Monday, August 31, 2009

No Power to the People!

My recent letter to National Review magazine, commenting on Mark Steyn's brilliant essay.

Re: Ethiopia Comes to You, by Mark Steyn

Dear Sirs:
Mark Steyn's recent skewering of the anti-population lobby could be applied in equal measure to the anti-energy lobby. Both are born of the environmental movement, whose blatant inhumanity places Mother Earth on a higher ethical scale than people. Talk about your pagan gods!

The legislators in my gone-crazy home state of Pennsylvania recently passed a bill requiring electric utilities to produce increasing LESS power, in graduated steps over the next five years, than the unhampered economy would demand. The environmentalists--such as my state representative, Chris Ross--claim that conservation efforts will make up the difference. But here lies a great logical fallacy. One does not produce electricity by conserving it. In fact electricity CANNOT be conserved; it can only be produced. The raw materials of nature, such as oil, waterfalls, uranium, etc. are not energy. They are merely oil, waterfalls, uranium, etc. One may say that energy lies trapped within them, awaiting the ingenuity of man to release it. But NOT releasing the energy accomplishes nothing of economic benefit.

Not harnessing the materials of nature--to avoid the energy police, and don't think they won't come!--forces man to move down his consumer preference scale. The lights must be turned off somewhere; a factory must close somewhere. Devices that use less energy in order to accomplish the same economic benefit divert resources that would have gone to satisfy something man valued more. The owners of businesses and homes have always invested in energy saving devices, without the heavy hand of governmental mandates, when it became clear that the savings would outstripped the cost. But governmental mandates to speed up this process merely lower everyone's standard of living. Unemployment and poverty follow.

PECO, my local utility, wants me to allow them to shut off my power when demand exceeds the government-mandated maximum supply. Of course, these peaks occur during very hot weather, when everyone runs his air conditioner. Who is most likely to sign up for such a program? The elderly, because they are trying to stretch their fixed income over increasingly expensive necessities. Will Representative Ross or any of the environmental lobby take responsibility for the deaths that will result? Not on your life!

As Mark Steyn might say--No Power to the People!

Friday, August 28, 2009

WHAT IS FRACTIONAL RESERVE BANKING? And why do most Austrian economists want to end it?

There are few things more misunderstood than the practice of fractional reserve banking and its impact on our economy. There are reputable Austrian economists on both sides of this issue. Most, like myself, believe fractional reserve banking to be fraud and injurious to the efficient and ethical working of the economy. (Read Jorg Guido Hulsmann’s excellent The Ethics of Money Production, available at the online bookstore at Others, such as Ludwig von Mises himself, would not ban fractional reserve banking but would allow the market to regulate it. Mises was more concerned with the prospect of government intervention in the monetary system and feared that laws against fractional reserve banking would be the camel’s nose under the tent mitigating in favor of more regulation.

It is difficult to understand fractional reserve banking without understanding some of the history of banking and how fractional reserves originated, for our current system maintains a fiction that has long since been made irrelevant. That irrelevancy is that something of lasting value backs our money; that is, something that would exist even if the nation/state that issued the monetary unit ceased to exist. Think of the difference in value between a gold coin of ancient Rome and the Confederate dollar, for example.

Fractional Reserves and Bank Runs

Historically banks came into existence as warehouses for gold and other precious commodities. Gold has always been a universal medium of exchange, even when other commodities competed with it for acceptance in the market. The first bankers were goldsmiths, who owned safes in which to store the raw materials of their profession. Wealthy individuals paid goldsmiths a fee to store their gold, and goldsmiths issued them receipts. Eventually these individuals started using the warehouse receipts as fiduciary media; meaning that rather than go to the goldsmith and redeem one’s gold in order to purchase something, these individuals started endorsing over their warehouse receipts. Thusly, the warehouse receipts circulated in the economy rather than the gold itself. Over time the goldsmiths realized that they could issue warehouse receipts in excess of the gold held in their vaults and reap a profit, because at no time did all the people who owned warehouse receipts for gold travel to the bank at the same time to redeem their certificates for gold specie. Now, the goldsmiths did not simply spend the excess receipts on consumer goods; rather, they lent them to borrowers and earned interest. (Doubtless the goldsmiths and even some economists today do not consider this practice to be fraud.) Since there now were more warehouse receipts for gold circulating in the market than gold in the vault to back them, it was said that the gold reserves amounted to only a “fraction” of the outstanding claims. Notice that two things had happened. One, the goldsmith gains from his fraud; that is, he made a profit (if the loan was repaid on time) from the use of goods that he did not own. Two, the money supply increased by the amount of the excess warehouse receipts. However, the money supply could not increase by very much, as we shall see.

