The $59 Recession Solution

Joseph Salerno, professor of economics at Pace University and author of Money, Sound and Unsound, recently taught a course in Austrian Macroeconomics at the Mises Academy.  For a $59 registration fee that included all the reading material, anyone with access to the internet could sign up. As with all Academy courses, the lectures were recorded and are made available to students indefinitely.

In his final lecture Salerno presented the Austrian Business Cycle Theory and showed how, during a recession, the policy prescriptions of the Austrians differs from those of the Keynesians.  The chart below summarizes and contrasts the policies.

What follows is my understanding of the chart, and any errors of interpretation are mine alone.  In English, the chart reads as follows:

Fiscal policy, Austrians: Lower Taxes (down-arrow T), reduce government spending (down-arrow G), and balance the budget (Taxes minus government spending equals zero).  Note: Paul Krugman would likely condemn this policy as “fiscal austerity,” and it is - for the government.  But obviously not for the taxpayers.

Fiscal policy, Keynesians: Lower taxes, increase government spending, and run deficits (government should spend more than it collects in taxes).  Note: Lowering taxes in a recession is the one area where Austrians and Keynesians agree, though President Obama, who in other ways follows the Keynesian playbook, has raised taxes.

Monetary policy, Austrians: Freeze the money supply M (delta M equals zero), let the interest rate adjust according to the time preference of market participants.

Monetary policy, Keynesians: Goose the money supply (up-arrow M), annihilate the interest rate (down-arrow i).

Microeconomic policy, Austrians: Repeal all laws keeping the market from clearing, including policies that prevent wages W and prices P from adjusting to supply and demand.

Microeconomic policy, Keynesians: Use the power of government to keep wages and prices from adjusting to market conditions.

Regulatory policy, Austrians: Remove government regulations and allow the market to perform its regulatory function instead.

Regulatory policy, Keynesians: More government regulations, especially in the financial sector.

No one in the seats of power saw the financial crisis coming because, we’re told, financial crises are a lot like “earthquakes and flu pandemics,” difficult to predict.  Not coincidentally, none of those in power are Austrians.  After five years of Keynesian and other anti-market “remedies,” Europe overall is in recession, while U.S. growth in the last quarter of 2012 declined by $4.9 billion even with a $165 billion “stimulus” behind it.  Before the Fed and the government decided to “do something” about a floundering economy, crises lasted on average 18 months to two years.  Although this last one was officially over in 2009 - see Robert Murphy's take on what this means - unemployment is still high, while optimism among consumers and small business owners remains very low.

I don't recall reading any restrictions that would've prevented central bankers and senior government officials from registering for Salerno's course.  It's too bad for them but especially for us, because given their track record we can expect even bigger calamities down the road.  If they found the registration fee too pricy but would otherwise be willing to take the course, I would be glad to empty my piggy bank on their behalf the next time it's offered.

We need to let the market breathe before the Keynesian maestros put us out of business. 
  

Currency wars are fiat wars

The financial press is tossing the term “currency war” around with more abandon than partiers circulating punch at a New Year’s bash.  Most commentators tell us we’re having such a war right now, though at least one denies it.  James Rickards has published a book on the subject that’s become a hot seller.  So what exactly is a currency war and why are nations engaging in it?

Wikipedia offers an explanation that reminds me of a man traversing a rickety bridge over a deep canyon.  The first few planks feel secure, leading him onward to the middle, where the bridge sags and sways in the canyon’s updrafts.   We read that a

Currency war, also known as competitive devaluation, is a condition in international affairs where countries compete against each other to achieve a relatively low exchange rate for their own currency.

Why would countries devalue their currencies?

As the price to buy a particular currency falls so too does the real price of exports from the country.

Cheaper exports means - what?  If an American dollar buys 5 Mexican pesos, then the dollar is said to be stronger against the peso, the peso cheaper against the dollar, and Mexican products marketed in the U.S. will be priced lower in dollars than otherwise.  If those prices are lower than those of competing American firms, they will be more appealing to American buyers.  Other things equal, low bid wins.

