by Doug French

Recently by Doug French: Who Serves During Disaster?

Jon Corzine told the House Agriculture Committee, "I simply do not know where the money is, or why the accounts have not been reconciled to date." The public is outraged that the former CEO of bankrupt global financial-derivatives broker and prime dealer in US Treasury securities MF Global doesn’t know where the missing $1.2 billion in client funds went.

Corzine is the member a few exclusive clubs: he is a Goldman Sachs alum, former US senator, and former New Jersey governor. After the incumbent Corzine was beat by Chris Christie in the 2009 New Jersey gubernatorial race, the MF board probably rejoiced, believing the guy to fix their problems was suddenly available. Now he’s in the club of taking a mere 20 months to create the eighth largest bankruptcy in history.

As a stand-alone entity, MF Global was born in 2007 when it was spun off from UK hedge-fund giant, Man Group. MF booked revenues of $4 billion that year from interest earned by using its customers’ funds, an operation that sounds like fractionized banking: short-term embezzlement used to make profits.

For banks, the practice was sealed in English common law in 1811 in the court case of Carr vs. Carr, where Master of the Rolls Sir William Grant ruled that debts mentioned in a will included bank accounts since the money had been deposited into the bank and wasn’t earmarked in a sealed bag. The deposit was thus a loan rather than a bailment.

The same Judge Grant ruled the same way five years later in Devaynes vs. Noble, despite an attorney’s argument that "a banker is rather a bailee of his customer’s funds than his debtor … because the money in … [his] hands is rather a deposit than a debt, and may therefore be instantly demanded and taken up."

In 1848, in Foley vs. Hill and Others, Lord Cottenham ruled,

"Money, when paid into a bank, ceases altogether to be the money of the principal; it is then the money of the banker, who is bound to an equivalent by paying a similar sum to that deposited with him when he is asked for it.… The money placed in the custody of a banker to do with it as he pleases."

It’s been clear sailing for bankers ever since. No questions asked.

At the same time, people are surprised that a commodity brokerage firm would misplace client assets. As Christopher Elias explains for Thomson Reuters,

"MF Global’s bankruptcy revelations concerning missing client money suggest that funds were not inadvertently misplaced or gobbled up in MF’s dying hours, but were instead appropriated as part of a mass Wall St manipulation of brokerage rules that allowed for the wholesale acquisition and sale of client funds through re-hypothecation. A loophole appears to have allowed MF Global, and many others, to use its own clients’ funds to finance an enormous $6.2 billion Eurozone repo bet."

Free bankers are always insisting that fractional-reserve banking is A-OK, as long as bankers inform depositors up front that the bank will be using their customers’ money to make loans and investments.

That is exactly the case with MF Global. The company’s customer agreements included the following clause:

7. Consent To Loan Or Pledge You hereby grant us the right, in accordance with Applicable Law, to borrow, pledge, repledge, transfer, hypothecate, rehypothecate, loan, or invest any of the Collateral, including, without limitation, utilizing the Collateral to purchase or sell securities pursuant to repurchase agreements [repos] or reverse repurchase agreements with any party, in each case without notice to you, and we shall have no obligation to retain a like amount of similar Collateral in our possession and control.

Back in 2007, customer funds held by MF as collateral against commodities trades could be invested in two-year Treasuries earning north of 4.5 percent. But in the wake of the ’08 meltdown, the Bernanke Fed has flattened yields to be counted in basis points. With these low rates MF Global revenues fell to $517 million in 2010.

The old bond trader Corzine thought he could juice up MF’s earnings with a little financial razzle-dazzle. Thinking outside the box (and off the balance sheet), Corzine moved $16.5 billion in assets into repos. A repo involves putting up assets as collateral, assets to be repurchased later, and borrowing money against those assets. MF used an off-balance-sheet repo called a "repo-to-maturity" where the loan and the collateral in the transaction have the same maturity. US accounting rules consider the transaction a sale and the assets can be moved off the balance sheet.

Most of these assets were bonds from Italy, Spain, Belgium, Portugal, and Ireland, all paying healthy coupon rates that would easily cover the repo interest rate and provide a nice profit. MF Global would have virtually no skin in the game (their customers provided it) and be earning a nice interest-rate spread.

Although things have been rocky in euroland, the collateral value of the short-term bonds appeared safe with the guarantee provided by the European Financial Stability Facility (EFSF).

With the $16.5 billion in assets moved off its balance sheet, MF Global then ramped up a net-long sovereign-debt position of $6.2 billion on its balance sheet – exposure that was five times the company’s net worth.

While the EFSF guarantee would insure against the default of the sovereign debt if the bonds were held to maturity, MF was still at risk to make margin calls, if the bonds dropped in price day-to-day. Elias writes,

"Like Wall Street cocaine, leveraging amplifies the ups and downs of an investment; increasing the returns but also amplifying the costs. With MF Global’s leverage reaching 40 to 1 by the time of its collapse, it didn’t need a Eurozone default to trigger its downfall – all it needed was for these amplified costs to outstrip its asset base."

So while MF Global’s eurozone bets had not defaulted, the company’s liquidity was drained making margin calls and trying to meet short-term-debt obligations as the euro-crisis news flow out of Europe vacillated.

MF Global was able to leverage up its euroland bets by way of the rehypothecation of their clients’ collateral. Hypothecation is pledging collateral for a loan. Like the mortgage on your house.

Customers of MF posted cash, gold, or securities as collateral to backstop their commodity futures and derivatives trading. MF would then take those customer assets to back its own trades and borrowing. Mr. Elias explains, "The practice of re-hypothecation runs into the trillions of dollars and is perfectly legal. It is justified by brokers on the basis that it is a capital efficient way of financing their operations much to the chagrin of hedge funds."

Under US rules, a prime broker is allowed to rehypothecate assets to the value of 140 percent of the client’s liability to the broker. The rules are more liberal in the United Kingdom, where there is no limit and in many cases UK brokers rehypothecate 100 percent of collateral value placed in their custody.

Elias writes that by 2007, rehypothecation was half the shadow banking system.

"Prior to Lehman Brothers’ collapse, the International Monetary Fund (IMF) calculated that U.S. banks were receiving $4 trillion worth of funding by re-hypothecation, much of which was sourced from the UK. With assets being re-hypothecated many times over (known as ‘churn’), the original collateral being used may have been as little as $1 trillion – a quarter of the financial footprint created through re-hypothecation."

All of this churning has created rivers of liquidity, much of it with no asset backing. And what assets do provide backing aren’t the quality they used to be. The repo rules were liberalized in the Clinton era. So instead of AAA government paper being required, AA sovereign debt works just fine; after all, as James B. Stewart writes for the New York Times:

"The law also allows commodities firms like MF Global to use segregated customer funds as a source of low-cost financing for their own operations, but they are required to replace any customer assets taken from segregated accounts with supposedly ultrasafe collateral of the same value, typically United States Treasuries, municipal obligations and obligations whose payments of principal and interest are guaranteed by the government." [emphasis added]

Of course all this rehypothecating creates mountains of counterparty risk, all dependent on dubious collateral that has been pledged multiple times. The equivalent of having four mortgages on a house, each having been sold to other parties who have been told their mortgage is in first position. When the property value starts dropping or the borrower doesn’t pay, only one lender will get there first and legal fistfights ensue.

This rehypothecation activity may be the biggest credit bubble of all time, according to Elias. J.P. Morgan alone has rehypothecated over half a trillion dollars in 2011, Morgan Stanley $410 billion, Goldman Sachs $28 billion, and the list goes on.

Americans have been told US banks have little exposure to European sovereign debt, but according to the Bank for International Settlements (BIS), US banks hold $181 billion in the sovereign debt of Greece, Ireland, Italy, Portugal, and Spain. And while Germany is considered the belle of the Continental ball, Grant’s Interest Rate Observer reports that Deutsche Bank is levered at 43:1 and the Bundesbank has doubled its leverage since 2007 when it was geared at 75:1 – these days the central bank is levered at 153:1.

Extreme leverage is a problem if the slightest thing goes wrong – anywhere. When the cost of swapping euros for dollars soared at the end of last month, a coordinated central-bank cavalry charged out of nowhere, cutting swap rates and establishing temporary bilateral-liquidity swap arrangements. Nobody but financial news junkies seemed to know or care.

The truth about the financial crash wasn’t known until Bloomberg chased its request for information all the way to the Supreme Court to obtain documents that shed light on how much dough the Federal Reserve really provided the banks during the 2008 meltdown.

For instance, it turns out Wachovia shareholders got lucky as the bank was floated a secret loan from the Fed of $50 billion to keep the doors open while a sale could be arranged with Wells Fargo for $7 a share rather than shareholders having to take the buck-a-share offer from the wounded Citibank.

"This deal enables us to keep Wachovia intact and preserve the value of an integrated company, without government support," Wachovia’s chief executive Robert Steel said at the time.

Right, no government support at all.

Instead of being among the bailed out, Corzine and MF Global are now joining Lehman, IndyMac, Colonial, and all the small-fry banks lacking the friends in high places needed to keep them afloat. In the fractional-reserve world, markets don’t decide the winners and losers; government does.

Stewart writes for the NYT, "SIPC will replace up to $500,000 of securities and cash (but not futures contracts) missing from customer accounts at member firms," and the notion of even covering futures accounts has been floated on CNBC by Senator Debbie Stabenow, just as the FDIC replaces deposits up to $250,000. But covering the losses of clients and depositors is hardly the reflection of sound capitalism and the honoring of property rights.

Murray Rothbard wrote,

“If no business firm can be insured, then an industry consisting of hundreds of insolvent firms is surely the last institution about which anyone can mention ‘insurance’ with a straight face. ‘Deposit insurance’ is simply a fraudulent racket, and a cruel one at that, since it may plunder the life savings and the money stock of the entire public."

So it’s unlikely Jon Corzine knows where the $1.2 billion in customer money went any more than the president of a failed bank would know exactly where the customer deposits went.

The bigger issue is that, day by day, Mr. Corzine looks to be merely a canary in the fractional-reserve coal mine.

Reprinted from Mises.org.

Doug French [send him mail] is president of the Ludwig von Mises Institute and the author of Early Speculative Bubbles & Increases in the Money Supply. He received the Murray N. Rothbard Award from the Center for Libertarian Studies. See his tribute to Murray Rothbard.

The Best of Doug French

by Doug French

Recently by Doug French: Waffle House Economics

Mayor Mike Bloomberg’s plan for New York City with hurricane Irene bearing down on the Big Apple was to evacuate residents and force businesses to close in low-lying areas. Move in with friends and relatives living on higher ground, stay out of the way, so government’s first responders can handle real emergencies was the message.

The result, as one of my friends who lives in Manhattan wondered, "They closed down the city, and all we get is a rainstorm?"

Meanwhile, as Irene ravaged other parts of the eastern seaboard, causing millions to be without power, the eatery of last resort, Waffle House, kept its doors open in many locations, using generators and serving a limited menu designed specifically for emergency situations.

"Hurricane Irene knocked out power in Weldon, N.C., on Saturday evening," writes Valerie Bauerlein for the Wall Street Journal, "but as the sun rose on this tobacco-farming town at 6:30 the next morning, the local Waffle House, still without electricity, was cooking up scrambled eggs and sausage biscuits."

The venerable Waffle House has learned a thing or two about responding to crisis, given their locations up and down the eastern seaboard. Panos Kouvelis, PhD, the Emerson Distinguished Professor of Operations and Manufacturing Management and director of the Olin’s Boeing Center for Technology, Information, and Manufacturing explains, "The companies that are most frequently exposed to supply-chain disruption are the ones that have the best risk management plans."

Kouvelis instructs his students about the "Waffle House Index" first coined by Federal Emergency Management Agency Director W. Craig Fugate in the wake of the Joplin, Missouri, tornado in May this year.

If the index is green, Waffle House is open with a full menu. If Waffle House is only serving a limited menu, the index is yellow; and if Waffle House is closed, the index is red.

A red index is rare. Waffle House management will do anything not to close.

"They know immediately which stores are going to be affected and they call their employees to know who can show up and who cannot," Kouvelis says.

They have temporary warehouses where they can store food and most importantly, they know they can operate without a full menu. This is a great example of a company that has learned from the past and developed an excellent emergency plan.

The company even has a mobile command center that looks to be a rolling Waffle House restaurant. The RV is known as EM-50, named after Bill Murray’s urban-assault vehicle in the 1981 movie Stripes. When bad weather looms, EM-50 is mobilized. Sales volumes can double after a storm, when cooking a hot meal at home is often impossible. So company managers have every incentive to be staffed up, supplied up, and open for business. At the corporate level, items such as eggs and ice will be shipped to warehouse staging locations outside of harm’s way, ready when stores need them most.

Bauerlein explains that the Waffle House

hurricane playbook explains how to reopen a restaurant and what to serve if there is gas but no electricity, or a generator but no ice. An important element is limiting the menu so the company’s supply chain can focus on keeping certain items stocked and chilled or frozen.

Because of this planning, district manager Chris Barnes had the only restaurant along I-95 in North Carolina that was open after the storm.

What professor Kouvelis leaves out is the Hayekian insight that Waffle House gains its knowledge through market mechanisms for discovery, communication, and use of knowledge in the allocation of productive resources. Waffle House can only serve customers and make money if they are open. The company does little advertising and doesn’t hold press conferences. The secret to its success is serving good food and always being available. This may involve being open but only serving a few items. By narrowing their focus, the company can more effectively ensure that it can push a limited number of ingredients through a disrupted supply chain. The company would only breed dissatisfied customers if it remained open only to run out of eggs or hash browns.

According to Pat Warner, a member of the Waffle House crisis-management team, in the short-run, the profit motive is secondary to building customer good will.

If you factor in all the resources we deploy, the equipment we lease, the extra supplies trucked in, the extra manpower we bring in, a place for them to stay, you can see we aren’t doing it for the sales those restaurants generate.

Customers appreciate it and depend upon it.

"I hadn’t had a hot meal in two days, and I knew they’d be open," Nicole Gainey told the WSJ.

Meanwhile, Mayor Bloomberg has no market mechanism to punish him or his city government if he overreacts. While private citizens were inconvenienced and local businesses lost revenue, the mayor frequently mugged for cameras during the storm, issuing warnings in English and Spanish. City hall didn’t lose a thing and now pats itself on the back for being prepared.

Two kayakers who were rescued after their boats capsized off Staten Island during the storm were issued summonses by the city. The mayor told reporters that being in the water was "reckless" and their needed rescue had "diverted badly-needed N.Y.P.D. resources." City government was only interested in herding people and stopping commerce prior to and during the storm, not "protecting and serving."

And while Irene did much less damage than expected to Manhattan on Sunday, subway service did not resume until 5:40 a.m. the following Monday. Evidently, that’s close enough for government work.

"Today government worked," Governor Andrew M. Cuomo is quoted in a press release from the governor’s office.

Days of preparation and coordination prevented much injury and loss. The MTA will begin resumption of subway service Monday morning. I applaud the good work of the thousands of MTA professionals, National Guard and first responders for their advanced planning.

Ludwig von Mises held the view, as summarized by Murray Rothbard, that even if Mayor Bloomberg had the knowledge that Waffle House has gained over the years, "they still would not be able to calculate, for lack of a price system of the means of production. The problem is not knowledge, then, but calculability."

Either way, with no market to compete in, New York City government doesn’t worry about developing good will. Waffle House, on the other hand, "has built a marketing strategy around the goodwill gained from being open when customers are most desperate," writes Bauerlein.

Government monopolies have the incentive to provide the least amount of service for the highest cost. So, the government brass suspends services and tells their constituents to go away and come back when it’s more convenient. Meanwhile, Waffle House fires up the generators, eager to serve their faithful customers in the worst of conditions.

Reprinted from Mises.org.

Doug French [send him mail] is president of the Ludwig von Mises Institute and the author of Early Speculative Bubbles & Increases in the Money Supply. He received the Murray N. Rothbard Award from the Center for Libertarian Studies. See his tribute to Murray Rothbard.

The Best of Doug French

by Doug French

Recently by Doug French: The Higher-Education Bubble HasPopped

Imagine the good fortune of having a Waffle House within walking distance of home and the office. Yes, Waffle House number 1882 is one of the newest in the chain of over 1,600 stores. Strategically located within stumbling distance of Auburn’s downtown college bars, it’s attracted some of the most decorated wait staff in the chain.

On a sultry mid-morning trip to the restaurant, I noticed that my server’s name tag was cluttered with gold pens and a red star. When asked what it takes to get a red star, Andrea said, "Oh, it just means I can train people." The gold pins? "I’ve been here a long time," she said, before turning to the shift manager, asking if they could please turn up the air. "Even the customers are complaining," she said in a low but authoritative tone.

The food chain is ubiquitous in the South. Its buildings are tiny, while its signs are tall and impossible to miss in bright yellow with black letters. The menu is as uncomplicated as the building. Likely the hash-browns capital of the world, there is nothing pretentious about the Waffle House. The restaurant welcomes a diverse clientele of, not only happy families and young lovers, but also the lonely, the deranged, and especially the intoxicated.

The 9 p.m.–7 a.m. third shift does three quarters the business of the traditional first shift, which includes both the normal breakfast and lunch hours. In Waffle Street: The Confession & Rehabilitation of a Financier, James Adams writes,

At 2:30 A.M., the restaurant doors explode. Within fifteen minutes, sixty barflies and club hoppers occupy a diner with seating capacity for only forty-two persons. I and two other harried servers struggle to placate them as they drunkenly clamor for service. Plunging into the maelstrom, I ask myself which part of my job description contains the phrases "crowd control" and "hangover mitigation."

Adams was no veteran when given the third-shift opportunity. He had only been on the job at Waffle House for a few weeks. His Chartered Financial Analyst designation and MBA provided scant seasoning for the assignment. The five years as an investment analyst for a couple of life-insurance companies were no help. Neither was his most recent job of providing "verbal and written commentary on the performance of forty bond portfolios whose strategies covered nearly everything under the sun" for a company he refers to as "Alpha Managers."

One look at the book’s cover featuring a plated waffle atop the financial pages makes a reader want to dive in. And the author doesn’t disappoint. The author’s Waffle House work experience is fun and interesting, but that’s not all the book has to offer. Adams frequently digresses and teaches some sound economic principles.

Adams is a devotee of Jean Baptise Say. His reference list includes not only Say’s Treatise on Political Economy but Murray Rothbard’s Classical Economics: An Austrian Perspective on the History of Economic Thought, Ron Paul’s End the Fed, Tom Woods’s Meltdown, as well as titles by Henry Hazlitt and one of this year’s featured ASC speakers, Steven Kates.

The author provides a good explanation of fractionalized banking and also examines the chain of debts within the shadow-banking system. The cause of the 2008 financial crack-up becomes very clear as Adams lays out layer upon layer of debt chasing inflated asset values, piled upon a miniscule amount of capital.

A short history of the Waffle House chain, started by Joe Rogers Sr. and Tom Forkner in Avondale Estates, Georgia, is provided. The company began franchising its restaurants in 1960, and Waffle House remains privately held, never succumbing to Wall Street’s siren song of a public offering.

Annual sales figures are not public, but the company claims to serve two percent of all eggs used in the industry, and is the world’s leading seller of T-bone steaks at over 10,000 per day. Waffle House servers earn around $15 per hour, with all but $2.13 paid by customer’s tips.

Adams’s story is as much about his mentor, master grill operator Edward Jarvis, as it is about him. Edward, like many of Adams’s coworkers, is an ex-con, but "was leagues brighter than anyone else in the store," Adams explains, and, as a "relief manager," Edward was trusted to change out the cash drawers at the end of each shift.

Waffle House is not only the eatery of last resort after hours, but, for many coming out of prison, the restaurant chain is one employer that provides a second chance in life.

Edward’s common sense and management style are quickly displayed.

"If you’re so good at abstract thinkin’," Edward said, "Did you see the big crash coming?"

"I expected a slowdown, but not necessarily a crash."

"Is that a yes or a no?"

"No, I guess not, Edward."

He directed me to follow him to a booth that had recently been vacated.

"Can you see all these syrup stains?" he asked, pointing to the table.

"Yes."

"Outstanding. Even though you can’t find anything else in the store, you’re still more valuable in here than you were at your last job. Now grab a wet towel and get to it."

Anyone dining at Waffle House notices there are no computers to communicate orders to the cooks or calculate customer checks. Servers call their orders verbally in a specific manner from a specific spot on the floor. Servers first tell the grill operators to "PULL" the proper number of meat items to fill their order. Next, grill operators are told to "DROP" the hash brown orders, and lastly "MARK" indicates the particulars of each dish.

The cook marks the plates using a proprietary system wherein condiment packets represent meat and eggs. Mayonnaise indicates bacon or sausage, depending on its position; ketchup signifies a cheesesteak; a butter cup indicates a T-bone, and so forth. The arrangement of packets indicates the temperature of the meat and how the eggs are cooked. Any egg or meat plate not marked for hashbrowns is assumed to be receiving grits. Waffles are always called last.

Sitting at one of the four low bar seats on my recent visit, I was able to watch all of this drama unfold between the bar and the grill. Servers and grill operators move in a sort of coordinated, chaotic dance that produces customer orders in rapid succession. No one working at Waffle House ever just stands around. There are always dishes to wash, side work to do, and cleanup.

