Use Logic to Understand Economics

The citizenry of the world are being misled by the faulty economic doctrine of Keynesianism, which places consumption as the most important factor in producing prosperity. Business is slow? Then boost spending! Already in debt up to your eyeballs? Then borrow even more! Can’t borrow more? Then lobby the federal government to spend! It is not limited in its spending; it can print all the money that it needs. This is what passes for economic reasoning at the pinnacles of government power throughout the world.

The challenge of understanding economics is that observation of economic activity sheds little light on the “why” of things. If business is slow, observation does little to inform us why business is slow. People aren’t buying; goods are accumulating on shelves; they can be sold only by dropping prices, probably below cost. Our observation and experience tell us that selling below cost is the route to bankruptcy. So, it is easy for government to convince us that deflation—i.e., falling prices—is an evil that must be avoided. Therefore, only the government has the power to boost total spending, clearing the market of unsold goods, and at a profit, too!

Unfortunately, this doesn’t work. Our observation of conditions may be accurate, but a higher level of thinking is required to understand how we came to those conditions and how to correct the problem. This is the role of logic, the foundation of Austrian school economics.

Keynesian economics would place itself solidly within the discipline of the natural sciences, which have gained such a well-deserved reputation since the beginning of the industrial revolution. The natural sciences call upon research based upon observation and empirical testing to arrive at the truth or at least the truth until new observations and new testing arrives at a greater truth. In the natural sciences there is no such thing as irrefutable truth. We may be absolutely certain about physics, medicine, and even mathematics, until some new observation comes along to give us a new truth. An example is that of Einstein supplanting Newtonian physics. So all truth in the natural sciences is conditional and subject to refutation, even though we may believe that there are some things that will never be supplanted. But this just is not the case. It is this wing of science into which the Keynesians have attempted to place all of economics.

Contrary to placing economics in the natural science, observational and testing discipline, the Austrians claim that economics is a social science subject to deductive reasoning. Deductive reasoning requires NO observation and NO testing. If one postulates an irrefutable maxim and deduces other maxims from it in a logical manner, then these other maxims are irrefutable, too. Thusly, we arrive at the truth, and this truth requires no observation.

Here is the primary maxim in Austrian economics, as postulated by Ludwig von Mises—Man Acts. This is an irrefutable maxim, because if one attempts to refute the maxim he has only confirmed it: to refute the maxim that Man Acts is to “act”! The maxim is irrefutable! Furthermore, from this maxim much truth can be implied. For example, we must conclude that man acts purposefully; that is, he is rational and his actions are not merely physiological reflect actions; he acts in the context of time, performing one act ahead of another; he acts out of an understanding of cause and effect, for he believes that prior actions will bring about later desired results; he performs the more important actions ahead of the less important ones; he expects the result of his actions to improve his position in some way; etc., etc..

Let us now turn to how an Austrian would analyze the previously mentioned condition that business is slow. Austrians know that supply and demand constantly move toward equilibrium; this is known as Say’s Law. Therefore, Austrians would ask what external forces intervened to cause a general overabundance of unsold goods. Austrians would examine subsidies that encourage production of more goods of one type at the expense of other goods more desired by the market. This is the case with many agricultural gluts, which have their origin in government subsidy programs. Austrians would examine why costs are so high in relation to what consumers are willing and able to pay. Labor, environmental, safety, and licensing rules would draw their attention.

In other words, Austrian economists would look for the logical causes of undesirable circumstances, which most often reside well in the past. Therefore, the Austrian prescription of what to do differs radically from those of the Keynesians. Austrians would recommend the removal of all obstacles to the smooth interplay of supply and demand in a free market; whereas, the Keynesians would recommend more interventions, such as greater subsidies to more businesses in order to prevent their failure.

There is no doubt that the Keynesian prescription of vigorous, direct action is more appealing, at least in the short run, than the Austrian one of removing the shackles on the smooth running of the market. The Keynesian points to recipients of government bailout money and proclaims that businesses and jobs were saved; the Austrian advises that what is unseen is the price the rest of society pays through monetary debasement. The Keynesian prescription is further boosted by the shameless claim that what we have is a failure of the free market. But no country in the world today has a free market. All are managed, guided, restricted, and encouraged in some form by government. Some markets may be more free than others, and some are freer by some measures and less free by others; for example, some countries may have lower taxes but more stringent labor laws. This merely reflects the internal power politics of given countries.

The challenge to those of us who believe that we understand “real economics” is to recognize the appeal of the Keynesians and counter that appeal with a more powerful one of our own—the appeal to freedom. Keynesianism represents more government intervention and more loss of freedom; Austrian economics represents less government intervention and more freedom. America was founded on the principle that man is born free and that it is the proper role of government to protect his freedom not stifle it. The greatest attack upon our freedom has not come from foreign enemies bearing bombs and guns but from false economic doctrines bearing the poisonous idea that by giving up our economic freedom we will get the greater freedom of economic security. Not only is this a false statement—those countries with the least economic freedom have the least economic security--but freedom itself is indivisible. Economic freedom cannot be separated from political freedom--just try not paying your new healthcare taxes and see what happens!

Trade Protectionism Does Not Enhance National Security

As a general concept, free trade has many supporters. Most of us agree that trade with other nations is a good thing. We get stuff that we would not otherwise have and/or it is much cheaper. Examples include many food items that grow only in special climates, such as fruits and vegetables. Some foodstuffs cannot be grown here, or they can be grown only in special climate-controlled facilities. If the U.S. prohibited the importation of these foreign foods, we would not have them at all or they would be very high priced and, therefore, not available on the mass market. Therefore, it is not difficult to advocate free trade in these items, although even here the U.S. shamefully prohibits the free importation of sugar cane from poor Caribbean nations and corn from poor African nations, just to name two of the most egregious protectionist policies. These are nothing more than gifts to mostly rich American sugar and corn producers, at the expense not only of the American consumer but also, perhaps more importantly, at the expense of poor farmers in the Caribbean and Africa.

