Posts
From: patrickbarron@msn.com
To: wsj.ltrs@wsj.com
Subject: Russia Bans Grain Exports
Date: Fri, 6 Aug 2010 08:05:33 -0400
Re: Russia Bans Grain Exports
Dear Sirs:
Russia is suffering from excessive heat and wildfires. So President Putin has banned the export of grain and has set up an emergency relief fund of $1.2 billion for farmers. These measures usually meet with approval by those unfamiliar with economics. But President Putin's arbitrary decisions overrule the wishes of millions of Russians. If Russians want more grain, they can divert their spending from less important choices. But they will have less money with which to do so, because President Putin also has confiscated it for handouts to farmers. The market is far superior in reacting to natural disasters than arbitrary government edits. Yet politicians must grandstand, so they wave their hands and pass laws to convince the public that they can make it all better. We saw this farce in spades five years ago when Hurricane Katrina hit New Orleans and the Gulf coast.
Patrick Barron
Friday, August 6, 2010
My Letter to the Financial Times re: France Preventing Outsourcing by State Industries
From: patrickbarron@msn.com
To: letters.editor@ft.com
Subject: Re: France to reign in state-backed groups
Date: Thu, 5 Aug 2010 19:09:25 -0400
Re: France to rein in state-backed groups
Dear Sir:
By prohibiting state-backed companies from seeking the lowest cost and/or best quality factors of production, the French economy will revert, by just that much, to a lower production possibility frontier. This process will create an economic cancer in the French economy, because these industries will require higher and higher levels of subsidies, robbing other, more entrepreneurial businesses of life-giving capital. This is just another obstacle placed on the French economy by its Mercantilist-style governmental policies.
Patrick Barron
To: letters.editor@ft.com
Subject: Re: France to reign in state-backed groups
Date: Thu, 5 Aug 2010 19:09:25 -0400
Re: France to rein in state-backed groups
Dear Sir:
By prohibiting state-backed companies from seeking the lowest cost and/or best quality factors of production, the French economy will revert, by just that much, to a lower production possibility frontier. This process will create an economic cancer in the French economy, because these industries will require higher and higher levels of subsidies, robbing other, more entrepreneurial businesses of life-giving capital. This is just another obstacle placed on the French economy by its Mercantilist-style governmental policies.
Patrick Barron
Thursday, August 5, 2010
My Letter to the WSJ re: Geithner Pushes Tax Boost for the Wealthy
From: patrickbarron@msn.com
To: wsj.ltrs@wsj.com
Subject: Geithner Pushes Tax Boost for the Wealthy
Date: Thu, 5 Aug 2010 08:20:00 -0400
Re: Geithner Pushes Tax Boost for the Wealthy
Dear Sirs:
By defending increasing taxes on the wealthy, Treasury Secretary Geithner honestly reveals three things about this administration that the American people should know. One, that this administration wants more of the peoples' money; two, that the administration knows that the only place to get it is by taking more of the money from the nation's most productive people (that's why they are paid more); and, three, that the administration believes that savings is bad for the economy. Seldom has a high administrative official been so revealing about the vast chasm that exists between those who must work for a living and those who live as parasites off the fruits of others' labor.
Patrick Barron
To: wsj.ltrs@wsj.com
Subject: Geithner Pushes Tax Boost for the Wealthy
Date: Thu, 5 Aug 2010 08:20:00 -0400
Re: Geithner Pushes Tax Boost for the Wealthy
Dear Sirs:
By defending increasing taxes on the wealthy, Treasury Secretary Geithner honestly reveals three things about this administration that the American people should know. One, that this administration wants more of the peoples' money; two, that the administration knows that the only place to get it is by taking more of the money from the nation's most productive people (that's why they are paid more); and, three, that the administration believes that savings is bad for the economy. Seldom has a high administrative official been so revealing about the vast chasm that exists between those who must work for a living and those who live as parasites off the fruits of others' labor.
Patrick Barron
Wednesday, August 4, 2010
Understanding the Relationship between Money and the Price Level
One of the conundrums of current economic life is why the increase in the money supply had not caused runaway price inflation. Furthermore, the federal government has run a one-trillion-dollar deficit this year, with promises of more for several more years, while at the same time interest rates have fallen to unprecedented low levels. Both of these phenomena seem to violate economic law. Shouldn’t more money drive up prices? And shouldn’t government’s massive borrowings cause interest rates to rise? Yet prices for most goods have remained stable and the interest rate is at historic lows. Has all economic law been shown to be fallacious?
In this essay I will explain the fundamental forces at work to explain the relationship between the money supply and the price level, which will, coincidentally, help to explain the low rate of interest. There is no violation of economic law. The seeming anomalies stem from the fundamental error of placing economics within the realm of the physical sciences and not in the realm of the social sciences. The view of economics as a physical science leads one to the conclusion that economics is mechanical and can be explained by formulas; whereas understanding economics as a social science leads one to understand that human volition cannot be predicted or reduced to mathematical formula with substantive and temporal exactness.