The flip side of this means that the country with the cheapest currency will experience diminished import trade.  In our example, fewer American products will be sold in Mexico, ceteris paribus.  Why?  Because it requires more pesos to buy them.  In other words,

Imports become more expensive.

Wikipedia concludes:

So domestic industry, and thus employment, receives a boost in demand from both domestic and foreign markets.

Our bridge crosser has had a plank split under his foot.  How could domestic industry and employment as a whole receive a boost?  Domestic exporters receive a boost in demand in foreign markets because their stuff is priced lower in foreign countries.  Employment in domestic exporting firms will receive a boost because of the increase in foreign demand.  But domestic industry as a whole does not receive a boost because currency devaluation means their domestic customers have to pay higher prices.  Industries that don’t export or whose exports are not a significant part of their revenue will suffer.

The Wikipedia article agrees, sort of:

However, the price increase for imports can harm citizens' purchasing power.

What about price increases generally, caused by the flood of new money?  These too will be impoverishing.  Furthermore,

The policy can also trigger retaliatory action by other countries which in turn can lead to a general decline in international trade, harming all countries.

According to the U.S. Department of Commerce, exports accounted for 13.8% of GDP in 2011, a record high but still a small fraction of the total. Devaluing the currency for the alleged benefit of a small segment of the economy hardly makes economic sense when it penalizes all participants with higher prices.  It also buttresses the sense that the currency wars will ignite a shooting war and end like all wars, with only a handful of winners and millions of losers.  As we know Keynesians star-struck with World War II believe otherwise, and Keynesians run the economy.

Even the exporting firms will get hit when the devaluation stops and demand in foreign markets declines.  If the devaluation doesn’t stop voluntarily, it will end at the brick wall of hyperinflation.

Nations are not unaware of this possibility and of the need to reassure investors that they’re not in fact on a fast track to monetary oblivion.  MarketWatch tells us that

The Group of 20 finance ministers and central bank governors on Saturday [2-16-2013] pledged to monitor negative currency spillovers to other countries caused by monetary policies implemented for domestic purposes.

“Negative currency spillovers” is a euphemism for the harm inflicted on trading partners by subsidizing exports through monetary inflation.  Of course they have only “pledged to monitor” these “spillovers,” not eliminate them.  How careful they are with words when they’re careless with money.

The Swiss are traditionally anti-inflationary but they caved to their export firms after the Fed’s QE made the Swiss franc rise in value against the dollar.  The Swiss bought up dollars (and euros) to keep the franc from rising in value against those currencies.  The Swiss buy them up by printing more francs - i.e., by inflating - i.e., by counterfeiting.  Japan is trying to do the same thing.

The whole purpose of government sovereignty over money is to inflate it to the advantage of itself and certain favored groups, beginning with the fractional reserve banking cartel.  The inflation (or counterfeiting) will always work against the vast majority through higher prices and repeated cycles of euphoria followed by depression.

The solution is to establish a monetary system governed exclusively by the market forces of profit and loss.  Banking and money should be completely divorced from government, without which the system as it presently exists would have collapsed long ago.   On the market - the free market - there is no such thing as too big to fail or prices that are too low.  The first step in getting there is to allow open competition of currencies. 

Thomas Paine on war, commerce, government, and paper money

Thomas Paine, born 276 years ago today in 1737, was a profoundly influential public figure and one of history’s most widely read authors.  John Adams is reputed to have said that without the pen of Paine, the sword of Washington would have been wielded in vain.  Yet Adams, like many others in the forefront of the political cataclysms of the late 18th century, loathed almost everything about Paine.  “The longer John Adams lived,” writes Harvard historian Jill LePore, “the more he hated Thomas Paine, and the more worthless he considered that seventy-seven-page pamphlet” Common Sense that sparked the American Revolution.