The goldsmith, now transformed into a banker, was limited by the market in how many fractional reserve receipts he could issue. All would be well until the public became concerned that the bank had over-issued certificates. (Sometimes rumors were started by his competitors.) Then the holders of the certificates would “run” to the bank to redeem them for gold. A bank run had been born. Then the bank’s only course of action was to call in its loans, get paid in gold, and then pay its depositors in gold. If his borrowers could not repay, the banker would be forced to declare bankruptcy.

Sound Money and Credit Money

Notice that the certificates backed 100% by gold could always be redeemed without any difficulty. Thusly, such money could never be the source of inflation or deflation. But the excess certificates were not back 100% by gold; they were backed by the promise of the borrower to repay--that is, this money was backed by DEBT! If the debt could not be repaid, these excess money certificates could not be redeemed for gold. The money supply—composed of indistinguishable certificates, some backed 100% by gold and some backed only by debt—had been expanded when the goldsmith issued the excess certificates. Now the money supply shrank back to its former, sounder level.

Of course, money certificates today are backed by nothing—not gold, nor silver, nor cockleshells. The money we use is fiat money, and yet governments everywhere maintain the fiction that banks must hold reserves in some small percentage amount in order to cover their customers’ deposits. But what are these reserves? These reserves are debt, too. Let me explain.

The Basis of All Fiat Money Is Debt

In the U.S. the only money that may be used legally “for all debts public and private” is a Federal Reserve note. These notes—the money we carry in our wallets—are referred to as “standard money”. There is no recourse to anything beyond these paper notes. If a person wished to “redeem” his Federal Reserve note, he could go to the nearest Federal Reserve Bank and redeem it for…another Federal Reserve note. It might be one that was brand new off the printing press, but it would be the same type of note. If that person deposited his Federal Reserve note in a bank, the bank would create a demand deposit, also known as a checking account. The bank would send to the Federal Reserve Bank the Federal Reserve notes that it collected whose numbers were above what it deemed necessary to meet the normal needs of its customers for pocket cash. These notes would be deposited in the bank’s reserve account at the Fed. (A bank’s “reserve account” is nothing more than a checking account.) But the bank would not be required to maintain a 100% reserve account balance to match the total of all of its demand deposits. It is required to hold only a fraction in reserve--along a sliding scale, the fraction becoming greater for larger banks--to meet the withdrawal needs of its customers. The rest of his reserve account balance is “excess”, meaning not required to meet his “reserve requirement”.

Excess Reserves Become the Building Blocks of the Money Supply

So what can a bank do with its “excess reserves”? It can create a loan to another of its customers, credit that customer’s demand account, which will increase its reserve requirement and reduce its excess reserve position at the Fed by a fraction of the amount of the loan. The bank—actually, the banking system--can continue to lend and create demand deposits in this fashion until its reserve account balance matches its “reserve requirement”. This is how banks create money out of thin air, and one can readily understand the enormous ability of the banks to expand the money supply from this updated fractional reserve banking practice.

The key point is that the bank created the new demand deposit by creating a loan—the loan is an asset on the bank’s books and the demand deposit is a liability. Thusly, money in our bright new world of fractional reserve banking is backed by DEBT! In order for a deposit to be redeemed would require that the loan be repaid. If the loan cannot be repaid, the bank cannot meet its withdrawal obligations and goes bankrupt. This has been the cause of bank failures since the inception of modern banking.

The Central Bank Creates Reserves and Makes the Banks Bankrupt-Proof

But, enter a new player--the central bank. Our Federal Reserve Bank (or European Central Bank, or Bank of England, or Bank of Japan, or Bank of China) was created to prevent bank insolvency. The central bank stands ready to loan our bank unlimited funds so that it may honor its deposit withdrawal obligations. There are several ways that the central bank can accomplish this, such as purchasing bank assets or simply by a direct loan (called the discount window). It really doesn’t matter as long as the Fed can place the proceeds in the reserve account of our troubled bank. Ah, but where did the Fed get the funds to place in our troubled bank’s reserve account? Why, it created them out of thin air, too! For example, it can credit the federal government’s checking account in exchange for federal debt—called “monetizing the federal debt—or it can buy assets as discussed above, or it can lend directly to the banks at favorable terms. The central bank has become a money creation machine.

