A Child in a Man's Body: An Austrian Looks at the Economics of Paul Krugman

Nobel Laureate in Economics Paul Krugman delivered an address to a packed hall of (mostly) admirers on the University of Iowa campus last week, giving his explanation for our current economic problems and the steps he thinks should be taken to restore prosperity. His was an excellent example of the importance of economic theory in any attempt to fathom the underlying causes of something so complex as economic life. Krugman proclaimed himself an admirer of the writings and teaching of John Maynard Keynes. Those readers familiar with economic schools of thought will find nothing new in Krugman’s views. Nevertheless, I was shocked at some of his interpretations of economic history and felt that the audience, mostly fawning Big Government fans, was somewhat uneasy with his views, especially during his question and answer period. Perhaps becoming a Nobel Laureate leads one to believe that one’s views would be accepted uncritically. If there were one word that I would use to describe Krugman’s speech, it would be "childish".

Take, for example, Krugman’s answer to a question from the audience about the threat of trade protectionist measures among the world’s major trading nations. It was obvious that the questioner was concerned that the nations of the world continue to advocate free trade and not repeat the disastrous tit-for-tat protectionist measures that exacerbated the Great Depression. At first Krugman reassured the audience that, although there were a few calls for protectionist policies, these were not likely to be implemented. Good! But then he said that it was a myth that trade barriers had had much effect on causing and prolonging the Great Depression of the 1930s! He followed this bomb by claiming that it was the failure to repeal them that was the big problem. Huh? This makes no sense. If trade protection had little to do with the Great Depression, why should the failure to repeal these measures be a problem? But the Great Man had spoken and we all must nod our heads in agreement, apparently.

This was just one of Krugman’s inconsistencies. Again, a thoughtful question from the audience exposed a fundamental error in his thinking. (Since he had been reading his speech, one must conclude that he had given much thought to the passage that prompted this question. I happen to agree with Krugman’s analysis of this point, by the way, but not his proscription for future policy.) Krugman had said that the Greenspan Fed had been too activist in slashing interest rates whenever the economy showed any signs of weakening. He claimed that the downturn after the Savings and Loan Crisis of 1991 and the Dot-Com bust of 2001 should have been allowed to run their course and allow for the necessary corrections to an essentially weak American economy. By reflating the economy so quickly Greenspan’s Fed had indeed moderated each recession, but each intervention perpetuated and broadened the weaknesses, which showed up a few years later. Greenspan’s early and vigorous lowering of rates short-circuited a necessary process through which inflated economies must eventually pass. Had Greenspan not intervened as aggressively, the American economy would be in much better shape today. I was shocked to hear this essentially Austrian interpretation of events from a man who proclaimed Keynes as his idol!

The subsequent question from the audience exposed Krugman’s inconsistency, for the Great Man had told us earlier in his speech that the government should spend massively, since the people were hoarding their stimulus check money and the banks could find few worthy borrowers with their bailout funds. The audience member pointed out that since Krugman claimed that previous interventions had made our current situation worse, shouldn’t the proper government policy be to avoid a repetition of this intervention, for it will make things even worse in the future. Here is where Krugman showed his dedication to Keynes. He said that we shouldn’t dwell on past mistakes or worry about the future—we need to act to alleviate distress in the present. He, thus, adhered to his idol’s famous dictum that "in the long run we are all dead."

Seen in this light one understands Krugman’s policy proscriptions, which he had outlined earlier in his speech. Government’s $800 billion stimulus plan is inadequate by a factor of four! When an audience member questioned whether there existed a political consensus for such a huge program, Krugman replied that the Obama administration should bypass the normal rules of procedure and follow the "reconciliation" tactic, which does not require a filibuster proof—sixty Senate vote—majority. He admitted that this is a controversial procedure, but he recommended its use anyway. (Bloomberg New’s Brian Faler discussed this option on the front page of the March 19th issue of The Bulletin: "Cutting Out the GOP".)

There seems to be no humility in Krugman’s psychic makeup. He quoted the Taylor rule--developed by Stanford Professor John Taylor--to support his claim that the economy needs more money. According to Krugman, Stanford Professor John Taylor’s rule for setting interest rates would require a current Fed Funds rate of minus eight percent! Krugman did not question whether this ridiculous projection just might show the fallacies in Professor Taylor’s rule or perhaps that the rule was not applicable to mismanaged and grossly inflated fiat currencies. (Professor Frank Shostak explains and refutes the Taylor Rule in "The Fed Cannot Fix Itself", found here: http://mises.org/story/1540)

Other Krugman proscriptions show disdain for private life, our allies’ independence, and a childish confidence in government power. For instance, government should nationalize the banks, guarantee their debts, and impose new regulations limiting their actions. The European Union should follow our lead. It should adopt massive spending programs and lower interest rates. Krugman regrets that each European government sets it own fiscal policy, for some nations just will not spend as much as he thinks necessary. Furthermore, the European Central Bank, similar to our Fed, has not lowered rates quite as far as Krugman desires. Claiming that the New Deal just did not go far enough, all of the nations of the world should spend massively and debase their currencies in unison. This will end the crisis, says Krugman. We should not tolerate pain in the present nor concern ourselves with future consequences of these interventions.

Krugman’s mentality is oriented totally to the present, as is the unformed mind of a child. It is the hallmark of an adult mind to consider present actions in light of future consequences. Krugman will have none of this, even though he admits that similar actions in the past to the ones he now recommends have caused our present crisis. Krugman believes in public spending and money creation--the future be damned! An unthinking and uncritically loyal disciple of Keynes, his is a childish mind in a man’s body, Nobel Prize or not.

Mother Earth Is Not a Person

Ask 100 people if the earth needs to be protected and you will get 100 "of course" answers. Well, make that 99 "of course" answers, if I am one of the hundred so asked. Now, before you cancel your subscription to The Bulletin for publishing an essay by a barbarian, let me explain my position.

All environmental advocacy proceeds from the logical error of elevating nature from the status of property which may be privately owned to the status of persons to be protected by governmental law. Environmental laws are not necessary for the protection of privately owned property. Owners do not destroy their own property. You do not need a law to force you not to push your car off a cliff, burn down your own house, or poison your own water supply. But there are laws to protect your car, your house, and your water supply from others who may inflict such damage. These laws are not designed, per se, for the protection of these physical things - they are designed to protect you from the predation of others, because without privately owned property you will perish.