During the last years of Paine’s life, rabidly pro-British and firebrand journalist William Cobbett used his widely-read Porcupine’s Gazette to attack Paine on nearly every issue.  Quoting Cobbett in his biography of Paine, author Craig Nelson writes:

Whenever and wherever [Paine] breathes his last, he will excite neither sorrow nor compassion; no friendly hand will close his eyes, not a groan will be uttered, not a tear will be shed.  Like Judas he will be remembered by posterity; men will learn to express all that is base, malignant, treacherous, unnatural and blasphemous, by the single monosyllable, PAINE. [p. 5]

Cobbett had sized up the public’s contempt quite accurately.  After the Quakers had denied Paine his wish to be buried in their cemetery, Paine, who died on the morning of June 8, 1809, was interred on his farm in New Rochelle, NY.   His close friend Marguerite Bonneville recounted the burial:

The interment was a scene to affect and to wound any sensible heart.  Contemplating who it was, what man it was, that we were committing to an obscure grave on an open and disregarded bit of land, I could not help feeling most acutely. . .  Looking round me, and beholding a small group of spectators, I exclaimed, as the earth was tumbled into the grave, “Oh! Mr. Paine!  My son stands here as testimony of the gratitude of America, and I, for France!” [p. 324]

As I wrote in an earlier essay, “The man who inspired the country to secede from a corrupt state had six people in attendance at his funeral, none of whom were dignitaries.”

Yet, amazingly, after Paine’s death Cobbett underwent a radical conversion.  Of all the issues on which he had to concede Paine was right, perhaps none affected him more than Paine’s essay, The Decline and Fall of the English System of Finance, in which the author predicted the Bank of England would fail from “Britain’s never-ending warmongering” and “her escalating national debt, crushing taxes, and overreliance on paper money.” [p. 4]  Aided by Marguerite Bonneville, Cobbett wrote “a definitive Paine biography, doing penance for having been the American publisher of Francis Oldys’s The Life of Thomas Paine, a slanderous attack subsidized by the British government.” [p. 6]

Paine was a polemicist of the highest order who held strong convictions.  He wrote in language that was easily understood by anyone, which because of his radical views often made him subject to the charge of rousing the rabble.  He attacked monarchy and believed the path to peace and prosperity was found in democratic republics.  He did not anticipate the breakdown of “free states” into functional authoritarianism that developed and accelerated in the early 20th century and continues unabated to this day.  So, for example, when he writes: “Government on the old system is an assumption of power, for the aggrandizement of itself,” he was referring to monarchies, but we can apply that observation to any government of today.

In celebration of his birthday, I have collected a few of his insights into war, commerce, government, and paper money.  All italics are in the original.

From the writings of Thomas Paine . . .

On this question of war, three things are to be considered. First, the right of declaring it: Secondly, the expense of supporting it: Thirdly, the mode of conducting it after it is declared. The French Constitution places the right where the expense must fall, and this union can be only in the nation [the people]. The mode of conducting it after it is declared, it consigns to the executive department. Were this the case in all countries, we should hear but little more of wars. - Rights of Man, The Complete Writings of Thomas Paine, Volume 1, p. 285.


Whatever is the cause of taxes to a nation, becomes also the means of revenue to a government. Every war terminates with an addition of taxes, and consequently with an addition of revenue; and in any event of war, in the manner they are now commenced and concluded, the power and interest of governments are increased.

War, therefore, from its productiveness, as it easily furnishes the pretense of necessity for taxes and appointments to places and offices, becomes a principal part of the system of old governments; and to establish any mode to abolish war, however advantageous it might be to nations, would be to take from such government the most lucrative of its branches. The frivolous matters upon which war is made, show the disposition and avidity of governments to uphold the system of war, and betray the motives upon which they act. - ibid., pp. 342-343


Why are not republics plunged into war, but because the nature of their government does not admit of an interest distinct from that of the nation? Even Holland, though an ill-constructed republic, and with a commerce extending over the world, existed nearly a century without war: and the instant the form of government was changed in France, the republican principles of peace and domestic prosperity and economy arose with the new Government; and the same consequences would follow the same causes in other nations. - ibid., p. 343


If universal peace, civilization, and commerce, are ever to be the happy lot of man, it cannot be accomplished but by a revolution in the system of governments. All the monarchial governments are military.