A Thing of Frightening Beauty—a Siren Song to Bankers and Politicians

Thusly, all central banks are the source of what the public calls inflation, creating money out of thin air to prop up bank credit expansion made possible by fractional reserve banking. The entire Rube Goldberg mechanism is a thing of frightening beauty, beloved by college professors who force their students to understand all the gory details, but especially beloved by bankers and politicians who can literally paper over bad debt with massive increases in the money supply. It does seem as if we have entered a new era in which it can be made impossible for banks to go bankrupt and fail to pay off their depositors. The central bank need only to invent some new rationale for replenishing the troubled banks’ reserve accounts; thus, the Troubled Asset Relief Program (TARP) and other such programs were born. The long-term harm to the economy is found on many fronts, from higher prices (perhaps even hyperinflation) to moral hazard to civic unrest as interest groups fight one another to feed at the government’s feed trough. Each dollar of new money, born of debt and not production, reduces the purchasing power of all other dollars already circulating in the economy. Nothing has been produced, not one nut or bolt, not one new car…nothing. But more money creates the temporary illusion of prosperity. One’s home increases in value. One’s 401K increases in value. Jobs are plentiful. New office buildings pop up to house all the new businesses that are born. The only problem is that nothing has been built on true savings, only debt. Yes, it is a brand new world, but it is a frightening one that cannot last.

Tuesday, August 25, 2009

A Glimpse of Things to Come

Officials from the Federal Reserve Bank are touring the country—very quietly, it turns out—to gauge populist opinion of its handling of the current financial crisis and to garner support to increase its regulatory power to become the sole financial regulator in the country. I attended one such event in Des Moines, Iowa, which was hosted by Iowa Citizens for Community Improvement (CCI). This group has been around for several decades and is aligned with a national organization called National Peoples’ Action (NPA). NPA claims to have been instrumental in passing the Community Reinvestment Act in the 1970s, which extorted banks to make loans to those with less than stellar credit records and to make mortgages on properties in blighted areas. Both CCI and NPA are proud of their achievements and see no linkage between their lobbying efforts to force banks to make marginal loans and the resulting sub-prime lending crisis.

Several hundred people—my estimate is at least five hundred—crowded into a Des Moines church and sat for two and a half hours while CCI and NPA officials berated the hapless consumer affairs representatives from the Federal Reserve Bank’s Board of Governors in Washington, D.C. and consumer affairs representatives from the Federal Reserve Bank of Chicago, the local Fed office for Des Moines. About a dozen people were paraded before the Fed panel, telling their tale of financial woe. In this day of the tell-all reality show, no one seems embarrassed to confess his personal financial ineptitude in front of hundreds of people and the recording cameras. And sorry tales these were. And like all tell-all reality shows, no one took personal responsibility for his actions, which was just fine with CCI and NPA.

The Link Between Personal Irresponsibility and Big Government

A Ms. Kathleen Keest, currently of the Center for Responsible Lending and a CCI board member from its founding in the 1970s, listed four supposed fallacies that prevent the common man from getting his fair share of society’s goodies: the acceptance of personal responsibility, the desire for personal choice, concern over unintended consequences, and the free market. According to Ms. Keest, all four are false gods. It is impossible for man to take personal responsibility for something as complex and important as borrowing money; personal financial planning is too complex to allow the common man to exercise his free choice; the concern over the unintended consequences of government action should be dismissed out of hand; and, the free market is the cause of all our problems in the first place.

Now, consider how wonderfully Ms. Keest’s analysis dovetails into the Fed’s desire to increase its power. True, the poor punching bags from the Fed’s consumer affairs offices had a rather nasty day being yelled at for over two hours, but the benefit is that Ms. Keest and the other professional busybodies actually called for INCREASING THE FED’S POWERS! Undergoing hours of tongue-lashings is worth the price of obtaining even more power and bigger budgets.

Of course most of those in attendance at this meeting did not understand that the Fed itself is the underlying cause of our problems. Speaker after speaker laid the blame squarely on the shoulders of the lenders, who forced their money upon an unsuspecting public, all the while knowing that the public could not repay the loans. The logic of this argument is so ridiculous that I will not take the time to refute it. But let me at least point out that all the many regulatory agencies also failed to detect the crime of irresponsible lending at its inception. Now everyone’s hindsight vision is 20/20.

Despite the fact that few in the audience understood that massive money expansion, which led to massive credit expansion, was at the heart of the current crisis, there is one thing that everyone understood perfectly clearly; that is, that the Fed has enormous power to transfer wealth. Speaker after speaker stated this fact as the reason for inviting the Fed to the meeting—they all want the Fed to shower its benevolence upon themselves and not others. The common mantra was that it is time for the Fed to help Main Street and not Wall Street. The Fed bailed out Wall Street and now all the big banks are paying big executive bonuses with their bailout money. It’s time for the same thing to happen on Main Street. Exactly what this means was not made clear, and I believe it was left unclear on purpose, so as not to alienate potential allies in calls for more money creation and more government economic intervention.