Thusly, others who may pour noxious poisons into the ground commit no crime as long as the poisons remain on their property. But when the poisons leach into the ground water and enters the water supply of another, that person has been harmed because his property has been harmed. Then the person so harmed may seek redress for this "tort" or harm. Notice that under this common sense rule, it is not enough to claim that something has harmed nature itself. The harm must accrue to privately owned property or to another person's body.

The chief advantage to regarding environmental predation as a tort which has been committed against another person rather than regarding nature itself as such a person is that courts will require objective evidence of real harm rather than that arbitrarily set environmental standards have been violated. All environmental advocacy today over global warming attempts to set some new arbitrary standard that must be attained without ever proving that anyone has been harmed by an act of another. Environmentalism has become nothing more than political advocacy for a straw man (or woman) - Mother Earth - whose demands can never be satisfied. As soon as the environmentalists lobby successfully for one new standard, such as permissible smokestack emissions from power plants, they demand that the standard be tightened even more.

This is the case in Pennsylvania over permissible levels of arsenic emissions from coal-fired power plants. Pa. utilities have met the stringent (and arbitrarily set, by the way) federal standard, but now the environmentalists want to reduce allowable arsenic emissions by a factor of ten without one shred of evidence that even one person anywhere has been harmed by the trace arsenic levels currently allowed into the atmosphere. Three hundred Pa. coal-fired power plants are out of compliance with this new proposed rule. Whether they can achieve compliance at all or, if so, at what cost, is unknown at this time. But either way Pennsylvanians will find their standard of living threatened by higher utility costs, which the state utility commission must allow the utilities to recover, or brown outs and black outs California-style.

Mother Earth has become a person, actually a ward of the state. The state decides when its ward has been harmed, according to standards set by those who do not own her. Since every human action can be regarded as causing her some harm, no matter how insignificant, there is no objective standard for ever determining that she is safe from man's very existence in her presence. The "carbon footprint" that supposedly every living person creates can be regarded as a harm to her. Thus, the environmental movement is inhumane in the sense that by its internal logic it must be opposed to the existence of people. This mindset has even permeated our popular culture. In the daily comic strip "Sally Forth," Sally and her husband are thinking about having a second child. Naturally they are concerned about the financial implications. Then a fellow office worker, to whom Sally has confided her worries, says that she also has to be aware of the child's potentially harmful carbon footprint. On the same day as this "Sally Forth" strip appeared, another strip had a similar message. The teenage boy of "Zits" is learning to drive, and both he and his mother are concerned about the teenager's potential carbon footprint. Although both comic strips' creators may have intended this as a joke, one cannot help but find the idea that man should not be allowed to drive or possibly even exist as appalling and not a little frightening. The last century experienced fascist and communist regimes that attempted to make the world better by exterminating those it deemed as undesirable.

The answer to this made-up problem is capitalism and freedom. Capitalism rightly regards natural objects as things to be privately owned by man. When left to freely acquire property and dispose of it for his own benefit, man will protect such property and apply it to useful purposes. He will not destroy it; he will take every effort to protect it. But when nature is not privately owned, it is neglected and plundered. Making Mother Earth a person under the protection of government leads to poor public policy, because government ownership is not the same as private ownership. The largest environmental disaster site in the United States is the federally owned former nuclear facility in Hanford, Wash. Each year government neglect is evident for all to see as the publicly owned western forests in the U.S. burn out of control. Ask any German about how well the communist government of the former East Germany protected the environment. U.S. government employees were as negligent in their stewardship of Hanford and our western forests as their East German communist counterparts were in polluting half the German nation. U.S. government employees succumb to the demands of politicians, who are not owners, to ignore the environmental consequences of building nuclear weapons just as they are to the demands of environmentalists, who are not owners either, that the Forest Service not build rudimentary roads into wilderness areas for fire fighting purposes.

Our environmental laws are unnecessary and counterproductive, stifling our industries while neglecting our commonly held resources. Our western lands should be auctioned off to private ownership. The Environmental Protection Agency should be abolished so that private industries can negotiate acceptable levels of pollution with those who may be affected by it. Pollution is a local issue. Mother Earth is not a person. Private ownership and freedom are the answer to failed attempts at collectivism and coercion, as in all other societal controversies.