War is their trade, plunder and revenue their objects. While such governments continue, peace has not the absolute security of a day. What is the history of all monarchical governments, but a disgustful picture of human wretchedness, and the accidental respite of a few years' repose? Wearied with war, and tired with human butchery, they sat down to rest, and called it peace. - Rights of Man II, ibid., pp. 355-356


Almost everything appertaining to the circumstances of a nation, has been absorbed and confounded under the general and mysterious word government. Though it avoids taking to its account the errors it commits, and the mischiefs it occasions, it fails not to arrogate to itself whatever has the appearance of prosperity. It robs industry of its honors, by pedantically making itself the cause of its effects; and purloins from the general character of man, the merits that appertain to him as a social being. - ibid., p. 356


Government on the old system is an assumption of power, for the aggrandizement of itself; on the new, a delegation of power, for the common benefit of society. The former supports itself by keeping up a system of war; the latter promotes a system of peace, as the true means of enriching a nation. The one encourages national prejudices; the other promotes universal society, as the means of universal commerce. The one measures its prosperity, by the quantity of revenue it extorts; the other proves its excellence, by the small quantity of taxes it requires. - ibid., p. 363


. . . it is nevertheless true, that a great portion of mankind in what are called civilized countries, are in a state of poverty and wretchedness, far below the condition of an Indian. I speak not of one country, but of all. It is so in England, it is so all over Europe. Let us inquire into the cause.

It lies not in any natural defect in the principles of civilization, but in preventing those principles having an universal operation; the consequence of which is a perpetual system of war and expense, that drains the country, and defeats the general felicity of which civilization is capable. - ibid., pp. 398-399


Commerce is no other than the traffic of two individuals, multiplied on a scale of numbers; and by the same rule that nature intended the intercourse of two, she intended that of all. For this purpose she has distributed the materials of manufacturers and commerce in various and distant parts of a nation and of the world; and as they cannot be procured by war so cheaply or so commodiously as by commerce, she has rendered the latter the means of extirpating the former. - ibid., p. 400


When in the last, as well as in the former wars, the commerce of England sunk, it was because the general quantity was lessened everywhere; and it now rises because commerce is in a rising state in every nation. If England, at this day, imports or exports more than at any former period, the nations with which she trades must necessarily do the same; her imports are their exports, and vice versa.

There can be no such thing as a nation flourishing alone in commerce; she can only participate; and the destruction of it in any part must necessarily affect all. When, therefore, governments are at war, the attack is made upon the common stock of commerce, and the consequence is the same as if each had attacked his own. - ibid., p. 401


It is not whether this or that party shall be in or out, or Whig or Tory, or high or low shall prevail; but whether man shall inherit his rights, and universal civilization take place? Whether the fruits of his labor shall be enjoyed by himself, or consumed by the profligacy of governments? Whether robbery shall be banished from courts, and wretchedness from countries? - ibid., p. 404


But as the principles of the present Revolution differed from those which preceded it, so likewise did the conduct of America both in government and war. Neither the foul finger of disgrace nor the bloody hand of vengeance has hitherto put a blot upon her fame. Her victories have received luster from a greatness of lenity; and her laws have been permitted to slumber, where they might justly be awakened to punish. War, so much the trade of the world, has here been only the business of necessity; and when the necessity shall cease, her very enemies must confess, that as she drew the sword in her just defense, she used it without cruelty, and sheathed it without revenge. - Letter to the Abbe Raynal, The Complete Writings of Thomas Paine, Volume 2, pp. 220-221


I shall enumerate some of the evils of paper money and conclude with offering means for preventing them.

One of the evils of paper money is, that it turns the whole country into stock jobbers. The precariousness of its value and the uncertainty of its fate continually operate, night and day, to produce this destructive effect. Having no real value in itself it depends for support upon accident, caprice and party, and as it is the interest of some to depreciate and of others to raise its value, there is a continual invention going on that destroys the morals of the country.