The Case for Trade Protection

But, I digress. The issue is protectionism as a necessary policy in order to enhance national security. Here the argument takes many forms. All involve the construction of straw men--meaning, the advocates of protectionism start from some extreme premise, whereby, once the premise is accepted, there appears to be no rational or logical alternative to protectionism. For example, one common argument assumes that some key industry just would not exist if Americans were to be allowed to purchase this industry’s product from overseas producers who had a natural advantage or were subsidized by their governments. The steel industry is often cited. It is assumed that the American steel industry is the target of foreign governments. These governments are hostile to the U.S., although not officially at war with us. These governments extend subsidies to their steel industries in order to monopolize the U.S. market, depriving American producers of necessary revenue and driving them out of business. Once the American steel industry has been destroyed, these governments can do two things. They now can inflate the price of steel so that our steel-dependent industries, such as autos, cannot compete internationally, or they can boycott sales to the U.S., making it impossible for us to arm ourselves with ships, tanks, artillery, etc. Under this scenario, our free trade posture makes us so dependent on one foreign producer that we would be forced to become a backward nation or surrender militarily. What is wrong with this argument?

The Impossibility to Monopolize the World Market

Well, first of all, when writing the above scenario, I found it difficult to construct this straw man so that the argument would appear possible. From a practical standpoint, the argument appears ridiculous. There are many nations eager to sell steel (or whatever good the protectionists cite) on the world market. If China, for example, subsidized steel to such an extent and for such a long time that it did manage to destroy American steel companies, what would it gain? As soon as it raised its price or refused to sell to us, other steel producers would rush in to sell on our market, for many countries have robust steel industries. What is China to do—sell subsidized steel all over the world in an attempt to destroy the steel industries in every country? This hardly seems plausible. But this practical objection is not the most powerful one against the protectionist argument. Read on.

The Inalienable Right for Man to Trade with Man

Economic theory helps us clarify the free trade position to such an extent that even seemingly practical objections can be viewed with renewed skepticism. One of the key concepts in Austrian school economics is that man trades with man and that both expect to benefit. Notice that I did not say that America trades with China. The free trade position stands upon the right of the individual to trade with whomever he desires. This right does not end at our nation’s borders. We have just as strong a right to trade with foreigners as we have with next door neighbors. This is a right embodied in our Declaration of Independence, which calls our right to life, liberty, and property (the pursuit of happiness) as inalienable, meaning that it is God given and may not be given away much less taken from us by legal means. Our Constitution became the practical implementation of this principle. As our “Supreme Law of the Land”, our Constitution lays a sacred obligation at the foot of government to protect us in our inalienable rights. Our Constitution makes no provision for our government to grant these rights or even to interpret them. Seventy-five years after our Declaration of Independence a Frenchman explained this issue in as clear terms as have ever been penned. Frederick Bastiat, in The Law, stated that it is impossible for government ever to obtain powers that did not once belong to man himself. Because government is a creation of man, man cannot grant to government any powers that he himself did not already possess. Since man does not possess the right to deprive other men of their property, government cannot legally exercise this right, no matter the number of people who clamor for it to do so. This is the philosophical foundation of free trade. Since man has no individual right to prevent his neighbor from trading with anyone he chooses, government cannot obtain the power to do so. But there is more; there is economics.

“Society” Benefits when Man Benefits

A fundamental tenet of Austrian school economics is that man acts in a purposeful way to accomplish something that he considers will be an improvement upon his existing condition. Now, I know the previous statement sounds odd, but the implications of it are far reaching. First of all, it places man at the center of all action. It does not say that societies act; no, it says that man acts. Man is the building block, so to speak, of society; that is, society is nothing more than the aggregate of all men and their actions. No man, no society. Therefore, it follows logically that when man acts in a purposeful way to improve his condition, any subsequent improvement may be regarded as an improvement for society, too. There is no such thing as an improved condition of man that translates somehow into a deteriorated condition for society. This is impossible. Now, this is not to say that man may improve his condition by committing a crime or some other physical harm upon another man. No, he may not. This is the “No Harm” doctrine of Dr. Thomas Patrick Burke of the Wynnewood Institute. When two men agree to trade, both expect to gain, and, in pursuance of their goal, they may not cause physical harm to another man. Notice that I said “physical” harm. Refusing to trade with another does not constitute harm. If I decide to switch my grocery shopping patronage from store A to store B, I have not harmed store A. The fact that I change my car buying patronage from an American company to a foreign company likewise does no harm to the American company. I have gained (or expect to gain, if my research is correct that the foreign car will meet my expectations) and the foreign carmaker gains. If either of us did not expect to gain we would not have traded in the first place. But there is more yet.

All Subsidies Are Transfers of Capital

Some trade protectionists will agree with my analysis of the situation, yet they still will advocate protectionism under the theory mentioned earlier that the foreign carmaker was subsidized by his government. The problem with this theory is that it fails to understand that all subsidies are transfers of capital. If the American government subsidizes its farmers, for example, the farmers gain and the buyers of farm products gain to the extent that their lower price exceeds the cost of the subsidy they provided. Since American taxpayers pay the subsidy to farmers, as a class of farm product consumers they cannot gain. In fact, they lose, since the cost of running the farm subsidy program detracts from the amount of the subsidy the taxpayers send to the farmers and, as a result, the price of farm products are not as low as they would otherwise be. One can see that if China subsidizes its steel industry, it transfers capital to the American consumers. Continue this exercise long enough and widespread enough, and China will ruin its economy by running out of capital.