The Quantity Theory of Money
At the foundation of our understanding of money and prices resides the quantity theory of money. At this most basic level it is axiomatic that the price level is the intersection of the quantity of goods for sale on the market and the amount of money available to purchase these goods. Prices can rise for only two reasons. One, the quantity of money rises faster than the quantity of goods for sale. Two, the quantity of goods for sale drops faster than the quantity of money. Of course the reverse is true about a falling price level. Prices can fall for only two reasons. One, the quantity of money falls faster than the quantity of goods for sale. Two, the quantity of goods rises faster than the quantity of money.
Let’s use a simple example. Assume that there is only one commodity for sale in the economy. One hundred units of this commodity are produced. The money supply consists of one thousand units of currency; we’ll use dollars as our money supply unit. The only price that will clear the market of all goods offered for sale is ten dollars per unit. ($1,000 divided by 100 units) Let us suppose that there is a production improvement that allows the market to produce two hundred units of the same commodity. Then the market-clearing price will be five dollars per unit. ($1,000 divided by 200 units) Likewise, let us assume that the money supply increases to two thousand dollars while the ability of the market to produce goods remains the same at one hundred units. Then the market-clearing price will be twenty dollars per unit. ($2,000 divided by 100 units) From this simple example one can clearly see that, if we admit that the U.S. economy produced more goods today than it did twenty years ago, then the primary reason that prices have not fallen is that the money supply increased concomitantly. If the money supply had remained stable, the only way that the market could have cleared the supply of goods for sale would have been for prices to fall. Since most price statistics show that prices have not fallen and in fact have risen somewhat, then the only explanation is that the money supply increased.
(Although the quantity theory of money knows no definitive author and has been known for centuries, Professor George Reisman has written extensively on the subject. I recommend pages 505 and 506 of his magnum opus Capitalism for a brief explanation. Then the reader can continue elsewhere in this magnificent book for further and more detailed discussion of money, prices, and production.)
There Are Only Three Uses of Money
Yet my illustration above and recent experience seem to make a mockery of economic science. I had said that economics was not a physical science, and yet I used mathematics to illustrate my point. Is not mathematics a physical science? Furthermore, my illustration would predict that prices must rise when the money supply increases, and yet in recent months the money supply HAS increased and prices have not followed. Should we discard the quantity theory of money? No. The theory is at the foundation of understanding money and prices and it does explain long-term trends. (Since 1990 M2 has increased by a factor of 2.62 while nominal GNP has increased by 2.57, which leads one to the conclusion that the economy has not really grown at all in terms of real goods and services in two decades. All of the increase GNP can be attributed to higher nominal prices caused by an increase in the money supply.) But other factors operating within this foundational theory determine market prices in the short-term.
There are three and only three uses for money—to hold (hoard), spend, and invest. Of the three, only the size of the spend-and-invest components determine the price level; i.e., spending and investing are those components of the money supply that are brought to market to purchase goods available for sale. As the total quantity of spending and investing increase in relation to the quantity of goods and services brought to market, prices will increase. If either or both of these components decrease, prices will decrease. Furthermore, if the money supply increases—that is, the total of all three uses increases—and all of the increase goes into hoarding, the price level will remain the same.
(As is the case with the quantity theory of money, the concept that there are only three uses of money was not discovered by any single economist, but I refer the reader to chapter seven of Hans-Hermann Hoppe’s The Economics and Ethics of Private Property for an excellent discussion of the subject.)
Here is an example that I use in my Austrian economics class at the University of Iowa: Suppose that the Fed printed enough paper money to give everyone in America one million dollars. Since there are 300 million Americans, the money supply would increase by 300 trillion dollars! Surely that would trigger higher prices! But let us also assume that every American took the money and placed it under his mattress. He did not spend one cent. What would happen? Well, the money supply would increase by 300 trillion dollars, but the price level would remain the same. All the new money would have gone into hoarding and would have no impact on prices.
Now we get a glimpse of what has been happening for several years. Central banks around the world have been printing money, but most of this money has been hoarded. When governments spend money without first borrowing it from the existing monetary stock or taxing it from the citizenry, the new spending eventually goes into bank reserves. Since the banks have not increased lending, the money supply has not increased. As of July 28, 2010 bank excess reserves stood at $1.012 trillion dollars. This is a form of money hoarding. Another form of money hoarding is the buying of sovereign debt. For example, the U.S. government has sold hundreds of billions of dollars of debt to our trading partners. This happens when foreigners foolishly believe that running large trade surpluses is somehow a national advantage. But Frederic Bastiat exploded this fallacy over a century and a half ago in his essay Government. By holding its currency cheap in order to export goods, a country impoverishes itself by shipping useful goods in exchange for depreciating paper money. Since these foreign governments have no use, so far, for American products, they buy U.S. Treasury debt in order to “park” the money until some future date. This, too, is a form of hoarding, because the money does not finance spending and/or investing.
The End to Hoarding
There is no way to predict the end to hoarding, but when it comes American prices will rise: the hoarded money will flow into spending and/or investing. At some point the hoarded money will burn a hole in peoples’ pockets. The first holders of large amounts of American money will be able to exchange their dollars for goods, services, and assets at today’s prices. But as this hoarded money flows into spending and investing, prices will start to rise. Other holders of hoarded U.S. dollars will realize that nothing can stop the depreciation of the dollar, as illustrated by relentless price increases. Now we will enter what Ludwig von Mises called the “danger zone”. Even if the central banks try to stop the flow of hoarded funds into spending and investing, they will be unsuccessful because market psychology has changed. No one will wish to hold depreciating dollars; they will be spent as rapidly as possible, creating the real possibility of what Mises called the “crack-up boom”. Money becomes worthless.
