the eBay sellers and informed them of what they owned, rather than buying it from them. But then in this case, those sellers probably would have simply jacked up their asking price. The magazines would ultimately end up in the hands of Dr. Seuss lovers. The only question is, Who should reap the profits from the discovery – Cohen or the ignorant original owner?

Conclusion

Following Mises, modern Austrian economists stress the primacy of the entrepreneur. At bottom, the entrepreneur simply buys low and sells high. But in order to do this, the entrepreneur must see an opportunity in the market pricing structure that others have overlooked.

By pursuing personal profits, the entrepreneur ends up rearranging goods in a way more pleasing to consumers. The case of Seuss enthusiast Charles Cohen beautifully illustrates the harmony between personal profit and service to others in the voluntary market economy. For good or ill, entrepreneurs will provide what the customers want – whether it’s one fish, two fish, red fish, or blue fish.

Reprinted from Mises.org.

The Fed Is a Sinister Joke

Bob Murphy — Sat, 19 Mar 2011 05:00:00 +0000

Recently by Bob Murphy: WaPo Hit Piece on DiLo

As YouTube and other digital media move beyond computer-savvy young people into the ranks of even stodgy businessmen, these subversive outlets become serious problems for the ruling elite. This trend is epitomized by the radical change in the Federal Reserve’s image. In just a few short years, the Fed has transformed in public opinion from a mysterious, wise, and boring institution into a fascinating engine of corruption and comedy.

Challenging Bernanke

The chinks in the Fed’s armor of legitimacy are multiplying, all made possible by the ease of producing and distributing high-quality critiques. An early example was the spoof of The Police’s "Every Breath You Take" that Columbia Business School students made in "honor" of Ben Bernanke’s ascent to Fed chairman over their own dean, Glenn Hubbard.

It’s true, the satirical music video really wasn’t a critique of Bernanke’s policies; after all, he had only just been given the keys to the printing press. Nonetheless, it illustrated the new power of the Internet. Creating the video took a lot of effort, and it would probably not have been worth doing had the students only been able to distribute it through, say, copying it on VHS cassettes.

At the same time, although the potential market – people who would have appreciated geeky references to "bips" (basis points) and the like – was substantial, it was dispersed throughout the population. Saturday Night Live certainly wouldn’t have run such a video, and even higher-brow shows such as Bill Maher’s wouldn’t have done it either, simply because the niche was too limited.

The Internet, and specifically YouTube, solved these problems. As of this writing, the video has been watched some 1.7 million times, making it an obvious hit. The creative students were rewarded for their efforts in terms of esteem and fame, and hundreds of thousands of financially savvy people got a good laugh or two.

Laughing At "The Bernank," Not With Him

If the music satire was all in good fun, the more recent animated video, "Quantitative Easing Explained" was anything but. Relying on the same Xtranormal technology that I used for launching my debate challenge to Paul Krugman, this video features two bears discussing the Fed’s program of massive bond purchases.

The tone of this video is much edgier and harsher than that of the music-video spoof. While the fake Sting dreams of punching Bernanke in the face, it is clearly in jest. In contrast, when the cute bears curse and accuse Bernanke of lying in order to shovel billions into the hands of his rich buddies, the creator really means it.

The Importance of "Common Knowledge"

As a grad student at NYU, I once listened to a fascinating presentation in the Austrian Colloquium on the importance of multiple levels of knowledge. The presenter argued that in certain areas of life, it wasn’t enough for people to know (or believe) something, it was important that they know others know it too.

For example, if an advertiser buys a 30-second TV spot on the Super Bowl, it’s not merely that tens of millions of people will see the ad. Beyond that is the crucial fact that tens of millions of people will know tens of millions of people are seeing the same ad. The presenter argued that this explains why advertisers push "network goods," such as smart phones or Macs versus PCs, during the Super Bowl and other events with high ratings.

In other words, if a particular good’s value to a user depends not just on its intrinsic properties, but also on how many other people are using it, then (this presenter claimed) its producers tend to advertise it during the Super Bowl, or perhaps on a busy subway car, where people who see the ad will know that other people are seeing the ad too.

Moving to the political arena, the presenter elaborated on why totalitarian regimes are so quick to clean up graffiti and other public challenges to the authorities. It’s possible for a dictator to remain in power even if a large number of his subjects hate him, so long as they think they are relatively isolated. But when someone writes, "Down with the Regime!" on a bridge, it is a signal that rallies the malcontents. Not only do they realize that they are not alone, but they know that other people like them are seeing the same subversive message.

In this context, the significance of YouTube and similar media is even larger than it seems at first glance. For example, I was thrilled when I saw "The Bernank" video, not because I learned something new from it – I already thought the Fed was a corrupt engine of inflation – but because I saw how many millions of other people had seen the video. And we can push it even further: I knew that they knew how many people were seeing the video.

This was the importance of "common knowledge," which the game theorists formally describe as something that (a) everyone knows, (b) everyone knows that everyone knows, (c) everyone knows that everyone knows that everyone knows … and so on forever. At first blush it might seem as if the deepening layers of knowledge are superfluous, but in some contexts they can be crucial.

To take an example adopted from the presenter at the NYU colloquium: Suppose Bill and John are on a crowded subway car, separated by dozens of people. The two are going to a Broadway show, and John is not familiar with the subway system, so Bill needs to signal to John when they should both get off the subway. However, because they are separated by so many densely packed people, the two men will have to use different exits to get off their car.

As the subway approaches the proper stop, Bill gives John a signal to get off. However, because there are so many people jostling about, Bill isn’t quite sure that John saw his hand motion. So Bill isn’t sure whether to get off himself, because it would be catastrophic if he stepped off and left John on the subway.

In this somewhat contrived example, we see the importance of layers of knowledge. Even if John did see the message – so that Bill knows it’s time to get off, and John knows that it’s time to get off – that isn’t enough. Bill needs to know that John knows. Yet that too is insufficient, because John needs to know that Bill knows John knows, and so on. (If John thought that Bill didn’t realize John had correctly interpreted Bill’s signal, then John might expect Bill to stay on the subway car, not wanting to abandon John. Hence John might not get off the car himself, even though he knows it’s the right stop, and even though Bill knows that John knows this.)

These fanciful musings shed more light on the power of YouTube’s viewership statistics, which greatly amplify the impact of the Bernanke-bashing bears. It isn’t merely that over 4 million people have seen the video blasting the Fed, but that we all know how many of us have seen it.

In a related vein, the surprising popularity of the Hayek-Keynes rap video, and the traffic rankings of explicitly Austrian sites such as Mises.org and LewRockwell.com, have encouraged more and more Austrians to come out of the closet, as it were. They can brush off the put-downs of the "respectable" mainstream economists, because they know that growing numbers of people agree that the Austrians have an important and neglected perspective when it comes to both economic theory and policy.

Not so long ago, the prevailing wisdom was that a young economist was committing career suicide by pursuing an explicitly Austrian research program. This is no longer the case. As I joked to the Grove City undergraduates at this year’s Austrian Student Scholar’s Conference, nowadays a young scholar is merely cutting off his left arm by announcing his love for Mises and Rothbard. This is progress!

Speaking Truth to Power

Commentators have extensively discussed the impact of Twitter and Facebook on the events in Egypt and elsewhere in the Middle East. What is less obvious is the tarnishing of the image of the Federal Reserve.

Last Saturday "AmpedStatus" (in affiliation with the hactivist group "Anonymous") announced "Operation Empire State Rebellion," in a YouTube video warning of nonviolent civil disobedience if the Federal Reserve doesn’t change course. The creepy video – complete with a distorted voice – specifically demands the resignation of Ben Bernanke as a sign of good faith.

More generally, "disrespectful-punk" websites catering to financial readers, epitomized by ZeroHedge and EconomicPolicyJournal, take it as a matter of course that Bernanke has no clothes. The anonymity of the Internet ensures that plenty of respectable Wall Street pros turn to these alternative media to get the real news about the economy – when their boss isn’t looking, of course.

The officials at the Federal Reserve and other power centers aren’t ignoring the budding green shoots of dissent. Bernanke’s duplicitous 60 Minutes appearance was a PR damage-control move that we normally would expect from politicians, not central bankers. Before the present financial crisis, the operations of the Federal Reserve were mysterious and boring.

“In central banking, as in politics, the ruling elite must keep the people in the dark.”

But now – because of Bernanke’s boldness, the ascendancy of the Ron Paul movement, and the resurgence in Austrian economics, among other factors – a large segment of the public is very interested indeed in what "the Bernank" is up to.

Conclusion

As Murray Rothbard emphasized, our modern banking system is based on fractional reserves, meaning the bankers are always vulnerable to a sudden loss in confidence. Just as political regimes can topple overnight with a change in public opinion, so too can the "strongest" of modern financial systems crumble in the face of a large-scale run on the banks.

In central banking, as in politics, the ruling elite must keep the people in the dark. The rise of the Internet, and in particular outlets such as YouTube, are making that task far more difficult.

Reprinted from Mises.org.

WaPo Smears DiLo

Bob Murphy — Wed, 16 Feb 2011 06:00:00 +0000

Recently by Bob Murphy: Rise of the Free-Market Zombies

Any LRC reader who's not been holed up in Guantanamo has by now read all about Ron Paul's historic opening hearing in his new role as head of the subcommittee that oversees the Federal Reserve. In my navet, I am still shocked at the laziness of Dr. Paul's critics.

In this particular case, the critics directed their fire at Tom DiLorenzo, one of Paul's witnesses. Tom has already answered their general charges here, but I think it will be useful to go through and dissect this Washington Post article by Dana Milbank, since it so beautifully epitomizes the half-hour hatchet job in these affairs. (Full disclosure: Tom is a personal friend.)

DiLorenzo Hiding His True Views?

Right off the bat, Milbank implies that DiLorenzo was trying to sneak his anti-Lincoln views under the subcommittee's radar:

The Republican takeover of the House put a chairman’s gavel in the hands of Rep. Ron Paul of Texas, the gadfly GOP presidential candidate with a cult following. On Wednesday, he used that gavel for the first time – to remarkable effect.

The hearing itself was lively – based on Paul’s desire to abolish the Federal Reserve and bring back the gold standard – but what really stood out was Chairman Paul’s leadoff witness: a Southern secessionist.

The “short bio” the witness provided with his testimony omitted salient pieces of his resume, including his 2006 book, “Lincoln Unmasked: What You’re Not Supposed to Know About Dishonest Abe.” But the subcommittee’s ranking Democrat, William Lacy Clay (Mo.) did some homework and learned more about the witness, Thomas DiLorenzo of Loyola University Maryland.

Milbank certainly gives the impression that DiLorenzo had taken all of his "nutjob" Lincoln stuff out of his bio, and perhaps left in only his doctoral dissertation and some other academic pieces — hoping against hope that the lazy congressmen wouldn't find out about the dark side of DiLorenzo the bomb-thrower.

But anybody who knows Tom, knows that he is hardly squeamish about his views. So I asked Tom to send me a copy of the "short bio" he sent to the subcommittee. It contains this:

Dr. DiLorenzo's major research and publication interests are economic history, industrial organization, and political economy. He is the author or co-author of fourteen books, including The Real Lincoln and How Capitalism Saved America: The Untold History of Our Country, From the Pilgrims to the Present. His latest book is Hamilton's Curse: How Jefferson's Archenemy Betrayed The American Revolution — And What It Mean for America Today. Among his other books (co-authored with James T. Bennett) are Official Lies: How Washington Misleads Us; Underground Government: The Off-Budget Public Sector; The Food and Drink Police: America's Nannies, Busybodies, and Petty Tyrants; and Destroying Democracy: How Government Funds Partisan Politics. Barron's magazine labeled The Real Lincoln as its "top pick" of books with economic themes for 2002.

Does the above look like somebody who is trying to pass himself off as a moderate Republican bean counter? It's true, the title "The Real Lincoln" by itself could suggest a book explaining what a great and religious man Honest Abe was. But in the context of all those other incendiary titles? I hardly think DiLorenzo was looking to avoid raising eyebrows.

Guilt By Association

After implying dishonesty in DiLorenzo's representation of his views, Milbank then moves in for the kill:

DiLorenzo, the congressman told the committee, had called Lincoln “the first dictator” and a “mass murderer” and decreed that “Hitler was a Lincolnite.” Worse, Clay charged, “you work* for a Southern nationalist organization.” “The League of the South is a neo-Confederate group that advocates for a second southern secession and a society dominated by European Americans.”

At the witness table, DiLorenzo scoffed and waved his hand dismissively at Clay. But neither he nor Paul attempted to refute Clay’s allegations.

Approached after the hearing, the witness said: “I gave a couple of a lectures to a group of college students 15 years ago that are associated with this thing called League of the South.”

As it turns out, “this thing” called the League of the South Institute was listing DiLorenzo on its Web site as recently as 2008 as an “affiliated scholar.” A secessionist Web site, DumpDC, identified DiLorenzo the same way last year when it published an interview with DiLorenzo in which he is quoted as saying “secession is not only possible but necessary if any part of America is ever to be considered ‘the land of the free’ in any meaningful sense.”

And there you have it: DiLorenzo had the chutzpah to say a guy who was directly responsible for a war that left over 600,000 people dead, was a "mass murderer." (For those questioning Lincoln's responsibility, keep in mind that (a) the Confederate states didn't want to take over the entire United States, they simply wanted to secede and (b) things like Sherman's March were war crimes, if that term is to mean anything.)

As far as DiLorenzo's affiliation with the League of the South: I realize Dana Milbank may not be familiar with how academia and non-profit relationships work, but there is nothing contradictory in DiLorenzo saying he merely gave some talks to a group, and then that group still listing him as an "affiliated scholar" years later.

At this point we can wonder what Milbank's point is. Don't worry, he tells us:

DiLorenzo, a self-proclaimed historical revisionist, is entitled to say whatever he likes. But it raises doubts about Ron Paul and his causes if this is the best he can come up with for his first act as chairman of the Financial Services Committee’s monetary policy subcommittee.

I have gone back and re-read the previous paragraphs in Milbank's article. I confess I still don't see what DiLorenzo's views on the necessity of secession have to do with Ron Paul's agenda with respect to auditing the Fed or bringing back the gold standard. Milbank certainly did nothing to refute DiLorenzo's claim that only secession could restore freedom to parts of America.

Gotcha Moments

Milbank pauses in his article to deploy his hatchet on Ron Paul and Richard Vedder. Milbank first accuses Paul of bad math, though here Paul probably meant dividing total Fed bailouts by the number of unemployed (rather than the whole population of the United States), in which case the "error" disappears.

As far as Vedder, yes he fell into a cross-examination trap. He had said that the Federal Reserve fosters bubbles, but declined to speculate on where the next bubble would arise. Vedder went so far as to say, "Economists who make predictions are foolish."

This then opened him up to a Democratic critic (Al Green of Texas) who asked him if the gold standard would be better for America, and then when Vedder said yes, Green brought up Vedder's earlier disdain for predictions. Okay, very nice, but that hardly disqualifies Vedder's general position that (a) we can be confident that a central bank will screw up the economy without (b) being able to predict beforehand exactly the form the screw up will next take. (By the same token, I could "predict" to the leaders of North Korea that pure capitalism would greatly enrich their people, but I would have no idea how many shopping malls would be in Pyongyang two years after the reforms.)

The Peculiar Institution

In his final paragraphs, Milbank moves the crosshairs back to DiLorenzo:

DiLorenzo went so far as to say there is no need for the government to guarantee bank deposits. “I’m not sure before we had an FDIC you could make a case bank runs were worse,” he argued.

“We had the Great Depression,” Green pointed out.

“Well, yes, for a few short periods,” the witness allowed.

It was peculiar to portray the Depression as “short.” Then again, it was peculiar of DiLorenzo to say last year that “I saw it as my duty to spread the truth about what a horrific tyrant Lincoln was.” And it was peculiar of DiLorenzo to write in 2005 that “the League of the South advocates peace and prosperity in the tradition of a George Washington or a Thomas Jefferson.”

As far as the FDIC issue, obviously Tom DiLorenzo was not saying the entire Great Depression was short. What he was saying is that there were a few years of bank runs during the Great Depression, but that this was not sufficient to make the case for FDIC. (DiLorenzo was contrasting taxpayer-guaranteed bailouts of irresponsible banks, with the earlier system of bankruptcy proceedings.)

Now on to Lincoln, the real "problem" with DiLorenzo: Yes, it is "peculiar" for him to hold those views, in the sense that most Americans have been taught that Lincoln is a hero, the greatest of presidents who "saved the Union." Yet as DiLorenzo's work has documented, Lincoln was a tyrant. And it's not even the "mere" issue of not allowing people to leave the government of which he was the sitting head, but also rather tyrannical things like locking up newspaper editors who disagreed with his policies. (Here's an example from a non-pro-Southern website of Lincoln seizing newspapers for apparently printing hoaxes. The reader can surely see the slippery slope involved, but again I am offering this "understandable" example since it comes from a neutral source that isn't condemning Lincoln in the discussion.)

People who worry about the abuse of civil liberties under the Bush and Obama administrations should recall that Lincoln famously suspended the writ of habeas corpus. Fortunately, we live in a system of checks and balances, and a U.S. district court overruled Lincoln. Oops, he just ignored them. But, when you're trying to achieve important goals, you can't be bothered by individual rights and what a U.S. district court thinks of your policies.

Finally, let's deal with Milbank's last "shocking" quotation, where DiLorenzo praises the League of the South as being in the tradition of George Washington or Thomas Jefferson. First of all, if you click through and read the article, you will see that DiLorenzo is defending his friend Tom Woods from similar character attacks. In other words, when Woods made a splash with his own book on American history, people trotted out the zombie strategy of linking him to the "neo-Confederate" League of the South. So DiLorenzo was only talking about the League of the South to defend his buddy; it's not (as Milbank is obviously trying to imply) that DiLorenzo looked at his calendar and said, "Whoa, it's that time of the month when I have to go out and promote my employers, the League of the South."

But more important is the fact that someone who thinks the Southern states should have been allowed to secede is quite clearly endorsing the principles of the Declaration of Independence. That's the whole point, after all: When a people think that they are being oppressed by a government that is not representing their interests, then they have a God-given right to dissolve their ties with that government and form their own. That's what the people in the Confederacy were doing.

Of course, the elephant in the room in all this is slavery. Obviously it was an awful thing that the institution existed in the first place, and that the political leaders in the South wanted to perpetuate it. But guess what, Mr. Milbank? George Washington and Thomas Jefferson both owned slaves. And when the American colonies declared their secession from Great Britain, they consisted of a lot of slaveholders. If King George had — halfway through the War for American Independence — declared a new objective of freeing all U.S.-based slaves, would Milbank now say that the wrong side won that war?

This is the crux of the matter. If someone (like DiLorenzo) wants to praise the good things in the writings of the Founders, and also of the arguments in favor of Southern secession, that's consistent. If someone else (say a Black Panther) wants to denounce the Confederacy, but also all the hypocritical Dead White Males who signed the Constitution and endorsed its offensive 3/5 clause, that too is consistent; fair enough.

But what doesn't make any sense is for Milbank (and related critics like Paul Krugman and Matt Yglesias) to go along with the standard American civics lesson, which teaches that slave-owners George Washington and Thomas Jefferson were heroes of liberty, but then to recoil in horror at the idea that the Southern states should have been allowed to secede, because they had slaves and therefore forfeit any possibility of our (qualified) endorsement in that terrible episode in American history.

Conclusion

One of the most basic insights of Western civilization is that the ends don't justify the means. (For example, everyone is praising the nonviolent methods through which the Egyptian people recently achieved political change.) Nobody in this day and age is defending the institution of slavery as it existed in the Southern states. Even so, that doesn't mean Abraham Lincoln was right to wage an awful war, even if one of its outcomes was the eradication of slavery.

On the matter of consistency, neo-conservatives are fine: They supported George W. Bush's invasion to bring freedom to Iraqis, and they revere Abraham Lincoln as the greatest Republican of all time. But people like Krugman and Milbank are again being inconsistent: If Lincoln is so great — such that we don't even need to explicitly defend him from the criticisms leveled by critics such as DiLorenzo — then George W. Bush should at least be a pretty good guy. And yet Krugman and Milbank have been quite critical over the Bush administration's handling of war.

In any event, this entire episode actually encourages me. Everyone now knows that when Ron Paul holds a hearing on how the Fed contributes to unemployment, the "other side" has nothing much to say, except attacking the background of the witnesses.

This might resonate with professional pundits, and it may indeed raise doubts among some regular Joes who have never heard of Tom DiLorenzo. But I still bet if you polled a large number of black teenagers, and asked, "Do you think Ben Bernanke can't sleep at night, knowing that the official unemployment rate in your demographic is just shy of 50 percent?" they probably would laugh at you.

*NOTE: In Milbank’s original article, he quotes Clay as saying that DiLorenzo “worked for” the League of the South. However, DiLorenzo claims that Clay actually said “work for.” Although the audio quality is poor, it does indeed sound as if Clay said that (at about the 55:00 mark in this video).

‘Free-Market Zombies’

Bob Murphy — Fri, 24 Dec 2010 06:00:00 +0000

For his Sunday
column, Paul Krugman wrote a piece titled "When
Zombies Win." Krugman claims that "free-market fundamentalists"
– including Ron Paul – have been successful politically,
despite being thoroughly discredited by recent events. As we’ll
see, it’s a good thing that these ideas of shrinking government
refuse to die, no matter how often Krugman attacks them.

Krugman’s
Zombie Thesis

The opening
paragraph explains the title given to Krugman’s article:

When historians
look back at 2008–10, what will puzzle them most, I believe,
is the strange triumph of failed ideas. Free-market fundamentalists
have been wrong about everything – yet they now dominate
the political scene more thoroughly than ever.