Furthermore, when Americans buy cheap, subsidized Chinese steel, it is as if our steel industry found a new and more efficient method of production. We now get the same amount of steel by expending fewer economic resources. This allows us to expand our economy into new areas, because we now have increased capital to do so. The Chinese provided that capital to us free of charge! The American production possibility frontier expands while the Chinese production possibility frontier shrinks. But there is more! Cheap Chinese steel makes our steel-using products cheaper on the world market. We gain market share for any good that contains steel, because we can lower our price while maintaining our profit margins. The only way China can recoup some of its loss is to import these cheaper American finished goods. If they refuse to do this, then the subsidy is an out and out gift. But there is even more! To the extent that we build military hardware with subsidized Chinese steel, the Chinese are helping us pay for our national security. If we find that our current level of military preparedness can be purchased at a lower cost, we might decide to expand our military preparedness for the same budget dollars as before!

Conclusion—Free Trade Enhances Our National Security

In conclusion, rather than harm our national security, free trade enhances it. Military goods are cheaper; our economy expands into new frontiers made possible by an increase in capital; our exports are cheaper, so our businesses expand; and employment expands right along with an expanding economy, of course. So, bring on those foreign subsidies!

Achieving Energy Self-Sufficiency Would Be a Pyrrhic Victory

Everyone seems to agree that it would be a beneficial thing for America to become energy self-sufficient. Many reasons are advanced. The most common are national security and financial reasons. Sometimes these are one and the same; for example, that our oil dollars are financing global terrorism amongst people who at one time embargoed their product against us.

Nevertheless, this is not so. Once one digs into the issue for only a short while, he will realize the heavy costs associated with energy self-sufficiency—costs that negate and exceed the purely emotional benefit—making it, like King Pyrrhus’ victories over the Romans, so costly as to lose the war.

Why Do We Trade?

All the goods and services of modern life are the result of the division of labor carried to immense proportions. Self-sufficiency in anything, whether it be energy or toilet paper, means that we should restrict the division of labor to some extent. Think of our economic world as a bulls-eye. The small dot in the middle would be the goods and services represented by a subsistence economy, such as that of the North American Indian tribes. Small bands of people provided everything they consumed themselves. As capital and the division of labor expand, we move further out on the rings and the size of the economy grows exponentially larger. Instead of hunting our own food and weaving our own clothes, we rely upon the specialized skills of others, who perform only small pieces of the entire process but who perform their process unbelievably efficiently and productively. The division of labor expands to such a degree that we no longer understand how most goods that we consume are produced. We take all this for granted, yet it is a miracle of the free market. The more people engaged in the division of labor, the greater will be the total amount of goods and services available. Of course, the largest possible extension of the division of labor, until we trade with alien worlds, is the entire population of planet earth. (You can be assured that shortly after encountering our first alien civilization, entrepreneurs will be looking for trading opportunities!)

It is clear from this explanation that reverting backward from a more extensive division of labor society to a less extensive one means that society must accept a lower standard of living. There are two main causes for such an unfortunate occurrence—war and misguided economic policy. History is replete with examples of trade restrictions used as weapons of war. This makes perfect sense, too. If an enemy nation is denied trade, its total national product diminishes and its war-making capacity becomes a much larger burden upon the people. This burden may be so great that the war cannot be continued, lest the people starve. Therefore, it is ironic that societies often make war upon themselves! When they restrict the importation of some good, they force their society to revert to a less extensive division of labor, which results in a lower standard of living. Yet almost every country in the world restricts trade to some extent, almost always in order to protect the jobs and capital of some local industry which can no longer compete internationally. Government and special interest propaganda blind the people to the reality of the situation.

Energy Self-Sufficiency Would be a Pyrrhic Victory

The claim that our national security is enhanced by government restrictions on foreign energy imports and increased subsidies to domestic production fails to take into account that society at large is weakened by such action. Government intervenes to force business out of the production of goods more desired by the market and into domestic energy production. Few politicians and/or citizens recognize that an artificial requirement favoring some industry must come at the expense of another. We may get more domestic oil production, but we must have less of something else—the same capital and labor cannot be engaged in two production processes at the same time. If this process is carried far enough, an economy can collapse into backwardness. The Soviet Union is the prime example of our age. Its domestic production of goods to sustain life was so small that the people simply gave up. All production was geared to the military with no regard to the economy as a whole. Those who traveled there at the so-called height of Soviet power, like myself, were shocked at the state of the economy. There was nothing for the people—not housing, food, decent clothing, personal transportation, or even hot water! The Soviet Union had magnificent military hardware but little else. Its military might, achieved by ignoring the needs of the people, was a Pyrrhic victory. Society simply collapsed.

No one knows what sacrifices in lifestyle alone, not to mention capital investment in all other goods required by a modern country, would be required for America to become energy self-sufficient. Undoubtedly, our total energy consumption would be much less than it is today in addition to our loss of other goods. This means that our military budget would have to be cut unless we were prepared to go the way of the Soviet Union and simply ignore the needs of the people. We would be trying to support the same military preparedness on the back of a smaller economy.

All during the Cold War our military budget was a much smaller percentage of our country’s GNP than that of the Soviet Union, yet it equaled if not exceeded that of the Soviet Union in all objective measures of military power. Former economic advisor to Mikhail Gorbachev, Yuri Maltzev, estimates that the U.S. economic base was at least fifteen times that of the Soviet Union. In hindsight, it was no contest. And at no point during the Cold War was the U.S. self-sufficient in energy. In conclusion, rather than enhance our national security, attempts to achieve energy self-sufficiency actually would reduce it.

TWIN PILLARS OF CIVILIZATION UNDER ATTACK

Economic prosperity depends upon social cooperation under the division of labor. The larger the pool of people who cooperate with one another by specializing in the production of one or a very few goods or services, the greater will be their individual productivity and the greater will be the total amount of goods and services available for man’s economic benefit. This fact is undeniable, both from an empirical and a logical perspective. Of course, the largest possible pool of people would encompass the entire world. We need only look around us to recognize the benefits of worldwide trade—coffee from the tropics, wool from Australia and New Zealand, electronic goods from Asia, manufactured goods from Europe, not to mention oil from the Middle East, to name just some of the most obvious examples.