The highly decorated Andrea had her cheap $5 calculator positioned, precariously to my thinking, next to a tray of syrup bottles. She is enough of a veteran to know that, just as sand gets into everything at the beach, syrup seems to finds its way to unwanted places behind the counter at Waffle House.

When Adams is frustrated that someone’s calculator keyboard had been compromised by wayward syrup, he proudly brings in his Hewlett Packard 12c financial calculator, figuring no one would take it if he left it by the cash register. Doing average arithmetic on a 12c requires less-than-intuitive key punching. Besides, none of his coworkers had worked in the finance industry. He never saw his cherished 12c again after he forgot to take it home at the end of his shift.

A colorful cast of characters provides regular entertainment and occasional annoyance for Adams. There are the Repo Man, the Spy, the Linebacker, and the eccentric Kathy, who only missed her trips to sip coffee at Waffle House on days she was undergoing electric-shock treatment.

Adams waits on plenty of college kids, drunk and sober. He would sober three enrolled in the MBA program at a nearby university when he let them know he used to work for the dean of their school at "Alpha Managers" (per his severance agreement, Adam’s can’t name the firm). The three future masters of the universe can’t believe a guy could go from working at a big-time investment firm to waiting tables at Waffle House.

"A stellar resume or an MBA degree from a leading institution does not ensure finding a job in a tumultuous economy," Adams tells the hot shots, using an ominous tone. "Take a long, hard look at it," he says, leaning into one of the students, framing his name tag between his thumb and forefinger. "In a few more months, it could have your name on it."

More than once Adams loses his cool with obnoxious customers. An intoxicated coed came close to "going algreen on" him. The derivation of this term comes from an incident when Al Green‘s girlfriend hurled a pot of hot grits on the soul singer’s bare back. The resulting third-degree burns caused Green to give up R&B for the ministry. Waffle House customers are not in the habit of throwing their grits, but instead consume over three million pounds each year.

Edward was always the calming voice of reason during these dust-ups. The grill master’s prison experience taught him not to taunt people, and besides it wouldn’t be acceptable to management if both he and Jimmy were shot, requiring them to close the store for three or four hours. "They really hate to close the sto’ on account of anything," Edward tells Adams after an altercation.

But Adams does scrap with John Maynard Keynes in the pages of Waffle Street, lamenting, "How far we’ve fallen" in the area of economics education. Pointing out that Say’s Treatise was once the top economics textbook in America, he explains that now, "Instead of learning sound doctrine, today’s undergraduates are inundated with principles that will not bear the scrutiny of common sense and experience."

Although the author is generally for free markets, he is sympathetic to the bailouts and spends entirely too much time beating himself up for working in the bond industry that fell apart, losing money for investors. A reading of Rothbard’s A History of Money and Banking in the United States: The Colonial Era to World War II would benefit the author, who frets about a shrinking money supply and misinterprets the Jacksonian and Great Depression eras.

But he is spectacularly right that "World War II has the distinction of generating the greatest man made decline in living standards in human history," and notes the irony that Andrew Jackson, "the man who despised fractional reserving and central banks now had his mug on a paper note issued by a central bank."

Adams learns plenty on the job. In a rare reflective moment, Edward tells his protégé why he went to prison; after telling Jimmy about a robbery and the resulting accidental death, Edward says, "The main thing I learned in prison was that if you want anything in this world, you got to work for it in the first place. Greed will never take you anywhere good."

The owners of Waffle House make their money the way their employees do. Hard work. No financial alchemy from the Wall Street wizards. Just plain old serving the customer what they will trade their dollars for, watching costs, and growing with retained earnings.

Wall Street layoff announcements are prevalent this summer. Those laid off should know: Waffle House is always hiring.

Reprinted from Mises.org.

Doug French [send him mail] is president of the Ludwig von Mises Institute and the author of Early Speculative Bubbles & Increases in the Money Supply. He received the Murray N. Rothbard Award from the Center for Libertarian Studies. See his tribute to Murray Rothbard.

The Best of Doug French

by Doug French

Recently by Doug French: Paper Money Wears Prada

A college degree once looked to be the path to prosperity. In an article for TechCrunch, Sarah Lacy writes, “Like the housing bubble, the education bubble is about security and insurance against the future. Both whisper a seductive promise into the ears of worried Americans: Do this and you will be safe.”

But the jobs that made higher education pay off during the inflationary boom, kicked into high gear by Nixon waving goodbye to the last shreds of a gold standard, came primarily from government and finance.

In 1990, 6.4 million people worked for federal, state, and local governments. By 2010, that number had grown almost 6 times – to 38.3 million – with many of these jobs being white-collar.

In 1990, the financial sector was less than 7.5 percent of the S&P 500. By 2006, this sector had grown to 22.3 percent of the S&P, and that year the financial sector constituted 45 percent of the index’s earnings.

"Prices and wage rates boom," writes Mises.

Everybody feels happy and is convinced that now finally mankind has overcome forever the gloomy state of scarcity and reached everlasting prosperity.

In fact, all this amazing wealth is fragile, a castle built on sands of illusion. It cannot last. There is no means to substitute banknotes and deposits for nonexistent capital goods.

Times have changed.

Last week, HSBC Holding Plc announced plans to eliminate 30,000 jobs worldwide by the end of 2013. The job cuts will affect "support staff where we believe we have created an unnecessary bureaucracy in this firm over a number of years," HSBC chief executive officer Stuart Gulliver said.

Goldman Sachs plans to cut 1,000 positions. Bank of America is laying off 1,500 employees and closing 600 retail branches.

At the same time that banks are trimming their fat, according to a Labor Department report released earlier this month, from May 2010 to May 2011 local governments shed 267,000 jobs and state governments 24,000. Local government employment in May, at 14.165 million jobs, was the lowest since July 2006.

An increase in the amount of real savings, which induces a fall in the interest rate and a lengthening of the production schedule, increases an economy’s productive capacity, creating genuine growth brought about by the investment in higher-order goods such as factories and other production assets.

Conversely, easy, cheap credit fools entrepreneurs into believing that society’s collective time preference has fallen, enticing them into investing in higher-order goods, such as land, factories, and the like – when in fact the collective time preference hasn’t changed, and the demand for higher-order goods is merely a mirage. The result is booms and busts rather than genuine growth.

College degrees are similar to what the Austrians call higher-order goods. It’s thought that a student will gain knowledge and seasoning in college that will make him or her more productive and a candidate for a high-paying career. The investment of time and money in knowledge pays through higher productivity and is translated into higher income. Higher education is the higher-order means to a successful career.

PayPal founder and early Facebook investor Peter Thiel, questioning the value of higher education, tells TechCrunch,

A true bubble is when something is overvalued and intensely believed. Education may be the only thing people still believe in in the United States. To question education is really dangerous. It is the absolute taboo. It’s like telling the world there’s no Santa Claus.

The excesses of both college and homeownership were always excused by a core national belief that, no matter what happens in the world, these were the best investments you could make. Housing prices would always go up, and you will always make more money if you are college educated.

The New York Times’ David Leonhardt even claims,

Construction workers, police officers, plumbers, retail salespeople and secretaries, among others, make significantly more with a degree than without one. Why? Education helps people do higher-skilled work, get jobs with better-paying companies or open their own businesses.

Using data from the Center on Education and the Workforce at Georgetown University, Leonhardt asserts that dishwashers with college degrees make $34,000 a year while those without make $19,000.

No employer in their right mind would pay nearly double for a dishwasher with a college degree. However, there are plenty of fresh college graduates cobbling together multiple low-level jobs just to make ends meet.

"More college graduates are working in second jobs that don’t require college degrees," writes Hannah Seligson in the New York Times, "part of a phenomenon called ‘mal-employment.’ In short, many baby-sitters, sales clerks, telemarketers and bartenders are overqualified for their jobs."

Nearly 2 million college graduates were mal-employed last year, up 17 percent from 2007. Nearly half of all college graduates are working at a job not requiring a degree.

In the United States, 80,000 bartenders as well as 317,000 waiters and waitresses have college degrees. Nearly a quarter of all retail salespersons have a college degree. In all, 17 million Americans with college degrees are working at jobs that do not require a bachelor’s degree.

"Young college graduates working multiple jobs is a natural consequence of a bad labor market and having, on average, $20,000 worth of student loans to pay off," said Carl E. Van Horn, director of the John J. Heldrich Center for Workforce Development at Rutgers.

"The median starting salary for those who graduated from four-year degree programs in 2009 and 2010 was $27,000, down from $30,000 for those who graduated in 2006 to 2008, before the recession," Seligson writes, adding, "Try living on $27,000 a year – before taxes – in a city like New York, Washington or Chicago."

Like all booms, higher education has been fueled by credit. In June of last year, total student-loan debt exceeded total credit-card debt outstanding for the first time, totaling more than $900 billion.

All of this credit has pushed the average cost of tuition up 440 percent in the last 25 years, more than four times the rate of inflation. But while the factors of production on campus have been bid up, just as they are in any other asset boom, the return on investment is a bust. In 1992, there were 5.1 million mal-employed college graduates. By 2008, the number was 17 million.

Not only are the returns poor, but the quality of the product is poor (as in the case of new-construction quality in the housing boom). According to the authors of Academically Adrift: Limited Learning on College Campuses, 45 percent of students make no gains in their critical reasoning and thinking skills, as well as writing ability, after two years in college. More than one out of three college seniors were no better at writing and thinking than they were when they first arrived at their campuses.

Many projects contemplated and started during the real-estate boom are never completed, as prices are bid up, and owners run out of capital. Such is the case for many attending college, as over 45 percent of those who enroll as freshmen ultimately give up, realizing they lack the disciplinary and mental capital, and do not graduate.

Similar to the government push for increased homeownership, government is foursquare behind having more young people attend universities. One of President Obama’s top goals is to increase the number of Americans attending college.

But why? "Among the members of the class of 2010, just 56 percent had held at least one job by this spring, when the survey was conducted," reported the Times recently. "That compares with 90 percent of graduates from the classes of 2006 and 2007."

And because they can’t find jobs, 85 percent of college grads move back in with their parents after they graduate. According to a poll by Twentysomething Inc., a marketing and research firm based in Philadelphia, that rate has steadily risen from 67 percent in 2006.

Perversely, while the market tries to clear away malinvestments in finance and real estate, plus the jobs that supported them, colleges continue to turn out more business majors than any other discipline. In 2007 and 2008 there were more than 335,000 business degrees granted – 100,000 more than a decade before, according to the National Center for Education Statistics.

At the same time as law schools have a building boom underway, many new law grads can’t find work or are working temporary jobs at $15 an hour.

David Segal reports for The New York Times,

As other industries close offices and downsize plants, the manufacturing base behind the doctor of jurisprudence keeps growing. Fordham Law School in New York recently broke ground on a $250 million, 22-story building. The University of Baltimore School of Law and the University of Michigan Law School are both working on buildings that cost more than $100 million. Marquette University Law School in Wisconsin has just finished its own $85 million project. A bunch of other schools have built multimillion dollar additions.

And while law grads can’t find work, law schools are enrolling more students than ever before at tuition rates of $40,000+ a year. Segal explains that law-school tuition has increased at 4 times the rate of undergraduate education, which itself has increased 4 times the CPI. "From 1989 to 2009, when college tuition rose by 71 percent, law school tuition shot up 317 percent."

Students and their parents are investing in the higher-order good of a college degree, in the mistaken belief that plenty of jobs await college graduates at the end of four or six or seven years. However, time preferences haven’t changed. The demand for consumer goods remains, and that’s where the jobs are. The boom in demand for bankers, barristers, and bureaucrats is over.

Reprinted from Mises.org.

Doug French [send him mail] is president of the Ludwig von Mises Institute and the author of Early Speculative Bubbles & Increases in the Money Supply. He received the Murray N. Rothbard Award from the Center for Libertarian Studies. See his tribute to Murray Rothbard.

The Best of Doug French

by Doug French

Recently by Doug French: The Fed Obliterates the Savings Ethic

Anyone who doubts the world’s central banks’ ability to send excess liquidity sloshing around the globe only has to look at the recent boom in the area of art and luxury goods.

It’s always the case that cheap money flows to malinvestment.

While the monetary authorities look to create jobs on Main Street, the money inevitably flows to the latest speculative fashion, whatever it happens to be. No two Austrian business cycles are exactly the same. Like lightning, bubbles rarely strike the same sector twice.

Prada SpA, the maker of high-end accessories every girl wants to wear or carry, floated an initial public offering in Hong Kong priced at about 23 times estimated full-year earnings according to Bloomberg.

Although selling at the lower end of what some analysts believed the company would go for, the Milan-based maker of Miu Miu handbags still raised $2.1 billion for a mere 16.5 percent of the company to grow its brand. Sex and the City may be relegated to running sanitized episodes in syndication, but company president and head designer Miuccia Prada figures there’s a boom somewhere and there are plenty of women needing expensive bags. "It’s where the future is," she told the Wall Street Journal.

At the start of the year, Prada had 319 stores open for business, with another 80 on the way this year. The company prospectus points to China as the promised land for growth. "We are positive that the Greater China region is going to be one of the most interesting markets for the future of the luxury industry," Patrizio Bertelli, Prada’s chief executive, said Friday at a ceremony to celebrate the company’s stock-market debut.

Prada isn’t an isolated case. Roman jeweler Bulgari was picked up for a 60 percent premium by LVMH Moët Hennessy Louis Vuitton SA in March, reports Grant’s Interest Rate Observer. Two months later TowerBrook Capital tripled its money, selling Jimmy Choo to Labelux.

LVMH Moët Hennessy Louis Vuitton, the biggest luxury group in the world, is also following the money to China. The New York Times reports that last year, the company generated about 6.9 billion euros ($9.7 billion) in revenue in Asia, from its more than 800 stores. That compares with 4.6 billion euros in revenue, and 570 stores, in the United States.

The well-to-do are not just buying fashion. "The speed of the art market’s recovery is astonishing, but it’s a differently revived market," Michael Plummer, a principal of Artvest told the WSJ. "The lesson of the crash was to do your homework. Collectors feel wiser for the experience."

Vikram Mansharamani, in his book Boombustology, provides an interesting sidebar with a chart of auctioneer Sotheby’s common stock going back to mid-1988, just before the final run-up of the Japanese stock market. The Yale lecturer and global equity investor tracks the ups and downs of Sotheby’s common stock as a proxy for booms and busts in the art market.

The stock price for the auction house peaked as the Nikkei was peaking at the end of 1989. It ran to higher highs as the Internet bubble was cresting. Sotheby’s ran to an all-time high of $61.40 with US house prices in 2007. The shares have run up again since the ’08 crash busted the stock down to $6.05 with the China boom and the Federal Reserve’s QEs 1 and 2. Earning $2.34 a share in 2010, the stock traded smartly in the $50 range in April, but it has since slumped to $40. "Even the most optimistic among us would not have predicted such results just one year ago," Sotheby’s chairman Michael Sovern told Grant’s.

Back in April, Kelly Crow reported in a piece for the Wall Street Journal, "The Art Market Snaps Back," that the market would be tested as $1 billion of Impressionist, modern, and contemporary works go to auction next week.

Crow wrote that some buyers are shy this time, having been burned just a couple of years ago.

But plenty more, flush and giddy, are just now joining in and paying little attention to prices. As a result, the art market’s current state, while off from peak levels, still feels slightly breathless. Record prices are being paid for individual favorites like Pablo Picasso, whose "Nude, Green Leaves and Bust" sold at Christie’s last May for $106.5 million, the most ever paid at auction for a work of art.

Art sales peaked in 2007, when Sotheby’s and its main competitor, Christie’s, sold a combined $11.3 billion worth. Two years later, in the wake of the financial crash, total sales plunged to $4.8 billion. "Yet, with a speed surprising both collectors and dealers, the market regained much of its momentum last year, with the two houses combining for sales of $9.8 billion," Crow reports.

Reporting on the spring auction season, the New York Times’ Carol Vogel wrote, "Chinese and Russian could be heard in the Sotheby’s salesroom. … But in spite of the presence of Prada-clad international collectors, it was a tepid start."

But at the end of the day, "while ‘bidding was not euphoric,’" Simon Shaw, head of Sotheby’s Impressionist and modern sale in New York, told the NYT "in most cases there was solid activity."

A week latter, Vogel reported, "A mix of overly optimistic sellers and price-conscious buyers made for a bumpy evening at Sotheby’s sale of contemporary art on Tuesday night."

That evening Warhol’s "Sixteen Jackies" went for only $20.2 million with Sotheby’s fees, below the $30 million that was hoped for.

But while zero interest rates have only pushed the art market to ho-hum levels in the Big Apple, in Hong Kong, buyers can’t get enough. So far in 2011, Sotheby’s has moved $548.3 million worth during their Hong Kong auctions, more than double the $271.3 sold in the first half of last year.

And Chinese money prefers Chinese paintings and ceramics to Warhols. "They’ve now become among the top categories in the world," Sotheby’s Bruno Vinciguerra tells Grant’s, "and they’re growing so fast that it’s likely they will become the single-biggest category in the world." After sales in these categories doubled last year, they’re doubling again this year, says Vinciguerra.

Moneyed Chinese have been working hard to trade their renminbi for anything from Vancouver condos to beachfront villas in Vietnam for good reason. The money supply has been growing at a rate north of 15 percent. In May the price of pork – the meat preferred by most Chinese – increased by over 40 percent from last year. And while the Chinese government says prices are up 5.5 percent, the price of all food was up 11.7 percent in May from 2010.

While the view exists that the Chinese economic mousetrap is a better one, Carl Walter and Fraser Howie don’t see it that way. "We do not believe in Chinese exceptionalism," write Walter and Howie in Red Capitalism: The Fragile Financial Foundation of China’s Extraordinary Rise. "If there are such things as economic laws, they work just as well in China and for Chinese businesses as they do in other markets."

The authors cast a skeptical eye toward China’s government-controlled and propped-up banking system. Chinese bankers worry more about pushing the money out the door than the prospects of getting it back. As Jim Grant writes, "In China, the big banks don’t formally go broke. Rather, every 10 years or so, the state recapitalizes them." Bad loans are shifted from bad bank balance sheets to worse bank balance sheets, Grant explains. The Ministry of Finance provides its guarantee to the bad loans at par, banking life goes on, and the economic miracle remains alive, backstopped by the lender of last resort, the People’s Bank of China, levered at 1,233 to 1.

Economic miracles based on cheap and plentiful money are as old as John Law’s system and the Mississippi Bubble. Easy money shortens people’s memories and dulls their (good) sense. This one will end like all the rest, with the buyers of expensive art and luxury stocks wondering once again, "what were we thinking?"

Reprinted from Mises.org.

Doug French [send him mail] is president of the Ludwig von Mises Institute and the author of Early Speculative Bubbles & Increases in the Money Supply. He received the Murray N. Rothbard Award from the Center for Libertarian Studies. See his tribute to Murray Rothbard.

The Best of Doug French

by Doug French by Doug French Recently by Doug French: Higher Education

Depression babies learned early that "saving for a rainy day" was not something one hopes to do but a requirement. The saying originated when most people worked on the farm. And when it rained, the fields were too wet to plow, and the farmer – not to mention the hired hands – made no money.

Of course, my grandfather was the diligent sort who would use rainy days to do required maintenance on his implements, noting with derision other farmers who spent rainy days at the bar in town. He believed they would surely end up with broken equipment when the sun would reappear, keeping them from making hay.

So the idea of savings is not necessarily the return one receives on the money that’s socked away, but the piece of mind that, when the weather doesn’t cooperate, the saver has a little stash to tide him over. Of course, the vast majority of us don’t have to worry about the weather.

But an economic storm hit a couple years ago and plenty of people have not had work, rain or shine. Those who took heed of that old saw have no doubt weathered the storm better than those who didn’t. Most financial advisors recommend that a person have three month’s worth of living expenses saved – and some say six months worth, just in case. But how many people heed that advice?

There is no caveat to the counsel that says, "Keep six months of savings around if the money is earning at least six percent." Even if the money sits there all shiny, not earning a thing, it’s the liquidity and insurance against the unknown that’s the issue.

Unfortunately, a central bank’s debauchery of the currency serves to raise people’s time preferences and impair their judgment. In a blog post recently, I highlighted the advice of life coach and author John P. Strelecky, who advises people to spend their tax refunds on an experience they will remember forever, rather than saving the few hundred or thousand dollars that the IRS may be giving back.

Live your life for today, says the life coach – a couple thousand bucks isn’t going to matter anyway. I posted to the Mises Blog to point out how ludicrous this advice is. But most who commented sided with Strelecky:

I think his advice is spot-on, at least given the constraints of the times in which we live. What’s the point in saving if inflation will ravage whatever you manage to accumulate?

You play by the rules of the game. Your savings growth will be puny due to pathetic interest rates, erased by inflation, and confiscated by a rapacious state. So go ahead, enjoy the "money" now, while it still has some value.

Most people don’t really have a better place to put the money than into a pleasurable experience, which is all you will want in the end.

Gotta agree with the comments. Maybe not trips or other "experiences." But I feel safer with stuff than I do with Federal Reserve notes going forward.

That’s just what central bankers like to hear. They are worried about deflation. A few months ago, the Chicago Fed’s Charles Evans said,

It seems to me if we could somehow get lower real interest rates so that the amount of excess savings that is taking place relative to investment is lowered, that would be one channel for stimulating the economy.