The Slippery Slope to Tyranny

This travesty of a supposed public meeting to gain the peoples’ input perfectly illustrates the kind of society to which we are plunging headlong. It has taken the demagogues a hundred years to realize that control of the money supply is control of people. Therefore, special interest groups like CCI and NPA do not focus their efforts on the peoples’ representatives. They lobby for increasing the power of government agencies who then can be browbeaten into doing their bidding. One of the most frightening moments of the meeting occurred when a George Goehl, executive director of NPA, whipped the crowd into a frenzy by showing a short video of NPA demonstrating in front of Fed Chairman Bernanke’s Washington, D.C. home. The demonstrators eventually obtained a promise from Bernanke’s Secret Service bodyguards that they would deliver a list of demands to the Fed chairman. Then Mr. Goehl told the audience that just hours before the meeting we were attending he had exacted a promise from the Fed consumer affairs representatives that Fed representatives would meet several times a year with CCI and NPA representatives. The audience cheered wildly and Mr. Goehl basked in the adulation.

So, welcome to the future, where public policy will be made by non-elected bureaucrats who make deals with special interest groups who intimidate public officials in their private homes. Do our bidding and we will support your efforts to obtain greater power and prestige for yourselves. Of course, you must give us what we want and not what other special interest groups want. Like the Bolshevik revolution in Russia, the most radical groups will work cooperatively with other special interest groups, such as farmers and small businessmen, to form a coalition with greater lobbying power. But such coalitions are temporary. The most radical groups will take over, just as the most radical and charismatic members will take over the surviving pressure group. This is consistent with Friedrich Hayek’s explanation of why the worst rise to the top in politics—only the most amoral individuals lacking all concern for the rights of others are willing to persecute their fellow man in the name of some supposedly greater societal good.

But, of course, there is no greater societal good that justifies the use of power and coercion to control the lives of the many for the benefit of the few. Ms. Keest and Mr. Goehl struck me as of the type who always rise when a foolish people are willing to give control over their lives to self-designated masters in the hope of trading freedom for security. It is only just that such a people lose both their freedom and their security.

Thursday, August 13, 2009

The Real Cause of the Current Economic Crisis and Its Cure

The current economic crisis was caused by government intervention in the economy that thwarted the market process and prevented freely acting and cooperating individuals from assessing reality and taking appropriate action to improve their own well being. The main intervention was by the Federal Reserve Bank’s expansion of bank reserves, which led to an artificial lowering of the interest rate, which spurred massive malinvestment in longer-term production processes. These production processes eventually were abandoned because there were insufficient real resources available for their successful and profitable completion. The artificial lowering of the interest rate did not reflect the reality that real savings had not increased--the government had simply printed more fiat money. In fact, real savings decreased, because the lower interest rate reduced the incentive to save below that which would have existed in the absence of the intervention. Eventually this dichotomy between increased investment not funded by real savings revealed itself in business losses in these longer term investments.

The government guided much of the malinvestment into the housing sector through its purchase of subprime loans by it several housing finance banks—the FHA, Fannie Mae, and Freddie Mac—and other interventions such as the Community Reinvestment Act, although other sectors of the economy also expanded longer term production that was not supported by real resources.

The spectacle of lower credit standards for home loans, which now seem beyond the minimal level of prudence, are but consequences of excessive credit expansion made possible and encouraged by the Federal Reserve Bank and the promise of government finance banks to buy these loans from the originating institutions. The excess fiat money could not be prevented from entering the economy somewhere and touching off the Boom-Bust Business Cycle. The artificial Boom distorted the structure of capital and production so that the real desires of people are not being met. This malinvestment must be redeployed, where possible, and liquidated if it cannot be redeployed. The longer this necessary adjustment process is delayed—for example, by government’s current actions to reflate the Boom—the longer the readjustment process will take and more non-specific capital will be lost that could have been redeployed.

The cure for the Boom-Bust Business Cycle is 100% gold-backed money, a legal prohibition on fractional reserve banking, an end to central banking, and an end to legal tender laws. These actions will prevent future expansions of credit not funded by real savings. Such a monetary system is the only one compatible with our Constitution. The Constitution of the United States clearly charges the federal government with establishing a standard for the dollar and prosecuting counterfeiters (Article I, Section 8). The United States had a relatively free banking system from the demise of the Second Bank of the United States in 1837 until the formation of the Federal Reserve Bank in 1913. During this period it enjoyed the greatest increase in wealth and production in the history of the world despite the death and destruction of the Civil War from 1861 to 1865. The Boom-Bust Business Cycles that occurred during this time were caused by the expansion of credit via fractional reserve banking; that is, the issuance of money substitutes not backed by gold. In other words, banks counterfeited their own money for their own profit, but eventually their fraud was revealed in the marketplace and banking customers scrambled for specie (gold). This is the origin of the “bank run”. Had the federal government prosecuted fractional reserve banking as the fraud that it is, these Boom-Bust Cycles would not have occurred. Likewise, sound money and an end to fractional reserve banking will end Boom-Bust Business Cycles today.