Given the universal acceptance by economists that the division of labor accounts for all economic progress and that worldwide trade advances the division of labor, one would expect that mankind would be on a one-way escalator to higher and higher overall prosperity. But such is not the case. Even a supposedly free, capitalist country like the United States suffers almost routine, wrenching economic crises. Others seem on the road to permanent prosperity only to sink back into the Dark Ages, such as has occurred in many African nations since the spate of post WWII de-colonizations.

Statist apologists such as Nobel Laureate Paul Krugman blame the very foundation of our prosperity—capitalism--for these crises and demand that governments take a guiding role in important economic affairs. A frightened citizenry, constantly bombarded by this message, know that government has the power to redistribute wealth and, at least temporarily, protect vociferous, well organized, and high profile special interest groups. Such has been the case with the auto unions. They can deliver the make-or-break votes to key politicians and wage a well-financed publicity campaign to quiet dissenters. But one does not need to be a rocket scientist to understand that government cannot bail out everyone in society. If it could, there would be no crises in the first place. So either government interventions for the benefit of special interests is limited so that the real economy is able eventually to cure itself, or continued interventions will create what has been called a “vampire economy” marked by capital consumption. Then the plundered many will sink further and further into destitution until, eventually, the plunderers themselves will find fewer and fewer sources of capital to plunder and the entire economy will collapse. According to former Gorbachev economic advisor Yuri Maltsev, this was the scenario, carried out in the most brutal fashion, that caused the collapse of the former Soviet Union.

In contrast to capital consumption, capital accumulation proceeds from the above-mentioned process of social cooperation under the division of labor. But one must understand the policies that cause the two different outcomes. In other words, what policies aid and abet a division of labor society? It is that question to which we now turn and from which discussion will be revealed the twin pillars of civilization—money and the rule of law.

Money and the Division of Labor

In order to specialize, man must be able to exchange the goods and/or services that he produces above and beyond his own needs for goods and services produced above and beyond the individual needs of others. There are two ways to accomplish this exchange—direct exchange and indirect exchange. Direct exchange, also known as “barter”, requires a coincidence of wants; that is, A produces what B wants and B produces what A wants. The two agree to exchange. But direct exchange has limited usefulness. What if A does not desire the production of B, even if B desires the production of A, or vice versa? And how can one ever expect to produce something like a locomotive or a jumbo jet and exchange it for any ordinary necessity of everyday life such as bread? It is obvious that man would produce only simple goods and live a very limited economic existence indeed.

But, man discovered that some goods were always in high demand; therefore, he traded for them, secure in the knowledge that he could re-trade them for goods that he really desired. Thus was born, gradually over time, indirect exchange. All indirect exchange originated in some useful commodity, and over the centuries many commodities have performed the function of indirect exchange. But the precious metals, especially gold and silver, have always been used as indirect exchange, even when in competition with other commodities. The precious metals are rare, difficult to counterfeit, easily stored, impervious to the elements, divisible into small amounts for small transactions, etc. Now man would be able to extend the division of labor into more time consuming and capital intensive goods and services.

The Law and the Division of Labor

But it was not sufficient to discover indirect exchange only. In fact, indirect exchange made it easier to obtain the goods and services of others without exchanging anything at all. In other words, man could steal money or, worse yet, counterfeit money. Whereas, it would be difficult to hide thousands of dollars’ worth of some every day good, such as bread, and use it oneself or exchange it over a long period of time, money is ubiquitous and imperishable. That is, all money looks the same, is readily accepted everywhere, and does not lose its usefulness over time. Therefore, over the centuries, man adopted standards of civilized behavior and sanctions against those who failed to follow such standards. Thus arose a body of law, enforced by government’s criminal justice system, to make man secure in all his property, especially his money. Man had delegated his inherent, God-given right to self-defense to government to protect his life, liberty, and property. Without such laws and without powers delegated to government, man never would have been able to fully exploit the power of money to extend the division of labor to greater and greater levels of production. Civilization would have stalled at a very low level of existence, perhaps no greater than that of the indigenous tribes of North America.


Money and The Law Under Attack

Today both money and the law are under attack, boding ill for the future of civilization. Money no longer is based upon a useful commodity; it is fiat money and may be manufactured in unlimited amounts by the very man-made organization founded for its protection—government. Furthermore, government has become the prime tool by which certain groups in society obtain the production of others without freely trading a good oR service of their own. Whether by the name of “welfare economics”, “economic stimulus packages”, “trade tariffs and quotas”, or some other outrageous sophist claim, government dwarfs even organized crime as a group of bandits to be feared, for there is no legal basis for protecting oneself and one’s property from its predations. Furthermore, the third party beneficiaries give their wholehearted approval to government’s counterfeit money production and resource redistribution operations! Thus, we witness the sad spectacle of government, formed to protect money through enforcement of the law, becoming instead the agent for civilization’s destruction.

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.

What Makes Theft a Crime?

If A takes something from B, we call this theft and consider it a crime. But why is this so? What exactly makes the taking of something from another considered a crime? The socialists desire that all things be held in common for the good of all. If this is so, how can anyone be considered a criminal when he takes something, since all things should be commonly owned? Is not A part of the commons and just as entitled to the possession of whatever it is as B? This is no small matter.

Of course, there are several valid reasons why theft is a crime, and all are based upon undeniable facts of nature. For one thing, we all need resources in order to live; therefore, if we are not secure in the possession of some resources, we cannot survive. If I grab the food from your hand (and do so without committing a crime) just as you are about to eat it, eventually you will starve. Presumably I grabbed the food from your hand and not from the sky, because food is a scarce resource…it may not simply be conjured out of thin air to satisfy our hunger. Your possession of the food, in the absence of facts to the contrary, is testament to its ownership. So already we have two undeniable facts: that resources are scarce and that the ownership of resources is necessary in order that they may be useful to us. These undeniable facts stand as impassable barriers to the pipe dream of socialism; that is, the common ownership of valuable resources to be shared by all.