Before moving
on to Krugman’s specific claims, we need to stop and remark on just
how warped the above opening really is. For one thing, "free-market
fundamentalists" have not been wrong about everything.
It is true – as we’ll get to shortly – that many opponents
of fiscal stimulus and quantitative easing were warning of high
interest rates and price inflation. Those threats have not materialized
(at least yet), and on that score Krugman understandably can pat
himself on the back.

But the free-market
fundamentalists were certainly correct when they said that
the Obama stimulus package would not pull us out of recession. It
was not just Austrians but many Chicago School economists who were
reminding the public of basic observations such as "the government
can only spend what it first takes from the private sector."

At the time,
Keynesians such as Brad
DeLong and Krugman
went ballistic at such crude thinking, but if anybody has been vindicated
by what happened to employment and GDP in the last two years, it
has been those who said the Obama stimulus would just make things
worse.

It was not
merely Christina
Romer who famously predicted that unemployment without
the stimulus wouldn’t rise as much as it in fact did with
stimulus. It was also Mark Zandi (whom Krugman later
credited for his wonderfully accurate Keynesian models) who
predicted in November 2008 (see page 21 of this pdf) that real GDP
without stimulus would fall by 2.2 percent in 2009. Then,
with the Obama stimulus, the economy
in fact fell by 2.6 percent that year.

As far as the
free-market fundamentalists dominating the political scene "more
thoroughly than ever," I suppose Krugman is right, in the sense
that two French poodles could dominate a pit bull more than one
French poodle could. But as the Fed discloses its cumulative $9
trillion in backdoor loans, as the FBI
raids hedge funds, and as federal
spending as a share of the economy is at its highest level since
World War II, I hardly think that DC is being overrun by laissez-faire
shock troops.

Krugman versus
Ron Paul

To prove that
free-market fundamentalists have seized power, Krugman’s Exhibit
A is Ron Paul:

How did that
happen? How, after runaway banks brought the economy to its knees,
did we end up with Ron Paul, who says "I don’t think we need
regulators," about to take over a key House panel overseeing
the Fed?

Of course,
if we look at the actual
context of what Paul is saying, we find that he means it is
foolish to trust government regulators to nip asset bubbles in the
bud, while the Fed and other government programs do their part in
fueling such bubbles. Ron Paul was not saying, "Let
the banks do whatever they want," instead he was saying that
we shouldn’t be bailing them out when they screw up. Instead,
let them go bankrupt just like any other business would after making
horrible investment decisions.

In his article,
Krugman has some good examples of "right wingers" who
made predictions that, in retrospect, made them look foolish. But
it’s not as if the conventional Left is lacking in this category,
even if we focus just on the housing bubble and bank crisis.

For example,
Fed
economists and Ben
Bernanke himself denied that there was a housing bubble.
Barney Frank – hardly a Jedi Knight of libertarianism –
infamously defended
the solvency of Fannie and Freddie up until their seizures.

And let us
not forget Paul Krugman himself, who – it must be admitted
– did indeed recognize the housing bubble before many others
did. But, ironically, he praised Greenspan for creating it.
Many people have pointed to Krugman’s
2002 call for Greenspan to create a housing boom, but not as
many saw Krugman endorse it after the fact, as this October
2006 exchange with one of his readers illustrates,

NEERAJ MEHRA,
AMRITSAR, INDIA: Mr. Greenspan has done a disservice to the nation
by creating the housing boom. As a layman-observer, that’s the
lingering thought I’ve had. Your article reaffirms it.

The question
I have is this: Did he do the right thing – acting morally
by engineering a housing boom, more as a bridge loan, until something
else showed up at the horizon to shore up the economy – because
he didn’t have a choice, or did he undertake a path of mere political
expediency? And, that’s a question that’s nagging me for a while.

Would appreciate
it if you could shed some light.

PAUL KRUGMAN:
As Paul McCulley of PIMCO remarked when the tech boom crashed,
Greenspan needed to create a housing bubble to replace the technology
bubble. So within limits he may have done the right thing. But
by late 2004 he should have seen the danger signs and warned against
what was happening; such a warning could have taken the place
of rising interest rates. He didn’t, and he left a terrible mess
for Ben Bernanke.

Turning from
monetary policy to other government efforts to spur the housing
boom, Krugman’s story – in which he tries to exonerate Freddie
and Fannie, and pin the blame entirely on private-sector villains
– keeps changing, as others constantly correct his facts. Raghuram
Rajan gives the blow-by-blow account here.

Finally, regarding
bank bailouts, many Austrian economists (not so many among other
free-marketeers, unfortunately) were vehemently
opposed to them, as the issue was being debated.

In contrast,
Krugman was for
the bailouts (though of course they were not the textbook ideal,
in his opinion). Interestingly, when Krugman recently
tried to argue that he and his heterodox peers were in favor
of letting the Iceland banks go under, while the orthodox fuddy-duddies
were in favor of bailing out Ireland’s banks, this caused such cognitive
dissonance among Krugman’s readers (who remembered his support for
TARP) that he had
to explain his way out of the contradiction.

In sum, regarding
the worldviews of Ron Paul versus Paul Krugman, here’s what we can
say:

Ron Paul thought
it was a terrible mistake for Greenspan to fuel the housing bubble,
for government agencies to encourage banks to lower their lending
standards, and then for the Treasury (as well as the Fed) to bail
out the big banks from their mistakes.

Krugman, in
contrast, recommended that Greenspan blow up the housing bubble,
and his only criticism was that Greenspan began raising interest
rates to quell it, rather than simply jawboning the speculators.
Krugman continues to downplay any role that the government had in
encouraging reckless lending. Further, Krugman was in favor of bailing
out the banks, who he thinks acted recklessly.

So if we are
going to look at the current, dismal economy and blame somebody’s
policies for it, surely we can acquit Ron Paul. That doesn’t by
itself prove that Ron Paul’s views are correct, but it certainly
casts doubt on Krugman’s constant claims that he himself has been
a beacon of clarity over the years with his accurate Keynesian modeling.

Interest Rates
and Price Inflation

Finally, let’s
turn to the one legitimate point Krugman makes in his article:

It’s also
worth pointing out that everything the right said about why
Obamanomics would fail was wrong. For two years we’ve been warned
that government borrowing would send interest rates sky-high;
in fact, rates have fluctuated with optimism or pessimism about
recovery, but stayed consistently low by historical standards.
For two years we’ve been warned that inflation, even hyperinflation,
was just around the corner; instead, disinflation has continued,
with core inflation – which excludes volatile food and energy
prices – now at a half-century low.

It is true
that many opponents of massive deficits and money printing gave
warnings of interest rates and price inflation that at best were
premature; I myself fall
into this group. This is unfortunate, because our mistaken warnings
now give Krugman a convenient target when trying to distract people
from the failure of Keynesian pump priming.

To tackle this
issue would require another article in itself. For now suffice it
to say that there are indeed plenty of signs that the Fed’s inflation
is distorting the economy, not least of which is the record price
of gold. Even using the government’s own numbers, producer
prices are rising in proportion to how far removed they are
from the unemployed, debt-ridden consumer. I have been a faithful
reader of Krugman over the last two years, and I don’t remember
his predicting in early 2009 that oil
prices would double in 15 months.

Conclusion

Paul Krugman
is speaking nonsense when he argues that the last two years have
demonstrated the failure of free-market policies. Despite his claims,
it is encouraging to watch the growing respect given to Ron Paul
and others espousing small-government rhetoric. If these rising
stars of the liberty movement be zombies, we can only hope they
have enough brains to get the job done.

Reprinted
from Mises.org.

December
24, 2010

Bob
Murphy [send him mail],
adjunct scholar of the Mises Institute,
is the author of The
Politically Incorrect Guide to Capitalism,
The
Human Action Study Guide,
and The
Man, Economy, and State Study Guide.
His latest book is The
Politically Incorrect Guide to the Great Depression and the New
Deal.

The Trouble With Official ‘Free-Market’ Economics

Bob Murphy — Tue, 14 Dec 2010 06:00:00 +0000

In a recent
post "Triumph
of the Austrian Economists," David Frum laments the displacement
of the respectable Chicago School as the economists of choice among
the political Right. Frum fails to see that conservative Republicans
are justified in switching their allegiance to the Austrian economists,
because supply-side monetarists have a glaring blind spot when it
comes to the Federal Reserve.

Frum Is Flummoxed

Frum is dismayed
at the resurgent interest in Austrian analysis and policy recommendations:

An important
subtheme of Noah Green’s survey
of Fed critics is the triumph of Austrian over Chicago economics
within the modern political right.

Thirty years
ago, right of center economists did not accept recessions as necessary
and indeed healthful responses to speculative bubbles. They still
winced at the memory of Hoover era officials who welcomed the
Great Depression as a means to "purge the rottenness"
from the market system.

Thirty years
ago, right-of-center economists did not celebrate high interest
rates as a safeguard of the currency. Thirty years ago, they measured
inflation by the dollar’s ability to buy goods and services –
not its value relative to gold or some other commodity.

Even today,
probably most business economists – most Republican economists!
– reject those ideas. I notice that the e21
letter criticizing the Fed was not signed by two distinguished
right-of-center academic economists, Greg Mankiw and Robert Barro.
I notice that it was not signed by President George W. Bush’s
two leading economic advisers, Glenn Hubbard and Larry Lindsey.

In the first
place, Frum seems to have forgotten that, after several years of
Republican control of both Congress and the White House, we are
in the midst of the worst economic crisis since the Great Depression.
For all I know, the president ignored their advice, but the refusal
of economic advisers to George W. Bush to sign a letter hardly
makes me suspicious of the letter’s soundness.

Before delving
into the main focus of this article – namely, the superiority
of the Austrian over the Chicago School when it comes to the insidious
role of the Fed – I want to correct two historical errors in
Frum’s condescending post:

Frum’s line
about "Hoover era officials" who wanted to "purge
the rottenness out of the system" is a reference to Andrew
Mellon, treasury secretary to Herbert Hoover. In Hoover’s memoirs,
he describes the White House discussions following the stock-market
crash of October 1929. Hoover explains that Mellon did indeed advocate
a policy of liquidationism, in which the federal government would
stand back and allow the market to run its natural course.

This is the
point at which modern Keynesians – a category that includes
David Frum himself, whether or not he chooses to use the label
– stop quoting from Hoover’s memoirs. "Aha!" they
say, "Hoover sat back and did nothing, and that’s why the 1929
crash turned into the Great Depression. Quick, let’s spend some
more borrowed money!"

Unfortunately
for the Keynesians, if they would just read the
very next page in Hoover’s memoirs, he explains that he
rejected Mellon’s advice. Even though people like Paul Krugman,
Brad DeLong,
and yes, David Frum continue to insist otherwise, Herbert Hoover
was a big-government man who instituted a New Deal lite.

Incidentally,
that is why the financial crash that occurred on his watch
mushroomed into the Great Depression. If Hoover had actually been
the laissez-faire ideologue portrayed by his critics – if Hoover
really had done nothing much, just as his predecessors did when
facing their own financial panics – then modern
Americans wouldn’t know anything about him. How many Americans
can confidently identify the presidents during the Panic
of 1819 or the Panic
of 1907? Yet everybody "knows" that Herbert Hoover
caused the Great Depression because he believed in pure capitalism.

Besides perpetuating
the myth of a liquidationist Hoover, Frum also seems to be ignorant
of how the Volcker Fed ended the Carter-era stagflation and ushered
in the "Great Moderation." Specifically, Paul Volcker
restored people’s faith in the US dollar by jacking
up interest rates and by stabilizing commodity prices (as explained
at the time in the Wall Street Journal
by Arthur Laffer, whose Chicago School bona fides Frum presumably
can respect).

The Achilles
Heel of the Chicago School

People often
ask me why I call myself an Austrian economist, as opposed to a
more generic "free-market economist." After all, what’s
the big difference between the average Austrian and the average
supply-side monetarist?

Beyond the
methodological differences,
in practice the Chicago School has one major shortcoming: its neglect
of capital theory. Specifically,
many followers of Milton Friedman think that the Fed is "doing
its job" so long as the CPI does not rise too quickly.

Ludwig von
Mises and Friedrich Hayek
pointed out long ago that this "[consumer] price stabilization
rule" would lead to disaster. Indeed, Murray Rothbard stressed
that the stock-market bubble of the late 1920s – fueled by
the Fed’s policies – did not coincide with rampant consumer-price
inflation.

We saw a similar
pattern in our times, during the housing-bubble years. Many prominent
Chicago School economists thought everything was fine. After all,
the Bush administration had (modestly) cut tax rates, and although
it had increased spending far too much, that would hardly sow the
seeds for a minidepression. It was also true that Fannie Mae, Freddie
Mac, and other government incentives were pushing banks into making
risky loans, but I do not recall any Chicago School economists before
the crash saying that this would devastate the economy.

On the other
hand, there were plenty of academics
and investors
who relied on Austrian business-cycle theory to diagnose the housing
bubble. They quite rightly understood that the Greenspan Fed’s decision
to push interest rates down to incredible lows would distort the
capital structure of the economy (the regulation of which is, after
all, what the market-interest rate is for, in the Austrian
view). Artificially low interest rates could generate a euphoric
boom, but it would inevitably give way to a bust.

Paul Krugman
is right when he says that many of the current critics of Keynesian
policies were caught completely flat-footed by the housing crash.
In contrast, some interventionist economists (such as Nouriel
Roubini) went on record with surprisingly accurate predictions
of how fragile the economy was.

Conclusion

Conservative
Republicans have traditionally associated themselves with the Chicago
School. But if the only choice is between that approach – especially
in its most extreme rational
expectations form – and the worldview of a Roubini or Krugman,
conservatives will appear incapable of explaining major crashes,
which is a rather serious weakness.

No school of
economic thought is perfect; I personally learned more about international
trade from the work of Arthur Laffer than I have from the Austrians.
But when it comes to explaining the boom-bust cycle – and recognizing
the dangers of Bernanke’s actions – I turn to the Austrians.

Reprinted
from Mises.org.

December
14, 2010

Bob
Murphy [send him mail],
adjunct scholar of the Mises Institute,
is the author of The
Politically Incorrect Guide to Capitalism,
The
Human Action Study Guide,
and The
Man, Economy, and State Study Guide.
His latest book is The
Politically Incorrect Guide to the Great Depression and the New
Deal.

The Brewing Cyber Wars

Bob Murphy — Mon, 13 Dec 2010 06:00:00 +0000

As
thousands
joined in the Distributed Denial of Service (DDoS) attacks on
Mastercard et al., the first full-scale cyber war (or "Internet
War") had begun. I have already expressed my concern (here
and here)
that the boycotters of Amazon hadn't provided a compelling justification
for their strategy. In the present article, I'll offer some general
observations that I hope will help libertarians and antiwar activists
to organize their thoughts as the conflict escalates.

Amazon,
MasterCard, et al. have not been torturing prisoners or bombing
civilians; the U.S. government has. At best, these companies capitulated
to very real threats from the government, and at worst they cut
a deal to remove an earlier threat that had been hanging over
them. I personally cannot judge them too harshly, since I may
very well have done the same (though I would have needed to be
waterboarded before issuing the press
release that Amazon gave). Now I understand that some very
committed antiwar activists would have gone to jail under similar
circumstances, but they are in the minority. It is one thing to
say you will stand up to the government; it's something else entirely
when an actual senator is on the phone.

A silly
Star Wars analogy may help: The boycotters presumably liken
Amazon to Lando Calrissian, who sold out his friend Han Solo in
a deal with the Empire. But this isn't at all accurate. Amazon
didn't deliver Assange over to the authorities; his jilted
lovers did. Amazon's "betrayal" merely meant that
the WikiLeaks site was down for a few hours, and all Amazon did
was end its business relationship with the pariah organization.
It would be as if the Millennium Falcon needed to refuel, and
the first planet they stopped at told them to keep moving because
they were on Vader's blacklist. Now if that had happened
in the movie, and then after hitting the next depot (three hours
away) the rebels circled back and starting firing on the first
place for not selling them fuel, the audience would have been
quite perplexed. That's not what the good guys do. The good guys
study the schematics of the Death Star; they don't figure out
which groups of non-combatants they should punish next for not
joining the rebellion.

If you allow
yourself to become outraged when someone fails to martyr himself,
you have condemned yourself to a life of constant bitterness and
disappointment. You will be much healthier — and much more able
to further the causes you cherish — if you simply acknowledge
that most people will not stick their necks out if it will put
their careers or families in immediate jeopardy. Better to accept
that basic fact, and build your plans around it.

It is better
to herald heroism than condemn cowardice. Positive reinforcement
is more productive — and more likely to recruit others — than
punishment.

If your
proposed strategy requires the statement, "We're at war!"
to justify it, it is probably a very bad idea.

If you want
peace, then you should renounce threats, property destruction,
and of course violence. Those are the techniques of the government.

The world
is very complex, with billions of people reacting to each other.
It is impossible to predict all of the ramifications of our actions.
That's why moral rules are so important. If we set out
to do things "for the greater good," believing that
the ends justify the means, we may realize to our horror that
we have ushered in great evils.

The American
empire of military occupation and surveillance ultimately rests
on American public opinion. I am ashamed to say that I once was,
what we would now call, a "neo-con" (though the term
was not in usage at the time). But as I delved deeper into the
works of Austrian economists and Old Right conservatives, I realized
my intellectual confusion. It made no sense to oppose the welfare
state and government meddling in the domestic economy, while supporting
the trillions the U.S. government spent on foreign adventures.
Since I personally was convinced of the poverty of militarism,
I know that others can be likewise converted.

Disrupting
commercial operations, let alone engaging in physical property
destruction, will not recruit more Americans to our point of view.
Someone who gets his news about Assange from Sean Hannity will
not be goaded into reading Glenn Greenwald when he can't buy his
Christmas presents after Amazon's site crashes. On the contrary,
he will despise the "America-hating commies" behind
the attacks even more, and will applaud the government's crackdown
on the Internet to "keep him safe" from further acts
of cyber-terrorism.

The truth
is on our side. That is why WikiLeaks poses such a threat to the
ruling class; they scurry like cockroaches from the light. Those
who desire peace need not resort to hostility and aggression.
They simply need to bravely speak the truth.

In the long
run, the truth will out. Good will eventually triumph over evil.

December
13, 2010

Bob
Murphy [send him mail],
adjunct scholar of the Mises Institute,
is the author of The
Politically Incorrect Guide to Capitalism,
The
Human Action Study Guide,
and The
Man, Economy, and State Study Guide.
His latest book is The
Politically Incorrect Guide to the Great Depression and the New
Deal.

Now, Tell Me, Why Is Amazon Being Singled Out?

Bob Murphy — Wed, 08 Dec 2010 06:00:00 +0000

As
most readers already know, Senator Joe Lieberman publicly called
on Amazon to stop hosting WikiLeaks on its servers. When Amazon
capitulated to this request, many heroic opponents of US foreign
policy — whom we at LRC respect very highly — demanded a boycott
of Amazon (e.g. here,
here,
and here).
I did not understand the hostility to Amazon, and wrote
a column explaining why. Justin Raimondo was not
convinced, and reiterated calls to boycott Amazon.

I'm
still not convinced, and in particular I think Mr. Raimondo's article
does not explain — as my original piece asked — why are we singling
out Amazon?

Why
Single Out Amazon?

The
main reason I personally was not outraged at Amazon's decision,
is that I initially was very surprised that they hosted WikiLeaks
in the first place. I had been driving in the car, listening
to some right-wing AM talk show (much the same way I use my tongue
to play with canker sores because I'm curious about how bad it will
be). During the news break, the announcer said matter-of-factly
that WikiLeaks' main host had gone down, and that Amazon was now
hosting the controversial website instead.

I
was extremely surprised, bordering on flabbergasted. After all,
for months public figures had been calling for the "treasonous"
Assange, with "blood on his hands," to be executed without
trial. In such a climate, for a huge, public company like Amazon
— which depends on a huge volume of traffic for its low-margin business
— to publicly stand with WikiLeaks, bordered on extraordinary. I
was expecting the announcer to say that some obscure server in Australia
was hosting the site, not Amazon for crying out loud. This
was like Disneyland opening up an Abu Ghraib ride.

Teaching
Amazon a Lesson

With
this background, let me reiterate my point about what "lesson"
a painful boycott of Amazon would actually serve. The lesson is
not, "If you fail to disseminate information that is
critical of the U.S. empire, then you lose my business." As
I pointed out, there are plenty of companies that have done far
more to promote the U.S. empire, than Amazon ever did. Some
candidates include:

The radio
station I listened to earlier this morning, which reminded people
of the Japanese bombing of Pearl Harbor in a very rah-rah sort
of way.
The airline
(I don't remember which one) that had a stewardess ask us to clap
for the servicemen and women on board the flight as we taxied
toward the gate, when I flew on Veteran's Day.
Walmart
because of this.
Judge Napolitano's
show because it's on FOX.
30 Rock
because it's on NBC.
The Daily
Show because Jon Stewart is obviously still an Obama supporter,
when all is said and done.

Now
it's true, if the Amazon boycott were large enough to cause a huge
dent in their business this holiday season, then other visible corporations
who were already associated with WikiLeaks might think twice
before seeming to capitulate to U.S. government demands.

However,
it is also true that no other visible business would become
associated with WikiLeaks in the future. For example, suppose there
were a major law firm, thinking about representing Assange because
its younger partners are actually true believers in civil liberties.

However,
some of the older partners warn them, "We don't want to take
this guy on; he's too hot. We'd have Bill O'Reilly calling us traitors,
and we'd have senators asking us to drop Assange. We'd lose lots
of business from clients who didn't want to be associated with a
firm that was sticking its finger in the government's eye, because
they'd be worried that our trial cases would go against us."