The government’s attempt to solve and/or ameliorate the current crisis will only make matters worse, because it is attempting to solve the crisis with the very same policies that caused the crisis--namely, excess fiat money credit expansion. The government is compounding its errors by spending so-called stimulus money. This spending of even more money created out of thin air will lead to higher prices and possibly hyperinflation, if not rescinded. Since the government can spend only what it takes from the people, its increased spending will drive the people to poverty even if the spending is on what many might consider worthy infrastructure projects. Government must refrain from spending, just as individuals must, in order to pay down debt and allow the economy to recover on its own. Over two hundred years ago, Jean Baptiste Say explained that the unhampered market economy always tends toward equilibrium and becomes more stable, not less stable, over time.

In addition to the end of government-controlled fiat money production and the rescinding of profligate government spending, the government should refrain from regulating more of the economy. In fact, it should eliminate most of the regulations currently on the books and devote itself to its primary job of protecting life, liberty, and property. Freely acting and cooperating individuals are the best regulators of the market process. No new banking rules enforced by an army of new regulators can prevent the inevitable malinvestment from the expansion of fiat money credit just as all the regulators in the past were unable to recognize the consequences of the Boom-Bust Business Cycles of the past. Thusly, it is imperative that the Fed remove its almost one trillion dollars in excess bank reserves before these reserves can be converted into many multiples of new money via the lending process. It should do this by selling its assets at whatever low price (high interest rate) necessary to accomplish the task. Furthermore, the government should cease all attempts to bail out failed firms, especially large firms, for these actions merely destroy even more of the nation’s capital by funneling what resources remain available to profitable firms to those firms that have proven incapable of producing a profit. The still substantial assets of these failed firms will be sold to entrepreneurs who are more capable of placing them into profitable and productive use.

There is nothing that government can do to speed up or ameliorate the necessary corrections to the economy. It can merely prevent them from happening at a cost of an even greater correction in the future. It is crucial that such correction be allowed to take place before the economy is completely destroyed, as occurred in Germany under the Weimar Republic in 1923 and as happening now in several African nations, such as Zimbabwe, today. The Soviet Union collapsed, because its once formidable economy was denuded of capital via the same policies touted by our government as a cure for the crisis today.

A free market economy—the only economy capable of providing peace and prosperity for all—is not compatible with command-style money manipulated by government for political purposes. It is this dichotomy that will destroy our economy. The economy will either become entirely free or entirely unfree. At the present time we are rushing headlong into a complete loss of freedom, both in economic and political affairs, for the two cannot be separated.

Wednesday, August 5, 2009

My Trip to the European Parliament

I recently made my second trip to speak at the European Parliament. Last year I spoke in Brussels to a committee on international development about the benefits of sound money for developing countries. This year I spoke in Strasbourg, France as part of a panel of three Austrian School economists, representing the Right Approach Group, which seeks market solutions to current economic problems. Now, just consider these first two lines. Yes, the European Parliament, which is just one branch of the many-tentacled European Government, has two offices—one in Brussels and one in Strasbourg. This fact alone illustrates why the organization is unpopular with the European taxpayer—it spends too much money on itself.

Last year I was wowed by the size and beauty of the Parliament’s offices in Brussels. It is a modern masterpiece of architecture—lots of glass, huge open areas, vast meeting halls, multiple cafeterias and coffee shops, not to mention the hundreds, perhaps thousands, of offices for the members, their staffs, and the unionized civil service. The office complex in Strasbourg is the same—vast, beautiful, and busy. But busy doing what? Well, for one thing, moving. Each month the entire European government moves from its main offices in Brussels to Strasbourg for one week. The cost of this move is enormous. Twice each month the members and their staffs must pack and ship files and other official documents, then travel and reside at significant expense in another city. Strasbourg is much smaller than Brussels, so the prices of hotels rise to reflect the increased demand. And we have not even touched the cost of lost productivity—which assumes, of course, that one believes that something beneficial to Europe really comes out of its alleged continental government. This is the elephant in the living room--does Europe really need a continental government?

The history of the European project is, as are more things than we like to admit, an outgrowth of the two world wars of the twentieth century. After the Second World War, there was real concern that Germany could threaten the peace a third time. Today we may view this concern with incomprehension, but one must look at the facts and the temper of the times. Few statesmen after World War One—called the Great War and the War to End All Wars--believed that Germany intended to restart hostilities or was capable of doing so. Did not the French, for one thing, have the finest army in Europe? France’s great wartime leader, Georges Clemenceau, was one of the few who saw the danger, but his warnings were ignored in favor of worthless arms reduction treaties.