Lord Keynes was constantly worried that people were saving too much and consuming too little – thus the need for more and cheaper money to stimulate the economy. Mr. Bernanke is nothing if not a good Keynesian, and his low rates make even the savviest question whether to forgo consumption.

And likely no retiree, when contemplating leaving the workforce, figured 1 percent interest rates (or less) into their retirement cash-flow planning. In a front-page article, the Wall Street Journal took a look at "retirees who find themselves on the wrong end of the Federal Reserve’s epic attempt to rescue the economy with cheap money."

The WSJ rightly points out that the Fed’s low rates have been a windfall for banks and borrowers, but a problem for those needing income from their savings to live on. People who thought they played the game right, worked hard, saved money, and now want to take it easy, are panicked that money-market funds are throwing off but 24 basis points. "That’s one-tenth the level of late 2007 and the lowest on records dating back to 1959," the Journal reports.

As bad as the Fed-engineered low rates are for those trying to live off past savings, reporter Mark Whitehouse makes the point that the low rates keep young people from building up funds for the future – whether it’s for emergencies or retirement. Working Americans put less money into financial assets last year than at anytime on record – except 2009, when people pulled money out. And while the Department of Commerce says the personal savings rate has risen to 5.8 percent, Whitehouse explains, "That’s in large part because it counts reductions in personal debt, such as mortgages and credit-card balances, as savings." But most debt reduction, Whitehouse writes, has been driven by defaults, rather than saving.

The Fed’s interest-rate policy also leads people into taking more risk with their savings than they should. "That’s why most of us are in the stock market, because there’s no place else to go," says 70-year-old John Lehman, who would rather have his money in bank certificates of deposit but must resort to speculating. "I hope my assets don’t run out before I die."

Many retire with next to nothing as it is. According to AARP, 16 percent of Americans have not saved a dime for retirement, and nearly half have saved less than $50,000.

Those with no savings are more dependent on government and others when the unexpected occurs, whether it’s job loss or the washing machine quits. Professor Paul Cantor reminds us in his article, "Hyperinflation and Hyperreality: Mann’s ‘Disorder and Early Sorrow,’" that "money is a central source of stability, continuity, and coherence in any community. Hence to tamper with the basic money supply is to tamper with a community’s sense of value."

When the Fed makes saving seem futile and immediate pleasure seem rational, the world has been diabolically turned upside down. Just one step away from hyperinflation, the central banks’ actions are threatening "to undermine and dissolve all sense of value in a society."

"Thus inflation serves to heighten the already frantic pace of modern life, further disorienting people and undermining whatever sense of stability they may still have," Cantor explains.

The social order is upended in Mann’s story as wealth is transferred from those who diligently saved all of their lives to speculators. As it was in the Weimar Germany that Mann describes, so it is today, as people believe it futile to sock away a little money here and there, and instead feel compelled to either speculate or just blow what they have on good times.

And while the retirees mentioned in the WSJ article are being crippled financially, Cantor points out that Mann’s portrayal of hyperinflation uncovers "something psychologically more debilitating happening to the older generation." Impetuous, high-time-preference behavior displayed by the young appears rational in an inflationary period, while prudence and conservatism appear to be not even quaint but downright silly.

As Mann described so long ago, the world of inflation is the illusion of wealth, created by the government’s printing press, distorting everything we see and perverting our judgment. Meanwhile the cry for stimulus continues, while our culture and values are buried under a pile of paper.

Reprinted from Mises.org.

Doug French [send him mail] is president of the Ludwig von Mises Institute and the author of Early Speculative Bubbles & Increases in the Money Supply. He received the Murray N. Rothbard Award from the Center for Libertarian Studies. See his tribute to Murray Rothbard.

The Best of Doug French

by Doug French by Doug French Recently by Doug French: Gold Prices and Panic

The idea that a brick and mortar university education is the key to success and riches still has a hold on parents. Author Jennifer Moses’s piece in The Wall Street Journal last weekend made clear that her and her Rutgers professor husband will do anything and spend whatever to get their Moses twins into the one of the nation’s best colleges of their choice.

Evidently tuition cost isn’t a concern. However, Mr. and Ms. Moses must make sure the twins qualify for the Ivy league if that’s where they want to go. Don’t want them ending “up having to go, God forbid, to Rutgers,” she writes. So the twins have had plenty of SAT and ACT tutoring, according to Ms. Moses at $125 per session. Of course on top of this are the fees paid for the actual testing and travel to all these places of higher learning. Plus, an additional consultant is on the job to counsel the male twin to not do anything stupid that could jeopardize his chance of admission. Moses considers the consultant a bargain at $701.25 so far.

The thrust of Moses’s view is there are only so many spots available in prestigious universities and that dumb kids with rich parents have a leg up to getting those few spots, so parents must do everything possible to make sure their worthy children are accepted. “We are all caught up in a crazy arms race, where the order of the day (to borrow a useful term from the Cold War) is ‘escalation dominance,’” she writes.

All this while Richard Vedder’s work finds that 60 percent of the increase in college grads end up working in jobs where a degree isn’t required.

Vedder points to credential inflation that arises from a perceived need by individuals to demonstrate potential employment competence through a high-priced college diploma. He writes, “Employers are using education as a screening and signaling device, at a low cost directly to them (although not costless because of the taxes they pay to sustain much of this), but at a high cost to the prospective employees and to society as a whole.”

Support from the taxpayer may not last much longer as state governments teeter on the brink of bankruptcy. When push comes to shove middle-class tax payers will not be eager to keep subsidizing rich kids or their professors with light teaching loads. But for now, as Vedder points out, those in higher education that know college is a bad deal are keeping quiet out of their own self-interest.

Before throwing their hard-earned dough at their kids’ higher education, parents might want to read Walter Kirn’s Lost in the Meritocracy: The Undereducation of an Overachiever. Kirn is best known for his novel Up In The Air which was adapted into a movie that generated six Oscar nominations last year.

Much of Kirn’s very funny book chronicles his student life at Princeton where he roomed with eccentric children of the upper crust. The reader’s first glimpse at Kirn’s life at Princeton has him waiting for the effects of two black capsules to kick in so he can complete his Rhodes Scholarship application. Meanwhile his friend is seeing what happens when you smoke ground up Percocet tablets through a water pipe.

“I have other comrades in estrangement,” writes Kirn, “way out here on the bell curve’s leading edge, where our talent for multiple-choice tests has landed us without even the vaguest survival instructions.”

While Kirn went home to Minnesota for the summer, his classmates would spend the summer on the Cape, the Island, or the Vineyard. He classifies the Princeton student body into groups. For instance those that came back baked from spending the summer on sail boats, drinking gin and tonics, and wearing funny hats. These privileged students “napped during lectures, but rarely to their detriment because they could always charm some awestruck stranger–a plump girl with a limp, a science major with untied shoelaces–into giving them copies of their notes.”

There were those students who wanted to serve mankind and those who only stopped to eat and drink to sustain themselves for studying. And then there were those who pursued higher education by injecting cocaine.

Kirn worked the system and made it to Oxford. “Flexibility, irony, self-consciousness, contrarianism. They’d gotten me through Princeton,” explains Kirn. As for his education, it began when he was laid up in bed with pneumonia. Bored, he read the classics, books he’d never bothered with before. “And so, belatedly, haltingly, accidentally, and quite implausibly and incredibly, it began at last: my education.”

Reprinted from Mises.org.

Doug French [send him mail] is president of the Ludwig von Mises Institute and the author of Early Speculative Bubbles & Increases in the Money Supply. He received the Murray N. Rothbard Award from the Center for Libertarian Studies. See his tribute to Murray Rothbard.

The Best of Doug French

by Doug French by Doug French Recently by Doug French: Walk Away: The Rise and Fall of the Home-Ownership Myth

With gold selling for around $1,400 per ounce, it seems like everyone has jumped on the yellow-metal bandwagon. Resource-investment guru Rick Rule said about gold investing recently, "we’re no longer lonely in the gold trade. You couldn’t describe this as a contrarian activity, and you couldn’t describe this as a low-risk activity."

But while Rule and the likes of David Einhorn aren’t alone keeping some, or a lot of, money in gold, the Wall Street Journal ran a profile of a more typical investment guide who claims, "There’s no utility of gold." Investment advisor Tim Medley says people only trade their dollars for gold when they’re afraid, and they won’t be afraid much longer.

Medley is old enough to remember overflow crowds at financial conferences in the early 1980s listening to presentations about gold, only to have the metal’s price plunge and go nowhere for two decades. He’s figuring the same will happen again. "Given a choice between first-rate common stocks and gold over the next five to ten years, I feel strongly that stocks will do much better," says Medley.

Unless his clients specifically tell him to buy some gold or gold stocks for their accounts, Medley won’t touch the stuff. "There’s no organic growth" in gold, he says.

For sure, gold coins and bars silently gather dust. Gold has no staff, makes no product, earns no profit, and incurs no loss. The yellow metal owes no one, but at the same time it collects no interest either.

However, to say gold has no utility? Time and history would say otherwise. Murray Rothbard listed seven necessary qualities for money during a History of Economic Thought lecture at UNLV back in the fall of 1990. For a substance to be used as money it must be (1) generally marketable, (2) divisible, (3) durable, (4) recognizable, (5) homogeneous, and have a (6) high value per unit weight and (7) fairly stable supply.

Gold happens to meet the test of all seven attributes. However, investment advisor Medley seems to be equating the macroeconomic landscape today with that of 1980, when gold hit $850 per ounce, thinking that it’s all downhill from here for the price of the yellow metal, just as it was 30 years ago.

But he turns a blind eye to the fact that M2 was just short of $1.5 trillion in January 1980, while this past October it was $8.7 trillion. Gross debt in 1980 was $909 billion, on November 2 of this year, $13.7 trillion. As a percentage of GDP, the debt was 33.4 percent in 1980; today it’s 93.2 percent.

On February 15, 1980, the discount rate was goosed up to 13 percent and federal funds were yielding 14.5 percent to 15 percent (on the way to 20 percent a year later). Today, the discount rate is all of 75 basis points and federal funds fetch a yield of zero to a quarter percent.

And while Volcker’s policies spurred widespread protests due to the effects of the high interest rates on the construction and farming sectors, causing irate, bankrupt farmers to drive their tractors onto C Street NW, blockading the Eccles Building, Ben Bernanke invited 60 Minutes into the Fed’s chambers to go on camera assuring people he will keep rates near zero for as long as it takes.

Bernanke assured the national audience that the Fed was not printing money; however, he didn’t explain where the Fed was going to get the funds to buy $600 billion worth of treasuries.

Rick Rule already knows the answer; and it’s not just the Fed that’s creating money out of nowhere to buy government bonds. "The decision by the European Central Bank to emulate their American peers to print money to buy existent European bonds is tantamount to government counterfeiting," says Rule.

And while central-bank bureaucrats come up with fancy names for this counterfeiting, like "quantitative easing," the owner of Global Resource Investments differs with that characterization. He says, "I disagree; I think it’s a form of fraud. I think they are printing money to buy bonds that they couldn’t otherwise sell."

Tim Medley believes stocks are selling at good prices and have the potential to reward investors with significant gains, while he believes the gains in gold prices are likely short-lived. Rule also remembers the late 1970s gold bull market, and he contends this market hasn’t yet become the "echo market" that that one was:

In an echo market, the market might be kicked off by fear buying like we’re seeing in gold now, and the momentum established by the fear buyers attracts the greed buyers. The momentum associated with the greed buyers sparks more fear buying and backwards and forwards.

Based on what Bernanke said on 60 Minutes, it is hard to imagine that it’s really too late to be afraid.

Reprinted from Mises.org.

Doug French [send him mail] is president of the Ludwig von Mises Institute and the author of Early Speculative Bubbles & Increases in the Money Supply. He received the Murray N. Rothbard Award from the Center for Libertarian Studies. See his tribute to Murray Rothbard.

The Best of Doug French

by Doug French by Doug French Recently by Doug French: Love Horse Racing?

Introduction to Walk Away: The Rise and Fall of the Home-Ownership Myth

The idea that "a man’s house is his castle" is attributed to American Revolutionary James Otis from 1761, and his idea was that government should never be permitted to breach its walls. It is a good thought, in context, one that sums up a dogged attachment to the right of private property.

In the 20th century, however, government got behind the idea that every citizen should be provided a castle of his or her own. This is the essence of the good life, we were told, the very core of our material aspirations. The home is the most valuable possession we could ever have. It is the best investment, even better than gold. Government would make us all owners, one way or another, even if it meant violating rights to make it happen.

This became an article of faith, a central tenet of the American civic religion, and one that led to additional spin-off doctrines. We should fill our valuable homes with vast amounts of furniture, large pieces especially, things that suggest permanence and roots. If there was any doubt as to where to put our money, an answer was always ready: put it into the mortgage, where it will surely pay the highest return.

The home itself could provide full-time employment for half of the American citizenry, as all women became "homemakers" who devoted themselves to cooking, laundry, and cleaning, while all extra time that the man had was to be devoted to lawn care, household repairs, and landscaping. The home was the very foundation of community, of freedom, of the American dream. It embodied who we are and what we do.

Beginning in 2007 and culminating in 2008, this dream was smashed, as home values all over the country plummeted, wiping out a primary means of savings. Some homes fell by as much as 75–80 percent, instilling shock and awe all across the country. The thing that was never supposed to happen had happened. This meant more than mere asset depreciation. An article of faith had fallen, and there were many spillover effects.

The home was the foundation of our financial strategy, our love of accumulating large things, the core of our strategic outlook for our lives. Once that goes, much more goes besides. The things in the home suddenly become devalued. We look around ourselves in astonishment at how much stuff we have, and we are weighed down by the very prospect of moving. We are longing for a different way, perhaps for the first time in a century.

We are beginning to see the response in the new behavior of some younger people. The New York Times, the Wall Street Journal, and other major media outlets are starting to cover the trend of what we might call the new mobility. Young couples are selling off their possessions: their large furniture, their china and crystal, their enormous bedrooms suites, and even their cars. They are lightening the load, preparing for a life of mobility, even international mobility.

The collapse of the housing market – which has occurred despite every effort by the government to prevent it – coincides with the highest rate of unemployment among young people that we’ve seen in many generations. Economic opportunity is dwindling, at least in traditional jobs. The advance of digital technology has made it possible to do nontraditional jobs while living anywhere, and perhaps changing one’s location every year or two.

Millions have walked away from their mortgages. Those who have swear that they will never again be tricked by the great housing myth that this one asset is guaranteed to go up and up forever. The new source of value is not something attached to the biggest thing we own but rather in the most fundamental unit of all: ourselves, and what we can do. This change represents a dramatic change not just for one generation but for an entire ethos that has defined what it means to be an American for about a century.

To walk away might at first seem like a postmodern activity, one that disconnects us with history and community. We might just as easily see it as a recapturing and redefining of an older tradition that shaped the American ethos from the colonial period through the latter part of the 19th century: the pioneer spirit. Our ancestors moved freely, across great distances, beginning with oceans and then continuing across great masses of land, from New England to the West, all in search of economic opportunity and the fulfillment of a different American dream defined by freedom itself.

This change begins with a single realization: I’m paying more for my house than my house is worth. What, precisely, is the downside of walking away, of going into a "strategic default"? I lose my house. Good. That’s better than losing money on my house.

But what are the economic and ethical implications of this? Americans haven’t faced this dilemma in at least a century. But now they are, by the millions. They are awakening to the reality that the house is no different from any other physical possession. It has no magical properties and it embodies no high ideals. It is just sticks and bricks.

This book examines the background to the case of strategic default and considers its implications from a variety of different perspectives. The thesis here is that there is nothing ominous or evil about this practice. It is an extension of economic rationality.

But what about the idea that our home is our castle? My thesis is that the essence of freedom is to come to understand that the real castle is to be found within.

Reprinted from Mises.org.

Doug French [send him mail] is president of the Ludwig von Mises Institute and the author of Early Speculative Bubbles & Increases in the Money Supply. He received the Murray N. Rothbard Award from the Center for Libertarian Studies. See his tribute to Murray Rothbard.

The Best of Doug French

by Doug French by Doug French Recently by Doug French: What Kind of Person Runs for PublicOffice?

Seven years ago Burt Blumert wrote on these pages about waking up early to see the movie Seabiscuit. Being an expert on fast horses and hard money, Burt pointed out that Seabiscuit was more myth than champion, “a nice, gritty colt and a boon to California racing.”

Seabiscuit (the movie) was nominated for seven Academy Awards but, unlike its subject, came up empty. Will it be the same for this year’s horse racing movie entry — Secretariat? While the undersized Seabiscuit gave Americans hope during the Great Depression, the big red colt Secretariat took the country’s mind off Watergate, the war in Vietnam and stagflation.

There was nothing underdog about Secretariat, a horse whose heart was over twice the size of other horses’. Big Red’s 31-length victory to seal the Triple Crown was likely the greatest performance by any horse ever. His under two minute Kentucky Derby win may be the second best. It had been 25 years since a horse had won the Crown and many thought it would never be done again. We all know how the races turn out. But the story Randall Wallace directs is also a financial one.

Diane Lane is generating Oscar buzz for her portrayal of Denver housewife Penny Chenery Tweety who loses her mother and has to step in to take over the family business because her father is not capable of managing the horse-breeding farm. She quickly fires the surly and crooked trainer who has the farm on the edge of financial ruin and is advised by Bull Hancock (Fred Thompson) to coax Lucien Lauren (John Malkovich) off the golf course and back to the stables.

Lauren says he’s “tired of training half-ton animals that are as stubborn as their owners,” but agrees to work for Ms. Chenery when he learns she lost a coin flip, ending up with the colt whose dam is Somethingroyal, sired by Bold Ruler. The colt which miraculously stands immediately upon birth, turns out to be, after 10 name submissions are rejected by the Jockey Club, Secretariat.

When aggressive jockey Ronnie Turcotte (Otto Thurworth) is matched with Big Red the magic begins and Secretariat earns horse of the year honors as a two year old. But Uncle Sam lurks, wanting $6 million in inheritance taxes. Penny’s brother, “even though he teaches economics at Harvard, doesn’t know how to create $6 million out of nowhere” and insists that the horse of the year be sold. Penny’s husband (Dylan Walsh, from TV’s Nip/Tuck) sides with Penny’s brother, and later can’t believe she turns down $8 million for Big Red.

Instead she syndicates the breeding rights, but has to provide a performance guarantee, all the while being constantly reminded that no son of Bold Ruler has ever gone a mile and a half. If Secretariat doesn’t win the Triple Crown, it means financial disaster. And until the final stretch, the Kentucky Derby looked like it belonged to Sham, a horse that had defeated Big Red decisively at the final Derby-prep race, the Wood Memorial.

The only thing disputed about Secretariat’s Preakness win is the time. The track’s electronic timer malfunctioned. But heading into the Belmont Stakes, Big Red was a national celebrity, appearing on the covers of Time, Newsweek and Sports Illustrated.

Appropriately, the Belmont is the movie’s climax. And while it’s hard to compete with the YouTube of the actual race, Wallace captures the amazement felt by the movie’s primary characters as Secretariat continues to run faster and faster, despite Sham fading after 6 furlongs. With Secretariat so far ahead it looked like a solo morning workout and Lauren yells “Don’t fall off Ronnie!” As CBS Television announcer Chic Anderson unforgettably described, “Secretariat is widening now! He is moving like a tremendous machine!”

Cynical turf writers Bill Nack (Kevin Connelly, HBO’s Entourage) and Andrew Beyer (Eric Lange, from TV’s Lost) are stunned as the big chestnut stallion destroys the field and they celebrate along with everyone else when Secretariat crosses the finish line. Big Red went off at 1-10 that day, paying only $2.20 on a $2.00 bet. Many winning bettors didn’t cash their tickets, instead keeping them as souvenirs. Andrew Beyer would later devise the Beyer Speed Figure, an essential tool for any horse racing handicapper. Beyer has gone back and calculated that Secretariat ran a 139 that day, the highest ever assigned.

In a memorable scene Penny comments to Bill Nack that he writes like a poet and asks why he writes about horse racing. He replies that he used to cover politics, but he wanted to write about both ends of the horse instead. Nack’s Secretariat: The Making of a Champion inspired the movie and was described by Red Smith as “The next best thing to watching Secretariat run.”

Nack recalls Secretariat as a “chivalrous prince of a colt who was playful and mischievous — he once grabbed my notebook out of my hand with his teeth, when I was talking to his groom, Ed Sweat — and stayed the same as a stallion at Claiborne. A kid could have ridden him. The older he got, it seemed, the more of a ham he became, and throughout his life he used to stop and pose whenever he heard the click of a camera.”

Secretariat sired over 600 foals before he died in 1989, and was buried, unlike most horses who are cremated.

Sure, some poetic license was taken with the story. For one thing the movie makes no mention of Riva Ridge, another of Penny Tweedy’s horses that came within one race of winning the Triple Crown the year before Secretariat. And it’s hard to imagine that Pancho Martin (Nestor Serrano) who trained Sham was as big a loudmouthed jerk as he was portrayed in the movie.

But if a cavalry charge of horses at the top of the stretch makes your heart pound, this movie is a must. I, like my old friend Burt, have spent probably too much time contemplating the immediate futures of thoroughbreds, attempting to make a buck or two. Burt ranked Secretariat as his 3rd greatest horse of all time, behind Man o’ War and Citation. Reasonable men can disagree. For my money Secretariat was the greatest horse of all time. There won’t be another one like him. And there won’t be another Burt Blumert. The only thing that would make Secretariat better is if Burt were here to see it.