Now
suppose some of the younger partners say, "Well let's at least
try and see what happens. You're just assuming all of those
bad things. But let's at least take Assange on, present our arguments
to the press that this is a free country where we're ruled by laws,
not men. If the heat gets to be too much, then OK we'll back off.
But let's at least give it a shot."

Yet
that option is no longer available to our hypothetical law firm.
Once they become intertwined with WikiLeaks, if they ever disassociate
from it, then they are on the wrong side of the barricades. Unless
they are willing to get dragged off to jail, saying, "To hell
with the government!" they are subject to a boycott for their
cowardice, at least according to Raimondo's
explanation for the Amazon boycott.

So
if those are the alternatives, how many companies are going to help
WikiLeaks with any of its business operations, going forward?

Holding
Up Amazon to a Stricter Standard Than Oneself?

I
also want to reiterate that it is naïve to think that Amazon
had nothing to fear from Lieberman. We don't really know what happened
behind the scenes. But the idea that Amazon could have hired expensive
lawyers and been fine, is silly. The FBI has been raiding multi-billion
dollar hedge funds for the amorphous crime of "insider trading."
Don't those Wall Street fat cats know how to hire a lawyer?

If
the people running the U.S. government wanted to apply pressure
to Amazon executives, they could simply announce that they were
investigating them for child pornography, and then name some of
the top people at Amazon who were under suspicion. It wouldn't even
matter if there ended up being no shred of evidence at all, save
some anonymous leaks to reporters. Those people's lives would effectively
be ruined. Who the heck is going to go to a cocktail party of someone
accused of child pornography in the New York Times?

Do
not misunderstand: If a large corporation went to the barricades,
like Sewell Avery, and its top executives ended up going to jail
in defense of liberty, then they would be heroes in my book. My
point is, failure to throw away your life in defense of WikiLeaks
— when the capitulation meant that WikiLeaks was down for a matter
of hours — is not a sufficient reason in my book to boycott Amazon.

How
many of the boycotters would take, say, a 10% pay cut this year,
in order that WikiLeaks not have its site interrupted for a few
hours? That is the immediate decision that Amazon may have faced.
(If Lieberman and other government officials called for a boycott
of Amazon heading into the holiday season, accusing them of aiding
a troop killer and committing treason, that could have been disastrous
for their sales.)

As
I pointed out in the previous article, it would be much more logical
— in response to the Lieberman/Amazon episode — for websites to
publicly call for a boycott of the IRS, to say, "We can no
longer in good conscience send our money to this organization."
But that's not what happened, because that would have drawn too
much heat. The lack of such a call is not a sign of cowardice, but
of prudence.

Conclusion

It
is true, as Raimondo pointed out, that some libertarians are praising
Amazon's business model (although that was never part of my argument).
Yet by the same token, there are many antiwar activists who are
clearly picking on Amazon precisely because it is a big,
rich company. The most obvious illustration of this is that Glenn
Greenwald — on the same day he called
for a boycott of Amazon — expressed nothing
but sympathy for Tableau, a Seattle-based software company that
stopped hosting completely innocuous charts for WikiLeaks in response
to Lieberman's demands. As I read Greenwald's post, I kept waiting
for him to explain why Amazon was evil but Tableau was a victim;
he never did so.

It
should go without saying that I (and presumably everyone associated
with LRC) applaud the heroic work of Justin Raimondo and others
who were outraged with Amazon. I am simply questioning the rationale
behind their calls for a boycott.

It
is an unfortunate fact that many Americans do not agree with our
assessment of the growing American empire and police state. Rather
than launching punitive campaigns, and drawing lines in the sand
saying that you are either with us or against us, I think the causes
of peace and liberty will be better advanced through gentle persuasion.

Bob
Murphy [send him mail],
adjunct scholar of the Mises Institute,
is the author of The
Politically Incorrect Guide to Capitalism,
The
Human Action Study Guide,
and The
Man, Economy, and State Study Guide.
His latest book is The
Politically Incorrect Guide to the Great Depression and the New
Deal.

Why Single Out Amazon?

Bob Murphy — Sat, 04 Dec 2010 06:00:00 +0000

Many opponents
of the U.S. empire are calling for a boycott against Amazon, after
its capitulation to Sen.
Joe Lieberman's calls for it to stop hosting WikiLeaks on its
servers. This is a controversial issue, with even LRC bloggers taking
nuanced positions (e.g. here
and here).
Although it's possible someone could give me a compelling
argument for boycotting Amazon, I am not yet convinced. Furthermore,
there are several concerns that I haven't seen the proponents of
a boycott address.

Of Course
You Have a Right To Boycott Amazon

Before I dive
in, let me defuse one objection. I have seen many boycotters argue,
"Hey, it's my money and I have the right to do what I want
with it." Well of course you do; nobody is denying that.
By the same token, I have the right to send $10,000 to Jonah Goldberg
because I'm outraged at what just happened. It doesn't mean that
my action would make a whole lot of sense, though.

So in the rest
of this article, we take it for granted that this isn't a discussion
about libertarian or antiwar principles per se; nobody is a criminal
for either using Amazon, or for boycotting it. I am just trying
to clarify some of the issues involved, to make sure the boycotters
have thought this through.

Why Single
Out Amazon?

My first concern
is that Amazon is being targeted only because it initially hosted
WikiLeaks. That's the only reason this is even an issue. If
Amazon is "censoring" WikiLeaks because it won't host
it, then the same is true for every other company that owns servers
in the world, except for the one in Sweden (Bahnhof AB) that currently
hosts WikiLeaks.

Now the boycotter
could respond that this is just silly, and that there are plenty
of principled owners of server space out there, who would be glad
to host WikiLeaks. OK fine, then that shows in the grand scheme,
Amazon didn't really "hurt the cause." And in actual fact,
WikiLeaks was down
for less than a day. Anyone who wants to sift through the secret
material still has it all at his disposal; Amazon's decision in
no way will protect the government from embarrassment.

I am sure the
average boycotter will think I am being incredibly obtuse: Why,
the whole point is that some companies — like the one in
Sweden — need to be brave and stand up to the U.S. government, rather
than fold at the first sign of trouble, as Amazon did.

Yet if this
is the argument, then still I have to ask: Why single out Amazon
for the boycott? To repeat, at least Amazon initially hosted
WikiLeaks; this actually surprised me when I heard it, since I thought
major corporations wouldn't want to touch Assange's website with
a ten-foot pole in this environment.

If we are to
boycott Amazon because it supported WikiLeaks, but then abandoned
it when things started to heat up, then surely we should also boycott
those corporations which we know would never have supported WikiLeaks
in the first place. For example, we should never buy another GE
appliance, because of the pro-empire spin of its media outlets.

And for a really
tough one: Are we still allowed to watch Judge Napolitano's show?
After all, he's associated with FOX, some of whose personalities
have not been entirely supportive of Assange. If the answer is,
"Yes, we can watch Napolitano because he's good on civil liberties,"
then why can't we buy Thoreau books from Amazon?

My concern
on singling out Amazon is best summed up by the declaration from
many boycotters that they would take their business to Barnes &
Noble. But why? Did Barnes & Noble host WikiLeaks? How did they
suddenly become the corporate heroes who laugh at profits and go
to the barricades for liberty?

The boycotters
seem quite sure that this episode will send a signal to major corporations
that they shouldn't leave critics of the government high and dry.
But this might actually backfire, and be akin to raising the minimum
wage, thinking it helps unskilled workers. Specifically, the lesson
to major corporations might be: "Whoa, let's not get ourselves
involved with any dubious groups or individuals, in case the government
cracks down and makes us look like the bad guys."

How Long
Will the Boycott Last?

I have another
question: How long is the boycott supposed to last? Until Amazon
once again hosts WikiLeaks? Until the War on Terror is over? Are
the boycotters really never going to use Amazon again?

As with the
invasion of Iraq after 9/11, I am concerned that some of the boycotters
are lashing out in rage because they don't like what just happened,
even though they haven't carefully thought through what their actual
objectives are, and what their "exit strategy" is.

The Real
Enemy

Let's not lose
sight of the fact that it was Joe Lieberman, representing
the might of the U.S. federal government, who caused Amazon to drop
WikiLeaks as a customer. I have read some boycotters arguing that
Amazon should have put up more of a fight, at least waiting for
a court order.

This strikes
me as very naïve. The government has all sorts of tools at
its disposal. The IRS could've hit Amazon with an audit. The company
could have lost its sales tax exemption. OSHA could've discovered
all sorts of safety violations at its offices. If Amazon had wanted
to acquire another company, the government could've held up approval.

Look at how
effortlessly Assange was demonized the world over, when he crossed
these people. This is the same group that is currently using robots
to blow people up, and claims the authority to unilaterally kill
U.S. citizens with no due process. So Amazon executives were supposed
to tell Lieberman to beat it, then lawyer-up and be immune from
government retaliation?

It's ironic
to think through exactly why Amazon ended up being the target of
the boycott, when even the boycotters would all quickly admit that
it was Lieberman who was more culpable than the Amazon executives.
Consider: If a would-be boycotter wanted to cause economic pain
because of the silencing of WikiLeaks, then the obvious move would
be to stop sending more money to the very government that is waging
wars and harassing Assange.

Yet the boycotters
aren't saying, "Hey everyone, let's stop sending our money
to D.C." Why? Because they are afraid of what the government
would do to them. In other words, they are behaving exactly
like the Amazon executives.

Let us not
forget that all of us, to the extent we pay taxes, are funding the
very organization that is carrying out operations that WikiLeaks
is trying to stop. In that light, it's odd to become indignant over
Amazon for merely withdrawing its support from WikiLeaks,
when the boycotters themselves continue to send their money to the
organization actively trying to shut down WikiLeaks.

Conclusion:
To Each His Own

I hope this
essay is not construed as an attack on those who urge a boycott
of Amazon. Especially after Amazon's
weasely press release, I completely understand the disgust with
large corporations that "play nice" with the government.

Judging from
the debates on this topic that I have seen, it seems the boycotters
and non-boycotters are content to go their separate ways in peace.
Nobody, for example, is suggesting that the boycotters be
boycotted for their unfair "disruption of commerce"; that
would be silly. And by the same token, I haven't seen any boycotters
threatening to disassociate from someone for crossing the picket
line and ordering Christmas presents from Amazon.

Yet it is this
very attitude of tolerance that makes me reluctant to punish Amazon.
I'm not going to stop doing business with somebody, just because
he boycotts Amazon. Why then would I stop doing business with Amazon,
just because they boycotted WikiLeaks?

As I said in
the beginning of this essay, these are not matters of property rights,
but rather ones of strategy for gaining one's ultimate objectives.
I do not condone the current U.S. apparatus of worldwide military
occupation and police state surveillance, and am going to use whatever
peaceful methods I can, to persuade as many people as possible that
there is another way to live.

Along the way,
I have made decisions, such as refusing to work for the government
in any capacity, including as a professor at a State-funded school.
That doesn't mean I condemn people who teach at State schools as
"sell-outs," it just means it was a decision I made for
myself. On the other hand, I pay my taxes in accordance with the
law, even though I know there are some extreme libertarians who
would condemn me for "feeding the beast" and perpetuating
the very system I claim to oppose.

It's very hard
to live a principled life, and the rapacious State makes it that
much harder. If someone wants to boycott Amazon because it dropped
WikiLeaks, I understand the motivation. I would just hope the boycotter
has thought it through.

Bob
Murphy [send him mail],
adjunct scholar of the Mises Institute,
is the author of The
Politically Incorrect Guide to Capitalism,
The
Human Action Study Guide,
and The
Man, Economy, and State Study Guide.
His latest book is The
Politically Incorrect Guide to the Great Depression and the New
Deal.

Federal Fakeroo

Bob Murphy — Sat, 27 Nov 2010 06:00:00 +0000

The national
furor over the TSA’s new procedures – culminating in yesterday’s
"Opt Out Day"
– has elicited the typical response from the bureaucracy and
its apologists. Why, these invasive scans and "enhanced pat-downs"
are only for your good, in order to ensure safe flying. You don’t
want another attack, do you?

This is a false
tradeoff. Especially in the long run, there is no tension between
freedom and safety. If airport security were truly returned to the
private sector, air travelers would achieve a much better balance
of privacy and legitimate security measures.

The Calculation
Problem

Whenever considering
government versus market provision of a good or service, we should
recall Ludwig von Mises’s famous critique of socialism. Specifically,
Mises argued that even if the central planners were angels, intending
only the best for their subjects, and even if these angels were
fully informed of the latest technical knowledge, nonetheless they
would be groping in the dark when they tried to design a blueprint
for the entire economy.

The socialist
central planners would suffer from a calculation
problem, meaning that they couldn’t evaluate whether a given
enterprise – such as a car factory or a farm – was making
efficient use of society’s scarce resources. Sure, the car factory
might be cranking out vehicles that the comrades enjoyed driving.
But that alone is not enough to prove that the car factory is economically
efficient. For all the planners know, the resources (steel, rubber,
labor hours) going into the production of the cars could be diverted
into other lines, increasing the production of items that the comrades
enjoy even more than the cars.

The market
economy solves this problem effortlessly through market prices and
the profit-and-loss test. If a car factory is using up resources
that consumers would prefer go into alternate sectors, this fact
manifests itself objectively when the accountant announces that
the car factory is "losing money." After all, to be unprofitable
simply means that the car factory cannot earn enough revenues from
its customers in order to pay the prices for resources that other
entrepreneurs are able to afford. That is the sense in which consumers
are "voting" (through their spending decisions) that
the car factory either reform or shut down.

In Mises’s
view, the fundamental superiority of the market economy over socialism
was not that entrepreneurs happened to be bold innovators, while
government bureaucrats were dull yes-men. No, the problem was an
institutional one. In the market economy, the factors of production
are privately owned, which allows the generation of market prices
for every unit of every resource. Thus people in the private sector
get immediate and constant feedback on the success or failure
of their operations. There is nothing analogous in government, because
its "customers" cannot withhold their purchases if they
don’t like the "services."

The Calculation
Problem and the TSA

When it comes
to the apparent tradeoff between privacy and security, the TSA suffers
from the same calculation problem that plagues all socialist agencies.
The proper balance of the various considerations cannot be discovered
through some "objective" procedure if it doesn’t involve
private property and market prices.

Consider: Even
if there are no further terrorist incidents on planes, that won’t
prove that the new patdowns and scans were the right thing to do.
For one thing, it’s possible that there are other security procedures,
which do not humiliate large numbers of customers, that would yield
the same success of zero incidents. In that case, the current TSA
procedures would be inappropriate because they cause needless suffering
with no offsetting benefit.

But more importantly,
it’s possible that the "efficient" number of terrorist
incidents – for the rest of US history – is not zero.
In fact, no matter what procedures are implemented, it’s always
possible that wily terrorists will still manage to beat the
system. In real life, we can never guarantee safety. This is why
so many pundits’ discussions of airline travel miss the mark completely:
they assume that there is some objective answer of "the right"
amount of security, when this is a complex economic question.

To see this
last point, we should switch from terrorism to something far less
emotional: car crashes. If the government completely nationalized
automobile production (something that may happen eventually), and
insisted on making a uniform model for every driver in America,
we would hear the pundits discuss various issues in the abstract.

For example,
Rachel Maddow
might argue that the government-issued cars should have three sets
of seat belts, air bags for every passenger, and a top speed of
55 miles per hour in order to contain healthcare costs (which would
also have been completely nationalized by this point). On the other
hand, Sean Hannity might go ballistic over the nanny-state regulations,
and point out that the Founding Fathers didn’t even have mirrors
on their stagecoaches.

The Market
Is the Only Solution

Yet such hypothetical
arguments over "the correct" amount of vehicle safety
would be absurd if they conceded the premise that the government
should set the standard and apply it uniformly to everyone (except
for the politicians, who would get to drive vintage Ferraris). The
only way to solve the conflict would be to privatize car production
and allow consumers to spend their money, focusing on whatever attributes
they cared about the most.

The same conclusion
holds for air travel. Only in a truly free market – where different
airlines are free to try different approaches to safety – could
we approach a sensible solution to these difficult questions. Passengers
who don’t mind invasive scanning or sensitive inspections could
patronize airlines offering these (cheap) techniques – assuming
they were really necessary to achieve adequate safety. On the other
hand, passengers who objected to these techniques could pay higher
ticket prices in order to fly on airlines that hired teams of bomb-sniffing
dogs, or set up very secure prescreening procedures (perhaps with
retinal IDing in order to board a flight), or implemented some as-yet-undreamt-of
method to keep their flights safe, without resorting to methods
that their customers found humiliating.

The Role
of Insurance

Most people
who are sympathetic to the free market would endorse the above sentiments,
but with one nagging concern: How does the airline take into account
the huge damages imposed on others if one of its planes is
hijacked?

One possibility
is that the legal system would hold airlines strictly accountable
for such property damage, and that the airlines would need to purchase
massive insurance policies before obtaining permission to send giant
steel containers full of jet fuel hurtling over skyscrapers and
shopping malls.

I spell out
the mechanics of such a system here.
For our purposes, let me deal with one possible objection: Someone
might say, "But what happens if an airline has lax security,
and terrorists use it to cause an enormous amount of damage, wiping
out their insurers? That’s why we ultimately need the government
in charge of security."

Yet I could
pose the same question: What happens if the TSA screws up,
and a major terrorist incident occurs? Will John
Pistole and his immediate staff be fired? Will the TSA itself
have its budget gutted? And who is to say that even the US federal
government could "afford" such a catastrophe?

Once we consider
the incentives (and lack of consumer feedback) plaguing the TSA,
we realize that not only will it err on the "invasive"
side of the spectrum, but that it will do so ineffectively.

Here’s one
obvious example that numerous people have pointed out: What’s to
stop a terrorist from placing a plastic explosive in an area where
it would not be detected by even an "enhanced patdown"?
Therefore it is not even true that these scandalous new procedures
"at least keep us safe."

Conclusion

As Murray
Rothbard pointed out, most of the vexing "social problems"
of the day would fade away if we lived in a voluntary society based
on private property. This result holds in the specific application
of airport security.

In the long
run, there is no tradeoff between freedom and security. To paraphrase
Franklin, those who would consent to temporary groping in order
to avoid terrorism will end up with both.

Reprinted
from Mises.org.

Bob
Murphy [send him mail],
adjunct scholar of the Mises Institute,
is the author of The
Politically Incorrect Guide to Capitalism,
The
Human Action Study Guide,
and The
Man, Economy, and State Study Guide.
His latest book is The
Politically Incorrect Guide to the Great Depression and the New
Deal.

Herbert Barack Hoover

Bob Murphy — Mon, 02 Aug 2010 05:00:00 +0000

In a recent piece in the New York Review of Books, Paul Krugman and Robin Wells discuss two IMF publications and Reinhart and Rogoff’s This Time Is Different: Eight Centuries of Financial Folly. Along the way, our reviewers repeat the myth that Herbert Hoover slashed spending, while the Federal Reserve implemented tight policies, and that this contributed to the severity of the Great Depression. I have pointed out repeatedly in prior articles that this simply isn’t true, but since the Keynesians keep saying the falsehood, I feel compelled to keep pointing out that they’re wrong.

Krugman’s Bogus History

To make sure I’m doing justice to Krugman and Wells, let’s quote liberally from their book review:

History can offer some evidence on the extent to which Keynesian policies work as advertised. As we’ve noted, Reinhart-Rogoff don’t address that question, but others have….

There has been … suggestive work from the economic historians Barry Eichengreen of Berkeley and Kevin O’Rourke of Trinity College in Dublin, who have coauthored two hugely influential papers exploiting the similarities between the current slump and the Great Depression. In the first of these papers, they showed that from a global point of view the first year of this slump was every bit as bad as the Depression: world industrial production fell as steeply, world financial markets were if anything more disrupted, and so on. All this suggests that the shock to the system was just as big this time around.

In successive updates, however, they have shown current events increasingly diverging from the historical record, with the world experiencing a recovery that may be disappointing, but is far better than the continuing downward spiral between 1929 and 1933. The obvious difference is policy: rather than emulating the grim austerity of policymakers three generations ago, who slashed spending in an effort to balance budgets and raised interest rates in an effort to preserve the gold standard, today’s leaders have been willing to run deficits and pump funds into the economy. The result, arguably, has been a much smaller disaster.

An even better test comes from comparing experiences during the 1930s. At the time, nobody was following Keynesian policies in any deliberate way — contrary to legend, the New Deal was deeply cautious about deficit spending until the coming of World War II. (emphasis added)

Now here Krugman has painted himself into a corner. Although elsewhere I have pointed out that Keynesians such as Christina Romer discuss the 1930s in misleading but technically truthful ways, in the above quotation Krugman (and Wells) are stating outright falsehoods.

In the United States, policymakers certainly didn’t "slash spending" or "hike interest rates" in the immediate wake of the 1929 stock-market crash, and so the difference in our recoveries (two years into the two crises) can’t be attributed to fiscal austerity versus prodigality. Moreover, under no sensible definition of the term — certainly not when juxtaposed with Krugman’s wailing against the Bush years — can the New Deal be described as "deeply cautious about deficit spending."

Hoover and the Fed, After the 1929 Crash

According to the NBER, the so-called Great Recession started in December 2007. Although the timid NBER wonks have yet to date the official trough, most analysts (including Krugman) would say that the economy officially entered a recovery in the summer of 2009. Incidentally, I am not endorsing these conventional dating methods or definitions, but I’m just trying to show that Krugman’s chronology — and consequent praise for Keynesian policies — doesn’t fit the historical facts.