Just as the psychology of today’s market mitigates holding dollars, once the floodgates have been opened the psychology of the market will reverse. In The Mystery of Banking Murray N. Rothbard explained that market psychology can change very slowly, as in America for the first two decades after World War II, or very rapidly, as in Germany after World War I, where in 1923 the world witnessed the worst crack-up boom ever to appear in a modern, industrial nation. Germany recovered only when it exchanged the old mark for the new Rentenmark at one trillion old marks for each new Rentenmark and the Reichsbank pledged to hold the supply of Rentenmarks stable. When the Reichsbank kept its word gradually the people regained confidence in their currency. But the damage had been done. The resources of the middle class had been wiped out, and, more importantly, the German peoples’ confidence in social institutions had been shattered, opening the door to the demagoguery of National Socialism.
It Can’t Happen Here
Americans are no less ruled by the iron laws of economics than are other, less fortunate peoples. Never in the history of the world has so dominant a world power engaged in such massive money debasement. The trillions of dollars held around the world represent claims upon the productive sector of the U.S. economy that simply cannot be met--at least not at today’s prices. The German hyperinflation of 1923 wiped out the German government’s war reparation debt, but at the stupendous price of ushering in the fascists. Likewise, the U.S. could technically pay its national debt by so devaluing the dollar that it effectively robs dollar holders of their good faith claims upon American resources. I would remind xenophobic Americans, who may believe that robbing foreigners is of no concern, that Americans hold dollar claims, too, and would suffer just as much, if not more.
At the present time there is no better market alternative to holding American dollars. All currencies are fiat currencies, managed by the whim of politicians buying votes with more entitlements. But forces are building to end American hegemony in monetary affairs. The Chinese, the Indians, the Arabs, and the Russians are floating rumors of issuing a gold-backed currency, and the market always rewards a better product. It would be the greatest tragedy to befall this nation, if our foolish government destroyed our currency at the height of our productive capacity, making indirect, peaceful, cooperative exchange an impossibility. It can happen here!
In this essay I will explain the fundamental forces at work to explain the relationship between the money supply and the price level, which will, coincidentally, help to explain the low rate of interest. There is no violation of economic law. The seeming anomalies stem from the fundamental error of placing economics within the realm of the physical sciences and not in the realm of the social sciences. The view of economics as a physical science leads one to the conclusion that economics is mechanical and can be explained by formulas; whereas understanding economics as a social science leads one to understand that human volition cannot be predicted or reduced to mathematical formula with substantive and temporal exactness.
The Quantity Theory of Money
At the foundation of our understanding of money and prices resides the quantity theory of money. At this most basic level it is axiomatic that the price level is the intersection of the quantity of goods for sale on the market and the amount of money available to purchase these goods. Prices can rise for only two reasons. One, the quantity of money rises faster than the quantity of goods for sale. Two, the quantity of goods for sale drops faster than the quantity of money. Of course the reverse is true about a falling price level. Prices can fall for only two reasons. One, the quantity of money falls faster than the quantity of goods for sale. Two, the quantity of goods rises faster than the quantity of money.
Let’s use a simple example. Assume that there is only one commodity for sale in the economy. One hundred units of this commodity are produced. The money supply consists of one thousand units of currency; we’ll use dollars as our money supply unit. The only price that will clear the market of all goods offered for sale is ten dollars per unit. ($1,000 divided by 100 units) Let us suppose that there is a production improvement that allows the market to produce two hundred units of the same commodity. Then the market-clearing price will be five dollars per unit. ($1,000 divided by 200 units) Likewise, let us assume that the money supply increases to two thousand dollars while the ability of the market to produce goods remains the same at one hundred units. Then the market-clearing price will be twenty dollars per unit. ($2,000 divided by 100 units) From this simple example one can clearly see that, if we admit that the U.S. economy produced more goods today than it did twenty years ago, then the primary reason that prices have not fallen is that the money supply increased concomitantly. If the money supply had remained stable, the only way that the market could have cleared the supply of goods for sale would have been for prices to fall. Since most price statistics show that prices have not fallen and in fact have risen somewhat, then the only explanation is that the money supply increased.
(Although the quantity theory of money knows no definitive author and has been known for centuries, Professor George Reisman has written extensively on the subject. I recommend pages 505 and 506 of his magnum opus Capitalism for a brief explanation. Then the reader can continue elsewhere in this magnificent book for further and more detailed discussion of money, prices, and production.)