Doug French [send him mail] is president of the Ludwig von Mises Institute and the author of Early Speculative Bubbles & Increases in the Money Supply. He received the Murray N. Rothbard Award from the Center for Libertarian Studies. See his tribute to Murray Rothbard.

The Best of Doug French

by Doug French by Doug French Recently by Doug French: In Defense of Deflation

Talk given September 18, 2010, at the Mises Circle in Colorado Springs, sponsored by Pikes Peak Economics Club

H.L. Mencken described politicians as "men who, at some time or other, have compromised with their honour, either by swallowing their convictions or by whooping for what they believe to be untrue."

"Vanity remains to him," Mencken wrote, "but not pride."

The Sage of Baltimore had it correct that to be elected and stay elected in American politics to any full-time position requires the suspension of any ethics or good sense a person may possess. Even those who begin political careers with the best intentions and have measurable abilities that would make them successful in any field soon realize that the skills required to succeed in politics are not those required outside politics.

Lew Rockwell explains that, while competition in the marketplace improves quality, competition in politics does just the opposite:

The only improvements take place in the process of doing bad things: lying, cheating, manipulating, stealing, and killing. The price of political services is constantly increasing, whether in tax dollars paid or in the bribes owed for protection (also known as campaign contributions). There is no obsolescence, planned or otherwise.

F.A. Hayek famously argued in The Road to Serfdom, that in politics, the worst get on top, and outlined three reasons this is so. First, Hayek makes the point that people of higher intelligence have different tastes and views. So, as Hayek writes, "we have to descend to the regions of lower moral and intellectual standards where the more primitive instincts prevail," to have uniformity of opinion.

Second, those on top must "gain the support of the docile and gullible," who are ready to accept whatever values and ideology is drummed into them. Totalitarians depend upon those who are guided by their passions and emotions rather than by critical thinking.

Finally, leaders don’t promote a positive agenda, but a negative one of hating an enemy and envy of the wealthy. To appeal to the masses, leaders preach an "us" against "them" program.

"Advancement within a totalitarian group or party depends largely on a willingness to do immoral things," Hayek explains. "The principle that the end justifies the means, which in individualist ethics is regarded as the denial of all morals, in collectivist ethics becomes necessarily the supreme rule."

Those wishing to get elected and stay elected must be prepared to break every moral rule they have ever known if the ends justify it. Economist Frank Knight notes that those in authority, "would have to do these things whether they wanted to or not: and the probability of the people in power being individuals who would dislike the possession and exercise of power is on a level with the probability that an extremely tender-hearted person would get the job of whipping master in a slave plantation."

But even as the pathological gain these high positions in government, they freely use the word freedom to describe their program. "Collective freedom" is promised, which does not mean freedom for individual members of society, but instead is "unlimited freedom of the [government] planner to do with society that which he pleases."

And there is no accountability: the higher the office, the more criminal wrongdoing a person can get away with.

Thus, it becomes "a psychic impossibility for a gentleman to hold office under the Federal Union," wrote Mencken. Democracy makes it possible for the demagogue to inflame the childish imagination of the masses, "by virtue of his talent for nonsense." The king can do the same thing in a monarchy, but only by virtue of his birth.

In stark contrast, in the natural order, as Hans-Hermann Hoppe explains in his monumental work, Democracy: The God that Failed, it is "private property, production, and voluntary exchange that are the ultimate sources of human civilization." This natural order, Hoppe notes, must be maintained by a natural elite which would come by these positions of "natural authority," not by election as in the case of democracy, or birth as in the case of monarchy, but by their "superior achievements, of wealth, wisdom, bravery or a combination thereof." This is just the opposite of what Mencken and Rockwell describe as a characteristic of democracy.

Hoppe writes in "Natural Elites, Intellectuals, and the State" that a few individuals in every society rise to elite status by their talent:

Due to superior achievements of wealth, wisdom, and bravery, these individuals come to possess natural authority, and their opinions and judgments enjoy wide-spread respect. Moreover, because of selective mating, marriage, and the laws of civil and genetic inheritance, positions of natural authority are likely to be passed on within a few noble families. It is to the heads of these families with long-established records of superior achievement, farsightedness, and exemplary personal conduct that men turn to with their conflicts and complaints against each other. These leaders of the natural elite act as judges and peacemakers, often free of charge out of a sense of duty expected of a person of authority or out of concern for civil justice as a privately produced "public good."

On the other hand, democracy affords the opportunity for anyone to pursue politics as a career. There is no need for the masses to recognize a person as "wise" or "successful," as Hoppe’s natural order would require. Nor does one have to be born into the ruling family, as in the case of monarchy. As the great American comedian Bob Hope, who was actually born in England, once quipped, "I left England at the age of four when I found out I couldn’t be king." Maybe because he knows he can never have Prince Charles’s job, Sir Richard Branson — knighted for "services to entrepreneurship" — sticks to business and reportedly owns 360 companies.

But, as Hoppe explains, democracies have expanded, and since World War I have been viewed as the only legitimate form of government. In turn, more people who have been successful at other pursuits are running for political office or becoming politically active. For instance, more and more billionaires are entering the political arena. While the wealthy tycoons of a previous generation were private and tended to covet seclusion, today’s captains of industry such as Ross Perot, Michael Bloomberg, Carly Fiorina, Meg Whitman, and Jon Corzine are running for office. And while Warren Buffett, Bill Gates, and George Soros haven’t sought public office personally, they spend millions of dollars on political contributions and are visible in trying to sway the public debate on political issues, when their time would obviously be more productively spent (both for them and everyone else) on other, wealth-creating endeavors. Also, it should be noted, a quarter of all House members and a third of all members of the Senate are millionaires.

There may be politicians who pursue elected office for the money, but many elected officials are already wealthy by most people’s standards. What makes the wealthy and otherwise successful want to hold office? Is it, as Charles Derber describes in The Pursuit of Attention: Power and Ego in Everyday Life, that politicians since "Caesar and Napoleon have been driven by overweening egos and an insatiable hunger for public adulation"?

The work of psychologist Abraham Maslow may provide an understanding as to why even successful entrepreneurs would seek public office. Maslow is famous for his "hierarchy of needs" theory, which is taught in most management classes in American universities. The theory is generally presented visually as a pyramid, with the lowest or most basic human need — physiological need — shown as a layer along the base of the pyramid.

Maslow’s view was that the basic human needs — thirst, hunger, breathing — must be satisfied before humans can accomplish or worry about anything else. The next tranche within the pyramid, shown on top of the physiological need, is the safety need. After satisfying thirst and hunger, humans are concerned about their continued survival. If a man is constantly worried about being eaten by a tiger, he doesn’t concern himself with much else.

The next layer presented within Maslow’s pyramid is the belonging need, which lies just above safety need. After the satisfaction of the two lower needs — physiological and safety — a person seeks love, friendships, companionship, and community. Once these needs are satisfied, according to Maslow, humans seek the esteem need. These first four needs were considered deficit needs. If a person is lacking, there is a motivation to fill that need. Once the particular need is filled, the motivation abates. This makes these needs different than the need at the top of Maslow’s pyramid, the need for self-actualization. The need for self-actualization is never satisfied, and Maslow referred to it as a being need, or the need to be all you can be.

Thus, humans continually strive to satisfy their needs, and as the more basic needs are satisfied, humans move up the pyramid, if you will, to satisfy higher-level needs. Of course, different humans achieve different levels, and it was Maslow’s view that only 2 percent of humans become self-actualizing. Maslow studied some famous people along with a dozen not-so-famous folks and developed a list of personality traits that were consistent with people he judged to be self-actualizing. Besides being creative and inventive, self-actualizers have strong ethics, a self-deprecating sense of humor, humility and respect for others, resistance to enculturation, enjoyment of autonomy and solitude instead of shallow relationships with many people. They believe the ends don’t necessarily justify the means and that the means can be ends in themselves.

One readily sees that Maslow’s self-actualizers have nothing in common with politicians in a democracy, but closely fit the profile that Hoppe describes of the natural elite that would lead a natural order. But a step down from the top of the hierarchy-of-needs pyramid is the need for esteem. Maslow described two types of esteem needs according to Maslow expert Dr. C. George Boeree, a lower esteem need and a higher one. And while the higher form of esteem calls for healthy attributes such as freedom, independence, confidence, and achievement, the lower form "is the need for the respect of others, the need for status, fame, glory, recognition, attention, reputation, appreciation, dignity, even dominance."

"The negative version of these needs is low self-esteem and inferiority complexes," Dr. Boeree writes. "Maslow felt that Adler was really onto something when he proposed that these were at the roots of many, if not most, of our psychological problems."

Now we see these qualities displayed by virtually all politicians in democracy: the constant need for status and recognition. The ends — compensating for an inferiority complex — justify whatever Machiavellian means.

Because democracy is open to any and all who can get themselves elected, either through connections, personality, or personal wealth, it is a social system where leadership positions become a hotbed for sociopaths. Maslow’s self-actualizing man won’t have an interest in politics. But those stuck on the need for esteem are drawn to it like flies to cow pies.

Even religious philosophers recognize the shortcoming of those in power.

Saint Augustine wrote about the theory of just war and held a different worldview from his predecessors, lacking the usual optimism that man strives to comprehend the ultimate verities, live in an orderly fashion, and find his way to God.

Augustine was pessimistic of human nature, believing men weren’t inclined toward righteousness, but instead had a tendency towards doing evil "as the result of Adam’s fall, pride, vanity, and libido domini — the lust for domination — entice men towards waging wars and committing all manner of violence," explains John Mark Mattox in Saint Augustine and the Theory of the Just War.

Judge Andrew Napolitano made the point during a speech at Mises University that libido domini is the thing in human nature that attracts people into government, in order that they may dominate their fellow man — that the same men who founded the United States government wrote laws as repugnant as the Alien and Sedition Acts.

Hoppe recognized that natural elites have responsibilities that extend far beyond themselves and their families.

The more successful they are as businessmen and professionals, and the more others recognize them as successful, the more important it is that they set an example: that they strive to live up to the highest standards of ethical conduct. This means accepting as their duty, indeed as their noble duty, to support openly, proudly, and as generously as they possibly can the values that they have recognized as right and true.

They receive in return intellectual inspiration, nourishment, and strength, as well as the knowledge that their name will live forever as outstanding individuals who rose above the masses and made a lasting contribution to mankind.

On the other hand, in democracy politicians demand attention, seeking acclaim for anything they do, continually taking credit for policies they say have made our lives better when in fact these interventions make our lives worse. There is no need to list the names of politicians who have committed crimes or ethics violations — it would take all day. The point is made.

With leadership in such dysfunctional hands, it is no wonder. "In comparison to the nineteenth century, the cognitive prowess of the political and intellectual elites and the quality of public education have declined," Hoppe writes in Democracy. "And the rates of crime, structural unemployment, welfare dependency, parasitism, negligence, recklessness, incivility, psychopathy, and hedonism have increased."

So while the electorate recognizes that they are electing at best incompetents and at worst crooks, the constant, naïve, prodemocracy mantra is that "we just need to elect the right people." But, the "right people" aren’t (and won’t be) running for office. Instead, we will continue to have "the average American legislator [who] is not only an ass," as Mencken wrote, "but also an oblique, sinister, depraved and knavish fellow."

So do we just throw up our hands? Is it hopeless? No, it can safely be predicted that the democratic welfare state will collapse, according to Hoppe, and what is necessary besides a crisis is ideas — correct ideas — and men capable of understanding and implementing these ideas once the opportunity arises.

So the natural elites have an obligation to make sure the truth is spread. Mises and Rothbard were only able to make themselves heard through the support of others. Lawrence Fertig and others supported Mises. Mises Institute donors supported Rothbard’s work.

As Hoppe writes, "Once upon a time, in the pre-democratic age, when the spirit of egalitarianism had not yet destroyed most men of independent wealth and independent minds and judgments, this task of supporting unpopular intellectuals was taken on by individuals." Hoppe explains that this is nearly impossible in this day and age.

He points out that a person’s first obligation is to make as much money as he can, "because the more money he makes, the more beneficial he has been to his fellow man." But the natural elites extend beyond that. It is for them to support the truth.

The outstanding individuals of the Pikes Peak Economics Club are the natural elites that made today’s program possible. They have accepted their duty to fight evil, even though they may never see the benefit. Thank you Pikes Peak Economics Club for keeping alive the truths of private property, free markets, and personal responsibility.

Not only are we in your debt, but future generations will be in your debt as well.

Reprinted from Mises.org.

Doug French [send him mail] is president of the Ludwig von Mises Institute and the author of Early Speculative Bubbles & Increases in the Money Supply. He received the Murray N. Rothbard Award from the Center for Libertarian Studies. See his tribute to Murray Rothbard.

The Best of Doug French

by Doug French by Doug French Recently by Doug French: The Cruise Business, Post—Financial Meltdown

The Obama stimulus and bailouts haven’t decreased unemployment rates or bankruptcy filings while home prices and home sales have fallen and can’t get up. PIMCO’s Bill Gross told Bloomberg this can all be fixed with nearly zero interest rates and additional debt to stimulate the animal spirits of investors and entrepreneurs. The federal-funds rate has been pegged at 0 to .25% since December 16, 2008, and Uncle Sam’s debt is $13.3 trillion and counting. If this hasn’t goosed the animal spirits, what will?

The failure of central bankers to make things all better again by creating some money and lowering some interest rates has the financial press fretting about deflation and thinking the US economy is turning Japanese. James Bullard, who heads the Federal Reserve Bank of St. Louis, came out with a paper entitled “Seven Faces of ‘The Peril’.” He concludes that the Federal Open Market Committee’s (FOMC’s) “extended period language may be increasing the probability of a Japanese-style outcome for the U.S.” To avoid that outcome, Bullard argues that the Fed’s most important tool is quantitative easing — printing money to buy government debt.

The Wall Street Journal’s James B. Stewart claims deflation is bad because "deflation erodes profits and asset values," in his "Smartmoney" column.

People wait to buy expecting lower prices, reducing demand. Lower profits cause companies to cut expenses, including employees. It is a downward spiral that, if Japan’s experience is any indication, is difficult to arrest.

Mr. Stewart is wrong on all counts. Profits are the difference between the price we sell a good for and the price it costs to produce that good. As Jörg Guido Hülsmann makes clear in his book Deflation & Liberty, "In a deflation, both sets of prices drop, and as a consequence for-profit production can go on."

And while asset values may drop, the assets don’t go away. The real wealth of the nation — assets used for production — are still available to produce. However, it may be that because the debt is liquidated on those assets as prices fall, new owners will own and operate the assets, but commerce and production will certainly carry on.

Lower prices increase demand; they do not reduce or delay it. That’s why more and more people own flat-screen TVs, cellular telephones, and laptop computers: the prices of these goods have fallen, and people with lower incomes can afford them. And there are more low-income people than high-income people.

Lower prices don’t mean lower profits; nor do they mean that employees will be laid off. More demand for a good or service means more employees needed to produce those goods and services. "There is no reason why inflation should ever reduce rather than increase unemployment," Hülsmann writes.

People become unemployed or remain unemployed when they do not wish to work, or if they are forcibly prevented from working for the wage rate an employer is willing to pay. Inflation does not change this fact.

Hülsmann goes on to point out that only if workers underestimate the amount of money created by the central bank and therefore reduce their real wage-rate demands will unemployment be reduced. "All plans to reduce unemployment through inflation therefore boil down to fooling the workers — a childish strategy, to say the least."

Of course, Mr. Bullard over at the St. Louis Fed doesn’t mention anything in his paper about individuals attaining their goals through subjective knowledge and pricing decisions. Instead he draws lots of lines on graphs and talks about Taylor-type policy rule, zero bound, the Fisher relation, "targeted" steady states, and lots of stuff that has nothing to do with economics.

So while the bond-buying Mr. Gross says zero rates will arouse the animal spirits in all of us, Mr. Bullard worries that "promising to remain at zero for a long time is a double-edged sword." Bullard writes that zero rates are "consistent with the idea that inflation and inflation expectations should rise in response to [that] promise." But in the same paragraph he continues,

But the policy is also consistent with the idea that inflation and inflation expectations will instead fall, and that the economy will settle in the neighborhood of the unintended steady state, as Japan has in recent years.

Wow, no wonder Keynesian central banking is so hard. You’re damned if you cut rates and damned if you don’t. "I moved the line on the graph. Let’s see some animal spirits for crying out loud!"

In the real world, banks aren’t lending because, as Murray Rothbard points out in America’s Great Depression, if rates are too low, bankers have no incentive to lend, especially in a risky economic environment. Also, as Professor Jeffrey Herbener wrote in the Asian Wall Street Journal, “with distressed banks, reflation fails to induce another bank credit expansion.”

Keynesians have mistaken the impotency of the Bank of Japan to restart credit expansion in the 1990s as a liquidity trap. But the problem is not that interest rates are so low everyone expects them to rise and therefore hoards cash. Banks refuse to lend because of the overhang of bad debt. Any cash infusion is held as reserve against it. Businesses refuse to borrow because of their debt burden, built up to expand capacity during the boom, and their over-capacity resulting from their malinvestments.

Japan has tried every stimulus trick in the book — in addition to holding rates at zero — and still its economy has been in a funk for two decades. But firing a worker in Japan is virtually forbidden and don’t get the idea that consumer prices have fallen through the floor. According to the International Monetary Fund (IMF), last year saw the biggest drop in consumer prices at 1.13%, after prices rose 1.4% the year before. The chart of Japan’s inflation rate is essentially flat. Not exactly the deadly deflationary spiral it’s made out to be.

Hülsmann explains that the Japanese government hasn’t allowed deflation to heal their economy, with “the only result of this policy [being] to give a zombie life to the hopelessly bureaucratic and bankrupt conglomerates that control Japanese industry, banking and politics.”

As for Bullard’s quantitative-easing (QE) idea, the Bank of Japan has done plenty of it, buying not only government bonds but corporate debt and stocks as well. Bullard’s colleagues over at the San Francisco Fed have studied whether it worked. In a 2006 report, Vice President Mark M. Spiegel wrote that QE lowered long-term interest rates and "there appears to be evidence that the program aided weaker Japanese banks and generally encouraged greater risk-tolerance in the Japanese financial system."

Spiegel concluded, "In strengthening the performance of the weakest Japanese banks, quantitative easing may have had the undesired impact of delaying structural reform."

"Deflation is one of the great scarecrows of present day economic policy and monetary policy in particular," Hülsmann told his Economics of Deflation class at this year’s Mises University. It seems a nation will destroy its finances battling the non-threat. The Organization for Economic Cooperation and Development (OECD) says the Bank of Japan "needs to keep interest rates close to zero and continue its asset-purchase program until there is a ‘definitive’ end to deflation," Bloomberg reports. But in the same report the OECD worried that the Bank of Japan’s ability to stimulate would be curtailed by Japan’s public-debt-to-GDP ratio approaching 200%.

Sounds like the folks at the OECD, like Mr. Bullard, can’t make up their minds. What Austrians know for sure is that, as Professor Hülsmann makes clear, “the dangers of deflation are chimerical, but its charms are very real.” Inflation, on the other hand, only helps those who are massively indebted and inefficient — governments.

Reprinted from Mises.org.

Doug French [send him mail] is president of the Ludwig von Mises Institute and the author of Early Speculative Bubbles & Increases in the Money Supply. He received the Murray N. Rothbard Award from the Center for Libertarian Studies. See his tribute to Murray Rothbard.

The Best of Doug French

by Doug French by Doug French Recently by Doug French: Gold and Guns

Just what is the ultimate symbol of excess that signals the peak in a market? The point when hubris takes over. When, as Christopher Wood writes about boom-time Japan in The Bubble Economy, "a collective self-confidence that too often bordered on arrogance" manifests.

When the buildings reach too high and the ships become too big, the boom has begun to unravel.

Optimism had already turned sour in capitalism’s newest outpost in the Middle East when the 162-floor Burj Dubai tower was completed on January 4 of this year, becoming the world’s tallest building — and this in the wake of the fact that Dubai’s debt woes had just come to light the previous Thanksgiving weekend. Just one more example explained by Mark Thornton’s prescient 2005 article "Skyscrapers and Business Cycles."

As Thornton points out, the skyscraper index’s predictive power began with the Panic of 1907, which was presaged by the building of the Singer Building and Metropolitan Life Building. Meanwhile, the modern cruise industry wasn’t born until the 1960s, and it only really captured the imagination of the American public when they began watching the weekly antics of Gopher, Doc, and Captain Stubing on The Love Boat TV series, which ran from 1977 until 1986.

In the early days, cruisers were mostly the "newly wed or the nearly dead." But in the 1980s the industry really set sail with a number of giant ships capable of carrying over 2,000 people with the message of "luxury for the masses." And the masses were ready to splurge — after all, the credit-card industry was newly born. "If, in the early decades of the century, it was impossible for a working man or woman to secure a loan from a legitimate lender, in the 1980s he or she could hardly refuse one," writes James Grant. "The descendents of the clientele of loan sharks became the valued credit-card ‘members’ of leading banks. In the 1980s the home-equity loan proliferated, and personal bankruptcy lost its stigma."