It was horrid to see, and hurtful to recollect, how loose the principles of justice were left, by means of the paper emissions during the war. The experience then had, should be a warning to any assembly how they venture to open such a dangerous door again.

As to the romantic, if not hypocritical, tale that a virtuous people need no gold and silver, and that paper will do as well, it requires no other contradiction than the experience we have seen. Though some well- meaning people may be inclined to view it in this light, it is certain that the sharper always talks this language.

There are a set of men who go about making purchases upon credit, and buying estates they have not wherewithal to pay for; and having done this, their next step is to fill the newspapers with paragraphs of the scarcity of money and the necessity of a paper emission, then to have a legal tender under the pretense of supporting its credit, and when out, to depreciate it as fast as they can, get a deal of it for a little price, and cheat their creditors; and this is the concise history of paper money schemes.

But why, since the universal custom of the world has established money as the most convenient medium of traffic and commerce, should paper be set up in preference to gold and silver? The productions of nature are surely as innocent as those of art; and in the case of money, are abundantly, if not infinitely, more so. The love of gold and silver may produce covetousness, but covetousness, when not connected with dishonesty, is not properly a vice. It is frugality run to an extreme. But the evils of paper money have no end. Its uncertain and fluctuating value is continually awakening or creating new schemes of deceit. Every principle of justice is put to the rack, and the bond of society dissolved: the suppression, therefore, of paper money might very properly have been put into the act for preventing vice and immorality.


The pretense for paper money has been, that there was not a sufficiency of gold and silver. This, so far from being a reason for paper emissions, is a reason against them.


As gold and silver are not the productions of North America, they are, therefore, articles of importation; and if we set up a paper manufactory of money it amounts, as far as it is able, to prevent the importation of hard money, or to send it out again as fast it comes in; and by following this practice we shall continually banish the specie, till we have none left, and be continually complaining of the grievance instead of remedying the cause.

Considering gold and silver as articles of importation, there will in time, unless we prevent it by paper emissions, be as much in the country as the occasions of it require, for the same reasons there are as much of other imported articles. But as every yard of cloth manufactured in the country occasions a yard the less to be imported, so it is by money, with this difference, that in the one case we manufacture the thing itself and in the other we do not. We have cloth for cloth, but we have only paper dollars for silver ones.

As to the assumed authority of any assembly in making paper money, or paper of any kind, a legal tender, or in other language, a compulsive payment, it is a most presumptuous attempt at arbitrary power. There can be no such power in a republican government: the people have no freedom, and property no security where this practice can be acted: and the committee who shall bring in a report for this purpose, or the member who moves for it, and he who seconds it merits impeachment, and sooner or later may expect it.

Of all the various sorts of base coin, paper money is the basest. It has the least intrinsic value of anything that can be put in the place of gold and silver. A hobnail or a piece of wampum far exceeds it. And there would be more propriety in making those articles a legal tender than to make paper so. . . .

The laws of a country ought to be the standard of equity, and calculated to impress on the minds of the people the moral as well as the legal obligations of reciprocal justice. But tender laws, of any kind, operate to destroy morality, and to dissolve, by the pretense of law, what ought to be the principle of law to support, reciprocal justice between man and man: and the punishment of a member who should move for such a law ought to be death. . . .

If anything had, or could have, a value equal to gold and silver, it would require no tender law: and if it had not that value it ought not to have such a law; and, therefore, all tender laws are tyrannical and unjust, and calculated to support fraud and oppression.