There Are Only Three Uses of Money
Yet my illustration above and recent experience seem to make a mockery of economic science. I had said that economics was not a physical science, and yet I used mathematics to illustrate my point. Is not mathematics a physical science? Furthermore, my illustration would predict that prices must rise when the money supply increases, and yet in recent months the money supply HAS increased and prices have not followed. Should we discard the quantity theory of money? No. The theory is at the foundation of understanding money and prices and it does explain long-term trends. (Since 1990 M2 has increased by a factor of 2.62 while nominal GNP has increased by 2.57, which leads one to the conclusion that the economy has not really grown at all in terms of real goods and services in two decades. All of the increase GNP can be attributed to higher nominal prices caused by an increase in the money supply.) But other factors operating within this foundational theory determine market prices in the short-term.
There are three and only three uses for money—to hold (hoard), spend, and invest. Of the three, only the size of the spend-and-invest components determine the price level; i.e., spending and investing are those components of the money supply that are brought to market to purchase goods available for sale. As the total quantity of spending and investing increase in relation to the quantity of goods and services brought to market, prices will increase. If either or both of these components decrease, prices will decrease. Furthermore, if the money supply increases—that is, the total of all three uses increases—and all of the increase goes into hoarding, the price level will remain the same.
(As is the case with the quantity theory of money, the concept that there are only three uses of money was not discovered by any single economist, but I refer the reader to chapter seven of Hans-Hermann Hoppe’s The Economics and Ethics of Private Property for an excellent discussion of the subject.)
Here is an example that I use in my Austrian economics class at the University of Iowa: Suppose that the Fed printed enough paper money to give everyone in America one million dollars. Since there are 300 million Americans, the money supply would increase by 300 trillion dollars! Surely that would trigger higher prices! But let us also assume that every American took the money and placed it under his mattress. He did not spend one cent. What would happen? Well, the money supply would increase by 300 trillion dollars, but the price level would remain the same. All the new money would have gone into hoarding and would have no impact on prices.
Now we get a glimpse of what has been happening for several years. Central banks around the world have been printing money, but most of this money has been hoarded. When governments spend money without first borrowing it from the existing monetary stock or taxing it from the citizenry, the new spending eventually goes into bank reserves. Since the banks have not increased lending, the money supply has not increased. As of July 28, 2010 bank excess reserves stood at $1.012 trillion dollars. This is a form of money hoarding. Another form of money hoarding is the buying of sovereign debt. For example, the U.S. government has sold hundreds of billions of dollars of debt to our trading partners. This happens when foreigners foolishly believe that running large trade surpluses is somehow a national advantage. But Frederic Bastiat exploded this fallacy over a century and a half ago in his essay Government. By holding its currency cheap in order to export goods, a country impoverishes itself by shipping useful goods in exchange for depreciating paper money. Since these foreign governments have no use, so far, for American products, they buy U.S. Treasury debt in order to “park” the money until some future date. This, too, is a form of hoarding, because the money does not finance spending and/or investing.
The End to Hoarding
There is no way to predict the end to hoarding, but when it comes American prices will rise: the hoarded money will flow into spending and/or investing. At some point the hoarded money will burn a hole in peoples’ pockets. The first holders of large amounts of American money will be able to exchange their dollars for goods, services, and assets at today’s prices. But as this hoarded money flows into spending and investing, prices will start to rise. Other holders of hoarded U.S. dollars will realize that nothing can stop the depreciation of the dollar, as illustrated by relentless price increases. Now we will enter what Ludwig von Mises called the “danger zone”. Even if the central banks try to stop the flow of hoarded funds into spending and investing, they will be unsuccessful because market psychology has changed. No one will wish to hold depreciating dollars; they will be spent as rapidly as possible, creating the real possibility of what Mises called the “crack-up boom”. Money becomes worthless.
Just as the psychology of today’s market mitigates holding dollars, once the floodgates have been opened the psychology of the market will reverse. In The Mystery of Banking Murray N. Rothbard explained that market psychology can change very slowly, as in America for the first two decades after World War II, or very rapidly, as in Germany after World War I, where in 1923 the world witnessed the worst crack-up boom ever to appear in a modern, industrial nation. Germany recovered only when it exchanged the old mark for the new Rentenmark at one trillion old marks for each new Rentenmark and the Reichsbank pledged to hold the supply of Rentenmarks stable. When the Reichsbank kept its word gradually the people regained confidence in their currency. But the damage had been done. The resources of the middle class had been wiped out, and, more importantly, the German peoples’ confidence in social institutions had been shattered, opening the door to the demagoguery of National Socialism.
It Can’t Happen Here
Americans are no less ruled by the iron laws of economics than are other, less fortunate peoples. Never in the history of the world has so dominant a world power engaged in such massive money debasement. The trillions of dollars held around the world represent claims upon the productive sector of the U.S. economy that simply cannot be met--at least not at today’s prices. The German hyperinflation of 1923 wiped out the German government’s war reparation debt, but at the stupendous price of ushering in the fascists. Likewise, the U.S. could technically pay its national debt by so devaluing the dollar that it effectively robs dollar holders of their good faith claims upon American resources. I would remind xenophobic Americans, who may believe that robbing foreigners is of no concern, that Americans hold dollar claims, too, and would suffer just as much, if not more.
At the present time there is no better market alternative to holding American dollars. All currencies are fiat currencies, managed by the whim of politicians buying votes with more entitlements. But forces are building to end American hegemony in monetary affairs. The Chinese, the Indians, the Arabs, and the Russians are floating rumors of issuing a gold-backed currency, and the market always rewards a better product. It would be the greatest tragedy to befall this nation, if our foolish government destroyed our currency at the height of our productive capacity, making indirect, peaceful, cooperative exchange an impossibility. It can happen here!