It’s been spend, spend, spend ever since. And as credit lines increased, so did the size of the ships. In 2003, the Mariner of the Seas was launched by Royal Caribbean International as one of the largest cruise ships afloat at 138,000 tons, with a capacity of just over 3,100 passengers and nearly 1,200 crewmembers.

From 1980 to the end of 2008 the average annualized growth of the North American cruise industry was 7.4 percent, according to Cruise Lines International Association (CLIA). The CLIA estimated that 13.2 million travelers cruised in 2008, up from 12.56 million the previous year. Back in 2000, CLIA member-line passenger volumes were 7.2 million, so annual passenger volume increased nearly 80 percent from 2000 to 2008.

Despite the recession, through the second quarter of 2009, passenger nights were 1.5 percent ahead of the pace of 2008, according to the United States Department of Transportation Maritime Administration. But to fill the ships, average fares were down 10.7 percent.

Since then, more capacity has come online. Ships like the Mariner aren’t big anymore. The world’s largest cruise ship set sail late last year as the finishing touches were being completed at the Burj Dubai tower. The Oasis of the Seas is the talk of the industry. At over 225,000 tons and capable of accommodating nearly 6,300 passengers, serviced by 2,165 crewmembers, the Oasis is the size of five Titanics. The Oasis was ordered in February 2006 with the US economy going full bore and the personal savings rate in America at negative one percent.

But at the same time the Federal Reserve was dousing the overheated economy with a higher federal-funds rate that would reach 5.25 percent that summer after being as low as 1 percent in 2003 and 2004. Total household debt would reach $13.7 trillion the next year at the same time the bubble in home prices peaked.

At the same time it ordered the Oasis, Royal Caribbean had STX Europe start work on the Allure of the Seas, the sister ship to the Oasis. The Allure cost a little less to build at $1.2 billion and made its maiden voyage about the same time as the Oasis.

The Oasis and Allure are raising the bar for cruise entertainment. Hairspray made its oceanic debut aboard the Oasis, and the Allure is set to feature the Tony-winning revival of Chicago: The Musical, in the ship’s 1,380-seat Amber Theater.

Both of these behemoths sail from South Florida, contributing significantly to what Cruise Industry News calls the first major capacity increase in years. As the US Department of Transportation Maritime Administration points out, "Capacity is based on two passengers per stateroom. A stateroom with two passengers is considered 100 percent occupied. Since many double staterooms can accommodate three to four people, occupancy rates are generally above 100 percent." And the Oasis and Allure are booked solid until next year.

If the cruise lines had it their way, their full passenger load would be fully loaded for the entire trip. Once on board, cruisers instinctively head straight to the buffet. But standing in their way are crewmembers offering alcohol to "get the trip/party started right!" Of course, the staff aren’t offering to ply the just embarked with a neat ounce or two of 16-year-old Lagavulin in a clean rocks glass. No, they thrust a tall hurricane tumbler in your direction, containing some fruity concocted nonsense adorned with a cherry and tiny umbrella.

For cruise ships to make money they must leave the port full, because, as CNBC reports, a quarter of all revenue from passengers is spent after they are on board. Booze, Botox, jewelry, spa treatments, acupuncture, gambling, and high-priced art are for sale at all hours. Not to mention shore excursions to shop, snorkel, make salsa, or zip-line across canyons and rappel down waterfalls in the Sierra Madres. "Shore excursions are our number one gross revenue producer," says Paul Goodwin, senior vice president of onboard revenue and tours at Holland America. And for the ports, as Julio Galindo, minister of tourism for the Bay of Honduras, told CNBC, "Every time a ship comes in, it’s like Christmas."

The food (with some exceptions), entertainment, sun, and great service are all provided with the cost of the cabin. Everything else, including soda pop, is for sale. Unlike the Love Boat, you won’t find many Americans working on cruise ships. The ships are registered in places like Nassau, Panama, or Liberia so US employment regulations don’t get in the way of serving customers. So, you might see your assistant waiter from dinner busing tables during the breakfast buffet rush. Most of the crew work 6 to 12 months at a stretch, 12 hours or more a day, with one day a week off at most. Most of them are supporting families in places like India, Turkey, and Jamaica.

Despite the long hours, these employees are amazingly cheerful and accommodating, many speaking perfect English despite it being a second language. These folks are quick to remember names and what their customers like. At the last dinner seating of a cruise there are hugs, handshakes, and plenty of tearful goodbyes between waitstaff and passengers.

During dinner service on my recent cruise aboard The Mariner of the Sea, the 200+ serving staff were from 37 different countries. They performed a rousing rendition of "O Sole Mio" although no Italians were waiting tables. There were 10,000 meals a day served on the Mariner as we cruised the Mexican Riviera, stopping at Cabo, Mazatlán, and Puerto Vallarta.

High-rise condos overlooking the Pacific are prominently for sale in all three port cities, but business is reported to be slow. Even after prices were slashed 30—35 percent for units in Puerto Vallarta last year, one local real-estate agent laments, "From my perspective the buyers are still few and far between." Mexico is said to be a haven for American expats and our exuberant and energetic guide in Mazatlán, Alejandro, told us 10,000 expats resided there. Tourism clearly drives these economies, but, unfortunately, there is "declining demand for the Mexican Riviera, attributed to media coverage of drug wars," reports CIN. We saw no evidence of the drug wars, but were told the Mariner will be moved from Los Angeles to Houston soon, ceasing its Riviera runs. Christmas will be coming less often to the western ports of Mexico.

Despite headwinds like a weak economy, the proposed Emission Control Area (ECA) for North America, the heavy-fuel ban in Antarctica, and the $50 head tax in Alaska, the cruise industry is upbeat. Cruising is only five percent of the vacation market, they claim, and only 17 percent of Americans have taken the plunge.

However, the cruise industry is tied to the financial health of the American consumer. According to GlobalSecurity.com, 80 percent of cruisers are from North America. The industry loves Americans. One head waiter on a cruise last year told me that he wished all passengers were Americans "because they spend money." He fondly remembered the free-spending boom-time Americans and couldn’t wait for them to return, displacing the tightwad Europeans that dominated that particular post-financial-meltdown voyage.

But now Americans (and their creditors) are paying the price for living it up. US consumer bankruptcies totaled more than 136,000 in May, nine percent more than May of 2009. Close to 390,000 people filed bankruptcy in the first quarter, so personal bankruptcies could reach 1.6 million for 2010. The official unemployment rate still hovers near 10 percent, but, more telling, chronic joblessness is the highest it has been since 1948, when the Labor Department started keeping track.

Our waiter was a delightful man with a family back in India he hadn’t seen in months but that he tries to call at least once a week. We asked him if he was going to try and work on one of the new big ships, the Oasis or the Allure. "They can’t even fill this boat," he said pointing to the empty seats in his station, "why would I want to work on a ship that, after the newness wears off, will have even more empty dinner seats?"

The ships are getting bigger, but Americans are getting poorer.

Reprinted from Mises.org.

Doug French [send him mail] is president of the Ludwig von Mises Institute and the author of Early Speculative Bubbles & Increases in the Money Supply. He received the Murray N. Rothbard Award from the Center for Libertarian Studies. See his tribute to Murray Rothbard.

The Best of Doug French

Scott Smith interviews Doug French Scott Smith interviews Doug French Recently by Doug French: Gold and Guns

Introduction: Douglas French is president of the Mises Institute and author of Early Speculative Bubbles & Increases in the Money Supply. He received his Masters degree in economics from the University of Nevada, Las Vegas, under Murray Rothbard with Professor Hans-Hermann Hoppe serving on his thesis committee.

Daily Bell: Can you give us some background about yourself? Where did you grow up and how did you become interested in Austrian economics?

Douglas French: I grew up in Abilene, Kansas and like Dwight D. Eisenhower, was an average student at Abilene High School. Sports was my primary interest in school. I lettered in three sports, and went on to play football at Washburn University in Topeka, Kansas.

I dropped out of college in my third year out and worked as a bartender and bar manager for ten years. During that time I returned to college to finish my undergraduate degree with a major in economics and finance.

After moving to Las Vegas in 1986, I took an entry-level job at a bank and ultimately worked in the banking business in Nevada for 22 years. In the fall of 1989 I decided to enroll at the University of Nevada at Las Vegas (UNLV) and pursue a masters in economics. In the fall of 1990 I took "History of Economic Thought" with Murray Rothbard and my life was changed forever. I took "U.S. Economic History" with Murray as well and wrote my masters thesis under his direction. While researching and writing my thesis on early speculative bubbles I became interested in Austrian Economics, especially Austrian Business Cycle Theory.

Daily Bell: Tell us what you do at the Mises Institute and how you came to your important free-market role.

Douglas French: I serve as the President of the Institute. Lew Rockwell and the late Burt Blumert asked if I would come to work for the Institute in the fall of 2008. Along with being a student of Murray’s I had been a donor to LvMI and had attended a number of events as well as speaking at a few conferences. So I feel like I’ve been closely involved with LvMI’s mission for a number of years.

Daily Bell: You studied under Murray Rothbard and with Professor Hans-Hermann Hoppe. Can you give us some background and anecdotes about them? What has made them such famous proponents of free-markets and human action?

Douglas French: Murray was the happiest person I’ve ever met. Especially considering that the UNLV economics department did all it could to discourage students from taking his classes and classes from Hans. He was generous with his time and his students would wait long periods just to chat with him. Thankfully, someone eventually found a chair and put it outside his door so we didn’t have to keep sitting on the hard tile floor in the hallway.

The first night of class I remember Murray walking through the door and he started talking immediately about the crazy politicians wanting to fix gas prices. Anyone who has taken classes with Murray will tell you he was a walking bibliography. His lectures were filled with endless reading suggestions. And not just book titles but author, publisher, date published. Of course, as a thesis advisor he was the best: references, strategist, and cheerleader.

Of course Murray selected the rest of my thesis committee for me and professor Hoppe was at the top of his list. However, I never had the opportunity to take classes from him.

My thesis defense lasted for more than a couple hours as I remember. Sitting through my oral defense had to seem like the longest two hours of my committee members’ lives. But none of the Keynesian faculty members who dropped by to comment chose to stick around long enough to critique me.

Since I had no background in Austrian economics or Libertarianism, at the time, I had no idea how lucky I was to be studying under the man who is considered the father of the modern libertarian movement and was the dean of the Austrian school until his death, not to mention having one of the most important scholars of our time and the current dean of the Austrian school as a thesis committee member.

Daily Bell: Give us a historical — economic — framework for Ludwig von Mises. How did his thinking evolve?

Douglas French: When Mises went to college he described himself as a statist "through and through" like most of his fellow classmates. However, he was anti-Marxist, writing that the "platitudes of Marxist literature repelled me." Mises believed that all the Marxist scholars he met were mediocre, except Otto Bauer.

By his fifth semester he began to have doubts about government interventionism. His work on housing conditions in Austria revealed to him that taxation hindered capital investment and limited supply leading to higher rents. But, reductions in these taxes didn’t reduce rents and led the government to impose other taxes to replace the taxes that landlords had been paying: early insight that one government intervention leads to a series of others due to the unintended consequences of this intrusions.

In 1903 Mises read Carl Menger’s Principles of Economics and from that book, he wrote, "I became an economist." Mises attended Eugene Böhm-Bawerk’s seminar in Vienna until 1913 and witnessed continuous debates between Böhm and Bauer over Marxist theory. Mises applied Menger’s marginal utility theory to money and the business cycle and these were the subjects of the seminar the last two winter semesters that he attended. The finished manuscript for The Theory of Money and Credit was in the hands of the publisher in early 1912.

Daily Bell: Mises is one of the greatest men who ever lived for his insights into what he called "human action." How did the concept of human action evolve in his mind and why is it one of the most profound statements about the human condition ever uttered?

Douglas French: It was actually Carl Menger who developed a complete theory of social institutions arising from interactions among humans, each with his own subjective knowledge and experiences. It is the spontaneous evolution of these human actions that create institutions whereby individuals discover certain patterns of behavior that aid each person in attaining his goals more efficiently. Menger, and then Mises, applied this insight to the development of money which in turn makes the division of labor possible and satisfaction of wants attainable. This reasoning is the bedrock for understanding how societies and human progress advance. Conversely, this same understanding reveals how government intervention causes society to devolve.

Daily Bell: Can you summarize his great work, Human Action for our readers? Can you recommend some other books by von Mises?

Douglas French: I remember Murray talking about Human Action in class. He said that after he had read it, someone asked him what the book was about, he replied, "Everything!" So, can I summarize a book about everything? Not adequately. To quote from the Introduction to the Scholar’s Edition, Human Action is "a comprehensive treatise on economic science that would lay the foundation for a massive shift in intellectual opinion that is still working itself out fifty years after publication."

Economics does not allow any breaking up into special branches. It invariably deals with the interconnectedness of all phenomena of acting and economizing. All economic facts mutually condition one another. Each of the various economic problems must be dealt with in the frame of a comprehensive system assigning its due place and weight to every aspect of human wants and desires. All monographs remain fragmentary if not integrated into a systematic treatment of the whole body of social and economic relations.

To provide such a comprehensive analysis is the task of my book Human Action, a Treatise on Economics. It is the consummation of lifelong studies and investigations, the precipitate of half a century of experience. I saw the forces operating which could not but annihilate the high civilization and prosperity of Europe. In writing my book, I was hoping to contribute to the endeavors of our most eminent contemporaries to prevent this country from following the path which leads to the abyss.

Bob Murphy, writing in the preface to his, Human Action Study Guide, "Suffice it to say, one cannot really claim to be an Austrian economist — certainly not a Misesian! — without reading Human Action."

In an essay written about Mises, Murray wrote that Human Action is "one of the finest products of the human mind in our century."

One can’t go wrong reading any books by Mises. For those interested in booms and busts, I leaned extensively on a book that is now titled The Causes of the Economic Crisis when writing my thesis. For those who wonder why intellectuals and opinion makers hate capitalism, The Anti-Capitalist Mentality is very revealing. Want to understand big government? Read Bureaucracy. Theory and History, which was Mises’s favorite next to Human Action.

Of course the big three are Human Action, Socialism, and The Theory of Money and Credit.

Daily Bell: Tell us how Mises and FA Hayek expanded and finalized the concept of the business cycle.

Douglas French: As I mentioned, Mises applied marginal utility analysis to money and the problem of the business cycle which became Austrian Business Cycle Theory (ABCT). As Murray Rothbard wrote in an essay about Mises, "At long last, economics was whole, an integral science based on a logical, step-by-step analysis of individual action. Money was fully integrated into an analysis of individual action and the market economy."

Mises exposed the fallacies of the quantity theory of money and Irving Fisher’s "equation of exchange." Mises put individual choice into monetary theory and dispensed with the "distorted concentration on mechanistic relations between aggregates." Mises’s Regression Theorem showed that money can only be established by the market, beginning with barter, not by government construct. This of course has been proved right as every fiat currency in history has ultimately been made worthless.

Mises formulated his ABCT during the 1920s out of three elements; the boom-bust model from the Currency School, Swedish "Austrian" Knut Wicksell’s delineation between bank interest rates and the "natural" rate, and Böhm-Bawerk’s capital and interest theory.

"Mises’s remarkable integration of these previously totally separate analyses showed that any inflationary or created bank credit," wrote Rothbard, "by pumping more money into the economy and by lowering interest rates on business loans below the free market, time-preference level, inevitably caused an excess of malinvestment in capital goods industries remote from the consumer."

Hayek’s ABCT work continued from Mises’s explaining the origin of the business cycle in terms of bank-credit expansion.

Daily Bell: Did John Maynard Keynes know Mises? Keynes knew Hayek, but we wonder if he avoided Mises somehow or was in some way reluctant to engage him.

Douglas French: I can’t find any evidence that Keynes knew Mises personally. But Keynes did review the German version of The Theory of Money and Credit for the Economic Journal and dismissed it as being unoriginal. But as Donald Boudreaux pointed out in a letter to the Wall Street Journal, "in his 1930 book Treatise on Money, [Keynes] confessed that ‘in German, I can only clearly understand what I already know — so that new ideas are apt to be veiled from me by the difficulties of the language.’"

Daily Bell: Were there differences between Hayek and Mises intellectually and otherwise. Was Hayek Mises’ favorite pupil?

Douglas French: Hayek attended Mises’s Private seminar, be he didn’t necessarily consider himself a student of Mises. He wrote in the introduction to Mises’s Memoirs that he was closely associated with Mises. But he came to Mises, "not as a student, but as a fresh Doctor of Law and a civil servant, subordinate to him, at one of those special institutions that had been created to execute the provisions of the peace treaty of St. Germain," Hayek wrote. "The letter of recommendation by my university teacher Friedrich von Wieser, who described me as a highly promising young economist, was met by Mises with a smile and the remark that he had never seen me in his lectures."

Murray writes in Keynes, The Man that Hayek was charmed by Lord Keynes but he didn’t succumb to Keynes’s ideas. However, Hayek never wrote a critique of The General Theory. And Mark Skousen speculates that Hayek backed off of Keynes in the 1940′s, not wanting to interfere with Britain’s financing of the war effort.

So while Hayek may have been politically pragmatic, Mises never was. Mises’s widow Margit described her husband’s character, quoting the words Mises wrote about Benjamin Anderson. "He never yielded. He always freely enunciated what he considered to be true. If he had been prepared to suppress or only soften his criticism of popular, but obnoxious policies, the most influential positions and offices would have been offered to him. But he never compromises."

"Of all the Misesians of the early 1930′s, the only economist completely uninfected by the Keynesian doctrine and personality was Mises himself," Rothbard wrote. "And Mises, in Geneva and then for years in New York without a teaching position, was removed from the influential academic scene."

Hayek was able to secure teaching positions at the London School of Economics and the University of Chicago, and in 1974 was awarded the Nobel Prize. Mises would never secure such positions, was driven from his own country and had to fight for students and a chance to teach at all. While Henry Hazlitt wrote in Barron’s, "If ever a man deserved the Nobel Prize in economics, it is Mises," he of course was never awarded the prize.

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Doug French [send him mail] is president of the Ludwig von Mises Institute and associate editor for Liberty Watch Magazine. He is the author of Early Speculative Bubbles & Increases in the Money Supply. He received the Murray N. Rothbard Award from the Center for Libertarian Studies. See his tribute to Murray Rothbard.

2010 The Daily Bell

The Best of Doug French

by Doug French by Doug French Recently by Doug French: Dollar Meltdown

In his extraordinary book Democracy: The God that Failed, Hans Hermann Hoppe points out that the process of civilization is stopped when government continually violates property rights.

The natural process of civilization comes through delaying consumption, saving, and building capital. Undoing it leads to higher societal time preference.

When natural disasters strike or a gunman robs you in an alley, "the effect of these on time preference is temporary and unsystematic," Hoppe explains.

Victims are entitled to defend themselves against the individual aggressor and prepare themselves for the calamities of the occasional act of God. Resources will be reallocated to defend one against potential robbers, and provisions will be made for potential natural disasters.

However, when government aggresses, it is considered legitimate and "a victim may not legitimately defend himself against such violations." Democracy legitimizes this government aggression because the violence is sanctioned by a majority of voters.

This decivilization process that Hoppe describes continues in fits and starts. The uneducated continue to live in never-never land, believing that each new ruler means change and that their lives and happiness can safely be put in the hands of a kind and caring government. But government’s current ham-handedness — with its bailouts, money printing, and rights violations — has alerted more than a few individuals to do what comes naturally: defend themselves and prepare for the worst.

The government’s legal-tender money — the dollar — is now under questioning. While the commercial-banking fractional-reserve monetary engine is stalled with loan write-downs and bank failures, the Federal Reserve has expanded its balance sheet like never before. Man of the Year Ben Bernanke is deathly afraid of deflation, and John Maynard Keynes is a hero again. The inflation cake is in the oven, albeit not quite fully baked.

And the current administration does not seem friendly to the property right of allowing us to protect ourselves. The president believes that only law-enforcement officers should have weapons.

So while high-time-preference folks like Shannan DeCesare shout "Merry Christmas to me" after unloading some gold jewelry for $610 at a gold party, low-time-preference types are lining up in pawnshops and gun shows to buy gold, silver, lead, and guns.

DeCesare attended a gold party that the Wall Street Journal describes as an example of the new Tupperware party. These parties appeal to the cash-for-gold crowd trying to maintain a boom-time lifestyle by unloading their valuables. The cash poor end up taking between 65 and 75 percent of what their gold would be worth to a refiner according to the WSJ.

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Doug French [send him mail] is president of the Ludwig von Mises Institute and associate editor for Liberty Watch Magazine. He is the author of Early Speculative Bubbles & Increases in the Money Supply. He received the Murray N. Rothbard Award from the Center for Libertarian Studies. See his tribute to Murray Rothbard.

The Best of Doug French

by Doug French by Doug French Recently by Doug French: A Young Champion of Liberty

The current investment climate is more perilous than ever. The Federal Reserve’s balance sheet continues to grow stuffed with the dubious paper purchased from the too-big-to-fail banks that are now wards of the state. The music stopped and there were no chairs, but the Fed and the Treasury snapped their fingers and trillions of dollars later the chairs appeared, the band played on and the banks live on. The taxpayers are now the not-so-proud owners of AIG, General Motors, Fannie and Freddie and dozens of banks. Where did the money come from? Out of thin air.