The first step on the road to creating a European government was the formation of the European Coal and Steel Community. Its organizers were very clear that they believed that Germany must not be allowed to become self-sufficient in these two key industrial sectors. It was Germany’s attempt at autarky, meaning self-sufficiency in key economic areas, which made it believe that it could wage “Blitzkrieg War” before its key supplies were embargoed. The allies were determined to prevent this from happening. So Germany’s industrial capacity was made dependent upon foreign-controlled resources.

Over the decades a new agenda--or, rather, multiple agendas--appeared. On the one hand, there emerged a liberal (in the good, classical sense of the word) agenda to erect a large, free trade zone among European countries. The obvious example was that of the United States. Its states exercised no control over interstate commerce. Goods and people could travel freely across state borders. This had given the United States a tremendous advantage in costs and efficiencies. The people of the United States were much more willing to move to a new state to secure a better life, rather than stoically acquiesce in the decline of regional industries. Our common heritage, language, culture, and money made starting a new life in another state less costly and less fearful. Not so in Europe. Just imagine if Pennsylvania and New York were separate countries, whose citizens spoke different languages, required passports for people to travel between them, and charged duties on trade goods. This was the case in Europe. It is a triumph of liberalism that there now are no physical barriers of any kind within the EU. Only a few lonely and abandoned guard shacks remain on some intra-European borders.

So far, so good. But another, more grandiose agenda arose—political integration that would weaken each nation’s sovereignty. To some extent this has been achieved. The Euro—the European Union’s standard money—is administered and controlled by the European Central Bank (ECB), a supposedly independent entity. Although it is just as susceptible to political pressure as is our Federal Reserve Bank, no nation in the Euro Zone (not all EU members are in the Euro Zone) has total control of the ECB. Furthermore, the EU has managed to impose many standard economic regulations on its members and it has been partially successful in standardizing taxation throughout the EU. The purpose of tax standardization is to prevent shifts of business headquarters from high tax countries to low tax countries within the EU. Moving headquarters is very easy to do now that there is relatively free movement of people and goods throughout the EU. But the “tax equalization” movement became a cover for closing the door to the few tax havens that remained in Europe. At one of the large worldwide economic summits recently, French President Nicholas Sarkozy called for the world to close down tax havens in places like the Cayman Islands. So the real purpose of tax equalization is to fleece business everywhere on the planet in order to prevent European headquartered companies from escaping Europe’s onerous taxation.

The downside of all this, as the so-called “Euro Skeptics” claim, is that the EU has become a giant protectionist zone which greatly restricts trade outside its borders and engages in massive transfer payments within it borders. Half of the EU budget goes to farm subsidies, and they are a constant source of controversy. My wife and I had a front row seat to one incident. Our hotel in Strasbourg was only a few minutes’ walk from the EU complex, on a broad avenue that led to the beautiful heart of the city, about two miles away. The farm lobby held a demonstration by marching from the downtown area to the Parliament. The demonstrators chanted slogans, carried signs, drove tractors, and even herded a few reluctant cows. That evening the “France 24 English” television station explained that the farmers want their milk subsidies increased, because the price of milk is so low. One member of the Parliament voiced his support. Apparently he had no conception of basic economics; to wit, subsidies encourage production, and more production lowers the market price. Increasing subsidies would encourage even more production and cause the price to go even lower. Ah, well, we Americans cannot take the moral high ground here, with our own outrageous farm subsidies. Furthermore, like America, the EU blocks imports of cheap food from its poorer neighbors. We Americans block cheap sugar cane imports form dirt poor Caribbean nations, while Europe blocks farm products from Africa. Taxpayers on both continents not only get the honor of paying higher prices for food staples, but we also get the honor of propping up tyrannical and corrupt regimes through our foreign aid. Were these countries allowed to trade freely with their richer neighbors, conditions would be established for the creation of a middle class that eventually would demand more representative and more honest governments.

On the TGV from Charles de Gaulle Airport, just outside of Paris, to Strasbourg I met Paul Nuttall, a newly elected member of the European Parliament, and enjoyed a good hour’s conversation with him. Paul is a member of the United Kingdom Independence Party (UKIP), whose members are Euro Skeptics. Actually they are much more than skeptical of the necessity of the EU—they want Britain to resign from the EU. (In the very complex nature of EU structure, Britain is an EU member but it doesn’t use the Euro—it has kept the Pound Sterling, which is administered by the Bank of England.) Paul explained that EU membership meant that Britain could not freely import products from members of the British Commonwealth, such as Canada. The EU may be a free trade zone internally, but it has high tariffs against non-EU countries. The UKIP members see this as a bad deal; that is, cutting centuries’ old free trade ties with Commonwealth countries in order to pay higher prices for EU products. Furthermore, the leading EU nations, such as France, make no secret of their desire to free themselves from American military and diplomatic dominance. This is understandable and even laudable; there is no reason that the EU, whose GDP is roughly twenty-five percent greater than America’s, should be subservient to anyone. But Britain has a time-honored “special relationship” with America that was solidified in the Second World War. Many in Britain would rather be a junior partner whose voice is, nevertheless, taken seriously in Washington than an “Anglo-Saxon” outsider to a Franco-German dominated Europe.