Follow me here, because this is an important point: In the long block quotation above, Krugman and Wells argue that the reason we went into a Great Depression in the 1930s, whereas we merely suffered a Great Recession in our own times, is that the fool politicians back then slashed government spending while the fool central bankers hiked interest rates. In contrast, our enlightened politicians (at least the Democratic ones) and Ben Bernanke had the wisdom to run massive budget deficits and to slash interest rates. That’s why unemployment zoomed to 25% in the 1930s but has yet to break 10% in our time.

Now for this story to make any sense, it must be the case that Hoover "slashed spending," while the Fed hiked interest rates, within the first 20 months of the Great Depression. Do you see why? In our time — the so-called Great Recession — the slump began in December 2007, and was over (according to the conventional framework shared by Krugman) by August 2009. So when we’re trying to see what Hoover and the early-1930s Fed did wrong, and why they didn’t experience a painful but not catastrophic downturn such as the one we just went through, it had better be the case that their alleged mistakes occurred within the first 20 months after the stock market crash.

Recall that the great crash occurred in late October 1929. For fairness, call it November 1929. That means Hoover and the Fed must have implemented their boneheaded austerity measures — based on the special case of full employment in classical economic models, rather than Keynes’s more general General Theory — sometime during the period before July 1931.

Okay, so let’s graph three different items from 1929 through 1931:[1]

the absolute size of the federal budget,
the size of the federal budget deficit as a share of GDP, and
the New York Fed’s discount rate.

Let’s see if we can spot the fiscal and monetary tightness, which allegedly turned a nasty financial crash into the worst depression the world has ever seen:

Some Comments on the Above Charts

Notice that federal spending went up throughout the period in question. It’s true, in fiscal year (FY) 1933, Hoover had cut the federal budget by $63 million (1.3%) from the previous year. But fiscal year 1933 didn’t start until July 1, 1932, which was two-and-a-half years into the Great Depression. Up until then, Hoover had steadily increased federal spending, just like Krugman would have recommended.

As far as deficits, the federal government actually continued the surpluses it had inherited from the Coolidge years through fiscal year 1930. However, the slight uptick in the surplus as a share of the economy (in FY 1930) is misleading; the actual surplus was about the same in both years (around $730 million), but the economy had shrunk from 1929 to 1930 and so the surplus was a bigger share.

In any event, by the summer after the stock-market crash Hoover’s spending — combined with plunging tax receipts — had moved the Coolidge surpluses into Hoover deficits, and by the following year the deficit was 4% of GDP. For comparison, note that in his first term — when he "cut taxes on the rich and started a war" — George Bush’s deficits were a maximum of 3.6% of GDP.

But I’ve saved my favorite for last. Look at what the New York Fed did with its discount rate. Immediately following the late October 1929 crash, the NY Fed began slashing rates. It kept periodically cutting until it got to 1.5%, which was the lowest rate in Fed history to that point.

Now it’s true, in October 1931 the NY Fed abruptly changed course, because the Bank of England the month before had severed the pound’s link to gold, and worldwide investors were fearful of a similar move by the US authorities. In order to stem the outflow of gold, the Federal Reserve did indeed find its hand forced and it had to jack up its rates.

But the point is that the Fed had implemented record "easy" policies from November 1929 through September 1931, some 22 months after the onset of the Great Depression. That is too long for Krugman’s historical narrative to make any sense. As we explained in the beginning of this article, at best Krugman has a 20-month window to work with, since our present-day Keynesian and loose-money policies allegedly nipped the Depression in the bud in that timeframe.

To tie up one potential loose end that might trouble the fair-minded reader — is it possible that the Great Depression wasn’t so bad in the early years, and only turned into the horrible slump after Hoover cut spending and the Fed raised rates?

Well, it’s true that things continued getting worse after October 1931, but they had gotten pretty bad leading up to that point too. The monthly statistics of those days are a bit speculative, but the average annual unemployment rate for calendar year 1930 was 8.9%, while for 1931 it was 15.9%. That means it was very likely the case that unemployment had already broken our current levels by the end of 1930 (in order to make the average for the whole year 8.9%).

When we turn from unemployment figures to output statistics, the comparison isn’t even close. From 1929 to 1930, real GNP fell 8.6%. Then from 1930 to 1931, it fell another 6.6%, for a total two-year drop of 14.7%. (In contrast, US real GNP was actually higher in 2008 than in 2007, according to the official figures, and it only dropped 2.7% from 2008 to 2009.) So it is clear that the awful Great Depression was in high gear even during the period of rising budget deficits and easy Fed policy; Krugman can’t say that the real pain only set in after Hoover cut spending and the Fed raised rates.

New Dealers Afraid of Deficits?

Finally, let’s deal with Krugman and Wells’s claim that the New Dealers were "deeply cautious about deficit spending." Here is a table of the federal budget deficit, as a share of GDP, from the inauguration of Roosevelt till just before Pearl Harbor. And for kicks, I’ve included the eight years of the Reagan Administration side-by-side with it:

Surplus/Deficit as Share of GDP

FDR’s Fiscal Years

FDR

Reagan

Reagan’s Fiscal Years

7/1/1933—6/30/1934

−5.9%

−4.0%

10/1/1981—9/30/1982

7/1/1934—6/30/1935

−4.0%

−6.0%

10/1/1982—9/30/1983

7/1/1935—6/30/1936

−5.5%

−4.8%

10/1/1983—9/30/1984

7/1/1936—6/30/1937

−2.5%

−5.1%

10/1/1984—9/30/1985

7/1/1937—6/30/1938

−0.1%

−5.0%

10/1/1985—9/30/1986

7/1/1938—6/30/1939

−3.2%

10/1/1986—9/30/1987

7/1/1939—6/30/1940

−3.0%

−3.1%

10/1/1987—9/30/1988

7/1/1940—6/30/1941

−4.3%

−2.8%

10/1/1988—9/30/1989

Now it’s true, under any metric Reagan’s budget deficits were bigger. Yet if we throw out the one year in which Roosevelt basically balanced the books, the two periods are pretty comparable. At the very least, if Roosevelt’s prewar spending record illustrated "deep caution" about deficit spending, then Ronald Reagan’s surely must have exhibited at least shallow caution. Yet somehow I think that if we combed Krugman’s archives to find him describing Reagan as a deficit-phobe, we would search in vain.

Conclusion

Today’s Keynesians love to point to history to "prove" the efficacy of their remedies. In particular, they adore Hoover’s budget cuts of 1932, and the Fed’s rate hikes of October 1931, as proof positive that ignorant conservatism caused the Great Depression. But prior to these turnarounds in policy, the federal government and central bank operated in a Keynesian fashion, though perhaps too timidly for Krugman’s liking. Krugman’s basic story doesn’t make sense. If the Keynesians were right, the economy should have been in a tepid recovery by mid-1931, and yet it was in fact still freefalling.

In total contrast, in the depression of 1920—1921, the federal government and Federal Reserve really did implement the harsh measures that Krugman et al. erroneously attribute to Hoover and company. And yet, as its name suggests, this earlier depression was over quite quickly, and paved the way for the Roaring Twenties.

On their face, the Keynesian prescriptions make no sense. When an economy is on the ropes, the last thing in the world it needs is for politicians to squander more resources and for the central bank to print up more green pieces of paper. Yet even if we set aside economic logic and just "look at the facts," we see that the Keynesian narrative doesn’t add up.

Notes

[1] Throughout this article, I rely on the following sources: Federal Budget Receipts and Outlays: T. Roosevelt — G.W. Bush; the Census Bureau’s Historical Statistics of the United States, Colonial Times to 1970 Part 2, Chapter Y, p. 38; my book on the Great Depression; and a list of Federal Reserve bank-discount rates that I acquired from Bill Barnett but is apparently no longer accessible online.

Reprinted from Mises.org.

Creating Money Out of Thin Air

Bob Murphy — Tue, 15 Jun 2010 05:00:00 +0000

Austrian economics is superior to Marxism in every respect, and this includes internal, sectarian squabbles. When we Austrians feel the time is ripe for another bloodletting — it keeps us strong by thinning the herd once in a while — we argue over fractional-reserve banking.

If you have never had the pleasure of watching such fireworks, I point you to Joe Salerno’s recent blog post; it has enough links to bring you up to speed. In the present article, I want to walk through a simple example to make sure everyone understands exactly why some of us think fractional-reserve banking is just plain weird.

Of course, weirdness is not proof of dubiousness, let alone fraud, but bankers who engage in fractional-reserve banking really do "create money out of thin air" in a sense that I think many commentators don’t fully appreciate. I offer this article to at least clarify what the ostensible problem is.

A Simple Example

Suppose a teenager, Bill, is rummaging in the attic and finds $1,000 in physical currency in an old chest. Bill is ecstatic and runs to the local bank, where he opens a checking account and deposits the green pieces of paper.

Under a 100-percent-reserve banking system, this would be the end of the story. In the act of making the deposit, Bill’s currency holdings would fall by $1,000, while his checkbook balance would rise by $1,000. Putting the money in the bank wouldn’t affect the total amount of money in the economy.

However, in our current system, Bill’s bank would see a new profit opportunity. After the bank put the $1,000 of paper currency into its vault, its reserves would be that much higher, while its outstanding deposit liabilities would have risen by $1,000 as well (in the form of Bill’s new checking account). But since banks in the United States are subject only to a reserve requirement of (approximately) 10 percent, the bank would have new excess reserves of $900. If it found a suitable borrower, the bank would have the legal ability to grant a new loan for this amount.

Suppose the bank found such a borrower, Sally, and charged her 5-percent interest for a 12-month loan. Assuming she paid off the loan in a timely manner, here is what the bank’s balance sheet would look like at various stages in the process:

I. Bank’s Balance Sheet after Billy’s Deposit

Assets

Liabilities + Shareholder’s Equity

$1,000 in vault cash

$1,000 (Billy’s checking account balance)

II. Bank’s Balance Sheet after Loan Granted to Sally

Assets

Liabilities + Shareholder’s Equity

$1,000 in vault cash

$900 loan to Sally at 5% for 12 months

$1,000 (Billy’s checking account balance)

$900 (Sally’s new checking account)

III. Bank’s Balance Sheet after Sally Spends Her Loan on Business Supplies

Assets

Liabilities + Shareholder’s Equity

$100 in vault cash

$900 loan to Sally at 5% for 12 months

$1,000 (Billy’s checking account balance)

$0 (Sally’s checking account balance)

IV. Bank’s Balance Sheet after Sally Sells Her Products for $1,000 Cash and Deposits the Proceeds in Her Account

Assets

Liabilities + Shareholder’s Equity

$1,100 in vault cash

$900 loan to Sally at 5% for 12 months

$1,000 (Billy’s checking account balance)

$1,000 (Sally’s checking account balance)

V. Bank’s Balance Sheet After Sally Pays Off Her Loan Plus Interest

Assets

Liabilities + Shareholder’s Equity

$1,100 in vault cash

$1,000 (Billy’s checking account balance)

$55 (Sally’s checking account balance)

$45 in bank shareholder equity

As our hypothetical example[1] makes clear, with the power of fractional-reserve banking, bankers can apparently earn income out of nothing! So long as Billy leaves his money in the bank, and so long as Sally is able to earn enough revenues from her business to avoid defaulting on her loan, the bank’s shareholders end up with $45 of the community’s cash, free and clear.

Now, the bank didn’t stick a gun in anyone’s belly, and the original owners of that $45 voluntarily traded them to Sally in exchange for whatever goods or services her business produced. Still, something seems a bit fishy in that the bank created $900 in new money, earned $45 in "old" money held by the outside community, and then destroyed the $900 when Sally paid back her loan.

Incidentally, it is because of these strange machinations that many critics of our current financial system describe it as "debt-based money." In a very real sense, if people stopped taking out new loans (from banks) and paid off their outstanding loans, the total quantity of money would shrink drastically. In my opinion this would be a good thing — especially if the politicians and the Fed sat back and let it happen — but it is nonetheless a very strange feature of our current system.

Creating Money Out of Thin Air?

Some people deny that commercial banks "create money out of thin air." They agree that the Fed does so when it buys assets by writing a check on itself. However, in our example above, it seems that the commercial bank at worst is taking $900 of "Bill’s money" and handing it over to Sally. Sure, that might be dubious, but it’s not as blatant as when the Fed literally writes checks drawn on thin air, right?

Actually, I think this standard textbook description — in which each new bank in the sequence creates new loans equal to 90 percent of the new deposit — is a bit misleading. There is nothing in the legal reserve requirement to prevent banks from making new loans that are large multiples of a new deposit. Instead, it is prudence on the part of the banks that enforces this restraint.

To see this, let’s repeat the above story but have the bank make a much larger business loan to Sally:

I. Bank’s Balance Sheet after Billy’s Deposit

Assets

Liabilities + Shareholder’s Equity

$1,000 in vault cash

$1,000 (Billy’s checking account balance)

II. Bank’s Balance Sheet after Loan Granted to Sally

Assets

Liabilities + Shareholder’s Equity

$1,000 in vault cash

$9,000 loan to Sally at 5% for 12 months

$1,000 (Billy’s checking account balance)

$9,000 (Sally’s new checking account)

Let’s stop at this point and consider what has happened. The bank’s balance sheet still checks out — $10,000 in assets and $10,000 in liabilities. So the accountant’s head won’t explode on account of the large loan to Sally.

But perhaps the bank in our updated scenario is running afoul of the 10-percent reserve requirement enforced by the Fed? Again, no — as of the moment of the new loan to Sally, the bank’s total customer checking account balances are $10,000, and the bank has $1,000 in physical currency in its vault, "backing up" those accounts. So the bank is satisfying the 10-percent reserve requirement.

To understand why the bank would be foolish to make a $9,000 loan to Sally after receiving Billy’s $1,000 in cash, we must look ahead one step:

III. Bank’s Balance Sheet after Sally Spends Her Loan on Business Supplies

Assets

Liabilities + Shareholder’s Equity

($8,000) in vault cash

$9,000 loan to Sally at 5% for 12 months

$1,000 (Billy’s checking account balance)

$0 (Sally’s checking account balance)

Now we see the problem: Presumably, Sally is not going to borrow $9,000 at interest, in order to let that balance sit in her checking account. She is going to spend the money, by writing checks on the account. The people who receive those checks are going to deposit them in their own banks; and, during normal interbank clearing operations, the original bank will receive requests to transfer out $9,000 of its reserves.

We now see why standard economics textbooks have banks only making new loans equal to 90 percent of the amount of each new injection of deposits. The assumption is that the new depositor won’t withdraw his money anytime soon, but that the new borrower (i.e., the person getting the loan) will withdraw the money very soon.

Let’s be clear though on the moral of the story: in this second scenario — which is not in violation of the reserve requirement (though it might violate capital requirements or other regulations) — the commercial bank is quite obviously "creating money out of thin air."

Consider: The bank received $1,000 in currency from Bill, and it then made a loan of $9,000 to Sally. This new money didn’t "come from" anywhere; it existed as soon as the bank clerk changed the numbers on the ledger. Sally went from having $0 in her checking account to having $9,000, with the simple push of a button.

Conclusion

In the present article, we have walked through a simple example to illustrate the strange nature of fractional-reserve banking. In a very real sense, this process creates money out of thin air. This observation alone doesn’t prove its illegitimacy, let alone its connection with the business cycle, but it should give pause to those who see nothing wrong with the practice.

Notes

[1] In the tables above, technically, with the passage of time the market value of the loan to Sally would increase from its initial $900. As the loan matured, its appreciation would be matched by an equal growth in the shareholder’s equity on the right side of the balance sheet. (In other words, the shareholder equity would gradually increase to $45 over the course of the year; it wouldn’t suddenly jump from $0 to $45 when Sally paid off the loan.) But we have neglected this complication to keep the above example as simple as possible.

Reprinted from Mises.org.

David Frum Is Wrong and Ron Paul Is Right

Bob Murphy — Wed, 31 Mar 2010 05:00:00 +0000

In the wake of Ron Paul’s straw-poll victory at the CPAC convention, neoconservative author David Frum told CNN’s readers that a return to the gold standard was both undesirable and impossible.

Frum and I have gone back and forth on the gold standard in the past, and I don’t want to repeat those arguments. In the present article I’ll raise new objections focused just on Frum’s latest attack on the gold standard.

Frum Confuses Americans With FDR

After downplaying the significance of Ron Paul’s win at CPAC, Frum concedes that many Americans have taken to Paul’s message of tying the dollar back to gold. Frum thinks that such a quaint view ignores American history. He writes,

G.K. Chesterton observed that you should never pull down a fence until you understand why it was put up.

So let’s rediscover why it was that Americans abandoned the gold standard in the first place.

In the first place, it’s a bit ironic to use a quip from G.K. Chesterton — the epitome of a wise conservative in the true sense of the word — to support the New Deal’s uprooting of the gold standard, which Frum himself acknowledges was considered a bulwark of Western civilization.

In any event, it’s very odd to say that "Americans abandoned the gold standard." Let’s recall the actual events: Gold was originally the voluntary, market-chosen money (along with silver). Americans were willing to hold paper notes denominated as "dollars" only because they were originally legal claims entitling the bearer to a specified weight of gold (or silver).

Then, in 1933 the newly sworn in President Roosevelt voided Uncle Sam’s contractual obligations. He further required that all Americans turn in their gold under threat of imprisonment and a $10,000 fine. It was not even legal for Americans to tie clauses of contracts to the world price of gold, until the 1970s.

It wasn’t even the case that FDR campaigned on a pledge to end the dollar’s tie to gold. Indeed, one of Herbert Hoover’s bitter complaints was that FDR caused unnecessary chaos in the financial markets after his election in November 1932 by not explaining what his gold policy would be during Hoover’s lame duck session. (In those days new presidents were not sworn in until March 4.)

There are many ways of describing the above history, but "Americans abandoned the gold standard" would not be high on my personal list. By the same token, if a Texan were complaining about outrageous federal taxes, I wouldn’t say, "Hey, you should recall why America retained the Confederacy."

David Frum, Keynesian Economist

Let’s explore Frum’s explanation of why "America" abandoned the gold standard in the early 1930s:

In 1929, the U.S. economy slumped into recession. Under the weight of a series of terrible decisions, that recession collapsed into the worldwide Great Depression.

But why did decision-makers make so many bad decisions? The short answer is that they were trapped. Almost all of the right decisions would have ballooned the U.S. federal budget deficit. As budget deficits expanded, investors would inevitably worry that their dollars might lose value in the future. They would demand to trade their dollars for gold at the fixed price of $20.67 to the ounce. Under the rules of the gold standard, the U.S. government would be obliged to sell.

As long as the deficits continued, the U.S. government would lose gold. Threatened with the exhaustion of its gold supply, the government felt it had no choice: It had to close the budget deficit. So, in the throes of a severe downturn, the U.S. government did exactly the opposite of what economists would otherwise advise: It cut spending and raised taxes — capsizing the economy even deeper into depression.

It’s very strange to hear gold standard advocates criticize President Hoover for imposing steep tax increases in 1932, the Depression’s worst year. Yet the gold standard they champion was the reason for the tax increases they deplore. (emphasis added)

I don’t need to dwell on the bad economics behind Frum’s assertions. David Friedman has already done a fabulous job, and I would merely be repeating the same things I wrote just one week ago when correcting Paul Krugman’s faulty ghost stories of Herbert Hoover.

For the present piece, I just want to make an observation: isn’t it ironic that David Frum, former speechwriter for George W. Bush and a fellow at the American Enterprise Institute, thinks that it is common knowledge that deficit spending is the way to fix a depressed economy?[1] To his credit, Frum is consistent: he actually criticized conservative Republicans for opposing Obama’s stimulus package.

In my younger days, when I was even more naïve than I am now, I couldn’t understand how "right-wingers" could be so good on domestic issues like taxes and business regulations, but so awful on foreign-policy issues. I couldn’t understand how self-described conservatives could detest and fear big government when it came to the Department of Health and Human Services, but not when it came to the CIA and the Pentagon.

Now I realize that there’s no hypocrisy or inconsistency at all, at least not among some of the top neoconservative theorists: They are quite consistent in believing that politicians in Washington, DC, have both the ability and the desire to make the world a better place, whether in foreign lands or in American inner cities. All it takes is several trillion dollars and a few experts like David Frum advising them.

Is the Gold Standard Impossible?

After painting a picture of how awful a modern gold standard would be — it would have made the recent trillion-dollar-plus deficits impossible, yikes! — Frum argues that the entire discussion is moot:

No government ever can return to the gold standard.

Back in the 1930s, governments accepted horrific suffering because they were terrified of the consequences of going off gold. When President Franklin Roosevelt told his budget director, Lewis Douglas, of his decision to quit gold, Douglas replied: "This is the end of Western civilization." He wasn’t kidding either.

In fact, the decision was the turning point of the Depression, the beginning of recovery. And every monetary economist knows it. Which means that the first thing any future gold-standard government would do in the event of recession would be to jettison gold. And every market trader knows that too.

So … as soon as the first sign of recession materializes on the horizon, the traders would dump the currency of the gold standard country. The gold standard country would then have to decide whether to self-impose draconian 1932-style budget-balancing or forgo the whole painful experience and surrender right away to what is inevitable sooner or later.

Since everybody knows that a gold standard country would quit gold as soon as times got tough, nobody will ever believe the decision to restore the gold standard in the first place.

It’s as dead as monocles and walking sticks. Deader, really.