But how do we gain legitimate ownership of anything? There are only two ways. Number one, we find some previously hidden and/or ignored resource. Since it was unknown or ignored by all, no one else may claim its ownership. But finding something is not enough. We must go further. We must turn the resource into something useful for man by, as John Locke said, “mixing our labor” with it. That labor may be something as simple as carrying the resource from the previously hidden place to our abode or it may be much more complicated, such as extracting some mineral from the earth, refining it, transporting it, etc. But we cannot claim ownership to something simply by planting our flag and proclaiming that it is ours and ours alone, as did the conquistadors when they planted the flag upon a beach in the Americas and preposterously claimed the New World as the possession of Spain.

The second way we gain legitimate ownership of something is through exchange of resources already possessed legitimately by someone. This is the way that most resources come to us. We exchange one resource that we value less for another one that we value more. Exchange can be direct exchange, meaning barter…apples for oranges, for example. But mostly exchange is indirect exchange, meaning money exchange…buying the apples or the oranges with money (the indirect exchange medium) that we earned through previous production.

Notice that theft does not involve either direct or indirect exchange. The thief takes without exchanging anything of value. He may do this stealthily, as would a pickpocket; or he may do it threateningly, as would an armed robber or through extortion, as do gangsters in the so-called “protection racket”; or he may hire someone to steal for him, promising political and legal protection for the thief. But the key point is that there is no mutually agreed upon exchange of some previously and legitimately obtained resource. One party gets something and the other nothing (or something less than he would accept in the absence of extortion or the threat of violence).

Now, then. How are we to categorize the actions of government? Mostly as a thief, in my opinion. Let us count the ways:

1. Stealthily. Through inflation of the money supply, which rewards government and robs the entire population of its previous and legitimately earned purchasing power. Expansion of government controlled money MUST enter the economic system somewhere, unjustly rewarding those first recipients of the new money.
2. Threateningly or through extortion. Pay your (fill in the blank) tax or we will confiscate your wages, sell your house, and send you to jail. It does not matter that you do not want the service, do not need it, or can purchase it more economically elsewhere.
3. The hired gun. Special interests promise to vote for politicians who will give them special privileges at the expense of the polity in exchange for returning them (the politicians) to lucrative and powerful elective office. In this case the thief is merely the agent of a criminal conspiracy. The “real” criminals are the special interests who “hire” the thief. The thief gets a salary for his services and the “real” criminals provide him with political and legal protection. The most well known “real” thieves in America are unions, farmers, the American Association of Retired Persons (AARP), and big businesses seeking trade protection. All seek undeserved economic advantages at the expense of everyone else not so well organized or shameless.

Of course, this is not to imply that all government taxation is theft. If government restricted itself to gathering taxes for maintenance of public safety and little else, then the entire polity will benefit from having its life, liberty, and property protected from criminals. This is the proper, legitimate role of government as envisioned by our Founding Fathers and enshrined in our majestic Constitution, the very same one that has been systematically debased practically before the ink was dry but with increasing disregard for its very words in the last one hundred years. America’s “living Constitution” provides no protection to its citizenry when it is government itself that has the power to interpret it for its own benefit, as does the Supreme Court.

But America was founded not on the Constitution but on another, more fundamental document—the Declaration of Independence. That document states very clearly that “…when a long Train of Abuses and Usurpations, pursuing invariably the same Object, evinces a Design to reduce them under absolute Despotism, it is their Right, it is their Duty, to throw off such Government and provide new Guards for their future Security.” We need no Supreme Court to tell us the meaning of those words. The Declaration of Independence is not a “living Declaration” that means what government says it means. The Declaration of Independence founded America, and America will remain eternal. Governments, however, are mortal.

Why No One Would Desire to Be a King of France

My wife and I just spent a delightful week and a half in France, during which we made the obligatory trip to the Palace of Versailles, home of the kings of France prior to the great Revolution of 1789. The crowds were massive. Even with pre-purchased tickets, we had to wait in line for over an hour just to get inside the palace. Of course, it is unbelievably ornate, but my impression, reinforced as our self-guided tour progressed, was how lucky we all are not to have lived in the era that this palace represents.

One’s first impression of Versailles is from a quarter mile away. The building is massive. I leave it to the gentle reader to Google all the details, but it struck me as a preserved dinosaur. Now, dinosaurs are very popular, with children especially. We anthropomorphize them through cartoons as gentle giants. Barney comes to mind. This is a common theme among children—to make them believe that something that is really quite dangerous is not to be feared. As we grow older, we may find the study of these long gone monsters to be of historical interest. But this does not mean that we desire their return or, if possible, our return to their age in history. I felt the same way about Versailles.

No one who has given the matter serious study would desire to return to the age of the kings of France, even if he were king himself! That is quite a statement, but bear with me. As one tours massive, ornate-beyond-belief Versailles, one is struck at the lack of true creature comforts. True, the king could drink out of a gold and bejeweled goblet; he could dine on the finest hand-painted porcelain; and he could sit on a plush chair. These comforts were the products of pre-capitalism, pre-industrial revolution France. They were the products of very little specialization. Just a few artisans--the best in the world, no doubt--produced the table service and furniture, but they produced these beautiful things over months and years of personal labor on one single item. Furthermore, these objects, beautiful as they are, performed no more utility than the commonest dinner service and easy chairs do today—they held food and beverage for our tableside consumption and provided comfortable seats for our weary backsides. The crystal chandeliers provided no better illumination, and probably worse, than a lamp purchased at any modern discount store.