My talk went well. The audience was attentive, as confirmed by the excellent participation in the Q&A session at the end. I was on three-person panel of Austrian School economists. Our twin goals were to educate and form alliances—educate potential allies in Austrian School principles so as to encourage them to use their influence to adopt sound economic policies. We met with mixed success, but better to speak to a skeptical group with some power than to preach to a choir who has none. As enjoyable as are my talks to those already friendly to Austrian School principles, we must face facts that we are outnumbered by the Keynesians in the halls of power. These are the people who must be presented with the likely consequences of their well-intended but disastrous actions. My points were simple—the actions of the past year to debase money, stimulate the economy, re-regulate the economy, and bail out failed industries must be repealed. The window of opportunity to do so is rapidly closing. The excess reserves injected into the banking system have not been leveraged, via the fractional reserve banking system, into massive amounts of new money media…yet. Only a small percentage of the stimulus package has been spent…yet. There is still time to prevent onerous and foolish new regulations on the financial system. And the bailouts must stop. The other two speakers—Professor Jorg Guido Hulsmann of the University of Angers and Dr. Thorsten Polleit of the Frankfurt School of Management—made similar points. Professor Hulsmann explained that Mercantilism was rising under a new name—Keynesianism--but it is the same, old, and discredited theories from before the industrial revolution wrapped in new garb. Dr. Polleit pointed out that proper policies to correct economic problems must be based upon a proper perception of the causes of the current crisis. Unfortunately, the world is under the impression that past government interventions not only did not cause the crisis, but that it was weak government oversight that allowed freely acting individuals to trash the system; therefore, more oversight is required. This is completely backward, and Dr. Polleit explained why.

Was anyone convinced? Maybe. I have received some emails from MEPs (Members of the European Parliament) who are interested in learning more. This is a start. Rome wasn’t built in a day and it didn’t collapse in a day. But the response of all industrial nations to our current crisis cannot work and will make things worse. The world needs to know why, and I, for one, will keep explaining why to anyone who will listen.

Tuesday, August 4, 2009

The Civilizing Influence of the Division of Labor

It is no exaggeration to say that all economic progress is the result of the division of labor, AKA specialization. Were each of us Required to live entirely on our own production, not one person in a million would live for more than a week. Consider if one were a Robinson Crusoe, marooned on an island that naturally provided many of our most pressing needs, such as water and some edible fruits. Nevertheless, in a very short period of time few of us would be able to feed, clothe, or house ourselves adequately. We would not be able to provide heat for cooking or keeping ourselves warm against the elements; we would not be able to provide ourselves with medical care, because we would not be able to produce something as commonplace as a bandage much less modern antibiotics. There would be no screens to protect us from insects or adequate roofing to protect us from rain. The list goes on and on. There is no historic record of man, even from primitive times, who was not part of some larger grouping.

For this reason we refer to man as civilized. He lives in a civil society of other men. There are few men--perhaps there are no men—who live completely autonomously on our planet. But for man to live in civil society requires that he adopt certain standards of behavior. Since he must specialize in one or only a very few tasks, he must rely upon others to provide him with all of his needs. This physical, and perhaps even emotional/psychological, need means that man must be cooperative, trustworthy, and ethical. Otherwise, other men would not cooperate with him.

A man who fails to exhibit these civilized characteristics becomes an outlaw. If he cheats his fellow man instead of living up to his promises to cooperate, no one will allow him into the circle of men who specialize for their greater benefit. In ancient times, one of the worst punishments to be visited upon a criminal was to be ostracized from Greek society. The criminal, whose activities are the antithesis of what is required for a civilized society, would be placed beyond the walls of the city and not allowed to return. He would be forced to wander alone, providing for himself as best he could or seeking acceptance into some other city. But why would some other city accept him? He had proven himself to be an outlaw. Ostracism became a death sentence for most, because it placed man outside the circle of those engaged in peaceful specialization.

This is the dilemma of those with criminal records today. They have trouble finding a job, which means that other men will not allow them to engage in the division of labor so that they may benefit from modern civil society. They must accept the meanest of employment, if they can find it, or live at the expense of others who are allowed to engage in specialization.