The Corruption of Civil Society

A few weeks ago I wrote of the Jacksonian meaning of corruption and compared it to our modern definition. Our modern definition, which equates corruption with criminal activity, fits our modern, shallow culture of voyeurism. It seems we love nothing more than to see that the mighty have fallen prey to padding their expense accounts, taking specious tax deductions, and even dipping their beaks into the public trough. This is criminal behavior and there is no justification for it; it will be with us as long as people have access to other peoples’ money. But this really isn’t a very strenuous definition of corruption. Real corruption does its work in the full light of day, corrupting the morals to the point that society stagnates, shrinks, and finally succumbs altogether. This was the Jacksonian definition of corruption.
Madoff Corruption vs. Government Corruption
For an example of the difference between the two, consider the personal corruption of renowned financial criminal Bernie Madoff. Apparently he stole $50 billion of money entrusted to him by individuals, rich and not so rich, and even public bodies. This is theft, and Madoff engaged in all kinds of subterfuges to hide this fact for years. Now $50 billion is a large chunk of change, but its loss will not bring down the American economy. In fact, I do not call what Madoff did "corruption". I call it theft. The fact that he engaged in a massive campaign of deception is testament to his guilt—there is no reason to cover up what he did if he thought he was engaged in a legal activity. Yet this is what we today call corruption.
Compare this to the recent bank bailout of the departed Bush administration and the various stimulus plans of the Obama administration. We are talking about over a trillion dollars in new public spending, twenty times the size of the Madoff theft, in just one year! Our federal government’s debt already exceeds ten trillion dollars, and that is just its external debt—that is; debt for which people hold government debt obligations, such as treasury bills—and not its unfunded liabilities. Its unfunded liabilities—for example, promises it has made to those who have paid into the Social Security and Medicare Systems—exceed fifty trillion dollars. No one really knows the true number. Now here is what marks this as corruption in the Jacksonian sense—it is conducted in the light of day. In fact its sponsors are proud of what they have done, as are many of our own citizens. Yet neither the smiling politicians nor their admiring followers consider the source of this expenditure.
Methods of Public Plunder—Price Controls and Fiat Money Expansion
In his 1959 classic The Rise & Fall of Society, Frank Chodorov explains how seemingly invincible societies fail. The simple answer is that over time--sometimes over very long periods of time, such as the centuries it took for Rome to fall—more and more citizens figure out how to live at the expense of others by seeking and obtaining special privileges from the state. Eventually society reaches a tipping point and fails. Although there are many explanations for Rome’s fall, modern historians agree that the invasion of the barbaric tribes was more a symptom than a cause. Something had so weakened Rome’s economy that formerly inferior forces overran her. The number one cause of Rome’s decline was price controls of essential commodities. This is a common theme of all socialist schemes—pretend that a scarce resource really is not scarce by interfering with its price. Price controls in the ancient world caused starvation and the abandonment of cities, as the common folk fled to the countryside in a futile attempt to grow their own food. The benefits of specialization, which gave rise to the cities in the first place, were destroyed by government interference in the marketplace. This lower level of specialization reduced the production possibility frontier of the ancient world until total production was insufficient to support Rome’s population.
This sad scenario has been played out for centuries. The Mises Institute offers a fascinating and instructive book about the effects of price controls over the millennia. Written by Robert Schuettinger and Eamonn Butler, Forty Centuries of Wage and Price Controls explains the destructive influence of this method of government intervention in the market economy, all in the name of attempting to make scarce resources—labor and commodities—not quite so scarce via government coercion. But modern man has invented something even better, worse actually—the modern fractional reserve banking system backed by a central bank issuing fiat money.
Jorg Guido Hulsmann of the University of Angers, France has tackled our modern banking system in The Ethics of Money Production. Also available from the Mises Institute, it belongs in the library of every citizen who values his freedom and searches for the source of our current problems. Well, search no more. Hulsmann explains that all money not backed by a commodity is theft. Seen from this perspective, which Hulsmann explains with irrefutable logic, we now comprehend the real source of modern corruption. Fractional reserve banking, in which the bank takes money that has been entrusted to its safekeeping and lends it to others as if it were its own, violates the law of property. Unlike other market participants who must offer something of value in order to receive money, banks CREATE money while offering nothing in return. Now we see why banking has always been so popular and why bankers are usually some of society’s crème de la crème. You would be a popular swell, too, if you were allowed to create your own money in broad daylight and pass it as legitimate!
In the absence of central banking a bank run ensues when the market learns that the bank does not have sufficient reserves with which to honor all presentments. Governments aid and abet the banks periodically by passing legislation allowing them to suspend payments; that is, avoid bankruptcy by legally denying to the depositor either his property or his share of the remaining assets of the bank itself. This interference with the law of property was bad enough in the days before central banking. Then central banking added another layer of corruption by creating a "lender of last resort" in order to remove this market discipline to excessive lending.
In addition to giving cover to the bankrupt practices of fractional reserve banks, the central bank is authorized to buy the government’s own debt. Called "monetizing the debt", the central bank creates money for the government to spend; it does not have to tax or borrow from the citizenry. Now the government’s spending appears to be limitless! Of course, this sleight of hand merely masks theft of the purchasing power of money already in the peoples’ hands and is nothing more than counterfeiting. This is the corruption that stirred Andrew Jackson to run for president in the early days of our republic--corruption out in the open; corruption that stole stealthily and silently from the masses of the people; corruption that pulled men into its inflationist schemes with the promise of riches for doing nothing of real value except be the first receivers of the counterfeit money.
With the advent of our third central bank in 1913 this form of corruption on a massive scale started anew. When the market saw that the new central bank could not honor its obligations to redeem its paper, President Franklin Roosevelt solved this knotty problem by confiscating the peoples’ gold at less than market prices. When the government blew through this gold, plus gold that had been entrusted to it by its allies in World War II, President Nixon simply reneged on the government’s promise to redeem dollars for gold. Now nothing can stop government corruption to steal the peoples’ wealth through printing counterfeit money…money based upon nothing at all; money that was never earned; money that was not even taxed by a vote of the peoples’ representatives in Congress.
Corrupting and Weakening Civil Society
This is corruption on a scale and with an audacity that is without precedence. This is corruption that forces us to line up at the government’s trough to get our share of the loot before the dollars that we currently hold become worthless. It corrupts our morals by diverting us from honest exchange to scheming for ways to plunder our fellow man through government coercion. Man can survive only by offering value in the market place or by plundering the value created by others. Fractional reserve banking, made bankrupt-proof by the central bank’s issue of fiat money, enables more and more of us to live via the plunder of others. Our current government would have us believe that those who create value are deserving of having it plundered. Too many of us are ready to believe this lie, because it provides a rationale for accepting this plunder. We have become corrupted by the limitless power of the government to use the banking system to reward its friends and punish its enemies. We no longer accept personal responsibility. Government must remove our excessive indebtedness, for example, and allow us keep what we cannot afford. It must print more money to prop up the stock market and save our 401K retirement plans. It must bail out auto companies that will never again turn a profit. It must reflate an overbuilt housing market. It must provide universal healthcare. It must do all this—and more!—without raising taxes on the mass of the citizenry and without crowding out private investment. Fractional reserve banking, protected by a central bank issuing fiat money, leads us to the ridiculous conclusion that all this is possible. It is not. It is corruption in the Jacksonian sense, and it will destroy our society as surely as wage and price controls have destroyed civilizations for centuries.

The Fox Bids to Be the Sole Guardian of the Henhouse

On Monday, March 9th, Federal Reserve Board Chairman Ben Bernanke spoke at the Council on Foreign Relations in Washington, D.C. and delivered a self-serving and barely veiled bid to become the sole, supreme, super regulatory and supervisory agency of all financial institutions in the United States. One really must read the speech in its entirety to get the full flavor of Mr. Bernanke’s hubris.

Taking absolutely no responsibility for the current financial crisis, he proposes that the Fed itself become a dictator of everything financial in the country. In typical Fed-speak, he invented new words--"procyclicality" and "macroprudential". This is a favorite tactic of all who desire to cover fairly common concepts with the aura of something grand. And since he invented the words, the words can mean whatever he wants them to mean. So said the Queen of Hearts in Alice in Wonderland. For the reader’s instruction, I gathered that "procyclicality" means to take some action that aggravates a current condition, and that "macroprudential" means to look at the big picture. But that just doesn’t sound very impressive, does it?