In the movie “National Lampoon’s European Vacation”, when comedian Chevy Chase first views the great Hall of Mirrors, he says “It’s good to be king.” But the great Hall of Mirrors does not enchant us as it did visitors in pre-capitalist France. Mirrors are as common today as, oh, hot and cold running water, something that the kings of France did not enjoy. Remember the old proverb about breaking a mirror bringing seven years’ bad luck? At one time, mirrors were so rare and so expensive that breaking one was worse than having one’s house burn down. Houses could be built quickly, but mirrors could not be obtained for love or money.

But the greatest and most striking reason that none of us would desire to be transported back in time to be a king of France is the lack of hygiene. Proper hygiene is the end result of massive industrial-scale specialization. Even a king could not command central heat and air-conditioning at the flick of a switch. He could not read by the soft light of a non-burning and smokeless lamp. He could not wash his hands and face in hot water at the turn of a knob, much less take a shower whenever the mood struck him. His teeth rotted from poor dental materials—no dental floss or fluoride toothpaste, much less regular checkups for early detection and repair of decay. Reader sensibility prevents me from discussing toilet etiquette in the absence of flush commodes and sewers systems. All these hygienic conveniences are the products of modern post-industrial revolution capitalism. The wonders of the division of labor among cooperating peoples has given us mass production of creature comforts. The price has been driven down to such a degree that today the poorest of the poor in the Western world take them for granted. All these products were unknown even to the very richest in the era of absolute kingships.

When King Louis XVI attempted to flee the revolutionary mob, his heavy carriage became bogged down on the muddy roads and he was captured. Later he lost his head…literally. Today’s tyrants fly in their personal jets to political asylum in a friendly country. No king of France could dream of such service. Contrary to Chevy Chase’s conclusion upon viewing the great Hall of Mirrors, it would NOT be good to be a king of France.

Save Some Jobs by Destroying Many More

Much of the Obama administration’s rationale for bailing out GM is that such actions will save American jobs. This is just one of the many unfortunate fallacies that stem from our century-old fiat money system.

Prior to the formation of the Federal Reserve System the American populace would have scoffed at such nonsense that the government can or even should tax all Americans in order to save the jobs of some Americans. It would have been apparent to anyone in the age of the gold standard that the government can give away only what it takes from someone else, exacting its overhead cost and throwing uncertainty of the future into the mix to boot. In the case of the GM bailout, the benefit will accrue to the unions, who bear primary responsibility for the systematic destruction of the American automobile industry since the 1930s. But the fact that we are no longer on a gold standard does not eliminate the economic truth that all of us who are not members of the United Auto Workers are being robbed by our government for the union members’ benefit.

The GM bailout perfectly illustrates why government gets away with this assault on the American taxpayers’ pocketbook. The benefit is concentrated and easily identified and quantified. The billions of bailout money will keep plants open and salaries flowing, at least for awhile. Smiling autoworkers--not all of them union members, of course—will be happy that they still have a job. I have no doubt that the mainstream media will interview them and allow them to relate how happy they are with the government’s actions.

But no one can interview the people whose jobs were lost or never created when the capital that would support them has been funneled to GM. GM has first claim upon America’s resources as the first recipients of new, fiat money. No one can interview the people who never got jobs from businesses that never expanded production, because GM has first claim upon America’s resources as the first recipients of new, fiat money. No one can interview the people who were never employed in the first place in businesses that will never be, for GM has first claim upon America’s resources as the first recipients of new, fiat money.

The GM bailout ignores the fact that capital resources are scarce. Government spendthrifts are led to this conclusion, if they ever think in such terms at all, because government can print all the money that it wishes to spend. This is the case only because our fiat money system creates the illusion that government spending is not paid by the populace. Because it prints all the money it wishes, government does not have to increase taxes or borrow honestly at high rates of interest. Under a gold standard there is no such illusion. Because gold is a part of the market economy itself, government cannot hide who must bear ultimate responsibility for what it spends—the people themselves through higher taxes now or more debt now and even higher taxes later. There is no escaping from financial truth. The GM bailout would be seen for exactly what it is—a transfer of wealth from the profitable and productive segments of the economy to an unprofitable and unproductive segment of the economy. Such a transfer destroys; it does not save anything.

The GM bailout, like the bank bailouts of the Bush administration, illustrates why government will never be the source of financial reform. Government is the biggest beneficiary of its ability to print money. It can lavish other peoples’ wealth on politically connected, high profile workers and appear to be generous and even wise for having done so. It can bail out those who cannot pay their mortgages and appear generous and even wise for having done so. It can send stimulus checks to low and middle income Americans and appear generous and even wise for having done so. Government gets to act like the ignorant Bonnie and Clyde characters of the 1930s reign of lawlessness, who claimed that they weren’t robbing people only banks…and the banks were owned by faceless rich people anyway who deserved to be robbed.

But robbery does not produce anything, whether from a Bonnie and Clyde or a duly elected government official. Those who worked and saved find their capital confiscated via the stealth tax of inflation for the benefit of those who squandered a rich heritage and show little hope that they have changed their ways. And what if they have? It is not government’s job to pick winners and losers. It is government’s job to protect our property. But instead of protecting us, government has become the thief itself.