Sunday, July 25, 2010
My Letter to National Review re: Two Excellent Book Reviews
From: patrickbarron@msn.com
To: letters@nationalreview.com
Subject: Two Excellent Book Reviews
Date: Sun, 25 Jul 2010 08:15:10 -0400
Dear Sirs:
Congratulations on the two excellent book reviews in your August 2nd issue--James V. DeLong's review of The Next American Civil War by Lee Harris and Travis Kavulla's review of Prairie Republic by Jon K. Lauck. It isn't possible for most of us to read all the wonderful and important books that are written each year, so we must rely upon book reviews to distill the essence of these books, which your reviewers did so well. I was especially glad to see Mr. DeLong's defense of the Tea Party criticism of today's political class--Mr. Harris's "meritocrats". Most of the people in this class do not attain their power by merit but by rent seeking. They join the ruling class at low levels, adopt the arrogant outlook of the class and advance through the ranks through Soviet-style internal alliances. These people seldom are capable of earning a living in the private sector that comes close to their remuneration via government jobs and/or organizations that feed off of government grants. And herein lies the problem. Although the meritocrats may be a small percentage of our population, they buy the tacit support of the vast majority of Americans through their welfare and subsidy programs. For example, few Americans are willing to scrap Social Security despite the fact that it is nothing more than a government-mandated Ponzi scheme that will either fail or bankrupt the nation. Even our supposedly-independent farmers are little more than agents of the government, deriving much of their annual income through incomprehensible (to the rest of us) farm subsidy programs. The entire ethanol and wind power industries are completely dependent upon government subsidies. We are becoming a nation of pickpockets--all standing in a circle picking the pocket of the person in front of us...and who will be the first to cry "Stop"?
Patrick Barron
To: letters@nationalreview.com
Subject: Two Excellent Book Reviews
Date: Sun, 25 Jul 2010 08:15:10 -0400
Dear Sirs:
Congratulations on the two excellent book reviews in your August 2nd issue--James V. DeLong's review of The Next American Civil War by Lee Harris and Travis Kavulla's review of Prairie Republic by Jon K. Lauck. It isn't possible for most of us to read all the wonderful and important books that are written each year, so we must rely upon book reviews to distill the essence of these books, which your reviewers did so well. I was especially glad to see Mr. DeLong's defense of the Tea Party criticism of today's political class--Mr. Harris's "meritocrats". Most of the people in this class do not attain their power by merit but by rent seeking. They join the ruling class at low levels, adopt the arrogant outlook of the class and advance through the ranks through Soviet-style internal alliances. These people seldom are capable of earning a living in the private sector that comes close to their remuneration via government jobs and/or organizations that feed off of government grants. And herein lies the problem. Although the meritocrats may be a small percentage of our population, they buy the tacit support of the vast majority of Americans through their welfare and subsidy programs. For example, few Americans are willing to scrap Social Security despite the fact that it is nothing more than a government-mandated Ponzi scheme that will either fail or bankrupt the nation. Even our supposedly-independent farmers are little more than agents of the government, deriving much of their annual income through incomprehensible (to the rest of us) farm subsidy programs. The entire ethanol and wind power industries are completely dependent upon government subsidies. We are becoming a nation of pickpockets--all standing in a circle picking the pocket of the person in front of us...and who will be the first to cry "Stop"?
Patrick Barron
Thursday, July 22, 2010
My Letter to National Review re: Discrimination
From: patrickbarron@msn.com
To: letters@nationalreview.com
Subject: Re: Discrimination in Public Accommodations
Date: Thu, 22 Jul 2010 15:24:35 -0400
Dear Sirs:
In his letter published in the August 2nd, 2010 edition Mr. Ken Jansen states that there is a "public accommodations principle" that requires Somali taxi drivers to pick up passengers who they find to be objectionable and that "we rightfully forbid many forms of discrimination". In a rhetorical slight of hand Mr. Jansen states that these taxi drivers should "get out of the public accommodation business." But the taxi drivers are not in the public accommodation business; they are in the taxi business. They have invested significant time and money in their businesses and have every right to defend their lives and property from those whom they deem objectionable. As a more powerful example, Mr. Jansen cites laws against discrimination in hotel accommodations. What Mr. Jansen overlooks in both cases is the sanctity of property rights and that failing to offer a service or buy a service does not cause anyone harm. The fact that I buy my groceries from A instead of B does not mean that I have harmed B. Likewise, by refusing to sell a product that I own to A and not B, no matter how objectionable the reason, causes no harm to B. Real harm is physical harm; but there is no physical harm in refusing to act in a manner that "society" dictates. In a truly free society, a business owner who discriminates for reasons that society finds objectionable would find his business in decline. My wife still refuses to eat at Denny's due to media reports years ago, whether true or not, that some restaurants discriminated on the basis of race. Our modern theory of justice has been so perverted that property rights are deemed to disappear as soon as one offers a product or service for sale. This is not justice but tyranny.