Interestingly, at the beginning of his speech—in which Mr. Bernanke makes a very brief attempt to explain the cause of the current crisis--he inadvertently (I must assume!) introduced an Austrian economic concept! Here is his exact quote:

"The increase in excess saving in the emerging world resulted in turn from factors such as rapid economic growth in high-saving East Asian economies…"

Did you catch the Austrian concept? He says that increased savings is compatible with rapid economic growth! This is exactly right, although it is the opposite of what Mr. Bernanke and the rest of the current D.C. elite say should be the solution to restore growth to the U.S. Here in the good old U.S.A., Mr. Bernanke, President Obama, and everyone else is singing the praises of spend, spend, spend, not save, save, save. Furthermore, the banks must help us spend by continuing to lend, lend, lend. None of us should save. No, sir, we should spend. Spending will bring us out of this recession, not savings, say the D.C. elite. But that is not what Mr. Bernanke claims happened over the last ten to fifteen years in the East Asian countries. The "high-saving East Asian economies" experienced "rapid economic growth". This is consistent with Austrian Business Cycle Theory, which states that increased savings provides the capital for building longer term productive capacity, which in turn expands the country’s production possibility frontier. In other words, if we save more we can build more plant and equipment, which will give us more stuff in the future. Even a caveman or a chairman of the Federal Reserve Board should be able to understand this concept. Mr. Bernanke lets this insight slip into his speeches, because I am certain that he knows that it is true. Yet he sings with the D.C. chorus that we must spend our way out of depression anyway. Such is to be expected of a government employee.

But the most chilling aspect of Mr. Bernanke’s speech was his very veiled reference to taking over the "too big to fail" banks. His reference in the quote below to "both models" refers to the Fannie Mae and Freddie Mac takeover and to an FDIC procedure for liquidating failing institutions. Here’s what he says:

"Both models allow a government agency to take control of a failing institution's operations and management, act as conservator or receiver for the institution, and establish a "bridge" institution to facilitate an orderly sale or liquidation of the firm."

Notice the key phrase "take control of…operations and management". This is very different from the current method of closing down the failed institution and selling its business piece by piece to its competitors for whatever prices the market determines. Giving any government agency the power to run the "operations and management" of a failed institution is a radical change from liquidating an institution; for one thing, there is no time frame for how long the government will run it or for what purpose (my guess is for political purposes!).

Earlier in his speech Mr. Bernanke reaffirmed his belief that some firms are too big to fail because they would cause "systemic" problems. But he never explains what a "systemic" problem is, how it would arise, and what makes big firms so crucial. We poor common people must believe that life just would not be the same without Goldman Sachs or Citibank, but there is no theoretical or practical reason that these institutions cannot be liquidated just like your insolvent neighborhood community bank.

Nowhere does Mr. Bernanke voice the concern that the bigger a bank is the LESS reason there is to propping it up with taxpayer money. Capital losing institutions make us poorer, so propping up the big ones just drives us to the poor house quicker. The argument should be the other way around—too big to save.

In addition, nowhere does Mr. Bernanke express even the slightest doubt that he (or some other earthly god, if another could possibly exist) possesses the knowledge to carry out plans from his understanding of the "macroprudential" situation. Here Mr. Bernanke falls prey to what Frederic Hayek calls the "Pretense of Knowledge"--that it is possible for anyone or any group to understand the totality of the economy. How does Mr. Bernanke know your plans for the future, for example? How does he know your purchasing preferences? Falling prey to the "Pretense of Knowledge" central planners engage in what Hayek calls "The Fatal Conceit" that man has total control to shape the world around him. The bloodthirsty economic planners in the Soviet Union and the smiling workaholics in Japan’s Ministry for Trade and Industry (MITI) could neither understand the market nor shape it to their wishes. The shame of it all is that no one needs to mimic the market, even if that were possible. The market itself consists of more decisions and preferences than could ever be understood by the fastest, most powerful computer. Only parts of the market coordinate with other parts to arrive at a conclusion that no one could predict yet that rewards all who participated. Why try to mimic and control this wonder of cooperative achievement?

The very thought of Mr. Bernanke sitting at his desk with computer screens flashing and couriers bringing in the latest polls and economic statistic to be followed by shouted orders from this pretentious egomaniac is almost comical were it not so frightening. For this is what Mr. Bernanke desires--to be the Great and Powerful Oz behind the screen, with lights flashing and smoke billowing, while the frightened citizenry cower before his pretended brilliance and his not-so-pretended police power to coerce and compel. It is the Road to Serfdom, as Hayek explained in his brilliant book written during the euphoric hours of World War II in which the central planning of the Allied victory was viewed as a model for a peacetime economy. Hayek—and many others, most notably Robert Higgs—have explained that the centrally planned war economy consumed capital and impoverished even the victors. It is not a model for anything, possibly not even a war economy itself. Yet that is the model that Mr. Bernanke sees for America, with himself at the forefront of an army of Fed statisticians. Preposterous! Balderdash! Let this be our battle cry—Give Us Liberty! End the Fed!