Inflation Will Harm the Economy, Not Spur Recovery

On Wednesday, May 20th Rich Miller of Bloomberg News reported that two well-known economists--former White House adviser Gregory Mankiw and Harvard professor Kenneth Rogoff--recommended higher inflation to spur the U.S. economic recovery. One would think that after so many decades of boom/bust business cycles and depreciation of the dollar to a mere fraction of its worth even Harvard economists would rethink their Keynesian philosophy. Inflation can occur only through the medium of exchange, of course, as too much money chases too few goods. It is caused by an expansion of the money supply, which one must assume is the desired mechanism for Mssrs Mankiw and Rogoff. But expansion of the money supply is what got us in this mess in the first place. The artificial lowering of the interest rate spurred more long-term projects than could be completed with the limited resources at hand. More money will perpetuate and exacerbate this malinvestment by keeping capital destroying businesses in operation for a few more months. But more money will not cure the underlying problem. On the contrary, it will make it worse and make the necessary recession longer and deeper, meaning it will take years rather than months and cause higher unemployment and more loss of capital than would otherwise be the case. The recession, of which higher unemployment is a manifestation, is an essential and inescapable process that must occur for the REAL economy to recover. Money losing businesses must close their doors and people must find work in profitable firms. Ours is a profit and LOSS system. The losses tell us just as much as the profits, for losses prevent us from destroying our capital. But Mssrs Mankiw and Rogoff--and so many other ill-informed economists like them--would have the U.S. consume all its capital rather than suffer the temporary adjustments needed to return the economy to long term growth. Like Nobel Laureate Paul Krugman, they demand instant gratification--the future be damned! But we must live in the future, and its foundations must be built now. It is time to get back to basics and cast off these false economic ideologies that promise so much and cause so much damage.

The Network of Fallacies Supporting Government Stimulus

The U. S government is attempting to reverse the economic downturn with a two-pronged policy of monetary inflation and fiscal stimulus. In previous essays I have exposed the role of the central bank in supporting the very monetary system—fiat money, produced in unlimited amounts by our fractional reserve banking system--that has triggered the Austrian business cycle, AKA the boom/bust business cycle. Once begun there is no way that the bubble, so induced by the expansion of credit not supported by real savings, can continue indefinitely. The bubble must burst and a recession must follow, which is simply saying that losing businesses must close and capital and people must find new, more market-oriented employment.

Nevertheless, our Federal Reserve Bank has expanded its lending—illegally, I might add—to non-member institutions such as insurance companies in addition to its massive expansion of reserves to the banking system. It has not worked and it will not work.

The Fallacy of Insufficient Consumer Spending

But in addition to this money expansion, the government has proposed a massive spending program, although the term “program” is too kind a word for this mishmash of boondoggle earmarks to all the left’s favorite socialist programs. Supposedly, it doesn’t matter where or how the money gets spent. Oh, no. All that matters is that it gets spent on something, anything, well…anything that meets the left’s agenda anyway. Solar panels and windmills are fine; drilling for oil in Alaska and off our coasts is not. The theoretical justification in this assault upon the pocketbook and common sense of the taxpaying American lies in a network of complementary economic fallacies that have become ingrained in university campuses and the halls of government. The short explanation is that insufficient consumer spending causes all recessions; therefore, the government must step into the breech and pick up the slack. For those who love formulas—which includes most university economic departments—here is their favorite formula: C + I = GNP. Consumer spending plus investment equals gross national product.

Of course, if one accepts this formula as representing reality, then it is easy to see that if consumer spending drops—C goes down—and investment does not pick up the slack—perhaps it goes down, too!—then GNP goes down. But, is that the cavalry I hear? Yes, it is the federal government, armed with its checkbook drawn against its account of newly created fiat money at the central bank. All government (G) has to do is increase its spending. The new formula becomes: C + I + G = GNP.

But the law of diminishing marginal utility tells us that government spending can never deliver the same satisfaction to the market as private decisions. We may acquiesce in some government spending as the necessary cost of civilization—for example, spending on public safety and an efficient and honest system of courts—but other government spending preempts private choice by purchasing goods and services for us. In addition to the presumption that such spending is good for us despite the fact that we can choose to purchase these goods and services ourselves, if we so desire, government spending is inefficient for it lacks the profit motive and the all-important feedback mechanism of the market. Ludwig von Mises explained that such government interference in the market place cannot succeed in satisfying human wants, due to the absence of socialist calculation. For example, choosing which services, quantities, techniques, etc. for the proposed universal healthcare system is beyond the capability of any planning agency. Therefore, a better formula to the one above would show that for each dollar extracted by the government from the private sector is returned to it in the form of something less than a dollar’s worth of satisfaction. This would be the new formula: (C + I – G) + .8G = GNP. The greater the government spending (G), the lower GNP becomes. In addition, investment declines, which restricts future growth, and it becomes ever more difficult to save enough capital to replace the depreciating existing capital stock. Welcome to the new Great Depression.

The Fallacy of the Paradox of Saving

A fellow traveler in this network of fallacies is the so-called Paradox of Saving. This is the under-consumption idea wrapped up in pseudo-scientific garb. Now the individual becomes subservient to the collective, for this fallacy states that what may be good for the individual—in this case saving—can be bad for society. Individual saving causes the dreaded decrease in total demand for goods and leads to a never-ending downward spiral from which the economy never recovers.

The idea that consumers lack the means to buy all of industry’s production is centuries old, but it took on new life in the 1920s and 1930s. In the 1920s Americans Waddill Catchings and William Trufant Foster wrote numerous essays on the subject and gained notoriety by offering a substantial reward to anyone who could successfully refute their thesis, as judged by a panel of referees. Future Nobel Laureate Friedrich Hayek was teaching at the London School of Economics at the time and did not learn of the challenge until it had expired: nevertheless, he wrote the definitive refutation. Defending Say’s Law—that supply and demand always tend toward equilibrium—Hayek explained that producers will drop the price of their goods to match supply; the market will learn from this error; and, no large scale malinvestment will emerge. All depends, of course, on the unhampered free market. Government interference to prop up prices or subsidize continued malinvestment would prolong and deepen the necessary market correction.

Unfortunately, John Maynard Keynes made the Paradox of Savings fallacy even more attractive by advocating massive government interventions at a time when most of the economic profession was becoming more socialist oriented. Government planning of production and control of prices during the recently ended Great War (World War One) had offered the heady allure of power to formerly obscure economists. This destructive partnership of interventionist economic theory wedded to activist politics survives to this day.