Patrick Barron
To: letters@nationalreview.com
Subject: Re: Discrimination in Public Accommodations
Date: Thu, 22 Jul 2010 15:24:35 -0400
Dear Sirs:
In his letter published in the August 2nd, 2010 edition Mr. Ken Jansen states that there is a "public accommodations principle" that requires Somali taxi drivers to pick up passengers who they find to be objectionable and that "we rightfully forbid many forms of discrimination". In a rhetorical slight of hand Mr. Jansen states that these taxi drivers should "get out of the public accommodation business." But the taxi drivers are not in the public accommodation business; they are in the taxi business. They have invested significant time and money in their businesses and have every right to defend their lives and property from those whom they deem objectionable. As a more powerful example, Mr. Jansen cites laws against discrimination in hotel accommodations. What Mr. Jansen overlooks in both cases is the sanctity of property rights and that failing to offer a service or buy a service does not cause anyone harm. The fact that I buy my groceries from A instead of B does not mean that I have harmed B. Likewise, by refusing to sell a product that I own to A and not B, no matter how objectionable the reason, causes no harm to B. Real harm is physical harm; but there is no physical harm in refusing to act in a manner that "society" dictates. In a truly free society, a business owner who discriminates for reasons that society finds objectionable would find his business in decline. My wife still refuses to eat at Denny's due to media reports years ago, whether true or not, that some restaurants discriminated on the basis of race. Our modern theory of justice has been so perverted that property rights are deemed to disappear as soon as one offers a product or service for sale. This is not justice but tyranny.
Patrick Barron
Saturday, July 17, 2010
REAL FINANCIAL REFORM
So Congress has finally passed its much-anticipated reform of the financial system. Like all modern pieces of legislation, it supposedly fixes a problem created by the free market but it actually is a problem that government itself caused. Its main tenets are pure demagoguery and would have the public believe that bankers are brainless. For instance, it proclaims that lenders must do sufficient due diligence to satisfy regulators that the borrower can pay back the loan. Wow! Now, who in the banking industry would ever have thought of that?
There is not sufficient space in an essay of this kind to explain all the easily identifiable adverse consequences let alone the likely unintended adverse consequences of this horrible legislation. Instead I will explain what real financial reform would look like. Now if you show this essay to most politicians or government bureaucrats, make sure they are sitting down, because my reform relies entirely upon the free market. Government’s role is restricted solely to the defense of property rights.
End Fractional Reserve Banking
Fractional reserve banking is the underlying problem. By allowing banks to hold fractional reserves, rather than requiring 100% reserves, more than one person has claim upon the same asset. Since the claims are identical--both owners hold dollars that must be honored “for all debts public and private”, according to our legal tender laws--eventually the market recognizes that there are not enough resources to complete the entrepreneurial projects that were started by the initial and sustained injection of new fiduciary media. This is the nickel explanation of the boom/bust business cycle. So, number one, the government must prohibit and prosecute the fraud of fractional reserve banking. This means that the only way the money supply can grow is by way of the entrepreneurial production of more standard money; i.e., gold or silver.
Deposit Banks and Loan Banks
A common confusion that emanates from our current fractional reserve banking system, especially with the Fed as lender of last resort and the FDIC as guarantor of bank deposits, is how banks would be able to loan money at all if required to maintain 100% reserves on one’s deposit. How can they lend out the money without committing fraud? Murray N. Rothbard offers the simplest explanation in The Mystery of Banking. Divide banking into deposit banks and loan banks. Only deposit banks must maintain 100% reserves.
Here’s how I explain it to my students at the University of Iowa. Suppose that over the summer each one of them earns money and places it in the deposit bank. Since the deposit bank must keep 100% reserves, there is no way that the bank can earn money to cover its operating expenses except by charging fees for its services. After a few weeks the student has built up a balance in his deposit account that exceeds his immediate spending needs. In other words, he has accumulated enough that he can SAVE in order to spend at some later time. Therefore, he writes a check against his deposit account and gives it to a loan banker. The deposit will carry a maturity date, exactly like today’s certificates of deposit. Next the loan banker will seek worthy borrowers for our student’s money. If the student wanted to give the banker his money for a short period of time, say three months, the banker would seek borrowers who wished to finance inventory accumulation or accounts receivable financing, for example, which liquidate fairly quickly. If the student felt that he could invest his savings for a much longer period of time in order to earn a higher rate of interest, he might buy a five-year certificate of deposit. Then the banker would find borrowing needs that correspond to this time frame, perhaps financing the construction of a factory. The interest rate is the mechanism that regulates the loan market. If depositors are short term oriented, businessmen cannot finance long term projects. If the depositors are more long term oriented, then these projects may become financially sound. In Austrian economics we call the depositor’s relative orientation to the shorter or longer term as his “time preference”.
The Impossibility of a Boom/Bust Business Cycle
Notice that no matter what the depositor’s time preference he gives up his ability to spend for some defined period of time. His standard money has been moved from his deposit bank to the loan bank for further transfer to a borrower. Eventually the borrower pays back the loan and the loan bank has funds to honor the depositor’s matured time deposit. At no time was more than one person claiming the right to spend the money; therefore, there is no way that two people can claim the same physical asset. No projects will be started for which there are inadequate resources for their completion. A boom/bust business cycle is impossible under such circumstances.