I have dealt with the history of governments breaking their ties to gold here. What I want to do now is show how Frum’s closing argument contradicts the writings of G.K. Chesterton, underscoring the irony I alluded to earlier. To reiterate, Frum is claiming that history has moved on and the gold standard is now obsolete. I couldn’t find a quote from Chesterton on the gold standard per se, but I did find this:

One of the first things that are wrong is this: the deep and silent modern assumption that past things have become impossible. There is one metaphor of which the moderns are very fond; they are always saying, "You can’t put the clock back." The simple and obvious answer is "You can." A clock, being a piece of human construction, can be restored by the human finger to any figure or hour. In the same way society, being a piece of human construction, can be reconstructed upon any plan that has ever existed. (G.K. Chesterton, What’s Wrong with the World)

It’s difficult to pinpoint the precise error in Frum’s reasoning, since it is a string of assertions. Under Murray Rothbard’s plan for a return to a genuine gold dollar, paper notes would be backed 100% by gold reserves. So even if investors around the world doubted the commitment of, say, a newly elected President Paul to honor the US government’s gold obligations, this would pose no problem. Governments get into trouble when they print more paper money than they can redeem, leaving themselves vulnerable to a "bank run" by speculators. Under a 100% reserve gold standard, it’s true that the federal government’s ability to run deficits would be curtailed, but that’s one of the advantages of the proposal.

Conclusion

Although he writes with confidence, David Frum’s rejection of the gold standard is based on faulty history, bad economics, and a belief in the power of Washington to manage the economy. On top of it all, Frum ends with a non sequitur akin to my declaration that a diet can’t reduce my waistline, since I would just go off it in two weeks.

Note

[1] After this piece was written, Frum parted ways with AEI.

Reprinted from Mises.org.

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An Economist’s Case Against God

Bob Murphy — Tue, 26 Jan 2010 06:00:00 +0000

University of Rochester economist Steve Landsburg is one of my favorite writers of popular articles and books. I often disagree strongly with him — indeed I use his "more sex is safer sex" thesis as a primary illustration of mainstream economic self-parody — but even when he’s wrong, he’s brilliantly wrong. It is with some disappointment, then, that I have to report his case against God is uncharacteristically weak.

Before proceeding to my critique, I should say that overall Landsburg’s new book, The Big Questions, is well worth the purchase price. (Although in my case, as a blogger who would likely review it, Landsburg arranged for me to get a complimentary copy. But hey, the book is definitely worth more than I paid for it!) In particular, Landsburg wrote one of the most succinct defenses of free trade that I’ve ever seen, and he also does a great job explaining the seminal contributions of Robert Lucas and his critique of old-fashioned macroeconometrics. If you are a fan of Landsburg’s previous books, there is still much to enjoy in his latest.

Yet as I said, if you are a theist and were expecting to be shaken to your core, I think you will be disappointed. Onward to Landsburg’s case against God.

Why Does the Universe Exist?

Before tackling Landsburg’s specific critique of theism, we need to first explain his own explanation for why we exist. To get things going, Landsburg first establishes that the "natural numbers (i.e. the counting numbers 0, 1, 2, and so forth)" are real things, not arbitrary social conventions: "You and I know the natural numbers are real. Not only are they real, they are necessary. By their very nature, they could not fail to exist" (p. 7).

Landsburg then generalizes to mathematical truths as a whole:

And likewise for other mathematical structures, of varying degrees of complexity…. The natural numbers together with the laws of arithmetic form a mathematical structure of profound complexity. The human genome, with its combinatorial structure of A’s, C’s, G’s, and T’s, can be described entirely in the language of arithmetic, so the very least, arithmetic is as complex as human life, and therefore as complex as your brain and the pattern of your consciousness. (pp. 7—8)

Already I think Landsburg is in serious trouble, but let’s hold off criticism and let him make his case. In the interest of brevity I can’t reproduce his whole argument, but here’s the punchline:

The Universe itself, in other words, is a mathematical pattern, containing your consciousness and mine as subpatterns. The Universe exists because it can; a logically possible Universe is a mathematical object, and mathematical objects exist by necessity. (p. 14)

So we see that Landsburg thinks he has disposed of the need for God, by offering an alternative explanation for the most eternal of questions. Yet I think Landsburg’s "proof" suffers from the exact problem that he fingers in Saint Anselm’s famous "ontological argument" for the existence of God. I’ll reproduce Landsburg’s handling of this matter, and then circle back to show why Landsburg’s own explanation is similarly flawed:

Anselm defines God as "the greatest thing imaginable." Now, existence is really really great, so if God didn’t exist, he couldn’t be the greatest thing imaginable, now could he? Therefore, by definition God exists! Case closed!

…

Regardless of what Anselm chooses to "define," there can instead be something very great, and then something even greater, and then something greater than that, ad infinitum — just as there are numbers, and then larger numbers, and then numbers that are larger still, ad infinitum. Anselm starts by assuming that there is a greatest thing imaginable. Start with an unjustified assumption and you’re sure to reach an unjustified conclusion. (pp. 34—35)

I think that Landsburg’s own explanation, while at first seeming quite profound, is just as question-begging as Anselm’s. Landsburg has replaced the traditional questions, "Why should we have consciousness? Why is the universe constructed this way, just-so in order to sustain our lives and allow us to ponder our existence?" with the question, "Why should mathematical structures exist, in such deep complexity?"

Landsburg spends most of his time going from the fact that purely abstract mathematical structures exist, to the conclusion that therefore we sentient beings exist and perceive "solid" objects around us. Now that leap may itself be invalid as well — I’m actually sympathetic to Landsburg’s arguments, which I’m not reproducing here — but my point is, Landsburg never really explains why these mathematical objects exist in such complexity so as to "give rise" to the traditionally complex subpatterns that every other philosopher seeks to explain.

For example, how do we know that mathematical patterns "really" exist? Maybe Euclid’s proofs just seem a priori true to us, because of the way our brains are hardwired. Perhaps other sentient beings could possess a "different logic" from ours. That strikes me as impossible, I grant you, but wouldn’t it seem impossible if what I am saying were true? Here’s what Landsburg has to say about the ultimate foundation of his whole worldview:

I am confident that mathematics exists for the same reason I am confident my hopes and dreams exist: I experience it directly. I believe my dining-room table exists because I can feel it with my hands. I believe numbers, the laws of arithmetic, and (for that matter) the ideal triangles of Euclidean geometry exist because I can "feel" them with my thoughts. (p. 6)

And so we’ve moved in a circle (assuming circles exist…). Landsburg explains the existence of everything we "know" in day-to-day life by pinning it on the ultimate existence of mathematical objects. And these exist because we directly experience them. As to why these mathematical truths have the form they do, Landsburg offers no other explanation except they have to have that form. How do we know? By thinking about them, in other words by "feeling" them with our thoughts.

When it comes down to it, I think Landsburg has done nothing truly deeper than to say, "Why do trees exist? Just look our your window, man! They do exist, that’s why."

This is a fundamental point, so let me restate it: Landsburg has tried to explain the tremendous complexity and apparent order in the universe — two things that traditional theists take as evidence of an intelligent Creator — by packaging them as implications of the tremendous complexity and yet order embedded in mathematics itself.

But all this move does is push the question back one step. Why should it be the case that there is this abstract set of objects which we call "real numbers" that possess so many interesting properties? For those who haven’t studied much higher mathematics, let me report that there are truly some "shocking" results, things that are completely unexpected and yet have to be true, if we wish to retain the logical consistency of our earlier mathematical discoveries. (And note that calling them discoveries — as opposed to mathematical inventions — is itself telling.)

I submit that Landsburg hasn’t really given us a deeper explanation for why mathematics is the way it is, besides his declaration that he has observed it to be so. Yet if an atheist biologist tried to pull this trick in a debate over evolution, no one would take him seriously.

A Note on Complexity

I am by no means an expert on information theory, but I want to mention that some people also do not agree with Landsburg’s argument that arithmetic is more complex than human life. (I am grateful to Silas Barta for discussions on this topic.) In particular, it’s not true that one can "represent" all of human life — and especially human consciousness! — by a sequence of four nucleic acids (in DNA). It reminds me of a critique I read of Michael Crichton’s Jurassic Park. In the movie (and presumably the novel, which I haven’t read), the scientists are able to grow a bunch of living dinosaurs from DNA they find preserved in a mosquito that had bitten a dinosaur millions of years in the past. But that alone wouldn’t be enough, because the dinosaur would have to develop inside its mother before being laid as an egg.

The same is true with humans. Contrary to science fiction plots, you couldn’t clone an adult replica of someone just from a blood sample. Someone’s DNA wouldn’t contain the history of that person’s environment as he grew up, and it wouldn’t contain the memories of his experiences and so forth. If lab technicians could provide an adequate simulation of the person’s mother’s womb, then at best they could reproduce an identical twin as a newborn infant. But in order to literally reproduce an exact replica of an adult human being, the scientists would need to reproduce (in principle) the entire universe in which the person grew up. And this all assumes that the philosophy of functionalism is true! If it turns out that people have immortal souls, for example, then the scientists still wouldn’t have truly reproduced the "person," just at best his physical body.

Before leaving the point, let me share Silas Barta’s analogy to show (part of) the problem with Landsburg’s procedure: Landsburg is saying that if X can produce Y, then X is necessarily more complex than Y. But bricks and mortar can produce a house, and not many people would say they are more complex than the house. If you try to point out the "flaws" in this analogy, just realize that they apply with equal validity to Landsburg’s assertion that arithmetic (using just A’s, C’s, G’s, and T’s) can describe all of human life. (Interested readers can see Landburg’s general response to Barta and me here.)

I Predict Landsburg Didn’t Really Try to Understand Theists

Although I think Landsburg’s argument about the existence of the universe is ultimately a non sequitur, at least it’s a serious argument and something that theologians should grapple with. I personally think the existence of mathematics is one of the most beautiful flourishes of God’s creation. Mathematical laws cannot be overridden, even by the most despotic of earthly rulers, because we simply perceive logical relations in the way we do; that’s how our minds work. (Landsburg would say, I believe, that this is so because our minds could not conceivably work differently, whereas I would say our minds work like this because God wanted us to live in an orderly, logical universe and so chose to design it this way.) Another neat thing about mathematics is that it shows the practicality of pure thinking. Pragmatists can deride poets for wasting their time daydreaming, but nobody doubts the usefulness of geometry textbooks.

So although I think the existence of mathematics per se can’t bear the explanatory weight that Landsburg puts on it, I at least understand his fascination with the approach. Unfortunately, there are other sections of the book where Landsburg’s hostility to theism struck me as downright silly. Here are a few excerpts and my reactions:

Now, to a true religious believer, the conviction rate [after committing a crime] is 100 percent. God sees all, knows all, and punishes all. Based on everything we know about deterrence, true believers should almost never commit crimes. But I have not been able to uncover a shred of evidence that those who profess belief are any more law-abiding than their atheist neighbors…. [H]ere we have a testable implication of the hypothesis that religious beliefs are sincere, and I look forward to seeing that test conducted. (p. 58)

This argument might hold for some theists, but not for evangelical Christians. Evangelicals believe that Christ died for their sins and that they are therefore forgiven. You don’t "get into heaven" by being a good enough person to pass some threshold. Once you accept Jesus as your Lord and savior, you are saved. (This is one of the reasons Christopher Hitchens finds Christianity repugnant, because it allegedly relieves individuals of responsibility for their actions.) Of course evangelicals ought to try to live a model life in order to avoid the appearance of hypocrisy and also out of simple obedience to Christ, but my point is that Landsburg’s argument that theists fear supernatural punishment for their sins is a bit of a caricature.

Let’s get back to Landsburg’s testable hypotheses:

Many religions promise not just punishment for the wicked, but a glorious afterlife for the righteous, and if believers are sincere, this, too, should affect their behavior. Surely people who expect to survive their own deaths should be less reluctant to die, and should therefore invest fewer resources in self-preservation. Do those who call themselves religious spend less on health care than the rest of us? Do they buy fewer smoke alarms? Are they more likely to jaywalk? Less likely to flinch when a foul ball is hit in the direction of their foreheads? I’m guessing not, and if my guess is right, it becomes almost impossible to imagine that their "belief" in an afterlife could be sincere. (p. 59)

Again, I don’t think we should waste time collecting the data, because I am not convinced that Landsburg has in fact teased out a true implication of religious belief. Christians, at least, are also supposed to view their bodies as temples to the Lord; doing reckless things would be sinful for that reason alone. To see the point a bit differently, does Landsburg think believing Christians ought to go on murder sprees (at least among other believers), in order to send as many brothers and sisters to be with Jesus as quickly as possible?

Christians do not enjoy the suffering of this world, and they do indeed look forward to the day when they can be reunited with their Creator. But in the meantime, we have a job to do, namely to spread the good news to as many others as we can, in the short time we have on this earth.

I’ve saved my favorite for last:

Religious believers, then, should, by and large, be students of — well, of what, exactly? Religion is first and foremost a physical theory — a theory of how the Universe was formed, what keeps it going, how it will end, and what sort of stuff (souls? angels?) inhabits it. I predict, then, that true religious believers should have a passionate interest in fundamental physics — even if only to figure out what’s wrong with the mainstream theories. But I also predict that the bookshelves of the average churchgoer are no more likely than anyone else’s to contain a good survey of, say, quantum chromodynamics. I conclude that the average churchgoer is not a believer. [Emphasis in original.] (p. 62)

Landsburg has gone entirely astray here. He is fascinated by physical theories, and so that’s why he thinks that’s what religion is "first and foremost." If you asked the average believer, "What is the Bible all about?" I doubt many would say, "It’s about the origin of the universe." Of course it does explain the origin of the universe, but that’s, well, just the first two chapters. The heart of the book, of course, is the personal relationship between God and His children.

Let me offer Landsburg some rival "predictions" that are think are much fairer to the theory that some people really are sincere in their religious beliefs. It would be easy to say things like, "They go to church more than professed atheists," or, "They have more books about God on their shelves than atheists," but Landsburg could dismiss that as a recreational activity.

Okay, what about this: I predict self-professed Christians donate more money than self-professed atheists. For sure, I predict they give more to churches, but I will go beyond the obvious and so they also give more to charities, if we include tithing in the total. This is a classic example of putting one’s money where one’s mouth is, so Landsburg should appreciate it. (To be really safe — and protect my prediction from people who really are just paying lip service — I could flip it around and say, "People who donate high fractions of their income are more likely to say they believe in God.")

For another example, I predict that self-professed Christians are much more likely than atheists to travel to foreign countries — often at great personal risk — to help build churches and spread the gospel. Some things of this nature can be dismissed as vacations paid for by other people’s donations, so Landsburg can restrict it however he wants. For example, "mission trips" to countries where other missionaries have been imprisoned or murdered within the last x years. Assuming it turns out that more professed believers engage in this behavior than people who say it’s all nonsense, isn’t the most obvious explanation that they actually believe in it? Why else would someone risk his freedom or even life to spread beliefs he doesn’t actually believe? Landsburg is a clever guy and will surely come up with theories, but I think the most obvious one is staring us in the face: many people actually believe in God.

Conclusion

Steve Landsburg’s new book is very provocative and covers an audacious range of topics. Yet on the issue of the existence of God, I found his arguments to be below his usual excellence.

Ushering in the Amero?

Bob Murphy — Mon, 14 Dec 2009 06:00:00 +0000

First under the Bush Administration and even more so under President Obama, the federal government has been seizing power and spending money as it hasn’t done since World War II. But as bold as the Executive Branch has been during this financial crisis, the innovations of Fed chairman Ben Bernanke have been literally unprecedented. Indeed, it is entirely plausible that before Obama leaves office, Americans will be using a new currency.

Bush and Obama have engaged in record peacetime deficit spending; so too did Herbert Hoover and then Franklin Roosevelt (even though in the 1932 election campaign, FDR promised Americans a balanced budget). Bush and Obama approved massive federal interventions into the financial sector, at the behest of their respective Treasury secretaries. Believe it or not, in 1932 the allegedly u201Cdo-nothingu201D Herbert Hoover signed off on the creation of the Reconstruction Finance Corporation (RFC), which was given billions of dollars to prop up unsound financial institutions and make loans to state and local governments. And as with so many other elements of the New Deal, FDR took over and expanded the RFC that had been started under Hoover.

In the past year, the government has seized control of more than half of the nation’s mortgages, it has taken over one of the world’s biggest insurers, it literally controls major car companies, and it is now telling financial institutions how much they can pay their top executives. On top of this, the feds are seeking vast new powers over the nation’s energy markets (through the House Waxman-Markey u201CClean Energy and Security Actu201D and pending Kerry-Boxer companion bill in the Senate) and, of course, are trying to u201Creformu201D health care by creating expansive new government programs.

For anyone who thinks free markets are generally more effective at coordinating resources and workers, these incredible assaults on the private sector from the central government surely must translate into a sputtering economy for years. Any one of the above initiatives would have placed a drag on a healthy economy. But to impose the entire package on an economy that is mired in the worst postwar recession, is a recipe for disaster.

Debt and Inflation

Conventional economic forecasts for government tax receipts are far too optimistic. The U.S. Treasury will need to issue far more debt in the coming years than most analysts now realize. Yet even the optimistic forecasts are sobering. For example, in March the Congressional Budget Office projected that the Obama administration’s budgetary plans would lead to a doubling of the federal debt as a share of the economy, from 41 percent of GDP in 2008 to 82 percent of GDP by 2019. The deficit for fiscal year 2009 (which ended Sept. 30) alone was $1.4 trillion. For reference, the entire federal budget was less than $1.4 trillion in the early years of the Clinton administration.

Clearly the U.S. government will be incurring massive new debts in the years to come. The situation looks so grim that economist Jeffrey Hummel has predicted that the Treasury will default on its obligations, just as Russia defaulted on its bonds in 1998. But another scenario involves the Federal Reserve wiping out the real burden of the debt by writing checks out of thin air to buy up whatever notes the Treasury wants to issue.

Many analysts are worried about Fed chairman Ben Bernanke’s actions during the financial crisis; Marc Faber is openly warning of u201Chyperinflation.u201D To understand what the fuss is about, consider some facts about our monetary and banking system.

The United States has a fractional reserve banking system. When someone deposits $100 in a checking account, most of that money is lent out again to other bank customers. Only a fraction — typically around 10 percent — needs to be held u201Con reserveu201D to back up the $100 balance of the original depositor. A bank’s reserves can consist of either cash in the vault or deposits with the Federal Reserve itself. For example, suppose a given bank has customer checking accounts with a combined balance of $1 billion. Assuming a 10 percent reserve requirement, the bank needs $100 million in reserves. It can satisfy this legal requirement by keeping, say, $30 million in actual cash on hand in its vaults and putting $70 million on deposit in the bank’s account with the Fed.

Normally, the Fed expands the money supply by engaging in u201Copen market operations.u201D For example, the Fed might buy $1 billion worth of government bonds from a dealer in the private sector. The Fed adds the $1 billion in bonds to the asset side of its balance sheet, while its liabilities also increase by $1 billion. But Bernanke faces no real constraints on his purchasing decisions. When the Fed buys $1 billion in new bonds, it simply writes a $1 billion check on itself. There is no stockpile of money that gets drained because of the check; the recipient simply deposits the check in his own bank, and the bank in turn sees its reserves on deposit with the Fed go up by $1 billion. In principle, the Fed could write checks to buy every asset in America.

Monetary Catastrophe

Since the start of the present financial crisis, the Federal Reserve has implemented extraordinary programs to rescue large institutions from the horrible investments they made during the bubble years. Because of these programs, the Fed’s balance sheet more than doubled from September 2008 to the end of the year, as Bernanke acquired more than a trillion dollars in new holdings in just a few months.

The Hope of Victory

Bob Murphy — Mon, 16 Nov 2009 06:00:00 +0000

May the God of hope fill you with all joy and peace as you trust in him, so that you may overflow with hope by the power of the Holy Spirit. (Romans 15:13, NIV)

We are engaged in a great struggle for liberty. There are forces at work in the world seeking to literally enslave all of mankind. At any moment in history, there is a small minority who have given their time, treasure, and even lives in an effort to hinder and ultimately defeat the would-be tyrants.

Ironically, some of the most passionate and zealous combatants — and the combat might not be physical, but instead take place on the plane of ideas — are acting inconsistently with their own professed views of the ultimate foundations of justice and morality. Only if we believe in some higher power, and moreover one that has constructed the very fabric of the universe to ensure that good will triumph over evil, does our struggle make any sense.

Reason Is Not Enough

Many champions of liberty have been agnostic or even outspoken atheists. It does not take an intellectual devotion to God to yield fine and courageous advocates of freedom. But do their heroics make sense, in light of their professed justifications?

We can find no better exemplar of this dichotomy than Ludwig von Mises. He did not justify his advocacy of private property and free markets by appeal to the alleged natural rights of man, let alone to the supposed commands of a supernatural being. For Mises, a society based on private property and the rule of law would be far more productive than one based on arbitrary government privilege, or worse yet a chaotic anarchy in which people stole and murdered with reckless abandon.

Therefore it seemed obvious to Mises that everyone bore responsibility in promoting the free society, because only in such a society could all of us achieve our long-term objectives through cooperation and the division of labor. Whatever temporary thrills one might derive from theft and violence, would be far counterbalanced by the inability to have large-scale capitalist production and market exchange.

Unfortunately there’s a flaw in Mises’ reasoning. He didn’t prove that everyone should be moral and law-abiding. Rather, Mises simply proved that everyone would be better off if everyone were moral and law-abiding. Those are two different propositions.

There are many situations in life that resemble a "prisoner’s dilemma" as discussed by the game theorists. That is, there are situations in which self-interest and reason leads each person to act in a way that makes the whole group worse off, compared to the outcome where everyone acts against his self-interest.

Hard-headed rationalists cannot get around this stubborn fact. It’s true that many social situations repeat themselves, and so even if they resemble the prisoner’s dilemma in any given iteration, in the long-run they actually foster cooperation. For example, even if one could get away with it, it would be foolish to skip out of a restaurant without paying the bill, if the diner expected to return to the same restaurant in the future.