Most of the advocates for tender laws are those who have debts to discharge, and who take refuge in such a law, to violate their contracts and cheat their creditors. But as no law can warrant the doing an unlawful act, therefore the proper mode of proceeding, should any such laws be enacted in future, will be to impeach and execute the members who moved for and seconded such a bill, and put the debtor and the creditor in the same situation they were in, with respect to each other, before such a law was passed. Men ought to be made to tremble at the idea of such a bare-faced act of injustice. It is in vain to talk of restoring credit, or complain that money cannot be borrowed at legal interest, until every idea of tender laws is totally and publicly reprobated and extirpated from among us. - Dissertations on Government, ibid., pp. 406-409

In counterfeiting we trust

If there is one central myth supporting the folly that passes for monetary policy and by extension fiscal policy, it would have to be the unchallenged assumption that money should be defined and controlled by government.  Given the role of money in the economy - that it is one-half of virtually every transaction - nothing has been more destructive to the well-being of most people than the government’s usurpation of money from the market.

Money was once the most marketable commodity (Ludwig von Mises, 1912).  Today, money is whatever the government says it is, and since 1933 in the U.S. it has been pieces of paper or their digital substitutes issued by the central bank and its members, the commercial banks. 

What’s wrong with having the government or its agent, the central bank, define money and regulate its supply, which in practice means regulating the rate at which the supply is increased?

First, the money is not theirs - it doesn’t belong to the government or the central bank.  Banks legitimately get their funds from depositors or investors.  Anything they create on their own through fractional-reserve lending is fraudulent, because they’re guaranteeing the same dollar to both a borrower and a depositor.  Government gets its revenue through the threat of violence and cannot rightfully claim ownership of any of it.

Property rights violations notwithstanding, why is this a harmful arrangement economically?  Because the government-supported banking system is a counterfeiting racket.  The act of counterfeiting money consists of duplicating the legal tender or standard currency and passing it off as legitimate.  The process allows the counterfeiter to default undetected on his end of the trade when he spends it because his money does not represent goods or services produced.  The subsequent increase in the supply of money puts downward pressure on the purchasing power of the monetary unit, so that holders of previously existing money are in effect paying for the counterfeiter’s purchases. 

Murray Rothbard discusses the counterfeiting process in his book, The Mystery of Banking. 

Counterfeiting, and the resulting inflation [of the money supply], is therefore a process by which some people—the early holders of the new money—benefit at the expense of (i.e. they expropriate) the late receivers. The first, earliest and largest net gainers are, of course, the counterfeiters themselves. . . .

Government is supposed to apprehend counterfeiters and duly break up and punish their operations. But what if government itself turns counterfeiter? In that case, there is no hope of combatting this activity by inventing superior detection devices.  pp. 36-37

Kings of old could debase their coins and pass them off as the real thing but this was a slow, tedious process that didn’t yield much revenue.  Not only that, people grew wise to it and found ways to tell a cheat from a genuine article.  And they saw it as a cheat, not as a way of increasing GDP, or making the price of exports more competitive, or stabilizing the price level.

Paper money changed all that.

People deposited their gold and silver in banks for safekeeping, then used the paper claims to the metal as convenient substitutes for money.  Bankers soon proved they couldn’t be trusted.  They would give in to the temptation to loan out some of their deposits at interest, having observed that most people were satisfied using the paper itself in their transactions and would rarely redeem it for the gold or silver. 

When noteholders and depositors came running to redeem their rightful claims and the banks proved unable to comply, the government allowed the banks to turn them away empty-handed while remaining in business.  

Slamming the doors on legitimate note holders and depositors was embarrassing to the banks, not to mention unprofitable.  Thus in the U.S. the biggest bankers pushed for and finally got a law passed in 1913 that created a central bank - the Federal Reserve.  Economist Joe Salerno describes the Fed as

a cartelizing device that limits entry into and regulates competition within the lucrative fractional-reserve banking industry and stands ready to bail it out, thus guaranteeing its profits and socializing its losses.  p. xxi

For a few years there was a serious problem with this arrangement: gold stood in the way.  Central banks could conceivably counterfeit gold but the fake coins would differ in composition from the real thing and would be subject to detection.  From the counterfeiters’ perspective, the beauty of paper money is that it all looked the same.