Every paper currency in history eventually reaches its intrinsic value — zero — and the Fed’s Ben Bernanke is doing all he can to see that the dollar becomes worthless sooner rather than later. As Marc Faber told an investment conference crowd recently, Zimbabwe’s serial inflator Robert Mugabe is Bernanke’s mentor.

Investors live in the here and now. We can’t pick what our investment climate will be. If only we could live our lives with the market deciding what money is and 100-percent reserve banks protected our money on deposit. No such luck. The financial waters are treacherous and we must navigate them.

Charles Goyette provides a roadmap for survival with his newly released book, The Dollar Meltdown: Surviving The Impending Currency Crisis With Gold, Oil, And Other Unconventional Investments. The former Phoenix radio talk-show host has learned from some of the brightest minds in economics and investing. It’s the rare book that engagingly teaches sound economic theory, provides the history of how we got in this mess and then provides solid investment advice that considers the precarious times we live in. As ambitious as this sounds Goyette’s fast-paced book gets it all done.

The author brings the reader up to speed writing about the bailouts and the nation’s debt. After explaining why gold has been the market’s choice for money for thousands of years, he writes about every saver and investor’s nightmare — inflation — using the modern example of Mugabe’s Zimbabwe, a once prosperous nation reduced to a Stone Age economy with the continuous printing of paper money. Everyone is a billionaire but nobody can buy anything.

Goyette looks to Murray Rothbard to explain the history of America’s Federal Reserve and fractional reserve banking, and to Ludwig von Mises to see what the crack-up boom might look like. He makes the poignant point that hyper-inflation is not just something engendered in banana republics. Israel experienced triple-digit price inflation in the late 1970s and early 1980s.

Every once in a while dissatisfaction with the dollar makes the news, most recently with super model Gisele Bündchen demanding to be paid in euros rather than dollars. But the Brazilian bombshell was not the first. Goyette writes that Bette Midler demanded gold Krugerrands to perform overseas in the 1970′s. No doubt the Devine Miss M was influenced by then manager and boyfriend Aaron Russo.

Ultimately inflation leads to a state-controlled economy and America is headed that way, evidenced by Washington picking which businesses survive and which are left to fail, not to mention how much executives — high level and low — can be paid. So what’s a person to do? There is no academic hemming and hawing with Goyette and don’t be looking for stock tips. The author suggests investing in real things and he especially likes the yellow metal. What’s especially valuable is the primer he provides for buying physical gold — something that many people ask about.

All the other ways of investing in gold are addressed along with a separate discussion about silver. Goyette knows the whole energy independence chatter is nonsense and spends a chapter discussing what the world will not be living without in our lifetimes — oil.

Specifics are provided on how to invest in other commodities and what to invest in to take advantage of the coming bond market crash. Goyette’s explanation of how volatility can eat up an investment in leveraged funds is especially helpful as well as his tip about TIPS.

For readers who want more information, the author’s suggested readings at the end of the book will arm investors with ongoing market and economic knowledge.

At the book’s end Goyette’s sadness of America’s loss of liberty is evident. He worries what will become of this country’s prosperity and freedoms. But he doesn’t waste time urging his readers to write their congressmen or elect the right people. It’s too late for that. Protect your assets, get out of the dollar.

Doug French [send him mail] is president of the Ludwig von Mises Institute and associate editor for Liberty Watch Magazine. He is the author of Early Speculative Bubbles & Increases in the Money Supply. He received the Murray N. Rothbard Award from the Center for Libertarian Studies. See his tribute to Murray Rothbard.

The Best of Doug French

by Doug French by Doug French Recently by Doug French: Mass Unemployment in the Name of NormaRae

As the state grows in power and influence seemingly each and every day, those speaking out are few and far between. It’s rarely a good career move. The local worthies don’t embrace the anti-state message. Few employers want the controversy. Seeking and speaking the truth is a lonely existence with benefits that don’t make you rich.

Sadly, the cause of liberty lost one of its promising lights last Thursday. Mike Zigler was found dead at his home the following day after he didn’t show up for work. Zigler who would have turned 30 this December was the editor-in-chief of the UNLV Rebel Yell prior to becoming news editor at CityLife, an alternative weekly publication in Las Vegas. For the past few years Zigler served as the communications director at the MGM Grand and in his spare time was the editor of Liberty Watch—The Magazine.

Mike and I met when he was at CityLife. He was filling in as editor one summer while then-editor Matt O’Brien explored the sewer system under Las Vegas for a book he was writing. Mike had published a column or two of mine and he unsuccessfully pitched the idea of me writing a weekly column for the left-liberal weekly.

We started meeting for lunch talking about whether a libertarian weekly could compete with the two leftist Las Vegas alternate papers whose editorial content was and continues to be constant agitation for more government.

The alternative to the alternative newspapers never materialized, but Liberty Watch—The Magazine did with the help of our friend George Harris. With Mike as editor Liberty Watch was slick, colorful, fast-paced and hated by the guys he left behind at CityLife.

Zigler had a hand in the magazine’s best moments, such as cover stories featuring Hans Hoppe recounting his political correctness harassment at UNLV, Vegas libertarian writer Vin Suprynowicz’s talking about his book The Black Arrow as well as interviews with John Stagliano and Drew Carey.

Being against war, Mike particularly liked running Joe Sobran’s syndicated column in LW, as well as Lew Rockwell’s, plus he was able to round up talented local writers like his friend Jarret Keene to write on Nevada issues. I remember us both being very proud of the September 2007 issue that featured Justin Raimondo on the cover and a short story by Vegas writer H. Lee Barnes.

The Vegas economy took Liberty Watch down like it has so many other businesses. But, Mike managed to produce handsome program editions for the last two FreedomFests. In fact the last time I spoke with him was after this year’s event, where he and Keene gave a presentation on police abuse. He was pleased that they had drawn a good crowd, but he was surprised at how some people unconditionally support the cops no matter what they do. Mike loved LewRockwell.com, read the site daily and had a couple of articles published there. As Las Vegas author John L. Smith wrote on his blog, Zigler was a "gifted writer and critical thinker." The world doesn’t have enough of either, let alone both wrapped into one. I will always remember the laughs we shared and Zig’s enormous talent and wonder what might have been had the heavens let us keep him a while longer.

Doug French [send him mail] is president of the Ludwig von Mises Institute and associate editor for Liberty Watch Magazine. He is the author of Early Speculative Bubbles & Increases in the Money Supply. He received the Murray N. Rothbard Award from the Center for Libertarian Studies. See his tribute to Murray Rothbard.

The Best of Doug French

by Doug French by Doug French Recently by Doug French: Bubble Economics: TheIllusionofWealth

Thirty years ago Sally Field won the Best Actress Academy Award for her gritty portrayal of Norma Rae, a widowed small-town Southern textile-mill worker. Even those who haven’t seen the entire movie have viewed stills or clips of a sweaty Field standing atop a work bench holding over her head a piece of cardboard with UNION written in black letters.

The scene portrayed happened verbatim to the woman who inspired the movie, Crystal Lee Sutton, who acted in defiance after being fired for copying a flyer put up by the mill that claimed black workers would run the union she and labor organizer Eli Zivkovich were agitating for at the J.P. Stevens textile mill in Roanoke Rapids, North Carolina.

Ms. Sutton passed away September 11th, a victim of brain cancer, and union leaders are using her death to rejuvenate interest in the Employee Free Choice Act (EFCA). As membership in unions has plummeted in the last half century from over 35 percent of all workers in 1945 to just over 12 percent currently — and only 7.6 percent if government workers aren’t included — labor leaders view EFCA as the magic bullet to increase union membership and, in turn, union political influence.

The EFCA is sometimes referred to in the press as the "card-check" bill because a key provision would do away with the requirement that the employees elect a union as their bargaining agent by way of a secret-ballot election. Instead, if a union is just able to obtain signatures on authorization cards from a majority of employees, EFCA would require that the union be certified by the National Labor Relations Board (NLRB).

Unions of course can (and do) harass employees at all hours of the day and night, coercing them to sign certification cards. A frightened employee who just wants to work and be left alone, will vote much differently if given the opportunity to cast a ballot in secret as opposed to having two thugs at his or her door late at night.

The card-check provision of the act has been a lightning rod for discussion on right-wing radio and TV, and Investor’s Business Daily reports that the Senate is proposing a compromise deal that would gut the card-check provision but still "meet labor’s objectives."

Senator Arlen Specter, D-Pa, who desperately needs union support come election time, says EFCA can’t pass with card check included. But Specter’s deal "would amend labor law by requiring: faster secret ballot elections in organizing workplaces; tougher penalties for firing organizers; giving unions equal access to workplaces if businesses hold mandatory meetings on union elections; and binding, baseball-style arbitration when newly organized unions and employers can’t agree on a contract," IBD reports.

Although union brass are insisting publicly that the card check must be included, labor experts know that the binding arbitration provision in the EFCA is far more damaging to employers and, in turn, to employment. It requires that the government step in after 90 days and bring the employer and the union together if a contract has not been finalized. The government would assign an arbitrator who would impose wage and benefit terms for the company for the next two years.

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Doug French [send him mail] is president of the Ludwig von Mises Institute and associate editor for Liberty Watch Magazine. He is the author of Early Speculative Bubbles & Increases in the Money Supply. He received the Murray N. Rothbard Award from the Center for Libertarian Studies. See his tribute to Murray Rothbard.

The Best of Doug French

by Doug French by Doug French Recently by Doug French: You Can’t Print Production andProsperity

The economic position that the United States is now in is the result of a series of economic bubbles. To explain the nature of bubbles, I’m going to start by talking about their history; I’m not going to go all the way back to Tulip Mania and John Law, but I do want to mention some things from the Roaring Twenties that might sound familiar to us today.

Over the eight-year period of that boom, the money supply increased by 62 percent. All kinds of new appliances and gadgets were sold: refrigerators, phonographs, electric irons, toasters, and vacuum cleaners. Many more cars were built — more than twice as many in 1929 than in 1919. More and more leisure activities became popular. More hotels were built, as were more roadside diners. There was an explosion of movie theaters, and of developments in Hollywood. Professional sports became a big business. Skyscrapers such as the Chrysler Building and the Empire State Building were started. There was a speculative boom in Florida real estate. The stock market boomed. Hoover promised a chicken in every pot. I don’t know what Obama’s going to promise — maybe pot in every kitchen.

I always talk about the economics of booms and bubbles in the framework that Murray Rothbard outlined in his great book, What Has Government Done To Our Money. He points out that inflation confers no general social benefit. Just creating more money does not create more benefit for the general public. It merely redistributes wealth to the first people to receive the new money.

Since 1998, the money supply (as measured by M2) has doubled. In fact, it has increased elevenfold since 1971, when we gave up the last ties of the gold standard. So we have an expansion in the money supply now that is similar to what we had during the Roaring Twenties. We also have a series of bubbles: a tech bubble, then a real-estate bubble — all part of what Bill Fleckenstein calls “Operation Enduring Bubble.” Of course, inflation and the resulting bubbles have disastrous economic effects. But in Human Action, Mises wrote that

The boom produces impoverishment. But still more disastrous are its moral ravages. It makes people despondent and dispirited. The more optimistic they were under the illusory prosperity of the boom, the greater is their despair and their feeling of frustration. The individual is always ready to ascribe his good luck to his own efficiency and to take it as a well-deserved reward for his talent, application, and probity. But reverses of fortune he always charges to other people, and most of all to the absurdity of social and political institutions. He does not blame the authorities for having fostered the boom. He reviles them for the inevitable collapse.

That is exactly what most people are doing today. They’re blaming Wall Street. Everyone congratulated themselves when their homes were doubling in value. Everybody thought they were smart to pick those stocks in their 401(k) plans. But now that the bubble has popped, it’s all Wall Street’s fault.

I spent 22 years in banking in Las Vegas — I guess that means I was somewhat in the bubble business myself. There was a couple in Las Vegas: the gentleman was a house painter and his wife was a hairdresser. One day, a lady came in to get her hair done. The hairdresser mentioned to her, “Gee, you know, I’m really interested in getting into real estate.” This was 2004, at the height of the real-estate bubble in Vegas.

Well, the woman getting her hair done said, “Boy, have I got the person for you. My husband’s a realtor, and he’s a mortgage broker; he can find you tenants; he can do the whole thing, soup to nuts.” The painter and the hairdresser had a combined income of $60,000. Nonetheless, they felt at the time that they were capable of buying seven homes. Of course, the guy who was a real-estate salesman and a mortgage broker found them not only one no-money-down loan; he found them seven no-money-down loans. And it just so happens that the broker’s wife was also a mortgage-loan processor. It really was a one-stop shop.

So the painter and the hairdresser bought the seven houses, taking on a debt of $2.6 million. And the real-estate broker said, “You know, you’ve made a great investment because, based on my calculations about where real estate’s going to go in Las Vegas, within five years you’re going to have home equity of $1.3 million.” Well, you already know how this turns out.

Their monthly debt payment was $5,772. If you take their $60,000, and divide it by 12, you get $5,000; so their payments were more than their gross income between the two of them. So they took on $2.6 million worth of debt, with the hopes that the properties would be worth $4.4 million within a couple of years. That assumption meant that the price of those seven homes had to reach $286 per square foot. Now, I can tell you that those homes in Vegas today are selling for less than $86 a square foot.

You might think that, in the end, these folks just filed bankruptcy, and learned a lesson — “Well, I guess we aren’t as smart as we thought we were.” No. They sued. They sued the realtor, who was of course the mortgage broker, whose wife was the mortgage-loan processor.

That story really captures what Mises was talking about in Human Action. In a boom, when it’s going well, we all feel really smart; we believe that all the good things that seem to be happening are our own doing. Then, afterwards, when things don’t work out, we blame it all on other people.

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Doug French [send him mail] is president of the Ludwig von Mises Institute and associate editor for Liberty Watch Magazine. He is the author of Early Speculative Bubbles & Increases in the Money Supply. He received the Murray N. Rothbard Award from the Center for Libertarian Studies. See his tribute to Murray Rothbard.

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by Doug French by Doug French Recently by Doug French: P.I.G. Tales

It’s hard to imagine that the monetary policy talk can get any nuttier, but we’ve likely only just begun. After all, despite the Federal Reserve growing its balance sheet by 140 percent and dropping rates essentially to zero, the bankruptcies just keep on coming. Ex-Fed governor Wayne Angell told Larry Kudlow’s CNBC audience, "monetary policy always works!" Although Angell does stipulate that it takes time before the tromping on the monetary gas pedal will spin the economic tires and spray the prosperity gravel.

But good grief, the Fed started cutting rates in September 2007, dropping the federal-funds rate from 5.25 percent to 4.75 percent, and it was cut, cut, cut until daddy set the target rate at 0 to .25 percent in December of last year. In the meantime, one trillion dollars has been added to the M-2 money supply.

Despite all this money creation, Circuit City, Sharper Image, Goody’s, Gottschalk’s, Comp USA, Levitz Furniture, Chrysler, General Motors, General Properties, and — most recently — Eddie Bauer have filed for bankruptcy protection. And personal bankruptcy filings are up in every state and soaring in Nevada, Georgia, Alabama, Tennessee, Indiana, and Michigan.

In May, forty-eight states had more people out of work than in the previous month or year, with the national unemployment rate increasing from 8.9 percent to 9.4 percent. Moreover, California, Nevada, North Carolina, Oregon, Rhode Island, and South Carolina had their highest rates of unemployment on record. Maybe Mr. Angell will change his mind when he gets laid off. Just how long are we supposed to wait for this monetary magic to work?

Now the word is that zero-percent interest rates are just too darn high. That’s why we haven’t seen a reinflation of bubble America. The Financial Times reports the existence of a Federal Reserve staff memorandum that makes the case for a negative-five-percent federal-funds rate. Meanwhile, Japanese authorities are toying with the idea of outlawing cash in their country. Despite using every fiscal trick in the book and keeping interest rates at zero percent for a decade, that economy has been mired in a postbubble depression. So the current theory "would suggest that nominal interest rates of [negative four] percent might be closer to what is required to rescue the economy from another deflationary spiral," reported the Times Online.

The talking heads and policy wonks are trying to tell us that we’re not borrowing enough, and that’s why we’re in a depression and why the Japanese economy has been depressed for more than a decade.

However, the real reason we’re in a depression is because businesses and individuals borrowed too much and invested it poorly. Economist Murray Rothbard explained that a depression is the recovery stage: "The liquidation of unsound businesses, the ‘idle capacity’ of the malinvested plant, and the ‘frictional’ unemployment of original factors that must suddenly and en masse shift to lower stages of production — these are the chief hallmarks of the depression stage."

That’s why monetary policy isn’t working and won’t work. People must save and pay off their debts. The malinvestments of the boom must be liquidated. New liquidity and zero-percent interest rates will only create new malinvestments, not a sound economy.

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But you won’t hear that on TV or read it in the New York Times. The Nobel Prize—winning economist and Gray Lady columnist Paul Krugman is now worried about the "paradox of thrift," the theory that, when consumers save too much en masse, the economy is worse off because there is not enough consumption.

But as economist Frank Shostak explains, it is savings — not demand — that enables the expansion of production of goods and services. "In short, no effective demand can take place without prior production," Shostak writes. "If it were otherwise, then poverty in the world would have been eradicated a long time ago." In other words, you can’t print production and prosperity, much as the Fed may try. And Ben Bernanke is trying.

For those not familiar with Krugman’s policy suggestions, he wrote back in August 2002 that "[t]o fight this recession, the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble."

Sir Alan followed Krugman’s advice, and look where we are now. More of the same will only create more financial pain.

This article originally appeared on Mises.org.

Doug French [send him mail] is president of the Ludwig von Mises Institute and associate editor for Liberty Watch Magazine. He is the author of Early Speculative Bubbles & Increases in the Money Supply. He received the Murray N. Rothbard Award from the Center for Libertarian Studies. See his tribute to Murray Rothbard.

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by Doug French by Doug French Recently by Doug French: War Eagle Condo Bust

It’s been famously said that the definition of insanity is to do the same thing over and over again and expect different results. Of course, if it’s the government and their cheerleaders, they just bend the truth to suit their purposes at best or just plain old lie about the results at worst. And now that the economy is experiencing the bust end of the boom-and-bust cycle, just like America in the 1930s, the folks in Washington and their propagandists yakking on CNBC and scribbling for the New York Times are preaching “mo money and mo government” as the prescription to get us out of this funk.

You know the history: Mr. Laissez-faire Herbert Hoover wouldn’t lift a government finger to aid the collapsed economy and it took the heroic Franklin Delano Roosevelt and his massive increase in government to make the Great Depression finally go away. As the story goes, thank goodness that the United States was provoked into World War II, otherwise America might have never got its economic mojo back. Oh and there’s that bit about the Federal Reserve being too tight with money, leading current Fed Chief Ben Bernanke to apologize to economist Milton Friedman saying the Fed would never let it happen again.

So, if it worked (but maybe a little too slow) last time, the guys and dolls at the Treasury, the Fed, and the White House figure they better throw the whole government kitchen sink at this economic problem pronto. After all, the new administration wants to make universal healthcare happen along with cap-’n-trade and who knows what all. Obama doesn’t have time for a depression right now — he’s got teleprompters to read and places to be worshiped.

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Of course, this is all nonsense, as Robert Murphy explains in his new book The Politically Incorrect Guide to The Great Depression and the New Deal. Hoover wasn’t a devotee of free markets and small government. FDR’s policies extended the depression and made it worse — and there is no such thing as wartime prosperity.

Like all books in the P.I.G. series, this edition is very easy to read with plenty of sidebars, suggested reading selections, along with schedules and graphs. The author is a rising star in the economic profession and a talented teacher. He knows how to present information to the modern reader. But at the same time, this is not lightweight stuff. Murphy takes dead aim at 2008 Nobel Prize winner Paul Krugman who preaches to the big-government faithful from his Gray Lady pulpit each week. In a December 2008 column, Krugman wrote that the Hoover administration “tried to balance its budget in the face of a severe recession.” But the real story is that Hoover ran a $2.6 billion deficit, which doesn’t sound like much except as Murphy explains,

For comparison, in FY 2007 the federal government would have needed to run a deficit of $3.3 trillion — rather than the actual deficit of $162 billion — to achieve the same proportion of overspending as Hoover did in his allegedly tight-fisted year.

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Just as with the case illustrated above, the bulk of the book is a one-by-one debunking of each and every myth we’ve been taught about the Depression and FDR’s New Deal. But there is some great economic theory in Murphy’s book as well. We are constantly barraged with the notion that a little bit of inflation is OK, and a lot of inflation is bad, but that deflation is catastrophic. It is the opposite that is true.

Deflation is fine: prices fall, money buys more, and more goods become available to more people. Living standards are raised. People will save more if there is deflation, making more capital available for entrepreneurs to make more products. And Murphy explains that entrepreneurs will continue to produce even in a falling-rate environment, pointing out that Henry Ford’s Model T sold for $600 in 1912 and only $240 by the mid-1920s, and Henry was doing just fine as more and more consumers could buy his product.

However, there are only inflationists on Capital Hill and Obama has a bigger bag of boondoggles than FDR could have ever imagined. Reading about Hoover’s and FDR’s mistakes and the coming Obama miscues won’t make the economy any better and may not make you feel better. But at least you’ll know why this depression will last a long time.

This article originally appeared on Mises.org.