Yet this clever answer doesn’t really solve the problem of evil. Is it really true that a secular humanist, armed with all the knowledge of economics, could convince a David Rockefeller or a Henry Paulson that his standard of living would be improved by abiding by the tenets of classical liberalism? If those examples leave the reader unsure, what about Kim Jong-il? If Ayn Rand were locked in a room with the North Korean leader, could she really convince him that the value of his own life would be enhanced by refraining from looting others?

Again, it is true that if the whole world embraced laissez-faire capitalism, even current despots would probably end up living with greater material prosperity. But that is not the choice any current despot faces. He looks at the options at his disposal, and the likely choices that others (including despots) will make during his lifetime. It is wildly unrealistic to assume that the most powerful (and evil) people on the planet are currently hurting their self-interest by violating the rules of traditional morality. A student of David Hume could explain why traditional moral rules benefit everyone, but he ultimately could not prove why anyone ought to be moral in the first place.

Heroes and Sociobiology

We can go further. If the foundation of morality really were a rationalist calculation of the actions promoting one’s self-interest, some of the most heroic defenders of liberty would be fools. Consider the dissidents under a thug such as Chile’s Pinochet. Many of them chronicled his abuses so that future generations would know the extent of his crimes, knowing full well that they would likely be murdered for daring to oppose his regime. Under the Misesian and especially the Randian framework, these rebels all behaved foolishly — indeed they arguably behaved immorally.

So why do even secular humanists cheer such heroes? Because they view themselves not as simply maximizing the chance of material prosperity, but as engaged in a battle of ideas. Many of today’s libertarians would rather live on the streets than become an IRS agent. Surely this decision wouldn’t be driven merely by an estimate of the likely long-run earnings from either career path (where other libertarians perhaps punish the person for seeking IRS employment and temporarily earning a higher paycheck). No, there is a much deeper sense among many secular libertarians that working for the IRS is just plain wrong and therefore it’s not even an option.

The Darwinists of course have something to say. Like many other creatures, we Homo sapiens experience strong feelings of altruism, especially for our kin. This is biologically programmed into us, because a genetic predisposition for a soldier to jump on a live grenade would tend to survive in a population. It’s no more "irrational" for people to die in the cause of liberty, the sociobiologists could argue, than for parents to spend $100,000 sending their kids to college.

This explanation is too glib. After all, evolutionary theorists can come up with stories to explain why people experience optical illusions and other "mistakes" in sensory experiences. Yet someone wandering in the desert who thinks he sees water would use his reason to resist the faulty biological urge; the same goes for someone caught in a blizzard who is experiencing hypothermia and suddenly feels very hot and wants to take off his hat and parka.

By the same token, then, a captured member of the French Resistance might feel a strong urge to tell his Nazi captors to go jump off the Eiffel Tower when they demand to know the addresses of his colleagues. Yet if he were a rational egoist, he would recognize those biological traits as dangerously inappropriate in that specific instance, nudging him to engage in behavior that would lead to his torture and death. Talk about a maladaptive response!

The Hope of Victory

The theist who believes in a just and omnipotent God does not suffer from the above inconsistencies. He can justify his passionate and heroic defense of liberty. Even if he dies, he knows he has done the right thing — where "right thing" is not defined as a set of strategies to maximize the likelihood of achieving earthly happiness.

Belief in the God of the Bible gives one hope in the ultimate triumph of good over evil. We know that those who enslave, steal, and murder may experience temporary victories, but that ultimately they are doomed to defeat.

Ironically, we have come full circle. The theist can tell David Rockefeller, Henry Paulson, and Kim Jong-il the following advice which is the epitome of realpolitik:

"You should stop what you are doing because it offends the Creator of the heavens and earth. You are making an intellectual error in your assessment of the strength of your position. Your armies are nothing compared to the might of the LORD, and your intelligence networks are nothing compared to His wisdom. Repent while you still can, and save yourself from ruin."

Bloody Fiat Money

Bob Murphy — Mon, 14 Sep 2009 05:00:00 +0000

A few years ago on these pages, I harshly criticized an article urging New Yorkers to “eat local,” and went so far as to dub the young lady’s column, “The worst economics article ever.” I am here to report that her record has been smashed. Floyd Norris’s recent New York Times article on the greenback is hands down the worst economics article I have ever read. Not only is it jam-packed full of false history, but it uses the falsehoods to justify monstrous crimes, both in the past and present.

The reader with a strong stomach will have to click the above link to appreciate the full enormity of Norris’s accomplishment, but for those with limited attention spans I’ll detail some of its biggest problems below.

Bernanke Saved the Credit Markets?

The article opens up with claims about the health of the world economy that are misleading at best:

Six months after the financial world seemed to be coming to an end, the world’s economies appear to be recovering. Banks that seemed to be on the brink of failure less than a year ago are now able to pay back investments made by the Treasury.

It is too early to declare victory, but the world looks much safer than it did only a few months ago. Credit markets are recovering, to the point that the junk bond market will have its best year ever if it manages not to lose any money over the rest of 2009. The stock market has just finished its best six months since 1938.

If victory is to be had, it will owe a lot to the willingness of American policy makers to set aside cherished policies and simply create money. And that is one reason it is appropriate to pause and celebrate an unheralded bicentennial: The father of the greenback, Elbridge Gerry Spaulding, who was born 200 years ago, in 1809. (emphasis added)

Now hold on just a second. I want to challenge this claim that things are now recovering. Concerning banks paying back their TARP money, I have dealt with that issue here. Regarding the stock market, Norris is right: it’s way up (so far) in 2009. But I don’t remember Henry Paulson, Timothy Geithner, Ben Bernanke, or Presidents Bush and Obama ever justifying their rescue programs by saying, “We need to do this to resuscitate the stock market.” I grant you, they may (and probably did) say that the stock market would be helped by their programs, but pumping up stock prices was never the justification given to the American public.

As I recall, the justifications were all about J-O-B-S. Specifically, Paulson told Congress that he needed the $700 billion TARP package to save the banks, not because anybody cares about Wall Street fat cats, but because plenty of businesses needed short-term financing to meet their payrolls. (A lot of us wondered at the time what types of businesses paid their employees with borrowed money, but solving that kind of mystery is why the Treasury secretary makes the big bucks.) And of course, the Obama administration warned everyone that without pushing through the $787 billion “stimulus” package, aggregate demand would collapse even more and the unemployment rate would skyrocket.

So let’s check up on these two things. Below is a chart (reproduced from Greg Mankiw’s blog) showing what the administration forecasts were for the unemployment rate, with and without the stimulus package:

(Original image source here.)

So just to be clear, Obama’s economic team warned America that without their stimulus plan, unemployment might flirt with 9 percent, whereas with the Keynesian shot in the arm, unemployment wouldn’t break 8 percent. After getting the stimulus, the actual unemployment rate is now nearly 10 percent.

It’s true, this awkward set of facts doesn’t prove that the stimulus was a bad idea. It is theoretically possible that Obama really did inherit an economy in worse shape than his team realized back in January, and that without the stimulus, the actual unemployment rate now would be, say, 14 percent. But since plenty of free-market economists were warning that deficit spending just transfers productive resources into the bloated government sector, doing nothing to really help the economy, the above chart should be embarrassing indeed for the Keynesians. Yes, it’s not the whole story, but it certainly is evidence that the free marketeers were right.

Now what about this issue of the credit markets? Norris isn’t original in his description; the conventional wisdom now is that the credit markets were on the verge of collapse, but that the unprecedented Treasury and Fed countermeasures (concentrated in September and October 2008) turned the situation around. According to this story, it wasn’t just the overleveraged Wall Street firms that were in trouble; the amount of credit available to regular, mid-sized businesses — who hadn’t dabbled in mortgage-backed securities or credit default swaps — was shriveling up. Paulson and Bernanke swooped in to save the day.

Suppose for a moment, just for fun, that this story about the credit markets is just as backwards as the story about the stimulus package. What would that mean, if the story is 100% wrong? Well, I guess it would mean that the total amount of business loans was actually rising and in fact at an all-time high, up to the point when Paulson and Bernanke decided to throw caution to the winds. And then after their heroic intervention, the total amount of business loans fell like a stone. Can we agree that something like this would mean the story Norris has repeated is exactly backwards? Well feast your eyes on this:

Now let’s be fair. Someone could plausibly argue that the business loans dried up when they did, in response to the collapse of Lehman and so forth. In this view, the drop that we see in the chart above would have been far greater were it not for the Fed’s rescue efforts and TARP. (There are other indicators people point to, such as the spreads between different types of debt.) But notice the similarity with the unemployment situation. Here too, the raw facts and Occam’s razor suggest that the interventions have hurt the ability of average businesses (not just the huge beneficiaries of the bailouts) to obtain financing. The chart above doesn’t prove that the TARP and Fed rescues were bad, but by no means should Norris be talking as if the recovery of the credit markets is a self-evident fact.

Don’t Worry About Fed Destructionism

Bob Murphy — Tue, 28 Jul 2009 05:00:00 +0000

In a recent article, Paul McCulley, managing director of PIMCO, was very enthusiastic about Bernanke’s handling of the financial crisis, and argued that the Fed had the tools necessary to avert large price inflation. Unfortunately, McCulley’s arguments have gaping holes; he has hardly dispelled my prediction of massive stagflation. Because McCulley’s piece crystallizes what many analysts have been saying, it will be instructive to pick apart his main points.

No Need for Fed to Soak Up Reserves?

McCulley’s most significant claim is that the Fed will be able to hike interest rates without selling off the assets on its balance sheet:

[T]his is really, really important stuff to understand, given the widespread yammering about the need for the Fed to have an exit strategy to de-create all the excess reserves it has created, as if they are intrinsically the kindling for an (eventual) rip-roaring inflationary fire. They are not….

It is … simply wrong to get wrapped around the axle about the amount of excess reserves in the system. The Fed now has the ability to hike the Fed funds rate, despite a huge reservoir of excess reserves, because it now has the legal ability to pay interest on those reserves.

Before evaluating McCulley’s claims, let’s set the context. Since the summer of 2008, Bernanke has more than doubled the Fed’s balance sheet. In essence, the Fed wrote checks on itself — drawing on money created out of thin air — in order to buy mortgage-backed securities and other “toxic” assets from financial institutions that had made horrible investments during the housing boom.

When the Fed buys (say) $10 million in mortgage derivatives, the asset side of its balance sheet rises by $10 million. The seller of the mortgage derivatives — let’s call him Joe Smith — deposits the Fed check in his own bank account. Thus Joe Smith’s checking account balance goes up by $10 million, while his bank itself clears the check with the Fed, so that the commercial bank’s reserves (on deposit with the Fed) also go up by $10 million.

Under normal circumstances, the process wouldn’t stop there. As many readers will recall from (horribly boring) principles lectures, our fractional-reserve banking system leads to a multiplier effect. The initial injection of $10 million into the banking system cascades into a much bigger expansion of the money supply held by the public. Specifically, what normally happens is that the commercial bank makes additional loans because of the increase in reserves.

Remember that banks only need to have a fraction of their customers’ checking accounts “backed up” by either cash in the vault or reserves on deposit with the Fed. So in our example, Joe Smith’s bank saw its reserves go up by $10 million, while its total customer deposits also went up by $10 million (in Joe Smith’s checking account). That means the bank now has “excess reserves,” i.e., reserves on deposit with the Fed over and above what it needs to cover its legal reserve requirement.

Should We Fear Deflation?

Bob Murphy — Fri, 17 Jul 2009 05:00:00 +0000

We who are advocates of sound, free-market money need to get our story straight. Are we predicting hyperinflation or massive deflation? Personally, I am much more worried about the former problem. Using a recent article by Mish, I hope to show that no one has made a convincing case for falling prices.

Mish’s Argument for Deflation

"Mish" is a very popular blogger on financial and economic affairs. His nickname is a melding of the first two letters of his two real names, Mike Shedlock. (My own friends called me "Romu" for a brief spell, but it didn’t catch on.) For some time Mish has been criticizing those warning about impending inflation, and in a recent post he summed up his position quite well.

Mish was responding to Gary North, who had written, "The Federal Reserve can re-ignite monetary inflation at any time by charging banks a fee to keep excess reserves with the FED."

Mish took issue with North’s claim:

Gary’s hypothesis … is just that, a hypothesis, and I believe a very poor one at that.

Bernanke’s idea to pay interest on reserves will slowly recapitalize banks over time. This is why he desperately wanted to do so. To suggest he is about to charge interest on deposits is silly.

The key fact now is there are not enough credit worthy customers for banks to want to lend, or for that matter willing borrowers looking to expand debt. Thus, if banks had to pay interest on reserves, rather than causing mass inflation, the Fed would cause mass panic.

I humbly submit that we have no idea what Bernanke is going to do next. Well, okay, we have some idea; Bernanke obviously isn’t going to call for the abolition of the Fed. But beyond that, it’s anybody’s guess. There are many economists who think Bernanke’s decision to start paying interest on reserves was a horrible blunder. In any event, Mish is simply assuming that the Fed officials don’t want to "cause mass panic," when an open-minded reading of history makes me wonder.

Let’s not get bogged down on the issue of Fed payment of interest. Here is the crux of Mish’s approach to inflation:

[Some] inflationists look at consumers prices, some look at commodity prices, still others look at the price of gold as a measure of inflation. Of those watching money supply, some concentrate on Base Money supply as Gary North does, others M2, M3, MZM, or even Austrian Money Supply as a measure of inflation…

Every one of them is wrong.

We have a credit based economy and anyone watching money supply and not watching credit is simply wrong. This is a statement of fact, not idle conjecture. Only those watching and expecting the collapse in credit and understanding the role of gold got things correct. This is a very small group of people.

Is Credit Part of the Money Supply?

Although every writer has his or her own nuances, I think it’s safe to generalize and say that the people calling for a "debt deflation" are assuming that the availability of credit acts as "virtual money," and causes prices to be higher than they otherwise would be. Some writers in this camp seem to think that we should just lump someone’s credit line in with his bank balance and currency on hand, in order to come up with how much "purchasing power" he has at his command.

Strictly speaking, that isn’t correct. For simplicity, picture an economy that has no credit system, and where physical gold serves as the commodity money. We start out in an initial equilibrium where the public collectively holds, say, 100 million ounces of gold as cash holdings. Prices of goods and services are quoted in weights of gold, and this vector of prices determines the "purchasing power" of an ounce of gold. Because we’re in equilibrium, everyone is happy holding his portion of the 100 million ounces.

Rothbard Express

Now suppose in this scenario, a budding entrepreneur gets the bright idea to form Rothbard Express, the first-ever credit card company. That is, Rothbard hands out plastic cards with his logo on them, and merchants agree to accept payment with use of such a card, rather than with actual gold coins. What will be the effect on prices?

At first blush, it seems as if the new business will push up prices. After all, people can now chase goods with not only 100 million ounces of gold, but also with the sum total of their credit lines as extended by Rothbard. In the new equilibrium, wouldn’t prices be higher because of the extra spending?

If Bob Murphy Were Extremely Rich and Powerful

Bob Murphy — Thu, 16 Jul 2009 05:00:00 +0000

If I were extremely
rich and powerful, and had absolutely no conscience, this is what
I might do:

I’d have a very popular and trusted Fed chair all of a sudden prime a massive bubble in the world economy. Then, just as it was about to crash, I’d make him take the fall and install a new chair.

The qualities I would seek in the new Fed chair would be threefold. First, he’d have to be a complete tool. Second, he’d have to be a very competent economist. And third, he’d have to be an expert on how to turn a huge financial crash into a worldwide economic depression.

Now the fun stuff. When everyone started flipping out, I’d use the crisis to bail out my associates at the big banks and investment firms who had had to go along with my reckless plan. Obviously I would zap anybody who hadn’t been playing ball with me, and give trillions to those who had the foresight to tell I was the coach of the winning team.

For some time I would have known that the US government was getting too big for its britches. As its global supremacy grew, there would be a greater and greater chance that the American presidents and senators I installed might decide they didn’t like my plan after all (even though that was the deal when I hired them). So I would gradually shift my power base elsewhere, and I would leave the US government in such a mess that it would take decades to recover.

In order to contain the US government, I’d get its military bogged down in foreign adventures. I’d do what I could to spur dictators (whom I couldn’t directly control) into developing nuclear weapons. (My plan there would be simple: I’d invade those dictators who disarmed like I demanded, and I’d give money to those dictators who repeatedly flouted my ostensible demands and openly developed an offensive nuclear program.)

On the economic front, I’d cripple the US economy relative to its major rivals by slapping on a huge new system of energy regulation. Once I had let that particular genie out of the bottle, I wouldn’t need to worry about economic growth from the US for decades.

Now just before jumping ship, I would crank up the printing presses and have the federal government incur unprecedented new debt. It would be one last parasitic HURRAH before my colleagues and I plunged the US government into truly Banana Republic status, and destroyed the dollar. In order to cover our tracks, I’d make sure that the crash originated from foreign speculators who “attacked” the dollar. I might even plant stories suggesting that Bernie Madoff (whose Ponzi scheme we had nurtured for years, knowing it would be a great pretext for further power grabs in the financial markets) had orchestrated the speculative attack from prison.

In order to make the dollar truly crash, I’d have my tool at the Fed pump in an absurd amount of new reserves, and then have him keep them bottled up in the banks by paying interest. I’d dangle that sword in front of the markets for several months, until they became desensitized to it. Yet deep down all the traders would know, in the back of their minds, that if they all began to anticipate a fall in the dollar, then it would immediately become a self-fulfilling prophecy. As the yields on dollar-denominated bonds suddenly went through the roof because of the speculative attack, the banks would rush to exchange their bottled reserves for Treasurys. The money supply held by the public would begin expanding at double-digit weekly rates, at the same time that foreign central banks would dump their dollar holdings.

Of course, there would be resistance to my plans. Most obvious, the other major financial players — US commercial and foreign central banks — would normally be unwilling to go along with my suggested course of action, since they would be devastated by the dollar’s collapse. In order to get them to follow my lead, and do what I wanted at the precise time I wanted, I would have to divide the spoils with them. I would give government guarantees to all the major US domestic players, to make sure they were whole when the smoke cleared, and that any of their losses were transferred to the US taxpayers. I’d also give plenty of advance notice to the central bankers, to give them time to expand their holdings of gold and hence offset their losses from the dollar crash. Also, I would remind China and Russia that their economies would benefit tremendously (at least in a relative sense) from the new regulations being slapped on to the American economy.

And at last, we come to the remaining obstacle to my plans: the charming American public. Even though they are ultimately the only force on earth that could physically stop me, I’ve known for years how to keep them in line. Through just a few companies, my associates and I dominate all of the major media, and we can keep them distracted about celebrity funerals and racist judges while the final elements of my plan are implemented.

Just to make sure that I kept the American public in line, I would have a black man in the White House when the crash occurred. This would keep the blacks from rioting, for their pastors and grandmothers would tell them they couldn’t let the first such administration go down in history as a failure. And if the president himself started to protest to me, saying he hadn’t agreed to all of this? I would gently remind him what happened to the last president who had gotten so popular that he thought he could buck the system. I’d also point out that his own second-in-command was just the kind of amoral power seeker who would have no qualms becoming president through any means possible.

Of course, at some point I might really have to drop the hammer on the dispersed and unorganized band of rebels who would catch on to my plans, and start raising a ruckus. Fortunately by then I would have perfected the Predator drones and my worldwide system of secret prisons.

The Hitman Doctor

Bob Murphy — Fri, 26 Jun 2009 05:00:00 +0000

To listen to the
mainstream media explain things, now that the feds have dealt with
the recession, reformed the banking sector, and come up with a plan
to fight global warming, it’s time for the politicians in D.C. to
fix the health care system. In reality, the Obama administration so
far has given us "solutions" that will only make the original
problems worse. Their plans to expand government involvement in health
care will likewise fail.

Two of the main complaints over health care are the rising costs and the hassles of obtaining service. Insurance premiums continue rising, placing insurance out of reach for many households. On the other hand, those with insurance must grapple with doctors and treatments that are "in plan" or "out of network," and they have to keep track of a bewildering set of rules governing health savings accounts, co-pays, and deductibles.

In light of the above realities, it is understandable that many citizens are furious over the state of the U.S. health care system. But how can any adult possibly think that the federal government will help with any of these shortcomings?

Let’s take the issue of rising costs. Is there a single government program in U.S. history that achieved falling costs? Look at higher education, for example. Has college tuition become more affordable over the years, given the huge sums poured in by the politicians? The Pentagon is a "single payer" when it comes to military hardware. Is that why fighter jets are so cheap?

We’ve seen that the government doesn’t have a stellar history when it comes to cutting costs. Yet it has a miserable record when it comes to reducing paperwork, too. When filling out tax forms every April, nobody says, "Wow, that was refreshingly easy! If only the rest of the world worked like the I.R.S.!"

The government ruins everything it touches. Many high school graduates are functionally illiterate, even though per pupil funding is much higher now than in previous generations. Despite billions in subsidies over the years, Amtrak continues to lose money. The Post Office, though not an official arm of the government, enjoys a monopoly on first-class mail and is not renowned for its efficiency. And when a comedian wants to illustrate poor customer service, his reference case is the Department of Motor Vehicles.

Why in the world do so many people want to entrust this same government with our health care?

Things get worse. It’s not merely that bigger government will exacerbate the problems in the health care industry. More than that, the problems themselves are largely the fault of earlier government intervention.