The Role of the Loan Banker’s Capital Account
Notice that the depositor understands perfectly that his savings is at risk. If he did not wish to risk his savings, he could hold standard money certificates (paper claims upon real money—gold or silver—held in the banker’s vault), a book entry on the deposit banker’s records—a checking account--, or the physical gold or silver itself. As long as the government prosecutes fractional reserve banking as fraud, there is no risk that the depositor will lose his money, because he holds an audited claim upon the physical money itself. But what about the saver who deposits his money with the loan banker? What guarantee does he have that he will get his money back, with interest, when the time deposit matures? This is where the banker’s capital account and, just as importantly, his reputation for probity enter the picture.
The higher the percentage of the loan banker’s capital account to his loans outstanding, the safer are his depositors’ funds. The safest loan bank would be one in which the banker’s capital account EXCEEDS his deposit obligations. Let us assume that Mr. Rockefeller capitalizes his new loan bank with $10 million and will accept savings deposits up to only $5 million. Let us assume that Mr. Rockefeller invests his $10 million in very safe short term Treasury bills. He accepts $5 million from savers and finds borrowers who will pay enough to cover Mr. Rockefeller’s interest expense to his depositors, his operating expenses, and a small provision for future loan losses. The excess of his interest revenue, obtained from his borrowers, over these three expense categories is his profit. One can see that, even if he lost all $5 million of his depositors’ money, his capital account will cover the loss by a factor of two! As time goes by and the market realizes that Mr. Rockefeller is a good banker, who suffers very few loan losses, they will be willing to accept that the capital account may be a smaller percentage of the loans outstanding. Mr. Rockefeller may accept (and the public will decide to deposit) MORE than his capital account can cover. This is NOT fractional reserve banking, since there still is only one claim upon each dollar. But let us say that Mr. Rockefeller now takes deposits up to $20 million. Now he can suffer a loss of half of his loans and still be able to meet his depositors’ claims out of his $10 million capital account.
One can see that the interest rate offered by Mr. Rockefeller and accepted by his depositors will be influenced by how safe is Mr. Rockefeller’s bank, as exemplified by his capital account and his history of sound lending. The market will have room for many lenders, each with varying percentages of capital to loans and different histories of banking success. Poorly capitalized loan banks with bad loan histories will fail to attract depositors and will be taken over by better bankers. Since there is nothing to trigger the destructive boom/bust business cycle, bad loans will be very few and loan banking will be safer than our current FDIC insured system, in which moral hazard has been institutionalized by bailouts of failed Go-Go, risky bankers.
This is not to say that a bank could not suffer loan losses in excess of its capital account, but there would be no systematic reason for widespread bank failures, as is the case now with inflationary fractional reserve banking. The unprofitable bank would attempt to liquidate before running its capital account dry; therefore, it probably would still meet its depositors’ matured time deposit claims. In other words, loan bankers might go out of business but most likely they would pay off their depositors out of what remained of their capital accounts before closing their doors. They would act out of simple self-interest to preserve as much of their capital as possible.
The only role for government in such a free market banking system is to ensure that deposit banks do not violate their requirement to keep 100% reserves. Government would have no role whatsoever in regulating or examining the loan banks. The army of regulators armed with thousands of pages of regulations would not be needed…the free market would regulate banking the same way it regulates the availability and price of any other product. The era of the boom/bust business cycle would be a thing of the past. The only barrier to this simple, common sense, free market system is the hubris of government that it can regulate banking better than the unhampered forces of the free market.
There is not sufficient space in an essay of this kind to explain all the easily identifiable adverse consequences let alone the likely unintended adverse consequences of this horrible legislation. Instead I will explain what real financial reform would look like. Now if you show this essay to most politicians or government bureaucrats, make sure they are sitting down, because my reform relies entirely upon the free market. Government’s role is restricted solely to the defense of property rights.
End Fractional Reserve Banking
Fractional reserve banking is the underlying problem. By allowing banks to hold fractional reserves, rather than requiring 100% reserves, more than one person has claim upon the same asset. Since the claims are identical--both owners hold dollars that must be honored “for all debts public and private”, according to our legal tender laws--eventually the market recognizes that there are not enough resources to complete the entrepreneurial projects that were started by the initial and sustained injection of new fiduciary media. This is the nickel explanation of the boom/bust business cycle. So, number one, the government must prohibit and prosecute the fraud of fractional reserve banking. This means that the only way the money supply can grow is by way of the entrepreneurial production of more standard money; i.e., gold or silver.
Deposit Banks and Loan Banks
A common confusion that emanates from our current fractional reserve banking system, especially with the Fed as lender of last resort and the FDIC as guarantor of bank deposits, is how banks would be able to loan money at all if required to maintain 100% reserves on one’s deposit. How can they lend out the money without committing fraud? Murray N. Rothbard offers the simplest explanation in The Mystery of Banking. Divide banking into deposit banks and loan banks. Only deposit banks must maintain 100% reserves.