The Jacksonian Meaning of Corruption

It is tempting to men who are entrusted with public responsibility to steal from the public purse. Many do so, but they hide the fact from their colleagues and constituents, for they face jail and shame when discovered. This is one of the inherent evils associated with big government—politicians and bureaucrats control so much money that it becomes almost impossible to keep track of it all and, therefore, men of weak character enrich themselves. When discovered, such men are rightly shamed, drummed out of office, prosecuted, fined, and jailed. This is the modern meaning of corruption. But it is weak and paltry thing next to the meaning of corruption as understood by one of our nation’s early great leaders—President Andrew Jackson. Jackson understood that far greater damage was done by the corruption to the body politic that occurred in the light of day.
Jackson was our first president not born and raised in one of the original thirteen colonies. Although not all of the Founding Fathers were wealthy, they all were part of a tightly knit elite who knew one another intimately. With the presidency of John Quincy Adams--son of our second president, John Adams—it seemed as if this tightly knit group would pass its baton of leadership to family members and other insiders. But the American people had other ideas. Andrew Jackson epitomized what was to become almost a caricature American—one who despised privilege and valued his personal freedom above all else. Jackson saw the threat of centralized power made possible by the stealth funding provided by a central bank.
The Second Bank of the United States—the nation’s second central bank and long ago ancestor of our current Federal Reserve Bank—was the favored tool of the Hamiltonians, who relished a strong, centralized national government. A central bank can be used to abrogate power to those whom it wishes to favor. Chartered by government, it is government itself that benefits most from a central bank, primarily from the central bank’s ability to finance the government’s debt. The Bank of England was the template, granting the British crown financial power that the British people would never grant it willingly. Our modern governments could not have attained a fraction of their current size and power without the central bank’s ability to fund government debt to unimaginable levels.
The Hamiltonians created our nation’s first major political riff by forming the Second Bank of the United States in clear violation of the Constitution’s prohibitions. Nowhere in the Constitution is the federal government granted the power to form a central bank. In fact the Constitution grants the federal government the power to ensure that only sound money—which the Founding Fathers knew to be gold or silver—would circulate within our borders. It even gave the federal government the responsibility to ensure that the states did not create machines of inflation.
Nevertheless, the Hamiltonians succeeded and the Second Bank of the United States was chartered in 1817. Immediately the new bank began to "buy" the government’s debt with money created out of thin air, which sparked an inflationary credit boom that benefited the bank’s insiders and political cronies in government. Andrew Jackson was determined to end this corruption.
Notice that Jackson was not claiming that bank officials were stealing--our weak-kneed modern definition of corruption. Oh, no. But they were using the unchecked powers of the bank to ensure that their crones were the beneficiaries of the credit expansion the bank set in motion. To Jackson this was corruption, and he was determined to end it. He engaged in a titanic struggle over many years, but eventually he was successful in ensuring that the bank’s charter was not renewed in 1837.
Today Jackson would see corruption everywhere and he would understand its source—the nation’s third central bank, the Federal Reserve Bank. Here are just two examples. Last week the Wall Street Journal’s investigative reporters were able to find out who were the beneficiaries of the Bush Bank Bailout in the closing month of his administration. Among others, Goldman Sachs received $6 billion. Why is this corrupt? Two reasons. First of all, the Treasury Department tried to keep the names of the beneficiaries secret. Of course they felt they had good reasons, but no reason is acceptable to a supposedly free nation with a government "of the people, by the people, and for the people". Secondly, Henry Paulson, then Secretary of the Treasury, had been a partner with Goldman Sachs for twenty years! Yes, yes, he sold his shares in the firm, but we must assume that he had boon companions who would lose all if not bailed out with taxpayer dollars. Thusly, then Secretary of the Treasury Paulson was able to rationalize the secret transfer of billions of our dollars to his old buddies on Wall Street.
Here’s another example. Who are the recipients of the Obama "stimulus" funds? (Forget for a moment that the stimulus will not work.) If the Obamiacs really believe that it is necessary for the government to create liquidity for the benefit of the nation, why doesn’t the government send checks to all of us? Even if many of us hoard the cash, surely enough of us will spend it to stimulate the economy as the Obamiacs desire. Even those of us who might hoard the cash will place it in government insured bank accounts, which would accomplish the same thing as giving the money to the banks directly—the banks would have money to lend, thawing the so-called frozen credit markets. So why bail out the banks directly and why spend the money only on projects desired by the government? The government has given us no economic reason to justify targeted expenditures rather than a broad-based one. In fact the government’s Keynesian economists themselves imply that what the economy needs is a broad-based stimulus that would effect all geographical areas of the country and all industries relatively equally. There is nothing in Keynesian theory that suggests that only certain industries are worthy of stimulating. Yet, the auto industry is bailed out. The insurance companies are bailed out. And, of course, the bankers are bailed out. The rest of the stimulus is going to the usual suspects: unionized industries and other liberal voting blocks.
Andrew Jackson would understand this as massive corruption—spending the public’s purse to buy votes and keep friends and cohorts solvent. And Andrew Jackson was right, despite the protestations that it is all for our own good. This is nothing more than rationalizing massive corruption. And just as in the Jacksonian era, America’s central bank is the mechanism through which the government funnels America’s wealth to political insiders. Unfortunately, we have only touched upon the debts of corruption that a central bank sets in motion. In a future essay I will discuss an even more deep-seated evil that emanates from the banking sector. It is nothing less that a corruption of our morals and our civil society. Give Us Liberty! End the Fed!