For example, government restrictions allow the American Medical Association to act as a cartel, limiting the supply of new health care providers. Many tasks (such as checking blood pressure, administering shots, and otherwise prepping a patient) could be safely administered by employees with merely on-the-job training. Yet many of these tasks are "union jobs" under the present system. Government regulations also restrict the supply of pharmacies who are able to fill prescriptions, tending to raise prices.

Excessive and unpredictable malpractice awards are another contributor to rising health care expenses. Doctors have to pay higher premiums themselves for malpractice insurance, and they order batteries of tests even for obscure risks, in order to protect themselves in court. These higher costs on suppliers ultimately lead to smaller output of medical services and higher prices for consumers.

Most people never stop and ask why their health care is tied to their employer in the first place. The answer is that government wage controls during World War II made it illegal for employers to attract skilled workers by offering higher salaries. Instead, they offered the legal maximum in explicit pay, but also offered to pay for a job candidate’s health insurance.

Thus we see the familiar process of unintended consequences: The government ran the printing press to help pay for the war effort during the 1940s. In order to combat the rising prices which followed, the government imposed price and wage controls. But this started the practice of employer-provided health insurance, which means that in times of high unemployment, millions of Americans are both jobless and uninsured. So a string of previous government interventions has led to a situation in which the government insists it needs yet more money and power in order to "fix" the country.

The way to fix health care is to get the government out of it. The same goes for every other "problem area" in society today.

Why I Expect Serious Stagflation

Bob Murphy — Wed, 17 Jun 2009 05:00:00 +0000

When doing interviews for my new book on the Great Depression, a natural question comes up: will the present crisis turn out as bad as the 1930s?

My standard answer is typical for an economist: "yes and no." On the one hand, there were very specific reasons that unemployment broke 25 percent in 1933, and we don’t have those factors in place today. So I don’t think the official unemployment rate will get anywhere near that catastrophic level, though it could very well come in at the #2 spot in US economic history.

However, even though unemployment rates will not be as severe, I still predict that we are in store for a miserable decade of economic stagnation. Given all of the huge assaults of the federal government into the private sector in just the past six months, I frankly don’t understand how anyone except true believers in Karl Marx can be seeing "green shoots."

What is perhaps worse, laid on top of the stalled output in goods and services, I predict Americans are in store for the worst price inflation in US history. Just as stagflation referred to the combination of high unemployment and price inflation rates in the 1970s — something Keynesians thought was impossible — we can use the term hyperdepression to refer to the mix of hyperinflation and a serious recession in real output. In the remainder of this article I’ll explain my pessimistic outlook.
Why Did Unemployment Hit 25% in the 1930s?

The single biggest blunder Herbert Hoover made was insisting that businesses maintain wage rates after the stock-market crash in October 1929. Hoover adhered to an "underconsumptionist" theory of the business cycle, in which a small shock to business could end up cascading into a full-blown depression if market forces were left to their own devices. In Hoover’s view, the worst thing businesses could do in 1930 would be to slash wage rates, because then workers would have even less money to buy products; there would be a downward spiral into oblivion.

The problem was that the United States was still on a gold standard, and so the Fed couldn’t inflate the economy with new paper money with reckless abandon (the way it has done in subsequent recessions). When Americans began panicking and pulling their money out of the banks, the overall quantity of money (measured by aggregates such as M1 or M2) fell sharply, declining by about a third from 1929 to 1933.

Because of the shrinking money stock as well as people’s desire to hold larger cash balances, prices in general fell substantially as well, falling at an annualized rate of more than 10 percent for portions of the Hoover years.

This is why Hoover’s high-wage policy proved so disastrous. With everything except labor getting cheaper by the month, unemployed workers found it difficult to re-enter the work force. With sales and revenues plummeting, no employer wanted to hire workers at the same wage rate prevailing at the height of the boom in 1929. Because Hoover insisted that wage rates stay the same, even though the market-clearing wage rate was falling with productivity and general prices, the result was larger and larger unemployment. This is Econ 101.

In our present crisis, we don’t need to worry about unemployment rates hitting 25 percent. Even though federal policies will reduce labor productivity, and even though Obama’s pro-union policies will exacerbate "wage stickiness," over the next few years I predict large price inflation that will tend to mitigate these factors. In short, most workers will still be able to find jobs, because Bernanke’s running of the printing press will ensure that their paychecks don’t buy very much at the stores. Consequently, it won’t be as difficult for employers to justify taking on people laid off from other firms, compared to the situation in the Hoover years.

Why Real GDP Will Stagnate

I am not going to be foolish and give annual rates of projected real GDP growth; let me simply summarize my view by saying that the economy will be in the toilet for a decade. (Consult another economics PhD for a precise translation of those terms.)

I really don’t understand how even some free-market analysts on CNBC and the like can talk about the recession ending this year, or who speculate that we’ve finally "hit rock bottom." If they really believe that, then I wonder why they spend so much of their careers praising free markets and blasting socialism? If all of Bush’s and now Obama’s enormous interventions only yield a few quarters of a moderately bad recession, then what’s all the fuss about?

We have all been desensitized to the federal power grabs, because they have been so sudden and so sweeping. The human mind is able to adapt to any new environment fairly quickly.

Hyperinflation Is Coming

Bob Murphy — Thu, 23 Apr 2009 05:00:00 +0000

People often accuse me of making “irresponsible” forecasts of massive price inflation. Even though they know that history is replete with examples of central banks ruining their currencies, these critics are sure that “it can’t happen here.” So in the present article I’d like to make the brief case for why we should all be very alarmed about the prospects for the U.S. dollar.

First, let’s look at what those penny pinchers in the federal government are up to. The Congressional Budget Office (CBO) recently released its analysis of the Obama Administration’s ten-year budget proposal. The projected deficit for (fiscal year) 2009 is a whopping $1.8 trillion. Now the president has said, in effect, that you need to spend money to save money, but the CBO projects deficits once again exceeding $1 trillion by 2018. In fact, over the whole CBO forecast from 2009—2019, the lowest the deficit ever goes is $658 billion.

This should be rather surprising to anyone who actually took Obama at his word when he promised to restore fiscal discipline to Washington. In fact, the CBO projects that the outstanding federal debt held by the public will increase from 40.8% of GDP in 2008 to 82.4% in 2019. In other words, the CBO predicts a doubling of the national debt in a mere decade.

One last thing to give you chills (and not the good kind): The CBO is not exactly a doom-and-gloom forecasting service. They’re run by the government, for crying out loud. This is the same CBO that projected at the start of the Bush Administration ten years of an accumulated $5.6 trillion in budget surpluses.

I would caution readers not to dismiss all CBO numbers as obviously meaningless. On the contrary, I think we will see the same pattern play out under Obama as under Bush: Because the CBO in both cases is grossly overstating future tax receipts, its projections for the Obama proposal are going to turn out just as rosy as they did back in 2001. Besides anemic tax receipts, if mortgage defaults continue to increase, the CBO projections on losses from the Treasury’s numerous “rescue” measures will also be far too optimistic.

In short, I think we should view the doubling of the national debt (as a share of the overall economy) over the next decade as a naïve best-case scenario.

If fiscal policy is a disaster, monetary policy is even worse. Unfortunately, the issues here get very complicated, and so it’s difficult for the layman to know whom to trust. Not only do left-wingers like Paul Krugman say that we need more inflation, but even (alleged) right-wingers like Greg Mankiw are saying the exact same thing. With all due respect, those guys are crazy.

Normally, I do my best unshaved-guy-wearing-a-sandwich-board routine by showing the scary Fed chart of the monetary base. But every time I do that, some wise guy argues that I don’t understand how our banking system works, and that because of “deleveraging” we are actually experiencing a shrinking money supply.

No, we aren’t. It’s true that there are forces tending to shrink the money supply, but Bernanke has more than overwhelmed them. All of the standard measures of the money stock went way up during 2008, even though prices (as measured by the CPI) fell in some months. For example, the monetary aggregate M1 consists of very liquid items such as actual currency held by the public, and checking account deposits. It does not include the monetary base (which we know has exploded through the roof). Even so, look at the annual percentage graph of M1 recently; it’s grown at almost a record rate:

Now the reason prices haven’t exploded is that the demand to hold U.S. dollars has also increased dramatically. (That’s also what happened in the 1980s: the Reagan tax cuts and Volcker’s squelching of severe price inflation made it much more attractive to hold dollars, and so the Fed got away with printing a bunch even though the CPI didn’t increase wildly.)

Once people get over the shock of the financial crisis, the new money Bernanke has pumped into the system will begin pushing up prices. Others have used this analogy before me, but it’s still apt: The U.S. economy right now is like Wile E. Coyote right after he runs off a cliff but hasn’t yet looked down. Once the spell of a “deflationary spiral” is broken by a full quarter of significant price hikes, there will be an avalanche as people come to their senses.

Some analysts concede that the traditional Fed policies have indeed left the dollar vulnerable to serious devaluation, but they think the central bank wizards can save the day by acquiring new “tools.” For example, San Francisco Fed president Janet Yellen has been arguing that the Fed should be able to issue its own debt, to give the Fed more flexibility. The idea is that when the time comes for the Fed to sop up the excess reserves it has pumped into the banking system, it would be devastating to the incipient economic recovery if the Fed has to dump a bunch of mortgage-backed securities, or Treasury bonds, back onto the market. This would ruin the banks with MBS on their balance sheets, and/or it would push up interest rates for the government. Thus, the Fed would have painted itself into a corner, and it would have to choose between massive CPI hikes or a renewed recession. To avoid that nasty tradeoff, Yellen argues that if the Fed could sell its own debt, then it could drain reserves out of the banking system without unloading its own balance sheet.

For a different idea, economists Woodward and Hall think the Fed just needs the ability to charge banks for holding reserves. The Fed already (recently) obtained the right to pay interest on reserves, and so Woodward and Hall think the Fed should also have the ability to do the opposite, i.e. to be able to pay a negative interest rate on reserves that banks hold on deposit with the Fed.

How does this avert the threat of hyperinflation? Simple, according to Woodward and Hall. If banks ever start loaning out too much of their (now massive) excess reserves, and thereby start causing large price inflation, then the Fed can simply raise the interest rate it pays on reserves. Banks would then find it more profitable to lend to the Fed, as it were, rather than lending reserves out to homebuyers and other borrowers in the private sector. Voil! Problem solved.

Obviously these tricks can’t avoid the consequences of Bernanke’s mad money printing spree. At best, they would merely push back the day of reckoning, while ensuring that it grows exponentially (quite literally).

A quick numerical example: Let’s say the Fed wants to drain $100 billion in reserves out of the banking system, in order to cool off rising prices. But it doesn’t want to sell off some of its assets on its balance sheet (like “toxic” mortgage-backed securities), so instead the Fed sells $100 billion worth of the brand new “Fed bonds,” as Yellen hopes.

In the beginning, this will indeed solve the problem. When people in the private sector buy the Fed-issued bonds, they write checks on their banks and ultimately those banks see their reserves go down at the Fed. There is less money held by the public, and so prices don’t rise as quickly.

But what happens when the Fed bonds mature? For example, if the Fed sold a 12-month bond paying 1% interest, then after the year has passed our private sector buyers will hand over the securities and now their checking accounts will be credited with $101 billion. At that point, the economy would be in the same position as before, only worse: there would be an extra billion in newly created reserves (because of interest on the Fed debt).

The financial gurus running our financial system and advising our political leaders aren’t even thinking two steps ahead when making their cockamamie recommendations. For those readers who share my skepticism, the solution seems clear: You need to transfer your wealth out of assets denominated in fixed streams of U.S. dollars, and switch to something that responds to large price inflation. In short, sell your corporate and government bonds, and start stocking up on precious metals.

Obama’s New Deal Won’t Work

Bob Murphy — Mon, 20 Apr 2009 05:00:00 +0000

Since late 2007, more and more commentators have drawn parallels between our current financial crisis and the Great Depression. Nobel laureates and presidential advisors [pdf] confidently proclaim that it was Herbert Hoover’s laissez-faire penny pinching that exacerbated the Depression, and that the American economy was saved only when FDR boldly ran up enormous deficits to fight the Nazis. But as I document in my new book, The Politically Incorrect Guide to the Great Depression and the New Deal, this official history is utterly false.

Let’s first set the record straight on Herbert Hoover’s fiscal policies. Contrary to what you have heard and read over the last year, Hoover behaved as a textbook Keynesian after the stock market crash. He immediately cut income tax rates by one percentage point (applicable to the 1929 tax year) and began ratcheting up federal spending, increasing it 42 percent from fiscal year (FY) 1930 to FY 1932.

But to truly appreciate Hoover’s Keynesian bona fides, we must realize that this enormous jump in spending occurred amidst a collapse in tax receipts, due both to the decline in economic activity as well as the price deflation of the early 1930s. This combination led to unprecedented peacetime deficits under the Hoover Administration — something FDR railed against during the 1932 campaign!

How big were Hoover’s deficits? Well, his predecessor Calvin Coolidge had run a budget surplus every single year of his own presidency, and he held the federal budget roughly constant despite the roaring prosperity (and surging tax receipts) of the 1920s. In contrast to Coolidge — who was a true small-government president — Herbert Hoover managed to turn his initial $700 million surplus into a $2.6 billion deficit by 1932.

It’s true, that doesn’t sound like a big number today; Henry Paulson handed out more to bankers by breakfast. But keep in mind that Hoover’s $2.6 billion deficit occurred because he spent $4.6 billion while only taking in $2 billion in tax receipts. Thus, as a percentage of the overall budget, the 1932 deficit was astounding — it would translate into a $3.3 trillion deficit in 2007 (instead of the actual deficit of $162 billion that year). For another angle, I note that Hoover’s 1932 deficit was 4 percent of GDP, hardly the record of a Neanderthal budget cutter.

The real reason unemployment soared throughout Hoover’s term was not his aversion to deficits, or his infatuation with the gold standard. No, the one thing that set Hoover apart from all previous U.S. presidents was his insistence to big business that they not cut wage rates in response to the economic collapse. Hoover held a faulty notion that workers’ purchasing power was the source of an economy’s strength, and so it seemed to him that it would set in motion a vicious cycle if businesses began laying off workers and slashing paychecks because of slackening demand.

The results speak for themselves. During the heartless "liquidationist" era before Hoover, depressions (or "panics") were typically over within two years. Yes, it was surely no fun for workers to see their paychecks shrink quite rapidly, but it ensured a quick recovery and in any event the blow was cushioned because prices in general would fall too.

So what was the fate of the worker during the allegedly compassionate Hoover era, when "enlightened" business leaders maintained wage rates amidst falling prices and profits? Well, Econ 101 tells us that higher prices lead to a smaller amount purchased. Because workers’ "real wages" (i.e. nominal pay adjusted for price deflation) rose more quickly in the early 1930s than they had even during the Roaring Twenties, businesses couldn’t afford to hire as many workers. That’s why unemployment rates shot up to an inconceivable 28 percent by March 1933.

"This is all very interesting," the skeptical reader might say, "but it’s undeniable that the huge spending of World War II pulled America out of the Depression. So it’s clear Herbert Hoover didn’t spend enough money."

Ah, here we come to one of the greatest myths in economic history, the alleged "fact" that U.S. military spending fixed the economy. In my book I relied very heavily on the pioneering revisionist work of Bob Higgs, who has shown in several articles and books that the U.S. economy was mired in depression until 1946, when the federal government finally relaxed its grip on the country’s resources and workers.

For a fuller exposition, you’ll (naturally) have to buy my book. But here’s the quick summary: Sure, unemployment rates dropped sharply after the U.S. began drafting men into the armed forces. Is that so surprising? By the same token, if Obama wanted to reduce unemployment today, he could take two million laid-off workers, equip them with arm floaties, and send them to fight pirates. Voil! The unemployment rate would fall.

The official government measures of rising GDP during the war years is also misleading. GDP figures include government spending, and so the massive military outlays were lumped into the numbers, even though $1 million spent on tanks is hardly the same indication of true economic output as $1 million spent by households on cars.

On top of that distortion, Higgs reminds us that the government instituted price controls during the war. Normally, if the Fed prints up a bunch of money to allow the government to buy massive quantities of goods (such as munitions and bombers, in this case), the CPI would go through the roof. Then when the economic statisticians tabulated the nominal GDP figures, they would adjust them downward because of the hike in the cost of living, so that "inflation adjusted" (real) GDP would not look as impressive. But this adjustment couldn’t occur, because the government made it illegal for the CPI to go through the roof. So those official measures showing "real GDP" rising during World War II are as phony as the Soviet Union’s announcements of industrial achievements.

I have only scratched the surface in this article of all the myths surrounding the Great Depression and the New Deal era. For example, we are also constantly told — this time by Chicago economists, not Keynesians — that "we learned in the Depression" that the Fed needs to rapidly expand the monetary base to avert disaster. Oops, turns out that’s bogus too. But you’ll have to buy my book to learn why.

Explaining the Boom and the Bust

Bob Murphy — Tue, 31 Mar 2009 05:00:00 +0000

In a recent debate, prominent Keynesian professor and blogger Brad DeLong claimed that the Austrian explanation of the business cycle “does not work as an intellectual enterprise.”[1]

DeLong quotes Paul Krugman who, back in December, apparently dealt the Austrian diagnosis a crushing defeat on both theoretical and empirical grounds.

In the present article, I will set the record straight. Krugman’s theoretical criticism of (what he dismissively calls) the “hangover theory” of recessions is silly, and his empirical test is also a poor one. Once we set up a more appropriate test, the “hangover” theory — i.e., the Mises-Hayek explanation — passes with flying colors.

Krugman’s Two-Pronged Critique of the “Hangover Theory”

On his popular New York Times blog, back in December, Krugman lamented the idiocy of his colleagues. He can’t believe that John Cochrane would say something this (allegedly) foolish:

“We should have a recession,” Cochrane said in November, speaking to students and investors in a conference room that looks out on Lake Michigan. “People who spend their lives pounding nails in Nevada need something else to do.”

In response to such (apparent) nonsense, Krugman offers first a theoretical objection:

The basic idea is that a recession, even a depression, is somehow a necessary thing, part of the process of “adapting the structure of production.” We have to get those people who were pounding nails in Nevada into other places and occupation, which is why unemployment has to be high in the housing bubble states for a while.

The trouble with this theory, as I pointed out way back when, is twofold:

It doesn’t explain why there isn’t mass unemployment when bubbles are growing as well as shrinking — why didn’t we need high unemployment elsewhere to get those people into the nail-pounding-in-Nevada business?

Before dealing with Krugman’s second (and empirical) objection, let’s handle this theoretical objection.

You can’t understand Austrian business-cycle theory (ABCT) unless you first understand the Austrian view of the capital structure of the economy. In this article, I showed how Krugman was simply incapable of grasping ABCT because he lacks a rich enough model of capital. For those newcomers who are unfamiliar with ABCT, I strongly encourage you to read the fuller discussion in the hyperlinked article.

For our purposes here, a brief recapitulation of the argument: In a market economy, prices really serve a function; they are not mere appendages of exploitative power relations, but instead market prices signal real, underlying scarcity and help everyone in the economy adjust his plans in light of reality. The interest rates on various loans also mean something; they are not arbitrary.

In particular, the market interest rate coordinates the “intertemporal” (i.e., across-time) activities of investors, businesses, and consumers. If consumers become more future oriented and want to reduce consumption in the near term in order to provide more for later years, what happens in the free market is that the increased savings push down interest rates, which then signal entrepreneurs to borrow more and invest in longer projects. Thus resources (such as labor, oil, steel, and machine time) get redirected away from present goods, like TVs and sports cars, and the freed-up resources flow into capital or investment goods like tractors and cargo ships.

Now when the Federal Reserve artificially reduces interest rates below their free-market level, it sends a false message to entrepreneurs. Firms begin expanding as if consumers have increased their savings, but in fact consumers have reduced their savings (due to the lower interest rates). Businesses that churn out durable goods, such as furnaces, cargo ships, and, yes, houses will find business booming, because these sectors respond positively to low interest rates.

On the other hand, other sectors don’t need to contract, because (unlike the scenario of genuine savings) nobody is cutting back on consumption. This is precisely why the Fed-induced boom is unsustainable — real resources have not been released from consumer sectors in order to fuel the expansion of the capital sectors. Because modern economies are so complex, the charade can continue for a few years, with entrepreneurs cutting corners and “consuming capital” (i.e., postponing necessary replacement and maintenance on equipment) while both investment and consumer goods keep flowing out of the pipeline at increased rates. But the music eventually stops, since (after all) the Fed’s printing of green pieces of paper doesn’t really make a country wealthier. When the Fed “cuts interest rates” it isn’t really creating more capital for businesses to borrow; it is instead distorting the signal that the market interest rate was trying to convey.

So, in this context, Krugman the Nobel laureate is confused. When the Fed starts dumping wads of newly printed cash into particular sectors of the economy, why does this foster a period of prosperity — however illusory and fleeting it may be? Why instead doesn’t the money drop cause millions of people to get laid off?

I admit I feel sheepish even phrasing the question that way, but go reread Krugman’s blog post; that’s what he’s asking. The answer, of course, is that businesses armed with newly printed Fed dollars must bid away workers from their original niches in the structure of production. Obviously, this process doesn’t lead to mass unemployment. The workers voluntarily quit their original jobs because the inflated money supply has allowed a few firms to offer them higher salaries. The Fed’s injection of new money has not yet distorted the whole economy, and so there is no reason for other businesses to suddenly find themselves in trouble and lay off workers at the beginning of the artificial boom.

In contrast, once the bubble has popped, many firms realize they are embarked on unsustainable projects. They need to lay off their workers. Unemployment goes up, and only as workers reluctantly accept lower wages can they be reintegrated into the economy. On average, workers are earning less during the bust period than at the height of the boom. This is because the salaries and wages of the boom period were exaggerations of the true “fundamentals” of worker productivity, and also because the fundamentals themselves have been hurt due to the waste of capital during the boom period.