Some countries become criminal nations. They wish to rob the rest of the world of its product. But in order to become a criminal nation, these countries must first become completely self-sufficient. For if they depended upon overseas trade to provide them with some necessities, they would be vulnerable to a cutoff in trade that would thwart their evil intentions. Therefore, Nazi Germany attempted to become completely autarkic by invading its neighbors for vital raw materials before the rest of the world could stop it. This was the necessity behind the Blitzkrieg or Lightning War. Once Germany became self-sufficient, it could take its time to threaten and plunder the rest of the world.

The nation today that exhibits these autarkic characteristics is North Korea. But it has found that its people will starve without a minimal amount of trade; therefore, it periodically agrees to some international demand that it dismantle its nuclear weapons program in order to gain necessary imports such as oil. When it feels it has stockpiled enough of the vital, missing resource, it reneges on its agreement. North Korea has done this time and time again, which must lead the rest of the world, especially its neighbors—South Korea and Japan—to conclude that it is intent upon a Blitzkrieg war. Their only rational response is to end further blackmail-type agreements and defend themselves to such an extent that the North Koreans would not dare attack. This means building an anti-missile defense shield and arming themselves with nuclear weapons. This response is the opposite of all the current so-called diplomacy which seeks to cajole the North Koreans into becoming…well, civilized, but it is the only response that has any hope of working. It is the very response that was adopted by the West against the Soviet Union and which our current Secretary of State has hinted may be used against Iran.

So, what are we to think of the demands by some that America stop “exporting jobs”, that we reign in “globalization” of business, etc.? America is not the only country with factions calling for measures to prohibit native companies from seeking suppliers from overseas. Obviously, this is a veiled call for an end to the division of international labor in favor of national autarky. This attack upon specialization is a call for an end to civilization, for by what principle are we to stop at an end to specialization beyond our shores? If international specialization has no benefit, why do we trade beyond our home state or city or neighborhood?

A call to end international specialization is a call for war, for if a nation does not need the cooperation of its neighbors in order to improve its economic condition, there is no need to consider the citizens of other nations to be anything other than victims to be plundered. This was the policy of the National Socialists in Germany. Attacks upon free exchange among all the peoples of the world are attacks upon the international division of labor and are attacks upon civilization itself. We should see through these demands and view them for what they really are—calls to behave as a criminal among the nations of the world.

Saturday, August 1, 2009


This past week Congress doubled down on its “clunkers for cash” program, authorizing another two billion dollars after the original one billion appropriation was drained. For a people who supposedly cannot manage our own spending so as to provide for our own healthcare, we certainly understand when we are getting a bargain…in this case up to nine thousand dollars for a worthless car as long as we “trade it in” for a new one. The Keynesians, who apparently have never heard of Henry Hazlitt’s “broken window syndrome”, think the economy will be enhanced by all this new spending on autos.

Now, there is so much wrong with this program that I am loath to burden the reader with all the fallacious economic theories. But something that professor Bill Dunkelberg wrote about the onerous effects of the increase in the minimum wage put me to thinking about this program. Professor Dunkelberg, writing for the Wynnewood Institute ( said that when General Motors wants to reduce its inventory of unsold cars, it reduces the price. Likewise, when labor remains unsold, meaning unemployed, the price must be reduced in order to employ all those seeking work. But, of course, our government is doing the opposite. It is raising the price of labor in the face of severe unemployment. This will only exacerbate the unemployment problem. Now back to the topic of this essay—the clunkers for cash program.

Our government took over the management of General Motors, promising to return it to profitability. But how can it do this when GM has huge unsold inventories? The only way to reduce inventories is to sell the cars for less, but GM has the highest cost structure of any carmaker in the world. The cars could be sold only for a loss. It would not do to have our government-managed carmaker experience such huge losses. Why, the electorate might lose confidence in the ability of that thirty-one year old political junkie, who has no experience in the automotive business, being able to turn GM around. Ah, that’s where the “clunkers for cash” program comes in. Rather than dump more bailout money directly to GM, the “clunkers for cash” program funnels the money through car dealerships. This allows GM to sell cars at a profit, with the subsidy booked somewhere else.

So, GM gets to sell its cars at a profit. Car dealerships get to make sales in the depths of a recession. People get to buy new cars for much less than they ever expected. Why, even the environmentalists see this as a wondrous thing: the public gets more fuel efficient cars. And the taxpayer gets to pick up the bill. After all, who cares about the taxpayer? They are nothing but rich, greedy people who deserve higher tax bills anyway. And we all know that higher taxes have absolutely no impact upon production, so these rich, greedy enemies-of-the-people will continue to risk their capital and work just as hard as before. What a country!