The Fox Bids to Be the Sole Guardian of the Henhouse

On Monday, March 9th, Federal Reserve Board Chairman Ben Bernanke spoke at the Council on Foreign Relations in Washington, D.C. and delivered a self-serving and barely veiled bid to become the sole, supreme, super regulatory and supervisory agency of all financial institutions in the United States. One really must read the speech in its entirety to get the full flavor of Mr. Bernanke’s hubris.
http://www.cfr.org/content/publications/attachments/031009_CFR.pdf
Taking absolutely no responsibility for the current financial crisis, he proposes that the Fed itself become a dictator of everything financial in the country. In typical Fed-speak, he invented new words--"procyclicality" and "macroprudential". This is a favorite tactic of all who desire to cover fairly common concepts with the aura of something grand. And since he invented the words, the words can mean whatever he wants them to mean. So said the Queen of Hearts in Alice in Wonderland. For the reader’s instruction, I gathered that "procyclicality" means to take some action that aggravates a current condition, and that "macroprudential" means to look at the big picture. But that just doesn’t sound very impressive, does it?
Interestingly, at the beginning of his speech—in which Mr. Bernanke makes a very brief attempt to explain the cause of the current crisis--he inadvertently (I must assume!) introduced an Austrian economic concept! Here is his exact quote:
"The increase in excess saving in the emerging world resulted in turn from factors such as rapid economic growth in high-saving East Asian economies…"
Did you catch the Austrian concept? He says that increased savings is compatible with rapid economic growth! This is exactly right, although it is the opposite of what Mr. Bernanke and the rest of the current D.C. elite say should be the solution to restore growth to the U.S. Here in the good old U.S.A., Mr. Bernanke, President Obama, and everyone else is singing the praises of spend, spend, spend, not save, save, save. Furthermore, the banks must help us spend by continuing to lend, lend, lend. None of us should save. No, sir, we should spend. Spending will bring us out of this recession, not savings, say the D.C. elite. But that is not what Mr. Bernanke claims happened over the last ten to fifteen years in the East Asian countries. The "high-saving East Asian economies" experienced "rapid economic growth". This is consistent with Austrian Business Cycle Theory, which states that increased savings provides the capital for building longer term productive capacity, which in turn expands the country’s production possibility frontier. In other words, if we save more we can build more plant and equipment, which will give us more stuff in the future. Even a caveman or a chairman of the Federal Reserve Board should be able to understand this concept. Mr. Bernanke lets this insight slip into his speeches, because I am certain that he knows that it is true. Yet he sings with the D.C. chorus that we must spend our way out of depression anyway. Such is to be expected of a government employee.
But the most chilling aspect of Mr. Bernanke’s speech was his very veiled reference to taking over the "too big to fail" banks. His reference in the quote below to "both models" refers to the Fannie Mae and Freddie Mac takeover and to an FDIC procedure for liquidating failing institutions. Here’s what he says:
"Both models allow a government agency to take control of a failing institution's operations and management, act as conservator or receiver for the institution, and establish a "bridge" institution to facilitate an orderly sale or liquidation of the firm."
Notice the key phrase "take control of…operations and management". This is very different from the current method of closing down the failed institution and selling its business piece by piece to its competitors for whatever prices the market determines. Giving any government agency the power to run the "operations and management" of a failed institution is a radical change from liquidating an institution; for one thing, there is no time frame for how long the government will run it or for what purpose (my guess is for political purposes!).
Earlier in his speech Mr. Bernanke reaffirmed his belief that some firms are too big to fail because they would cause "systemic" problems. But he never explains what a "systemic" problem is, how it would arise, and what makes big firms so crucial. We poor common people must believe that life just would not be the same without Goldman Sachs or Citibank, but there is no theoretical or practical reason that these institutions cannot be liquidated just like your insolvent neighborhood community bank.
Nowhere does Mr. Bernanke voice the concern that the bigger a bank is the LESS reason there is to propping it up with taxpayer money. Capital losing institutions make us poorer, so propping up the big ones just drives us to the poor house quicker. The argument should be the other way around—too big to save.
In addition, nowhere does Mr. Bernanke express even the slightest doubt that he (or some other earthly god, if another could possibly exist) possesses the knowledge to carry out plans from his understanding of the "macroprudential" situation. Here Mr. Bernanke falls prey to what Frederic Hayek calls the "Pretense of Knowledge"--that it is possible for anyone or any group to understand the totality of the economy. How does Mr. Bernanke know your plans for the future, for example? How does he know your purchasing preferences? Falling prey to the "Pretense of Knowledge" central planners engage in what Hayek calls "The Fatal Conceit" that man has total control to shape the world around him. The bloodthirsty economic planners in the Soviet Union and the smiling workaholics in Japan’s Ministry for Trade and Industry (MITI) could neither understand the market nor shape it to their wishes. The shame of it all is that no one needs to mimic the market, even if that were possible. The market itself consists of more decisions and preferences than could ever be understood by the fastest, most powerful computer. Only parts of the market coordinate with other parts to arrive at a conclusion that no one could predict yet that rewards all who participated. Why try to mimic and control this wonder of cooperative achievement?
The very thought of Mr. Bernanke sitting at his desk with computer screens flashing and couriers bringing in the latest polls and economic statistic to be followed by shouted orders from this pretentious egomaniac is almost comical were it not so frightening. For this is what Mr. Bernanke desires--to be the Great and Powerful Oz behind the screen, with lights flashing and smoke billowing, while the frightened citizenry cower before his pretended brilliance and his not-so-pretended police power to coerce and compel. It is the Road to Serfdom, as Hayek explained in his brilliant book written during the euphoric hours of World War II in which the central planning of the Allied victory was viewed as a model for a peacetime economy. Hayek—and many others, most notably Robert Higgs—have explained that the centrally planned war economy consumed capital and impoverished even the victors. It is not a model for anything, possibly not even a war economy itself. Yet that is the model that Mr. Bernanke sees for America, with himself at the forefront of an army of Fed statisticians. Preposterous! Balderdash! Let his be our battle cry—Give Us Liberty! End the Fed!