Here’s how I explain it to my students at the University of Iowa. Suppose that over the summer each one of them earns money and places it in the deposit bank. Since the deposit bank must keep 100% reserves, there is no way that the bank can earn money to cover its operating expenses except by charging fees for its services. After a few weeks the student has built up a balance in his deposit account that exceeds his immediate spending needs. In other words, he has accumulated enough that he can SAVE in order to spend at some later time. Therefore, he writes a check against his deposit account and gives it to a loan banker. The deposit will carry a maturity date, exactly like today’s certificates of deposit. Next the loan banker will seek worthy borrowers for our student’s money. If the student wanted to give the banker his money for a short period of time, say three months, the banker would seek borrowers who wished to finance inventory accumulation or accounts receivable financing, for example, which liquidate fairly quickly. If the student felt that he could invest his savings for a much longer period of time in order to earn a higher rate of interest, he might buy a five-year certificate of deposit. Then the banker would find borrowing needs that correspond to this time frame, perhaps financing the construction of a factory. The interest rate is the mechanism that regulates the loan market. If depositors are short term oriented, businessmen cannot finance long term projects. If the depositors are more long term oriented, then these projects may become financially sound. In Austrian economics we call the depositor’s relative orientation to the shorter or longer term as his “time preference”.
The Impossibility of a Boom/Bust Business Cycle
Notice that no matter what the depositor’s time preference he gives up his ability to spend for some defined period of time. His standard money has been moved from his deposit bank to the loan bank for further transfer to a borrower. Eventually the borrower pays back the loan and the loan bank has funds to honor the depositor’s matured time deposit. At no time was more than one person claiming the right to spend the money; therefore, there is no way that two people can claim the same physical asset. No projects will be started for which there are inadequate resources for their completion. A boom/bust business cycle is impossible under such circumstances.
The Role of the Loan Banker’s Capital Account
Notice that the depositor understands perfectly that his savings is at risk. If he did not wish to risk his savings, he could hold standard money certificates (paper claims upon real money—gold or silver—held in the banker’s vault), a book entry on the deposit banker’s records—a checking account--, or the physical gold or silver itself. As long as the government prosecutes fractional reserve banking as fraud, there is no risk that the depositor will lose his money, because he holds an audited claim upon the physical money itself. But what about the saver who deposits his money with the loan banker? What guarantee does he have that he will get his money back, with interest, when the time deposit matures? This is where the banker’s capital account and, just as importantly, his reputation for probity enter the picture.
The higher the percentage of the loan banker’s capital account to his loans outstanding, the safer are his depositors’ funds. The safest loan bank would be one in which the banker’s capital account EXCEEDS his deposit obligations. Let us assume that Mr. Rockefeller capitalizes his new loan bank with $10 million and will accept savings deposits up to only $5 million. Let us assume that Mr. Rockefeller invests his $10 million in very safe short term Treasury bills. He accepts $5 million from savers and finds borrowers who will pay enough to cover Mr. Rockefeller’s interest expense to his depositors, his operating expenses, and a small provision for future loan losses. The excess of his interest revenue, obtained from his borrowers, over these three expense categories is his profit. One can see that, even if he lost all $5 million of his depositors’ money, his capital account will cover the loss by a factor of two! As time goes by and the market realizes that Mr. Rockefeller is a good banker, who suffers very few loan losses, they will be willing to accept that the capital account may be a smaller percentage of the loans outstanding. Mr. Rockefeller may accept (and the public will decide to deposit) MORE than his capital account can cover. This is NOT fractional reserve banking, since there still is only one claim upon each dollar. But let us say that Mr. Rockefeller now takes deposits up to $20 million. Now he can suffer a loss of half of his loans and still be able to meet his depositors’ claims out of his $10 million capital account.
One can see that the interest rate offered by Mr. Rockefeller and accepted by his depositors will be influenced by how safe is Mr. Rockefeller’s bank, as exemplified by his capital account and his history of sound lending. The market will have room for many lenders, each with varying percentages of capital to loans and different histories of banking success. Poorly capitalized loan banks with bad loan histories will fail to attract depositors and will be taken over by better bankers. Since there is nothing to trigger the destructive boom/bust business cycle, bad loans will be very few and loan banking will be safer than our current FDIC insured system, in which moral hazard has been institutionalized by bailouts of failed Go-Go, risky bankers.
This is not to say that a bank could not suffer loan losses in excess of its capital account, but there would be no systematic reason for widespread bank failures, as is the case now with inflationary fractional reserve banking. The unprofitable bank would attempt to liquidate before running its capital account dry; therefore, it probably would still meet its depositors’ matured time deposit claims. In other words, loan bankers might go out of business but most likely they would pay off their depositors out of what remained of their capital accounts before closing their doors. They would act out of simple self-interest to preserve as much of their capital as possible.
The only role for government in such a free market banking system is to ensure that deposit banks do not violate their requirement to keep 100% reserves. Government would have no role whatsoever in regulating or examining the loan banks. The army of regulators armed with thousands of pages of regulations would not be needed…the free market would regulate banking the same way it regulates the availability and price of any other product. The era of the boom/bust business cycle would be a thing of the past. The only barrier to this simple, common sense, free market system is the hubris of government that it can regulate banking better than the unhampered forces of the free market.
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