In short, workers on average are not as economically productive during the recession because the whole structure of production has been thrown out of whack by the Fed’s injections of funny money. It is much harder for workers to switch jobs and take a pay cut versus quitting a job in order to take a better one that pays more.

That’s the simple explanation for why the Fed-induced boom sees low unemployment, while the necessary bust experiences high unemployment.

The Housing Bubble Has Nothing to Do With Job Losses?!

After his theoretical objection, Krugman turns to the data to raise a second objection to the “hangover theory”:

It doesn’t explain why recessions reduce [employment] across the board, not just in industries that were bloated by a bubble.

One striking fact, which I’ve already written about, is that the current slump is affecting some non-housing-bubble states as or more severely as the epicenters of the bubble. Here’s a convenient table from the BLS, ranking states by the rise in unemployment over the past year. Unemployment is up everywhere. And while the centers of the bubble, Florida and California, are high in the rankings, so are Georgia, Alabama, and the Carolinas.

This is rather surprising, isn’t it? Forget the Austrian theory; Krugman is here saying that the bursting of the housing bubble doesn’t help explain the onset of the recession! But don’t worry, Krugman’s analysis is flawed; you’re not going crazy.

First, note that the BLS table Krugman links to looks at the over-the-year change in unemployment (by state) from December 2007 to December 2008. Now, is that really a good measure of whether the bursting of the housing bubble has anything to do with the recession? After all, the bubble had well burst by December 2007. So if the “hangover theorists” are right, you would expect the connection between unemployment jumps and housing-price collapses to be weaker the farther along you get from the bursting of the bubble.

In response to an email from a grad-school friend, I decided to check on the relation during a time frame that more tightly captures the bursting of the housing bubble. The OFHEO has quarterly data on home prices by state; I picked the top of the bubble as the second quarter in 2006.

Then I picked the other variable to be the change in unemployment (in terms of absolute point changes, not percentages of percentages) from June 2006 to December 2008, which is available (though not in a very convenient form) from the BLS.

Armed with this data, I ranked the states according to these two criteria, and looked at the worst 10 in both rankings. In other words, I looked at the list of the 10 states that had seen the biggest percentage decline in home prices since the 2nd quarter of 2006, and I also looked at the list of the 10 states that had seen the biggest jump in the unemployment rate from June 2006 to December 2008. The 7th through 10th slots on the two lists didn’t match up, but check out the worst 6 slots in both lists:

Ranking of States By Point Increase in Unemployment Rate, June 2006—December 2008

Rhode Island (+4.9)
Florida (+4.8)
Nevada (+4.8)
California (+4.4)
North Carolina (+3.9)
Michigan (+3.8)

Ranking of States By Percentage Drop in OFHEO Housing Price Index, 2Q 2006—4Q 2008

California, —27%
Nevada, —26%
Florida, —22%
Arizona, —16%
Rhode Island, —11%
Michigan, —11%

Note that North Carolina and Arizona are the only ones that don’t match. That seems like a very strong correlation. (Depending on how we frame the problem, the chances of this matching occurring randomly are anywhere from 1 in 8,400 to about 1 in 350,000.)

Conclusion

Brad DeLong and Paul Krugman continue to mock the Austrian explanation for the business cycle, but their ridicule is based on their own deficient model of the economy’s capital structure. Moreover, Krugman’s quick empirical points turn out, upon closer inspection, to support the Austrian position. Unfortunately, because DeLong and Krugman have so fundamentally misdiagnosed the problem, their “solutions” are a recipe for further disaster.

Notes

[1] DeLong’s UC Davis debate against Michele Boldrin is available here. DeLong’s discussion of (what he calls) the “Marx-Hoover-Hayek axis” of business-cycle theory can safely be joined at the 10:00 mark of the video.

This article first appeared on Mises.org.

The Threat of Hyper-Depression

Bob Murphy — Fri, 27 Mar 2009 05:00:00 +0000

In the Keynesian heydays of the 1950s and 1960s, most economists and policy makers believed in the “Phillips Curve,” which was the (alleged) tradeoff between unemployment and price inflation. The idea was that the Federal Reserve could cure a recession by printing money, or that the Fed could cure runaway inflation by jacking up interest rates. Each of these moves had its downside, of course, but the point was that the Fed could choose one poison or the other.

This Keynesian orthodoxy was shattered in the 1970s when the United States suffered through “stagflation,” which was high unemployment and high inflation. This outcome was not supposed to be possible, according to the popular macroeconomics models, and it left policy makers with no clear choice. If the Fed raised rates to stem the inflation, it would hurt the economy even more, but if the Fed cut rates (through printing more money) the inflation problem would worsen. The vacuum created by this crisis in both theory and policy was filled by the Reagan Revolution and supply-side economics.

At this stage nothing is certain, but the country is currently headed straight into a period of very rapid price hikes and a very bad recession. It would not surprise me at all if the national unemployment rate and the annualized rate of consumer price inflation both broke through into double digits by the end of 2009. Moreover, regardless of when it actually starts, I predict that things will get much worse before they get better, and that the United States will be mired in a malfunctioning economy for at least a decade, with price inflation in the double-digits (possibly higher) the entire time. We can call this condition “hyper-depression.”

As with stagflation during the 1970s, hyper-depression will blow up the prevailing “cutting edge” models of the macroeconomy. Back when he was an academic, Fed Chair Ben Bernanke was actually an expert on the Great Depression. Bernanke adheres to the (alleged) lesson taught by Milton Friedman and Anna Schwartz in their classic A Monetary History of the United States. F&S argued that Fed officials bore a large share of the blame for the Great Depression, because they did not pump in enough liquidity. The quantity of money actually declined by about a third from 1929—1933, as panicked customers withdrew cash from the banks. (In a fractional reserve banking system, when people withdraw deposits, the banks have to shrink their outstanding checking balances because of reserve requirements.)

As the following chart illustrates, Bernanke has taken Friedman’s warning to heart: The Fed has more than doubled its balance sheet since the financial crisis began, leading to an unprecedented jump in the monetary base:

Thus far, this enormous injection of new reserves into the banking system hasn’t caused the CPI to explode, but that is because (a) the banks are mostly sitting on the new reserves because they are all terrified, and (b) the public’s demand for cash balances has risen sharply. But using very back-of-the-envelope calculations, there is now enough slack in the system so that if banks calmed down and lent out the maximum amount of reserves, the public’s total money stock could increase by a factor of 10. There is no way that the public will simply add that new money to its checking accounts or home safes without increasing their spending. Eventually, prices quoted in U.S. dollars will start shooting upward.

All of the financial analysts are aware of this threat, but they foolishly reassure us, “Bernanke will unwind the Fed’s holdings once the economy improves.” But this commits the same mistake as the Keynesians during the 1970s: What happens when the CPI begins rising several percentage points per month, and unemployment is still in the double digits? What would Bernanke do at that point? Expecting the Fed chief to relinquish his new role of buying hundreds of billions in assets at whim, in the midst of a severe recession, would be akin to hoping that a dictator would end his declaration of “emergency” martial law in the middle of a civil war.

There are even many free market economists who are predicting that the Fed’s massive money-pumping will “fix” the economy, at least for a while, but at the cost of high price inflation. Yet these analysts don’t realize that they are buying into — what we all thought was — the discredited Phillips Curve. The 1970s proved that the Fed cannot fix structural problems with the economy by showering it with new money. Hyper-depression is simply stagflation squared.

People need to stop wondering, “When will the market find its bottom? This month? Next?” The federal government has already done an incalculable amount of damage to the American financial sector, and the insults keep growing. Think of it: Besides the unpredictable “sometimes we seize you, sometimes we take billions of bad assets off your books, sometimes we let you fail” strategy with respect to major financial institutions, the government has also done childish things such as ban short-selling of financial stocks. No one knows what the rules will be next week in these markets. Only a fool would expose new capital to the American financial sector at this point — and the politicians have the gall to wonder, “Why are the laissez-faire credit markets frozen?”

Market interest rates are prices and as such they communicate important information about real, underlying scarcity. When the central banks of the world decided to drive interest rates down to practically zero, they crippled the ability of the world economy to heal itself after the overconsumption of the housing boom. People all over the world need to be saving right now, and yet governments are doing everything they can to squander what’s left of the capital stock.

I had resisted predicting that we are now living through the early period of the Great Depression II. After all, the conventional statistics today are nowhere near as bad as they were in the 1930s. However, the recent tussle over AIG bonus payments convinced me that we are in this one for the long haul. In particular, Senator Charles Schumer’s comments — and the proposed legislation to back them up — show that we no longer have property rights in this country:

“My colleagues and I are sending a letter to [AIG CEO] Mr. Liddy informing him that he can go right ahead and tell these employees that are scheduled to get bonuses that they should voluntarily return them, because if they don’t, we plan to virtually tax all of it. He should tell these employees if they don’t give the money back, we’ll put in place a new law, that will allow us to [tax] these bonuses at a very high rate, so that it’s returned to its rightful owners, the taxpayers. So for those of you who are getting these bonuses, be forewarned: You will not be getting to keep them.”

This is an extremely dangerous precedent. It’s true — as many outraged callers to the AM talk shows explain — AIG received billions in government handouts, and so there is a plausible case to be made that those contractual arrangements with its executives should have been amended. But if that’s the case, then the government should have made that a condition of the original “loan,” or at the very least the government should now exercise its power as the de facto owner of AIG. Liddy was handpicked by the government to run the company, so if the politicians don’t like his decisions, they should fire him.

In contrast, look what Schumer & Co. have done. They are establishing the precedent that if a particular group of rich people does something that angers the government, and if this group happens to be wildly unpopular with the general public, then it is noble for the government to implement ex post facto changes to the tax code, singling these people out and basically robbing them. Schumer’s speech against AIG executives is not much different from him declaring, “So I say to Rush Limbaugh and other talk show hosts: Go ahead and continue preaching your hatred and pessimism about the U.S. economy; this is a free country and you have the right to do that. But be forewarned that we are crafting new legislation that will tax 90 percent of your ad revenues from doing so.”

What people need to realize is that the government is going to keep making this worse. In other words, it is not enough to step back and say, “Well, the feds have already partially nationalized the entire banking system, and brought politics into all major business decisions — including how executives choose to travel to business meetings. What are the effects?” On the contrary, we need to realize that as things continue to deteriorate — and they will — the Obama Administration will keep upping the ante. “What? The first stimulus didn’t work? OK let’s borrow and spend another $1 trillion; maybe that will ‘take.’”

The American people need to prepare themselves for hyper-depression. The future is still uncertain, and if the folks in Washington suddenly found free market religion, that terrible outcome could be avoided. But I’m not holding my breath.

Bob Murphy [send him mail] adjunct scholar of the Mises Institute, is the author of The Politically Incorrect Guide to Capitalism, The Human Action Study Guide, and The Man, Economy, and State Study Guide.

Defend the Gold Standard

Bob Murphy — Tue, 17 Mar 2009 05:00:00 +0000

For some reason, there are a lot of people out there who can’t stand the gold standard. Maybe their hostility is in reaction to the large (and growing) number of gold bugs who think the worst day in history was August 15, 1971. But since I’m an economist, not a psychoanalyst, all I can really do is patiently explain how silly the antigold arguments are, rather than speculate on the motives of their authors. For today’s article I will focus on a recent Bloomberg piece with the suggestive title, “Gold Standard Fans Yearn for Great Depression.”

Gold Is Volatile?!

Early in his essay, the Bloomberg commentator Michael Sesit gives a rapid-fire sequence of flaws with the barbarous relic:

A return to the gold standard, where countries peg their currencies to a given quantity of the metal and thus to one another, is a bad idea. Gold-based monetary systems are overly rigid and restrictive, possess a deflationary bias and can be volatile. They make long-term inflation dependent on the pace of mining output in places such as China, South Africa and Russia.

Let’s take these one at a time. To criticize a monetary system based on gold as “rigid” only makes sense if you believe that printing green pieces of paper makes a country richer. After all, the only rigidity enforced by the gold standard is on the central bank’s use of the printing press. Requiring the government to maintain a fixed dollar/gold exchange rate is “restrictive” in the same way that the Bill of Rights limits the discretionary power of the feds.

So yes, if Mr. Sesit thinks that the government does a good job centrally planning the economy with injections of new paper money, then I can see why he would consider the gold standard a bad idea. But let me ask you this: would you trust your next-door neighbor to use a legal-tender printing press “responsibly”? Now what about the people in DC? If we’re going to be foolish enough to give them a printing press in the first place, don’t you think it’s a good idea to put some strict rules in place?

What’s So Bad About Falling Prices?

Sesit’s next point is that the gold standard has a “deflationary bias.” So what? That’s one of its virtues, that the purchasing power of the dollar doesn’t fall or might actually increase over time. Even mainstream macroeconomists — whether neoclassical or New Keynesian — have come to realize over the last few decades that long-term predictability in monetary policy has definite advantages, and that in the long run, the best thing the monetary authorities can do is provide a currency with stable purchasing power.

So you tell me: looking at the graph below of the Consumer Price Index, when was the value of the dollar stable and predictable, and when was it really volatile? In which environment could businesses and investors confidently make long-term decisions? Remember that FDR took away private citizens’ right to redeem dollars for gold in 1933, and then Nixon finally removed even the ability of central banks to do so in 1971.

As the chart above makes fairly clear, US prices (measured in dollars) exploded after Nixon formally closed the gold window. And what the chart above doesn’t reveal — since it only goes back to 1913 — is how stable US prices were throughout its early history, compared to the 20th century. To get a sense, consider the following chart showing the price of gold (measured in US dollars per ounce) over a long stretch of time:

Remember, Mr. Sesit is warning us that under the gold standard, things were very volatile.

Let me deal with a possible objection: the opponent of the gold standard might look at the above chart and say, “Well of course the dollar-price of gold is stable under a gold standard; that’s true by definition! The problem is that this enforced stability means that other parts of the economy get jerked around because of the arbitrary handcuffs placed on the central bank.”

But the historical record does not support this (typical) claim. I always remind people who tout the stabilizing virtues of central banks that the Great Depression started fifteen years after the Federal Reserve opened its doors. Whether you subscribe to the Austrian theory (see this and this) that the Fed pumped up the stock market with artificial credit in the 1920s, or whether you subscribe to the Friedmanite theory that the Fed pushed on the brakes too hard in the late 1920s and then didn’t inflate enough in the early 1930s, either way you are blaming the Great Depression on the botched policies of the Federal Reserve.

In contrast, throughout its previous 150 or so years, the American economy had managed to do just fine without the Federal Reserve “fine tuning” the money supply. Yes, there were occasional panics (the term they used before “depression”) when the major economic powers adhered to the classical gold standard, but these business cycles paled in comparison to the Great Depression.

What About Those Foreign Gold Producers?

As for entrusting our money supply to gold miners in China, Russia, and South Africa, so what? When it comes to money, the great danger is a massive inflation. That’s the only way you can really destroy an economy: through flooding it with more and more paper money so that prices start rising at runaway rates.

One of the prime virtues of using gold as money is that the annual output is a small fraction of the total world stockpile. We never need fear that prices — if they were expressed in terms of gold ounces — would rise at Zimbabwean rates. The absolute worst that could happen is that all of the major gold producers decide to stop operations in order to punish the United States. Note that they couldn’t simply refrain from selling to American buyers: because gold is even more fungible than oil, the gold exporting countries would need to cut off all of their buyers if they wanted to punish Americans. Now how long could they afford to do that?

Unlike oil or other commodities intended for use in production, when gold is used as a money, a given amount can always “do the job.” It’s true that a sudden interruption in the growth of the world stock of mined gold would put downward pressure on prices, if those prices are quoted in gold ounces. But soon enough people would adjust, and would factor in the new trend to their expectations. There were plenty of long stretches in world history where genuine economic prosperity went hand in hand with gently falling prices. In any event, could those mischievous gold miners in Russia do anything like this to our money supply?

A Gold Standard Won’t Work Because It Will Be Violated

Sesit concludes with an odd argument:

What’s more, a gold standard isn’t the panacea its advocates claim. A central bank’s ability to adhere to it is only as strong as the population’s willingness to endure the pain associated with enforcing the system.

Countries periodically abandoned the gold standard during times of war — Britain during World War I, for example — and free-spending Latin American countries were repeatedly forced to exit the system in the late 19th century. The Bretton Woods System collapsed in 1971 when the costs associated with fighting the Vietnam War forced President Richard Nixon to suspend the convertibility of dollars into gold.

If you don’t have faith in central bankers or politicians to ride herd over inflation, why would you trust them to keep a country on a gold standard for more than a short period of time?

I’m not sure how to answer this. It’s true, I don’t trust central bankers to stick to a gold standard; that’s why I think the government should get out of the money industry altogether. Suppose we were starting in an initial state of pure laissez-faire in money and banking, and someone said, “Hey I know! Let’s give this Princeton professor — what was your name, sir, was it Ben? — a printing press, but be very stern that he can’t overdo it and allow the gold price to rise more than 1 percent from the day he starts. Does that sound like a good idea?” In response, I would obviously say, “No, that seems rather risky. I think we should stick to the current system, where the market determines how much new money is brought into the economy through gold production.”

But that’s not where we’re starting. If we’re going to have a central bank, it makes a lot of sense to put in place rigid restrictions on it. Notice you could use Sesit’s argument for any recommendation to restrain inflation. For example, Milton Friedman famously recommended that the central bank announce a fixed rate of growth in the money stock. Well gee whiz, Dr. Friedman, if you don’t trust the central bank to responsibly exercise discretionary policy, how can you trust them to stick to a fixed rate of growth?

And the same thing applies to the Bill of Rights, too. If you can’t trust the politicians to respect freedom of speech, why would they respect the First Amendment?

Conclusion

In closing, let me admit that a hardcore libertarian really could say that it is a waste of time to defend the gold standard, or even the Bill of Rights for that matter. Maybe they really are diversions, little gimmicks that the politicians can use to fool a gullible public into thinking they are safe.

But that is clearly not what Sesit is arguing in his Bloomberg piece. No, he is arguing that the gold standard is a bad idea because it keeps the central bankers from using all the latest, cutting-edge macro models to fine-tune the economy.

Rather than his proposal, I would far prefer the classical gold standard. It’s true that the government can always renege on its pledge to maintain a fixed peg to gold, but at least everybody would know exactly when the government cheated. You would at least avoid absurdities such as the present crisis, in which people are actually praising the Fed for pumping in unprecedented amounts of new money in order to “help.”

Bob Murphy [send him mail] runs the blog Free Advice and is the author of The Politically Incorrect Guide to Capitalism.

Raise Prices in the Recession

Bob Murphy — Sat, 07 Feb 2009 06:00:00 +0000

In working on my forthcoming book dealing with the Great Depression, I noticed something intriguing about the discount rate of the Fed. Oh wait, I should first clarify — I’m talking about the New York Federal Reserve Bank, because the Fed banks had more autonomy in the beginning, and so you couldn’t talk of "the Fed’s" discount rate.

What I noticed is that from the time it opened its doors in November 1914, all the way through 1931, the New York Fed charged its record-low rates at the very end of this period. The "discount rate" was the interest rate the Fed banks would charge on collateralized loans made to member banks. For the New York Fed, rates had bounced around since its founding, but they were never higher than 7 percent and never lower than 3 percent, going into 1929.

This changed after the stock-market crash. On November 1, just a few days following Black Monday and Black Tuesday — when the market dropped almost 13 percent and then almost 12 percent back to back — the New York Fed began cutting its rate. It had been charging banks 6 percent going into the Crash, and then a few days later it slashed by a full percentage point.

Then, over the next few years, the New York Fed periodically cut rates down to a record low of 1½ percent by May 1931. It held the rate there until October 1931, when it began hiking to stem a gold outflow caused by Great Britain’s abandonment of the gold standard the month before. (Worldwide investors feared the United States would follow suit, so they started dumping their dollars while the American gold window was still open.)

Bob Murphy [send him mail] runs the blog Free Advice and is the author of The Politically Incorrect Guide to Capitalism.

‘Do You Austrians Have a Better Idea?’

Bob Murphy — Tue, 03 Feb 2009 06:00:00 +0000

A lot of people get annoyed with Austrian economists because they tend to be so dogmatic (we prefer the term consistent) and because they cloak their strictly economic claims with self-righteousness (we prefer the term morality). After a good Austrian bashing of the latest call to steal taxpayer money and waste it on something that will make a given problem worse, the stumped critics will often shout, "Oh yeah? Well do you guys have a better idea?"

Now, in truth, someone doesn’t have to have a better suggestion in order to point out that a recommended strategy will exacerbate the situation. If an allergic man has been stung by a bee, I don’t know what to do except rush him to the hospital and maybe scour the cupboards looking for Benadryl. But I’m pretty sure drawing blood from his leg, in order to inject it into his arm and thus "stimulate his immune system," is a bad idea on numerous accounts — not least of which, is that I’m pretty sure an allergic reaction means your immune system needs to calm down. But the point is, if a bunch of guys hold the man down — he has to be forced to endure the procedure for his own good, don’t you know — I feel perfectly qualified in yelling, "Stop!"

If you grasped that analogy, you can understand my feelings about anything Paul Krugman writes.

(All joking aside, I am pretty proud of the above analogy. But to make it even more accurate, let’s stipulate that a blind heroin addict, who has been convicted of manslaughter on three separate occasions, is the one entrusted with making the transfusion. Naturally he will use one of his own needles for the procedure.)

Bob Murphy [send him mail] runs the blog Free Advice and is the author of The Politically Incorrect Guide to Capitalism.