The Coming Monetary Tsunami

Remember pictures of the devastation wrought upon Southeast Asia by the Tsunami a few years ago? An underwater earthquake thousands of miles away lifted up the ocean and created a giant tidal wave that smashed unsuspecting coastal villages along thousands of miles of coast many hours later. One of the perverse characteristics of a tsunami is that the coastal tide actually retreats for some time before the tidal wave arrives. People walked out to areas that were formerly ocean bottoms and marveled at what would cause such a drop in the tide. They found out.
Like the unseen tsunami far out at sea, our leaders in Washington reassure us that there is no tidal wave of higher prices that is rushing towards us, triggered by their massive expansion of bank reserves that will translate into a doubling of the money supply. It hasn’t reached our shores yet, so why worry? In fact they point to the drop in many prices to justify their confidence that there is no cause and effect that links profligate spending and money expansion with higher prices.
The Austrian School of Economics is very careful with its terms and its theories. We Austrians call any expansion of the money supply not supported by an underlying commodity (such as gold or silver) to be inflation. All other things being equal, inflation of the money will cause higher prices at some point in the future. Higher prices, therefore, are not inflation—they are just higher prices.
Although it is not quite this simple, think of money as the clearing mechanism for goods and services. It is possible to expand the money supply in an inflationary way—that is, not supported by a commodity—and still experience lower prices IF goods and services expand, too. Let us consider the following scenario. Let us assume that a few years in the past the people changed their spending/savings ratio to funnel more money to savings and less to current consumption. Let us also assume that the money supply remained stable. This increase in savings will have two beneficial effects. One, prices of current goods will fall. The money supply remained unchanged, yet more of it is saved. This smaller quantity of money going to current consumption meets an existing inventory of goods and services that came into being expecting that consumption would be higher than it is. The only way the market can clear—sell—these goods is for prices to fall. Now the smaller pool of money for consumption can clear the now-too-large pool of goods and services available for sale. The market achieves a new equilibrium, just as predicted by Jean Baptiste Say. A few years go by and the new pool of savings has been funneled into longer-term production processes. These new producer goods start pumping out consumer goods in greater quantities; the nation’s production possibility frontier has expanded just as predicted by Eugene Bohm-Bawerk. This greater flow of goods and services reaches the market at the same time that the central bank engages in an expansion of the money supply. Had the central bank not expanded the money supply, the price of goods and services would have fallen, a most welcome event. But the money supply did expand—what Austrians call inflation—so prices do not fall at all or perhaps fall only slightly. Can the central bank claim that its policies were unconnected with the price level? Of course not! This scenario explains what actually happened in the 1920s. Rapid technological development led to greater output that caused prices to remain stable even though the Fed expanded the money supply in an inflationary way (i.e., not linked to an increase in gold).
Next lets examine the opposite scenario. Again the central bank keeps the money supply stable, but something happens to cause a drop in the nation’s production of goods and services. Perhaps there was some natural disaster, like Hurricane Katrina, that temporarily destroyed part of the nation’s oil production and refining capacity. Fewer goods and service reach market. Prices rise when the market realizes that its inventories are depleting too fast to avoid shortages. Did the central bank cause prices to rise? No.
Here’s another scenario. For whatever reason, the nation’s economy moves into recession. There is an excess of goods and services available for sale, but people are not buying. Perhaps, like the present time, a previous expansion of credit has resulted in large-scale malinvestment and business losses. Businesses are failing and unemployment rises. Consumption drops. Prices fall in a normal market reaction to clear inventories. But…the central bank intervenes to expand the money supply rather than allow the economy to clear the excess inventory and wait while workers find new jobs in industries that are still profitable. This takes time. Now bank reserves have been bolstered, and the money supply has grown somewhat but not to its full extent consistent with the new level of bank reserves. This too takes time. In the interim, prices fall. Can the central bank claim that its actions have no impact on prices? Of course not. The central bank has engaged in inflationary actions by creating the bank reserves that will be turned into an expansion of the money supply when confidence returns. Confidence will return—at least for awhile—when unemployed workers find new jobs and start spending again. But the increased money supply will find an old level of production, perhaps even a decreased level of production. The market will detect the excess money and start to raise prices in order to avoid shortages. The market will reach a new equilibrium at a new higher price level. This has been the series of events since the founding of the Fed in 1913. The price level today is twenty times what it was in 1913. Contrast this lamentable experience with the fifty years PRIOR to the founding of the Fed. The price level drop an average of four percent per year for fifty years, consistent with a stable price level, tied to gold, and increased productivity by American businesses and workers. The dollar truly earned its place in the common phrase "as sound as a dollar".
The lesson of all this is that our governmental leaders have set the stage for a tremendous increase in prices sometime in the future. No one knows when this tsunami will strike. But I wouldn’t venture too far out on the now-exposed ocean floor of lower prices if I were you.

Why Economic Theory Is Important

We live at the beginning of the era of the "New" New Deal. So say the propagandists for the current administration. This in itself is a chilling thought, because the "Old" New Deal mired the nation in economic depression for over a decade. Counting the Hoover administration’s contributions, which can rightly be called the "Pre" New Deal, America was saddled with incompetent economic interventions for fifteen years.

One of the hallmarks of the "Old" New Deal was its happy-go-lucky attitude toward trying anything and everything to bring the economy out of depression—everything, that is, except keeping its crummy hands off the economy and allowing it to recover on its own. Both "Old" and "New" New Dealers persist in claiming that our current crisis is unique in American history and, thusly, justifies these unprecedented interventions. Nothing could be further from the truth.
America has experienced boom-and-bust business cycles since its founding, and there is nothing mysterious about them at all. The same thing—artificial expansion of the money supply--caused every one of them. The depressions of 1819, 1837, 1857, 1873, 1890, 1907, and 1930 have been well documented but, for some not-so-mysterious reason, little understood, at least by our brilliant leaders.

Austrian School Economists have developed a sophisticated theory of the business cycle that explains every one of these financial crises, including our current one. I gave away the punch line in the previous paragraph, but a little more explanation is necessary and I will give the laymen’s version of this theory in a bit. First let me explain why a theory of anything, especially economic theory, is essential to our understanding of both past and current events. The "Old" and "New" New Dealers eschew theory or, at least, they do not feel required to present a coherent one to explain how they expect their interventions to work. This reinforces their love of power, for they feel no need to justify their harmful actions since they claim that it is action itself that is required--any action, the more vigorous the better. Action inspires confidence. Confidence is all that is lacking. But without a coherent theory, history yields no lessons. History becomes merely a recitation of random events carrying no lessons cause and effect for guiding us in the future. Since history never repeats itself, apparently there is nothing for us to learn.

But history does repeat itself, and its lessons are clear. Every period of economic boom has been preceded by an expansion of credit not funded by actual savings. The existence of a central bank is not required for such events to occur, of course, since the U.S. had several boom-bust cycles when it had no central bank. (The Second Bank of the United States closed in 1837 and the Third Bank of the United States—our current Federal Reserve Bank—was formed in 1913.) But private banks expanded credit beyond their means during these periods because they were protected by both national and state legislation allowing them to suspend specie payment; that is, they were not required to honor their depositors’ demands for payment in gold as promised. Governments of this time, just like our current one, regarded banking as somehow different from other businesses and allowed them to continue to operate even after they had demonstrated that they were bankrupt. They had fraudulently lent out their customers’ deposits when they were supposed to keep them readily available to meet these same depositors’ demands for payment.

By lending out these "demand deposits"--what we today call "checking deposits"--the banks expanded credit, which became an increase in money via the lending process. This money was created out of thin air, just as our current Fed creates money out of thin air. Initially all seems well. Projects are started. Employment booms. But, because no new capital has been created—people did not save more—not all of the projects can be completed. Prices start to rise as the market slowly learns that, contrary to our wishes that we have entered a new economy, scarcity still exists. We cannot have our cake and eat it, too; that is, we cannot consume and save the same money, which is what artificial credit expansion leads us to believe is possible. Many new start-up projects fail, because the peoples’ consumption patterns have not changed—we still desire the same old ratio of consumption goods to future goods. Our unchanged savings patterns reveal the error, but only after vast quantities of capital have been expended because the false signals of cheap credit have led us to the opposite conclusion.