Doug French [send him mail] is president of the Ludwig von Mises Institute and associate editor for Liberty Watch Magazine. He is the author of Early Speculative Bubbles & Increases in the Money Supply. He received the Murray N. Rothbard Award from the Center for Libertarian Studies. See his tribute to Murray Rothbard.

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by Doug French by Doug French Recently by Doug French: Bankruptcies Are Good News

Back in the middle of this decade, building anything seemed like a good idea. With the housing boom in full bloom, developers had the imagination, lenders had the construction money, and buyers had swarms of mortgage lenders panting to lend them the entire purchase price of anything their hearts desired. So imagine the confluence of combining Auburn Tigers football and real estate: a certain touchdown.

After all, the much-loved Tigers were undefeated in 2004 under the guidance of revered coach Tommy Tuberville and were ranked second in polls at season end. The 87,451 seats at Jordan-Hare Stadium would never go wanting on game day and what every red-blooded Auburn fan of means couldn’t live without was a game-day condo. Heck people would buy units just to have a parking place on game days when the population of Auburn more than doubles.

But by the summer of ’07, even with Tiger football still in a bull market after an 11—2 season, the real estate bubble was starting to lose air, just as the Tiger football suites project was being completed. The 73-unit complex is just a short walk from Jordan-Hare Stadium, with many of the units having balconies that face that direction. And if you couldn’t see the stadium from your unit, you surely would have a great view of the water tower across the street. Units facing north looked down upon the adjacent railroad tracks, and for those who enjoy the rumbling sound of a passing train what could be better than sleeping right next to the tracks?

But now two years later, Coach Tuberville is unemployed and Auburn football is rebuilding after a losing season. The real estate bubble has completely popped, so the 49 remaining unsold units at the football suites were put up for auction last week in what was dubbed the "WAR AUCTION!" in the auctioneer’s brochure. "It’s the Ultimate War Eagle Condo Auction and it’s Available for One Day Only!"

With an attempt to muster all the luck possible, the sellers scheduled the auction to start at 11:07am and about 80 folks here there when the auctioneer started the proceedings with a prayer. He asked the Lord "to be especially with the seller…oh, and the buyers as well."

But lucky numbers are no match for this market, and the requested divine intervention was not to be. Twelve of the 49 units were to be sold absolute, regardless of price. These 12 were auctioned first — presumably to build momentum and get the crowd revved up to bid more on the reserved-price units.

But there was no momentum to be had. The first unit up for bid was the two bedroom deluxe unit measuring 1,200 square feet. The auctioneer called for initial bids of $300,000 after all, the original asking price was $389,885. Despite aggressive urging by the auctioneer floor staff, there were no bids until someone up front shouted "$70,000!" The auctioneers collectively scoffed, and quickly moved on when $100,000 was offered. The 2bd deluxe finally went for $260,000 or 33 percent less than the original asking price.

It was all downhill from there. The next 2bd deluxe went for $245,000. Four of the 861sf, 2bd lockout units were sold absolute for between $125,000 and $135,000, less than half the original $279,885 asking price. Four of the spacious 894sf, 1bd deluxe units were sold for $105,000, a more than 60 percent haircut from the original $279,075 price. Finally, after a train appropriately rumbled by at 11:45, a 768sf one bedroom unit went for $70,000 and $63,000 was fetched for a 581sf studio suite, roughly a third the original prices of $210,075 and $188,825, respectively.

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When only $200,000 was the highest bid on the 2bd deluxe unit that was being auctioned with a reserve, and with most of the crowd gone, the auction was stopped. The absolute bid prices received were just too low and there was no sense going on was the word. But anyone who wanted to make a "reasonable offer" was invited to stick around and negotiate a price on the unit they wanted.

Of course the prices offered during the bidding were reasonable. As Bart Fuller wrote in a Mises.org Daily article: "The beauty of an auction is that it’s a very clear and simple example of what goes on every day in a free market — buyers and sellers meeting to negotiate a price." In the case of an absolute auction, that doesn’t mean the seller (or the seller’s lender) is going to like the price. If in two years time the seller can’t sell the units for what the seller wants, obviously what the seller considers a reasonable price is higher than what buyers consider to be reasonable.

Ironically, the War Auction bust comes less than three weeks after the US News and World Report selected Auburn as the second best place in America to live. "For Southern charm with collegiate vigor, consider Auburn, Ala.," writes Luke Mullins. "On football Saturdays, when die-hard fans arrive in droves to cheer their beloved Tigers, Auburn swells to the state’s fifth-most-populous city." But a US News and World Report endorsement doesn’t sell units in this market.

Auburn fans are counting on new coach Gene Chizik to quickly turn their team’s fortunes around. At the same time, the developer of football suites is hoping the real estate market quickly turns around. Neither has a prayer.

Doug French [send him mail] is president of the Ludwig von Mises Institute and associate editor for Liberty Watch Magazine. He is the author of Early Speculative Bubbles & Increases in the Money Supply. He received the Murray N. Rothbard Award from the Center for Libertarian Studies. See his tribute to Murray Rothbard.

Doug French Archives

by Doug French by Doug French

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There is an epidemic of bankruptcies: Circuit City, Sharper Image, Goody’s, Gottschalk’s, Comp USA, Levitz Furniture, Chrysler, GM. Not to mention all the local businesses that don’t make the news when they close up shop. And the rash of corporate bustouts is far from over according to consulting firm Bain & Company, who predicts nearly 100 large ($100 million or more in assets) corporate bankruptcies by next year.

We’re in a period of severe losses — a cluster of errors, as Murray Rothbard described it — with thirty-seven banks having failed already this year, and many more to come.

But as gruesome as the economic news sounds, Rothbard explained that this is the recovery.

The liquidation of unsound businesses, the "idle capacity" of the malinvested plant, and the "frictional" unemployment of original factors that must suddenly and en masse shift to lower stages of production — these are the chief hallmarks of the depression stage.

Many would like the boom to continue "where the inflationary gains are visible and the losses hidden and obscure," Rothbard wrote. "This boom euphoria is heightened by the capital consumption that inflation promotes through illusory accounting profits."

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But the boom is where the trouble happens — when resources are directed into malinvestments and distortions occur — and trouble we’ve had this past decade with a Capital T. The M-2 money supply increased 53% since year 2001, while at the same time total bank loans doubled and bank real-estate loans increased over 150%. The mistakes of bad entrepreneurs have been hidden, employment was directed to wasteful and unneeded occupations, unsound projects were built and business risk was ignored.

"The boom produces impoverishment," wrote Ludwig von Mises in Human Action.

But still more disastrous are the moral ravages. It makes people despondent and dispirited. The more optimistic they were under the illusory prosperity of the boom, the greater is their despair and their feeling of frustration. The individual is always ready to ascribe his good luck to his own efficiency and to take it as a well-deserved reward for his talent, application and probity. But reverses of fortune he always charges to other people, and most of all to the absurdity of social and political institutions. He does not blame the authorities for having fostered the boom. He reviles them for the inevitable collapse.

Many bankers continue to contend that their banks are sound, protesting that they didn’t make any subprime loans like those big Wall Street banks. But the cluster of errors doesn’t contain itself to one asset. Houses don’t suddenly appear. First, land is purchased. Then that land must be entitled — permission from local government must be obtained to build what the owner wants on the property. This is a lengthy process than can in the best case take months and in the worst cases take decades. Infrastructure improvements are then made and finally houses can be constructed.

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So, low interest rates spur consumers and investors to buy houses — in some cases creating housing shortages and exploding prices, which, in turn, cause developers to buy land and begin the lengthy development process just described. After money supply increases by way of credit expansion, businesses malinvest by "overinvesting in higher-stage and durable production processes," Rothbard explained in Man, Economy and State.

Real-estate developers by and large use debt financing every step of the way from when they buy the land to when they start construction. In the past, banks traditionally shied away from making land loans. But as the market overheated, more and more banks got in the land-loan business. Land lending is inherently risky because land doesn’t produce income and gaining government approvals in a timely manner is often problematic: land is many months from being converted to a use that is salable to the typical consumer. Lending for the construction is the least risky, but still the homes must be sold to pay off the loan.

Guaranty Bank of Austin recently demolished 16 new and partially built homes in Victorville, California. The cost of finishing the development exceeded what they could sell the homes for despite four of the homes already being complete. In early 2008, these homes were selling for $280,000 to $350,000 in the bedroom community 50 miles from LA.

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Doug French [send him mail] is president of the Ludwig von Mises Institute and associate editor for Liberty Watch Magazine. He is the author of Early Speculative Bubbles & Increases in the Money Supply. He received the Murray N. Rothbard Award from the Center for Libertarian Studies. See his tribute to Murray Rothbard.

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by Doug French by Doug French

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It’s widely acknowledged that hundreds if not thousands of banks are on the ropes and just waiting for regulators to wrap them in yellow tape some Friday evening. However, fewer than forty US banks have been seized this year. The Federal Deposit Insurance Corporation (FDIC) list of problem banks grew to 305 in the first quarter, the highest number since 1994, but of course the names of those banks are not released so that depositors can be forewarned.

The assets of those troubled banks total $220 billion, while the FDIC’s deposit-insurance fund has fallen to $13 billion. Not to fear: the Treasury Department tripled the FDIC’s line of credit to $100 billion in preparation for more losses. So, including the line of credit from taxpayers, the FDIC has just over two cents of reserves to cover each dollar it is insuring.

Sure, the FDIC is not yet staffed up to close down the sick banks as fast as they would like to, but how do these banks remain liquid enough to keep operating? After all, savvy customers surely must study bank balance sheets and income statements to know where to safely place their funds. Doesn’t the average bank depositor know the loan portfolio concentrations and past-due loan balances of their friendly neighborhood bank, only placing their funds in the safest of banks, leaving the worst banks to quickly run out of money and fail? Perhaps the most naive believe that.

Bernard Condon’s "The Reverse Bank Run" article on Forbes.com explains that with increased FDIC deposit-insurance limits in place (up to $250,000 for interest-bearing deposit accounts),

Americans seeking high yields on their money are causing deposits at struggling banks to mount in seeming lockstep with their troubles. The result is that banks that should fail are sticking around longer, making the cleanup when they do more costly.

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There is no incentive for bank depositors to go to the trouble of determining a bank’s soundness if the government is going to guarantee deposits. Not to mention that most folks aren’t equipped for the job anyway. On the other hand, if a legitimate banking system were in place, it would be based upon honoring property rights. Customers making a deposit in a bank expect the bank to guard, protect, and return their money — at a moment’s notice in the case of demand deposits. After all, that person has not traded a present good for a future good. The depositors believe the bank is warehousing the money for them and that it is available to them at any time. This deposit is not a loan — there is no fixed term, which would be required in the case of a loan — and availability hasn’t transferred.

However, we don’t have legitimate deposit banking but a fractionalized banking system that combines deposit banking with loan banking. Those that sympathize with fractionalized banking will contend that time certificate of deposit accounts are in essence loans from depositors, entitling the bankers to use the funds at their discretion for the term of the CD — just as long as the banker has the money ready when the CD matures. But if the money is lent secured by illiquid assets such as real estate, the banker is clearly not counting on those loans to satisfy expiring CDs and must count on attracting new CD money to pay off the old.

Bankers, pressured to earn returns for shareholders and protected from bank runs by FDIC insurance, have over time lent not only more of their deposits but advanced the money for riskier projects. James Grant in a recent Grant’s Interest Rate Observer reminisced about National City Bank, which back in 1954 had only lent out 41 percent of its deposits, with less than one percent of the portfolio being real-estate loans.

By the end of last year, the total loan-to-deposit ratio for all US banks and thrifts was 87 percent, and 60 percent of all loans were classified as real-estate secured.

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Doug French [send him mail] is president of the Ludwig von Mises Institute and associate editor for Liberty Watch Magazine. He is the author of Early Speculative Bubbles & Increases in the Money Supply. He received the Murray N. Rothbard Award from the Center for Libertarian Studies. See his tribute to Murray Rothbard.

Doug French Archives

by Doug French by Doug French

Strip clubs are the ultimate boom time creation. After all, the business model rests on masses of men overpaying for cocktails while overpaying lithesome young women to bump and grind on their laps — all of this after paying an exorbitant charge just to enter the building.

Prior to the great boom of the past decade the jiggle business was localized. Politically unpopular, zoning for such establishments is confined to industrial areas, tucked away from mom and the kids. Financing to build such businesses was hard to come by as many bank boards frowned upon the morals of the operation, turning a blind eye to the abundant cash flows. Publically traded strip club operators were unheard of.

Of course given their unpopularity with local do-gooders, entrepreneurs who are able to open an adult business become ongoing targets for extortion by local politicians. Since the government tightly controls how many can open and the rules when they do, adult business owners are often forced to bribe city officials first to gain approvals to open their businesses, and then to remain open.

Such was the case in one of the most fertile fields for the stripping business, Las Vegas. As home equity rich Americans were flooding Sin City after the shock of 9/11 wore off and Federal Reserve liquidity was making testosterone-filled young men feel like the good times would never end and money was for wasting, strip club owner Mike Galardi operated a small hole-in-the-wall money machine called Cheetahs. But with the town booming, he wanted to expand his feline-themed empire. But he wasn’t the only one. Everyone wanted to build a big club in Las Vegas. Convention traffic was soaring, gaming win was growing by leaps and bounds and more casino properties were planned for the Strip. Las Vegas was just getting started and the big-box strip club race was on. The 70,000 square foot Sapphire Gentlemen’s Club was underway right behind Circus Circus, as was the large, ornate Treasures located across I-15 from Palace Station. So many others were trying to open clubs that a moratorium was placed on new applications.

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With approvals for his 25,000 square foot Jaguars club hard to obtain, Galardi made a few hundred thousand dollars in gifts and cash payments to county commissioners to get Jaguars started and keep county inspectors off his back. Ultimately three Clark County commissioners, as well as Galardi, would go to prison in a political corruption case known as G-Sting.

Of course Galardi was only doing what he had to do. In his book, The Ethics of Liberty, Murray Rothbard explained that there “is nothing illegitimate about the briber, but there is much that is illegitimate about the bribee, the taker of the bribe. Legally, there should be a property right to pay a bribe, but not to take one.”

Former Galardi employee and friend Rich Buonantony told the San Diego Union-Tribune newspaper. “[Galardi] was giving hundreds of thousands of dollars, and do you think it was easy to remember giving five grand here and 10 grand there? It was nothing for him to give money. People looked at Mike Galardi like he was an ATM machine.” Those "people" Bounantony referred to were politicians.

But now that the boom has turned bust, business has flattened for strip clubs. The 25,000 square foot club that forever changed the lives of Galardi and three commissioners is now owned by the publically traded Rick’s Cabaret International Inc. Eric Langan, the man who took over Rick’s in 1998, ramped up the company’s growth in 2005 and now it owns 19 clubs around the country. Quite a story for a guy who sold his baseball card collection to finance his first club, "I just jumped in," says Langan. "With cold beer and some naked girls, it’s pretty easy to make money."

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With that initial $24,000 investment, Langan’s first club measured 1,600 square feet. Now, as he told BBook.com, some of his clubs have dressing room areas measuring more than three times that space. Back in 1999 Rick’s was trading for less than a buck a share on NASDAQ but by December of 2007, with his shares trading for $27 — more than the price of a lap dance — Langan’s goal became to own 50 clubs in three to five years. He bought a 47,000 square foot club in Miami for $25 million, a 25,000 square foot Dallas club for $9.5 million and he paid $18.7 million for the former Jaguars in Las Vegas. Rick’s balance sheet is now showing the strain. At September 30, 2006, liabilities totaled less than $17 million. Now with business sagging along with the asset values of the clubs, the company’s debts have soared to almost $72 million.

And the company has encountered expenses that Langan likely didn’t include in his pro forma when analyzing his company’s Las Vegas purchase. Cab drivers in Sin City have always collected bounties for delivering passengers to various businesses — especially strip clubs. But the price has soared in recent months as business has soured.

When a lot of loose cash is floating around, lawyers start taking interest. Attorney Al Marquis has filed a lawsuit to stop cabbies from being paid for delivering customers, thinking that it’s bad for Vegas. "The problem with paying for the delivery of customers is that it’s been escalating in recent years. It has begun to substantially alter the conduct of lots of different parties from hosts and doormen at casinos; to individual cab and limo drivers; to tourists getting diverted over their objection."

To regain market share Rick’s Las Vegas hiked cabbie payouts to $100 per head which led to an increase in monthly sales to $1.9 million in April, according to the Wall Street Journal. However, $1 million of that went to cabbies and the club lost money for the month. "You gotta remember, in our industry it’s all about the girls. So he who has the girls has the customers, and he who has the customers has the girls," Lagan philosophized during a recent investor conference call. "So it’s really a chicken and egg and which came first. The trick is keeping the girls and the customers on a platform…. The guys will always go where the girls are."

What Lagan didn’t say is that the girls are important because they pay to work. So, beyond the drinks and the cover charges and in some cases expensive meals, strip club cash flow depends first and foremost on entertainers paying to entertain. Back in the Las Vegas boom days it was $50 per shift (depending upon the time of day) and $75 or $100 during convention weeks. On top of that, dancers are expected to tip the disc jockeys, floormen and house mothers.

But the current bust means too many dances are chasing too few laps in too much square footage. "For an industry often thought to be recession proof," the WSJ’s Kris Hudson writes, "the transition has been sobering." Rick’s stock is trading below $7 and publiclytraded rival VCG Holding Corp. is trading at $2.40, a decline of 83% from its peak. And investors are not the only ones getting hammered by the softness in the bump and grind industry. The entertainers themselves are shaking their moneymakers for much less these days. Buffy, who plies her trade at Rick’s in Las Vegas told the WSJ that she is making only a quarter of what she did during the boom. However, that beats the mortgage business for Sara, who gave up making loans in the bay area, for stimulating conventioneers in her g-string at the Sapphire Gentlemen’s Club. Reportedly, "a laid-off paralegal, a laid-off fashion designer, a Bank of America banker, a former paralegal and two Los Angles real estate agents" have changed careers despite the lower returns to be had working in 8-inch heels. However, anyone who has spent time in strip clubs will tell you that obtaining reliable personal information from entertainers is problematic.

The overexpansion of the strip club business is yet another malinvestment created by the Federal Reserve’s monetary creation. As F.A. Hayek has explained, profits made through stock market or real estate appreciation in terms of money, "which do not correspond to any proportional increase of capital beyond the amount which is required to reproduce the equivalent of current income, are not income, and their use for consumption purposes must lead to a destruction of capital."

The wealth that strip club patrons and strip club moguls thought they had to throw around was but an illusion and the reality is sobering for the entertainers, cabbies, politicians and others that have been riding the strip club boom.

Doug French [send him mail] is president of the Ludwig von Mises Institute and associate editor for Liberty Watch Magazine. He is the author of Early Speculative Bubbles & Increases in the Money Supply. He received the Murray N. Rothbard Award from the Center for Libertarian Studies. See his tribute to Murray Rothbard.

Doug French Archives

Hope is everywhere this spring despite the awful economic numbers. The corner of Washington DC & Wall Street and its cheerleaders on CNBC have their noses stuck in Norman Vincent Peale’s The Power of Positive Thinking. No matter how dreadful the smoothed and sanitized government statistics are when released, instead of bombshells, these stats become mustard seeds and green shoots in the hands of the alchemists in the financial press.

"You’ve got to accentuate the positive" Johnny Mercer famously wrote and sang back in the ’40s. But for the reported 539,000 who lost their jobs in April it will be hard to keep their chins up. Meantime, the Dow soared on the news because after all the number crunchers had guessed the payroll number to be down more like 600,000. Never mind that the government signed on 72,000 warm bodies last month to do the upcoming census. Oh and that birth/death ratio added a few "jobs," otherwise the payroll number that the Squawk Box crew waits so breathlessly for would have been close to down 700,000. "Eliminate the negative and latch on to the affirmative. Don’t mess with Mister In-Between."

"Celebration in recession" wrote The Economist of this year’s Run for the Roses. The Kentucky Derby is America’s race and signals the arrival of spring and renewal each year. The sport of horse racing rarely takes a day off, but it is only on the first Saturday in May that the average American watches a race — 14 million according to the CNBC special "Run For the Roses." For those of us who have spent way too many afternoons at the track or in Las Vegas racebooks "the greatest two minutes in sports" is simply: Churchill Downs, Race 11. Long lines at the betting windows filled with people who have never bet a race. As annoying as the tipsy one-night-a-year drinkers are to the hardened lush on New Year’s Eve.

After being one of America’s top three sports back in the 1950′s, horseracing as a spectator sport has dwindled to virtually nothing. Sure, 154,000 showed up in Louisville to watch 19 three-year-olds tromp through the mud in search of racing immortality. But as Melissa Francis pointed out during the CNBC special only two or three thousand show up in person for a typical race day at any given track around the country.

The crowds for Derby Day at Churchill Downs and opening day at southern California’s Del Mar look like country club beauty pageants, with mint julep-sipping society women showing off the work of their personal trainers clad in sun dresses and topped with ostentatious hats. At tracks like Turf Paradise in Phoenix, the tiny crowds are dominated by t-shirted would-be wise guys with cigarette packs rolled up in their sleeves.

But as a betting sport, horseracing is far from dead. While much more is bet on Wall Street, $15 billion a year is still wagered on the short-term futures of four-legged animals. The computer age and simulcast has made it easy. No trip to the track required. For those who have no idea what horse to bet on the horses are numbered for your convenience: you can make it a numerological exercise. Every horse has a clever name: you can handicap playing the name game. For those who like others to tell them how to lose their money there is no end to the opinions that are for sale.