The Fallacy that a Growing Economy Depends upon a Growing Money Supply


But where will government get the money those socialist economists demand must be spent? Will not government be forced to raise taxes or increase debt, sapping the very purchasing power of the private sector that they are so determined to supplement? Will not each boost of government spending reduce consumer spending even more until the government has socialized the entire economy? This appears to be an insurmountable problem. This is the fear of the Austrian School economists. No, say the interventionist economists, for another fallacious theory rides to the rescue—that economic growth depends upon an increased money supply. In his masterful book The Ethics of Money Production, Professor Jorg Guido Hulsmann calls this “The most widespread monetary fallacy…” This fallacy gives the central banking authorities theoretical permission to print money and spendthrift politicians a duty to spend it. Neither taxes nor the interest rate need by raised, which might alarm the public to the danger that exists. But the danger will become apparent in the future when the additional money works its way through the economy, causing price increases as it travels, and leaving behind a devastated structure of production that cannot meet the needs of the market. The nation is left with an even greater inventory of unsold goods, such as houses it neither desires nor can afford and cars that are shoddy and overpriced compared to those produced by more market oriented companies. The only lasting legacy is that of increased public debt, an inheritance that guarantees a lower standard of living for our children, grandchildren, and generations beyond.

Austrian School economists proved that any quantity of money is sufficient for a growing economy. The money stock is part of the market economy and, as such, is subject to the same laws as any other marketable good. Its supply depends upon its demand. Of course, only commodity money is consistent with a free market economy, requiring no monetary authority to manage it. Say’s Law—that supply and demand tend toward equilibrium—applies to money as it does to all other goods in a free market. Fiat money, managed by a central bank, is incompatible with the free market. Our boom/bust business cycle and periods of rapidly rising prices, to be followed by rapidly falling prices, are symptoms of this incompatibility of the free market with unfree money.

This network of economic fallacies that give support to increased government spending must be challenged by free market economists armed with the truth of the superiority of freedom and liberty in all things.

A House Divided: Will Fiat Money or the Free Market End Up on the Ash-heap of History?

On June 8, 1982 Ronald Reagan addressed the Members of the British Parliament at the Palace of Westminster in London.

(Read his full address: http://www.reagansheritage.org/html/reagan06_08_82.shtml)

Barely a year as America’s president and presumptive leader of the free world, Reagan had taken office when the West seemed to be in retreat in the face of aggressive Soviet communism. But Reagan saw the inherent weakness in the Soviet position—its economic system. Pointing out various facts about the Soviet economy—for example, that the three percent of agricultural land allowed for private use accounted for one-fourth of Soviet agricultural production—he said, "What we see here is a political structure that no longer corresponds to its economic base, a society where productive forces are hampered by political ones." Reagan referred, of course, to the Soviet’s centrally planned, command economy.

Later in the speech he predicted the demise of the Soviet Union itself, brought about by the failure of its repressive economic system to meet even the simplest needs of the people. Its repressive economic system--that Reagan, in another speech, said actually was the absence of economics--simply was incompatible with man’s very nature. No threat of gulags could make it work. We who lived through those dangerous times were stunned by the following prediction:

"What I am describing now is a plan and a hope for the long term -- the march of freedom and democracy which will leave Marxism-Leninism on the ash-heap of history, as it has left other tyrannies which stifle the freedom and muzzle the self-expression of the people"

Communism on the "Ash-heap of history"! Yes, it had lasted many decades. Yes, it appeared to be as powerful and aggressive as ever. Yes, its people showed no sign of revolt. Yet here was our president predicting its end based upon the fact that its "productive factors are hampered by political ones."

Dare we predict the same thing today regarding our fractional-reserve fiat money banking system, forced upon us by a central bank and manipulated for political purposes rather than safeguarded to ensure our freedom? Is this system, so out of synch with our basically free enterprise economy, doomed to the ash-heap of history, too? Yes. Like Lincoln’s "house divided" we see that the U.S. economy is divided. The means of production are in private hands, yet our money is in government hands. This dichotomy cannot last. Our economy cannot survive half free and half controlled by political factors; it must become all one or all the other. We cannot expect the free half of our economy to survive and flourish as long as our money, which is at least one-half of every transaction, is as unfree as was the worthless ruble of the Soviet Union.

It is our fiat money system that allows our political leaders to "stimulate" voters and "bailout" special interests with the collusion of our supposedly independent central bank. Each monetary expansion to accomplish their unconstitutional actions hampers the free side of our economy all the more. How is it possible for businessmen to plan when the political authorities constantly undermine money’s value? They cannot. The more government expands the money supply the more resources it commandeers for its boondoggle, wasteful, unproductive ventures that sap the ability of private business to secure the resources necessary for true progress.

This is the great un-reconciled and irreconcilable divide within our economic system today. It is the same everywhere—in Europe, Japan, and China. Either our fiat money system will be relegated to the ash-heap of history or our free enterprise system will fail. There really is only one choice, for if we loose our free enterprise system we will suffer the same fate as did the Soviet Union. Even now we see our government moving in steps in the wrong direction. It has demanded veto power over General Motors’ restructuring plans, following GM’s acceptance of government bailout funds. Influential advisors, such as Nobel Laureate Paul Krugman, are demanding that the government nationalize the country’s largest banks. These are ominous signs indeed. But with the fatal consequences of politically run command economies so recently in our memories, why are we even considering such actions? Give us liberty! End the Fed!

A Drop in the Price of Oil Is a Good Thing

Unless one were a speculator in oil betting that its cost would rise, the fall of the price of any commodity is a blessing to mankind. The fall in the price of oil will help spur the economic recovery by lowering our cost of living; that is, our gasoline bills will be lower, providing funds for other necessities or enabling us to pay of debt or increase savings. Furthermore, oil is a vital component of American industry, so its reduced price will help business recover, too. This is the normal way that economies heal themselves, not from gigantic governmental spending programs, bailouts of failed industries or running the central bank’s money printing presses at full tilt.

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

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

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

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

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

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

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

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

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

Why Economic Theory Is Important

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

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

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

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

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

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

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