Those in government who snicker that all this is only "theory" are making a serious mistake in logic. Theory is not the same as an opinion. An opinion is not something that can be proven by logic, but theory can be so proven. It is my opinion that the Phillies will repeat as baseball’s world champions in 2009. Obviously, my opinion is merely a wish. But a theory has precepts that cannot be denied; it has internal logic that a rational person must accept; and a conclusion that must be accepted unless either the precepts or the logic can be shown to be faulty. We do not have to wait years or decades to know that artificial expansion of credit will lead to economic disaster—that is the benefit of a good theory. If we accept as true that fiat money expansion drives down the interest rate (and that is the Fed’s purpose, after all) without a complementary increase in savings, then we know the logical conclusion. Not all business plans that appeared sound may be fulfilled, because not enough capital is available due to the unchanged level of savings in the economy. (That’s why the interest rate was higher in the first place.) In fact the very act of driving down the interest rate exacerbates the savings shortfall by discouraging the marginal saver. This is theory, but it is unassailably consistent internally and it explains the history of boom-bust cycles in the past.

Why must we repeat this sorry scenario when we know where it will lead? Our governmental elite must be blind, incompetent, or willfully engaged in acts of self-aggrandizement to force this situation upon the nation once again. I leave it to the gentle reader to decide which of the three explains government’s behavior. It matters not, for the result will be the same. The Austrian theory of economic history proves it.

Is This the Start of the Gen X Revolt?

Just like the weather, everybody talks about the unfunded liabilities of the Social Security, Medicare, and Medicaid entitlements but no one does anything about them. That may be changing. Last summer, the Americans for Generational Equity (AGE) held its first Youth Entitlement Summit (YES) in Washington, D.C. Another will be held sometime again in June of this year. It brought together a bipartisan group of mostly young people who KNOW that the current entitlement system will impose unbearable costs on them. They also KNOW that they had no say in creating these entitlements. Isn’t that called taxation without representation? It looks like they are determined to right this injustice that is about to descend upon them. For there is one thing that is certain — it does not matter whether you wish these entitlements to continue or not, the giant Baby Boom Generation’s claim upon the production of the following generations is too great for them to endure.

Last fall, I met a young vice president of this organization and have been in intermittent contact with him ever since. I have been amazed and thrilled to meet someone of his young age who sees so clearly the financial disaster to which we are headed and is determined to do something about it. Thierry Dongala is a name to remember. You will hear from him in the future.

The Web site of the YES organization is interesting in many ways. (www.age-usa.org) On the one hand, it reaches out in a friendly way for all to join in this discussion. Surprisingly, many older politicos from both sides of the aisle have joined. I do not claim to know the purpose for which many have joined, but the mere fact that they feel it is important to have their voices heard offers a glimmer of hope. Perhaps sober minds have noticed that the youth of America are getting politically organized in order to defend themselves. But underlying this friendly offer for all to join the chorus is a clear and forceful statement that something must be done to remove the cloud of massive tax increases from the future of our children and grandchildren.

Even if the YES movement fails to gain traction, as they say in Washington, D.C., I am convinced that other like organizations will spring up in its place. The reason is that the train wreck of multi-trillion dollar unfunded liabilities cannot be ignored when the government starts writing the checks. Then the issue will be front and center and our options will be both limited and unpleasant. Better to face them now and build a coalition that can head off disaster. That is the message of YES and that is the truly statesmen-like approach. Work first to educate and then build a coalition to take action.

If entitlement reform fails, the consequences are bleak indeed. Our prosperity will be swamped by the cost of entitlements that the Baby Boom generation insists the following generations must pay. They will toil for less and less; capital accumulation will stop; our standard of living will decline. But that is not the worst of the many disastrous consequences. Read on.

Social Security — A Transfer Program Disguised As An Investment

Social Security is bad enough. A giant, coercive, government run Ponzi scheme, it absorbs 12 percent of our pre-tax income and transfers this spending to seniors, the disabled, widows and orphans. But at least it doesn’t regulate how the money will be spent. Medicare is a different story.

Medicare — A Transfer AND Regulatory Program

Medicare is slowly destroying the American health-care system, and should President Obama succeed in passing universal health care, that process will accelerate. The lesson from Medicare, plus the experience of our neighbor to the north and the European countries gives us a glimpse into the future. Health care will cease to be a service like any other, based upon capitalist principles. Instead it will become a command and control service in which the government makes all the decisions, even whether we will live or die. The reason is that state run health care systems, far from being "free," cost much more for the service actually delivered than the private systems they replaced. Higher costs lead first to deterioration in service quality and then, inexorably, to a reduction in health- care access. This will be the case even for those who are supposed to be the primary beneficiaries of a state run system — those currently without health insurance — who are characterized as lacking access to health care now.

Because costs accelerate following the demise of the private system, governments with universal health care systems are forced to ration care. In America, due to exploding cost, Medicare arbitrarily reimburses health care providers — doctors, hospitals, clinics, etc. — only a fraction of the cost of the care they provide. As a result, emergency rooms, trauma centers and even hospitals have been forced out of business when the percentage of Medicare patients reaches the point that revenue from other payers can no longer subsidize them. So our experience with Medicare plus the experience of the countries currently offering universal health care leads us to the obvious conclusion that less, not more, health care service will be available under a universal health care system. Even if America does not adopt such a system, the Medicare system will cause close to the same result but at a somewhat slower pace. Of course, before this happens, Medicare taxes will be raised in a futile effort to balance the books, leading to more generational injustice that is the concern of Mr. Dongala’s group.

I do not know whether it is possible to "save" either Social Security or Medicare. It is possible that the nation would accept a continuation of the current tax level and a decline in Social Security and Medicare benefits. (The Social Security Administration itself says that benefits will have to be reduced to approximately three-fourths of the amounts currently provided unless taxes are raised.) Medicare probably is beyond saving as currently structured. It is possible to conceive of scenarios in which health care providers would be allowed to refuse treatment to Medicare recipients who did not have supplemental insurance, for example, but accept Medicare recipients who did. Or both programs could become pure welfare programs, denying benefits of any kind to retirees with private incomes and some means. My prediction is that, even if this came to pass, fraudulent claims would swamp both systems as retirees who paid these taxes all their working lives saw services going primarily to the irresponsible. They would hide income and wealth in order to qualify. Such a system would make nominal criminals out of thousands, perhaps millions, of honest people.

Before this happens, let us try to do something about it. The first step is to determine what is politically possible. Forums such as Mr. Dongala’s Youth Entitlement Summit are a good first step and, according to an old Chinese proverb, a journey of a thousand miles begins with a single step.