But of course the hard-core horse players, the do it yourselfers, analyze the horses’ past performances in the Daily Racing Form, and make their educated selections based upon any number of strategies they’ve learned from reading any one of the hundreds of books on horserace handicapping or systems they’ve made up themselves. The fact is it all amounts to a wild-ass guess. In the case of the Derby, a person is wagering on the performance of three-year old horses — the equivalent of teenagers.

Breeding thoroughbreds is a huge gamble in itself, and a $4 billion business to boot. There are 40,000 thoroughbreds brought into the world each year and just over half will ever race. But breeding money follows bloodlines and past performance. So Derby winners command big stud fees. You won’t see many Derby winners racing into old age, at least not in the bubble economy when they could command $200,000 in stud fees. The owners of last year’s Derby winner Big Brown had their eyes on 100—120 mares a year at 200 grand a pop, until Big came up last in the Belmont Stakes and the economy sputtered. Now he commands a not-so-studly $65,000 per mare.

Thoroughbreds are made to run, weighing more than half a ton on long spindly legs. They can reach 40 mph and accidents happen. Barbaro won the Derby in 2006 and many thought he would be a Triple Crown winner. Instead he shattered a leg in his very next race and after many heroic attempts to save him, he was eventually put down. Last year, filly Eight Belles gamely took on the boys and finished second to Big Brown, only to snap both her front ankles just beyond the finish line and had to be euthanized in front of the stunned capacity Churchill Downs crowd.

But if horseracing means anything it is hope. And this year hope arrived in the form of a little $9,500 colt that was shipped in from New Mexico by the name of Mine That Bird. None of Mine That Bird’s connections thought he had much of a chance. Co-breeder Peter Lamantia even talked a friend out of betting $100 on the horse to win. "I cost her $5,000," Lamantia told the DRF, "Not for the life of me did I think he could win."

Indeed, when jockey Calvin Borel charged up the rail on Mine That Bird, blowing by the rest of the field, very few held winning tickets. The game colt went off at 50-1 and pulled off the second biggest upset in Derby history. For the first time in many years I had no financial interest in the Kentucky Derby. But reviewing the past performances, I can safely say I wouldn’t have had the winner. Many of the horses had better speed figures and there was just nothing for this handicapper to hang his hat on. I wouldn’t have bet him to win, place or show, or even included him in any exotic bets.

In hindsight, careful handicappers might have noticed that Mine That Bird’s sire is Birdstone, a horse famous for spoiling Smarty Jones’s Triple Crown bid in the Belmont Stakes in 2004. But his Dam, Mining My Own, was unraced calling into question his soundness.

Ironically, there will be no bidding war for Mine That Bird’s stud services — he’s a gelding. Canadian trainer Dave Cotey had the horse gelded, reportedly because the randy colt was showing too much interest in the neighborhood fillies, a distraction from training.

Mine That Bird’s next race will be the middle leg of the Triple Crown, the Preakness Stakes at Baltimore’s Pimlico racetrack this Saturday. Amazingly, the Derby champ may have a different rider in Baltimore. Calvin Borel has committed to ride super filly Rachel Alexandria for the rest of the year, including The Preakness if her owners enter her. But if rumors are correct, Mine That Bird will be in good hands Saturday. Hall of Fame Jockey Mike Smith has been approached to fill in for Borel.

No matter from where you watch the Kentucky Derby, the singing of "My Old Kentucky Home" before Race 11 at Churchill Downs brings a tear to the eye. That was especially the case this year, remembering that my horse-betting friend Burt Blumert would miss the race. Burt was a keen student of the sport and a good judge of horse flesh. He bet on plenty of long shots in his life, and more than a few came in. Mind That Bird would have probably caught his eye and Calvin Borel’s savvy ride would surely have made him smile.

Speaking of hope, 23 bettors hit the Derby superfecta, correctly picking the top four finishers in the correct order. A $2 winning superfecta ticket paid $557,006.40. Now that’s a green shoot.

Doug French [send him mail] is president of the Ludwig von Mises Institute and associate editor for Liberty Watch Magazine. He is the author of Early Speculative Bubbles & Increases in the Money Supply. He received the Murray N. Rothbard Award from the Center for Libertarian Studies. See his tribute to Murray Rothbard.

Doug French Archives

by Doug French by Doug French

Obama’s 100th day is upon us and the new president is ramping up an expansion of government that will place him alongside some of the most notorious dictators in history. CNN’s senior political analyst Bill Schneider may believe Obama’s personal qualities make him "the superpresident," but first and foremost, Obama with his $3.5 trillion budget sees himself as the new FDR, armed with a new New Deal.

But the New Deal wasn’t new when FDR did it. The charismatic Roosevelt was more than 200 years behind John Law’s Mississippi Bubble, described as "the first New Deal of the capitalist order," by John T. Flynn in his amazing book Men of Wealth.

In a chapter devoted to the money magician, Flynn cleverly calls Law the "evangelist of abundance." And conditions in France could not have been riper for Law’s fiscal chicanery in 1715. France was completely ruined by Louis XIV, a ruler whom history has been much too kind to, according to Flynn. He ravaged the country he ruled, while being a "shallow, egotistical, pretentious coxcomb."

Louis spent vast millions on his palaces and engaged poets and writers to write of his virtues, long before the days of CNN. As Flynn explains, industry had not come to France, thus the king stole his wealth from small farmers and city-dwelling artisans through oppressive taxation.

Those who managed to amass wealth in France did so by knowing "how to tap this stream of public money on its way to the government." There were no entrepreneurial fortunes being made, only parasitic ones.

While the typical French family lived as paupers, going barefoot and sleeping on straw, there were vast fortunes made by those granted government monopolies. Louis died in the fall of 1715 with his country hopelessly bankrupt. The treasury was empty and the army unpaid. It was proposed that the nation formally declare bankruptcy.

Read the rest of the article

Doug French [send him mail] is executive vice president of the Ludwig von Mises Institute and associate editor for Liberty Watch Magazine. He is the author of Early Speculative Bubbles & Increases in the Money Supply. He received the Murray N. Rothbard Award from the Center for Libertarian Studies. See his tribute to Murray Rothbard.

Doug French Archives

by Doug French by Doug French

For those thinking that the real estate bust is all over with — think again. The residential market has hit the ditch and continues to sink lower, but now the commercial property market is rolling over and will take many lenders down the drain with it. America’s small and regional bankers are pointing their fingers at the big banks, claiming the big money center banks "have tarred and feathered us," City National Bank chief executive Bill McQuillan told the Wall Street Journal during the Independent Community Bankers of America convention in Phoenix. But banks — large and small — all over the country are loaded with commercial real estate loans, and that collateral is heading south according to a Deutsche Bank report.

The folks at Deutsche Bank see price declines of 35 to 45 per cent and maybe more in commercial property, due to the large number of loans coming due between now and 2012 that will not be able to be refinanced. Not only are loan delinquency rates up and rents down, but the go-go years of aggressive loan underwriting are gone. The interest only, high low-to-value loans that drove capitalization (cap) rates to the five percent range are history. Property buyers who are required to put more money down will offer significantly less for the same net operating income to achieve the required return on investment. Thus, cap rates for properties in Las Vegas, for instance, are closing in on 9 percent according to a local appraiser and may be one their way to 10 percent.

But bankers are in a state of denial, according to real estate pro Andy Miller, who spoke at Doug Casey’s Crisis & Investment Summit in Las Vegas recently. Miller’s been in the business for 30 years and hasn’t seen a property financing market this tight. But the current note holders are saying "don’t worry, be happy." Miller told the capacity Casey crowd that bankers show him the door when he rains on their parade.

Despite being inexperienced and clueless, at least bank workout officers understand what’s going on, according to Miller, however the rose-colored glasses-wearing bank senior managements are counting on real estate values to turn around by year end. It’s the same sort of denial Miller saw during the S&L debacle. Eventually there was capitulation, but it took years. A Vegas appraiser who lived through the 1980′s Texas property meltdown echoes Miller’s view, remembering that it took property owners in Texas back then years before they figured out that their property values weren’t coming back any time soon.

The conventional wisdom is that people losing their homes will rent an apartment so apartments are a safe place for real estate investment dollars. Miller’s view is just the opposite, thousands of empty houses compete with apartments and a gigantic multi-family implosion is coming. The numbers in Deutsche Bank’s report confirm that the apartment implosion is already underway. The total current delinquency rate for apartment loans is 3.53 percent, much higher than the last peak in delinquency of 2.35 percent back in October of 2005. And the past due rate on new apartment loans are especially bad at over 5 percent. Tennessee, Georgia and Florida top the multi-family most delinquent list.

But no area of commercial property will be spared the bloodbath. Hotels are imploding according to Miller and cap rates for retail properties have jumped 250—300 basis points in a year, while office cap rates have increased 200 basis points. These cap rate increases translate to property value decreases of a quarter to a third, and the market is just starting to deteriorate. This property meltdown will "make the 1980′s look like a picnic," Miller says.

There will be tens of billions of dollars in losses in the Las Vegas condo market, Miller told the Casey faithful while pointing at the nearby Las Vegas Strip. But Sin City won’t be alone. The U.S. had 14 months worth of condo inventory at the end of last year and the 93,000 units scheduled to be finished this year will increase inventory 28 percent. A good share of those units — 12,000 — will come on line in job bleeding New York and northern New Jersey, reports the Wall Street Journal, while the Windy City will have an additional 5,500 units for sale and Miami will add nearly 3,500.

The condo crash is making life miserable for Donald Trump, who has projects in many of the once hot and now not markets. He’s fighting with his lenders in Chicago, has only closed sales on a quarter of his finished units in Las Vegas, and buyers in two projects in Miami bearing the Trump name aren’t showing up to close escrow.

But, The Donald is keeping the sunny side up. As for his Vegas tower, “We are doing very nicely considering that Las Vegas is in a massive depression,” Trump told the Wall Street Journal.

On the housing front, there was a nearly 10 month supply of unsold homes on the market at the end of February while the Case-Shiller home-price index plummeted a record 19 percent in January, causing David Blitzer of S & P’s index committee to say, "There’s no daylight that I can see in this report." But national homebuilder Pulte Homes must see daylight in their crystal ball. The company announced it will buy competing builder Centex.

“We believe this is the right combination at the right time in the business cycle," Centex Chairman and Chief Executive Officer Timothy Eller, said in a statement. "By acting decisively now, we’re creating unrivaled firepower to capitalize on the opportunities in home building that are now becoming visible on the horizon."

Lenders aren’t the only ones in denial.

Doug French [send him mail] is executive vice president of the Ludwig von Mises Institute and associate editor for Liberty Watch Magazine. He is the author of Early Speculative Bubbles & Increases in the Money Supply. He received the Murray N. Rothbard Award from the Center for Libertarian Studies. See his tribute to Murray Rothbard.

Doug French Archives

by Doug French by Doug French

This article is the introduction to Doug French’s new book Early Speculative Bubbles and Increases in the Supply of Money.

As all the world economies writhe in financial pain from the cleansing of the largest bubble in financial history, the same question is being asked — how could this happen? Of course the usual answers are trotted out — human greed, animal spirits, criminal fraud, or capitalism itself. Modern financial history has been a series of booms and busts that seem to blend together making one almost indistinguishable from the next. The booms seduce even the most conservative into taking what in retrospect appear to be outlandish risks speculating on investment vehicles they know nothing about.

In response to the financial meltdown, central banks are slashing interest rates to nearly zero and growing their balance sheets exponentially. With no more room to lower rates, central bankers now speak of a “quantitative easing” policy which in plain English means “creating money out of nowhere.” But no one is shocked or horrified by this government counterfeiting. All this, after the US central bank (the Federal Reserve) has already, at this writing, increased the M2 money supply by 11 times since August of 1971 when the US dollar’s last faint ties to gold were severed.

While history clearly shows that it is this very government meddling in monetary affairs that leads to financial market booms and the inevitable busts that follow, mainstream economists either deny that financial bubbles can occur or that the “animal spirits” of market participants are to blame. Economists running central banks even claim that it is impossible to identify asset bubbles. Meanwhile, the Austrian school stands alone in pointing the finger at government intervention in monetary affairs as the culprit.

Austrian economists Ludwig von Mises and Friedrich A. Hayek’s Austrian business-cycle theory provides the framework to explain speculative bubbles. The Austrian theory points out that it is government’s increasing the supply of money that serves to lower interest rates below the natural rate or the rate that would be set by the collective time preferences of savers in the market. Entrepreneurs react to these lower interest rates by investing in “higher order” goods in the production chain, as opposed to consumer goods.

Despite these actions by government, consumer time preferences remain the same. There is no real increase in the demand for higher order goods and instead of capital flowing into what the unfettered market would dictate — it flows into malinvestment. The greater the monetary expansion, in terms of both time and enormity, the longer the boom will be sustained.

But eventually there must be a recession or depression to liquidate not only inefficient and unprofitable businesses, but malinvestments in speculation — whether it is stocks, bonds, real estate, art, or tulip bulbs.

This book was my master’s thesis (with just a couple slight changes and additions) written under the direction of Murray Rothbard and examines three of the most famous boom and bust episodes in history. Government monetary intervention, although different in each case, engendered each: Tulipmania, the Mississippi Bubble, and the South Sea Bubble.

As the 17th century began, the Dutch were the driving force behind European commerce. Amsterdam was the center of this trade and it was in this vibrant economic atmosphere that tulipmania began in 1634 and climaxed in February 1637. At the height of tulipmania, single tulip bulbs were bid to extraordinary amounts with the Witte Croonen tulip bulb rising in price 26 times in a month’s time. But when the market crashed: “[s]ubstantial merchants were reduced almost to beggary,” wrote Charles Mackay, “and many a representative of a noble line saw the fortunes of his house ruined beyond redemption.”

What made this episode unique was that the government policy did not expand the supply of money through fractional reserve banking which is the modern tool. Actually, it was quite the opposite. The Dutch provided a sound money policy that called for money to be backed one hundred percent by specie, which attracted coin and bullion from throughout the world. Free coinage laws then generated more money from this increased supply of coin and bullion than what the market demanded. This acute increase in the supply of money fostered an atmosphere that was ripe for speculation and malinvestment, manifesting itself in the intense trading of tulips.

The Bank of Amsterdam, which was at the center of tulipmania, was an inspiration for one of history’s most notorious currency cranks — John Law. Gifted in math, Law learned the banking business from his father in Scotland. But after his father died, the young Law had more interest in games of chance and women. During the day he would write pamphlets on money and trade while enjoying the social life at night.

Law made various proposals to governments around Europe for what we would call today a central bank and was turned down until 1716 when one of Law’s partying friends, the Duke of Orléans, assumed control of the French government after Louis XIV died. The French government was on the verge of bankruptcy, and its citizens were fed up with their government’s currency depreciation, recoinage schemes, and increased tax collections. The situation was ripe for Law’s monetary magic.

Law sought to “lighten the burden of the King and the State in lowering the rate of interest” on France’s war debts and to increase the supply of money to stimulate the French economy, with the opening of General Bank, owned 25 percent by Law and 75 percent by the King, and the formation of a series of companies that when ultimately merged together were known as the Mississippi Company. Two years into his system, the regent granted Law’s request that the General Bank be made part of the state, becoming the Royal Bank, patterned after the Bank of England.

With the Royal Bank creating vast amounts of paper currency, Mississippi Company share prices took off which led Law to issue more shares, using the capital to refinance more of the government’s debt. Ultimately, the scheme unraveled, despite Law demonetizing gold and silver so that only royal banknotes and Mississippi Company shares would circulate as money. An outraged French public ultimately forced the regent to place the once-revered Law under house arrest.

While John Law was struggling to keep his Mississippi bubble inflated, across the English Channel, a nearly bankrupt British government looked on with envy, believing that Law was working a financial miracle. It was anything but, however Sir John Blunt followed Law’s example with his South Sea Company, which in exchange for being granted monopoly rights to trade with South America, agreed to refinance the government’s debt.

As the price of South Sea Company shares rose, as in the case of Law’s system, more shares were sold and more government debt refinanced. The company had no real assets, but that didn’t matter as speculators bid the share price higher and higher, spawning the creation of dozens of other “bubble companies.”

The South Sea Company lobbied the British government to pass a Bubble Act that would shut down these new companies that were competing for investor capital. Ironically, it was the enforcement of that act that burst the bubble with South Sea Company shares falling nearly 90 percent in price. Beloved British statesman Sir Robert Walpole reorganized the technically bankrupt South Sea Company, and it remained in business for years.

Although these episodes occurred centuries ago, readers will find the events eerily similar to today’s bubbles and busts: low interest rates, easy credit terms, widespread public participation, bankrupt governments, price inflation, frantic attempts by government to keep the booms going, and government bailouts of companies after the crash.

Although we don’t know what the next asset bubble will be, we can only be certain that the incessant creation of fiat money by government central banks will serve to engender more speculative booms to lure investors into financial ruin.

This article first appeared on Mises.org.

Doug French [send him mail] is executive vice president of the Ludwig von Mises Institute and associate editor for Liberty Watch Magazine. He is the author of Early Speculative Bubbles & Increases in the Money Supply. He received the Murray N. Rothbard Award from the Center for Libertarian Studies. See his tribute to Murray Rothbard.

Doug French Archives

by Doug French by Doug French

When a junior high investment club wrote in to CNBC’s Squawk Box to ask legendary investor Warren Buffett what he thought the price of gold would be in five years and whether the yellow metal should be a part of value investing, the Oracle of Omaha responded with:

"I have no views as to where it will be, but the one thing I can tell you is it won’t do anything between now and then except look at you. Whereas, you know, Coca-Cola will be making money, and I think Wells Fargo will be making a lot of money and there will be a lot — and it’s a lot — it’s a lot better to have a goose that keeps laying eggs than a goose that just sits there and eats insurance and storage and a few things like that. The idea of digging something up out of the ground, you know, in South Africa or someplace and then transporting it to the United States and putting into the ground, you know, in the Federal Reserve of New York, does not strike me as a terrific asset."

Obviously the junior high kids have been educated that inflation is coming down the pike given the massive monetary stimulus that the Federal Reserve is engineering. So it’s perfectly reasonable that they would pose their question to the world’s greatest investor. But Buffett doesn’t understand that gold is the people’s money. The yellow metal has been the free market’s currency for centuries. As Murray Rothbard explained, the necessary qualities for money are: generally marketable (non-monetary value), divisible, high value per unit weight, fairly stable value, durable, recognizable and homogenous. Gold satisfies all of these criteria. Shares of Coca-Cola and Wells Fargo don’t even come close.

The famous currency crank John Law held the same view as Buffett in the early 1700′s. In Law’s view the shares of the East India Company were better money than silver because the shares would rise in value along with inflation, as opposed to silver specie that would decline in value as more was discovered and produced. In Law’s mistaken view the capital of the East India Company was employed in productive activities, which would provide inflation protection. Law wanted his monetary system to be tied to productive assets, just as Buffett believes the productive assets of a soft drink maker and a bank will provide better protection than precious and scarce metals.

Law was given a chance to test his theory in 1716 when one of Law’s partying friends, the Duke of Orléans, assumed control of the French government after Louis XIV died. Law’s Royal Bank created vast amounts of paper currency, and his Mississippi Company share prices took off which led Law to issue more shares, using the capital to refinance more of the government’s debt. Ultimately, the scheme unraveled and the French people sold their shares and sought the safety of gold and silver, leading Law to outlaw precious metal possession except by goldsmiths and jewelers, effectively demonetizing the metals so that only Royal banknotes and Mississippi Company shares would circulate as money. An outraged French public ultimately forced the Regent to place the once revered Law under house arrest.

Early during the same CNBC program a viewer asked Buffett if he believed what his father Congressman Howard Buffett believed, which was: "So far as I can discover, paper money systems [like John Law's] have always wound up with collapse and economic chaos."

"Sounds like my dad, yeah," Buffett replied, "I heard that every night at the dinner table for a long time." The Oracle admits that the printing of paper money is inflationary, but being a consistent proponent of expanding government, he constantly dismisses gold and proposals to return America to a gold standard.

His father Howard understood the evils of unchecked government money printing. "The paper money disease has been a pleasant habit thus far and will not be dropped voluntarily any more than a dope user will without a struggle give up narcotics," Congressman Buffett wrote. "But in each case the end of the road is not a desirable prospect."

The Congressman’s son may have heard his father at the dinner table, but he wasn’t listening. When asked if everything will turn out alright, Buffett said, "I think your kids will live better than mine, your grand children will live better than your kids. There’s no question about that."

No question?

"But we can be approaching the critical stage," the elder Buffett wrote back in 1948. "When that day arrives, our political rulers will probably find that foreign war and ruthless regimentation is the cunning alternative to domestic strife. That was the way out for the paper-money economy of Hitler and others."

The current monetary inflation will end as badly as Law’s, and shares of Coca-Cola and Wells Fargo will be no place to hide. Kids, start hiding some gold — carefully.

Doug French [send him mail] is executive vice president of the Ludwig von Mises Institute and associate editor for Liberty Watch Magazine. He is the author of Early Speculative Bubbles & Increases in the Money Supply. He received the Murray N. Rothbard Award from the Center for Libertarian Studies. See his tribute to Murray Rothbard.

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