Gold was subsequently framed as one of the causes of the Great Depression and by decree paper, the money substitute, became money itself.  The president the people elected seized their gold and locked it up in the Fort Knox Bullion Depository.  As dollars can now be created with a few keystrokes, it has proven trivial to fund trillion dollar deficits and endless rounds of QE.

Today, the rich are getting richer and the poor are getting poorer not because of “capitalism,” but because of a government-supported monetary system that enriches designated counterfeiters and their beneficiaries at the expense of other dollar holders.

Ironically, Milton Friedman, never a champion of a gold coin standard, had priceless insight to how it worked:

If a domestic money consists of a commodity, a pure gold standard or cowrie bead standard, the principles of monetary policy are very simple. There aren’t any. The commodity money takes care of itself. p. 366

Given that monetary policy today consists of varying degrees of counterfeiting, we need to get government out of the way and let the market-designated money - whatever it may be - take care of itself.

Lessons not learned from World War II

Policymakers today draw what they consider obvious conclusions from the Good War.   The New Deal had been chipping away at unemployment and the economy was recovering, but then Japan’s surprise attack provided the political means for allowing the government to shift gears.  Over the next four years the American economy got a heavy dose of Keynesianism, and the results prove the Keynesian case: GDP soared and unemployment all but disappeared.  Only in 1946 did official GDP take a beating, though surprisingly, given that the government fired roughly 20% of the labor force, the unemployment rate rose to only 3.8%.  (Five percent is considered normal for a healthy economy.)

Since Keynesianism has been validated under fire in the real world, its advocates tell us, it is altogether appropriate that government spend and inflate the economy back to prosperity today or any other time.

This is why Obama in 2009 came charging into office touting a big spending plan.  Mark Zandi, one of the architects of Obama’s stimulus package (officially, the American Recovery and Reinvestment Plan of 2009), projected in November, 2008 that “even with the [$300 billion] stimulus [in 2009], some 1.8 million jobs will be lost, with unemployment peaking near 8%.”  Without the stimulus, God forbid, unemployment would reach 8.94% by October, 2009.

What actually happened?  By October, 2009, with a $250 billion stimulus (according to the CBO), unemployment reached 10.1%.  How did it happen that the cure made matters worse by more than a full point?  Always spin-ready, the administration’s post-facto claim was they had misjudged the degree to which Bush had ruined the economy.  Without the stimulus, you see, unemployment would’ve risen even further. 

They can say this with a straight face because they know big deficits and inflation did the trick in World War II.  They know because they’ve seen the data.  Even conservatives readily agree - “World War II got us out of the Depression.”

Conscription to the rescue

During the 1930s and up until Pearl Harbor, there were many deteriorating measures of economic health, but none worse than unemployment.  All the controls and regulations, all the taxes and inflation, all the fireside chats and damnations of the rich, all the privileges to the unions, all the deficits, were not restoring employment to anything close to pre-Crash levels.

Then the Japanese finally struck, giving Roosevelt the back door he had been looking for. 

Finally, the government was in a position to provide millions of men with a paying job - conscript them and send them overseas to fight a war.  Government’s pitch was we had tried minding our own business but the forces of evil spread to our shores - not our shores, exactly, but the shores of an island some 2,500 miles from the mainland where the U.S. Navy had been hanging out since the 19th century.

There was a sudden rush to kill a lot of people, and the government would pay men to do the killing.  Low pay, of course, but nonetheless something.  Since government was doing the “hiring,” the 10 million or so men who were drafted could either take the job or stay home in the comfort of prison.  In a display of patriotic fervor, most of them took the job.  The draftees had no way of knowing their beloved FDR had set them up by provoking an attack that killed over 2,400 people, including civilians.

Was the economy booming as a result of the war?  No.  People stateside were working, but they were building things for the military rather than private citizens.  People were getting paychecks but price ceilings, rationing, and other government controls made life anything but prosperous.

Let’s ask that question again: Was the economy booming?  Absolutely.  The GDP figures tell the story.  During the war years, GDP exploded.  The government component of GDP went wild while private investment shrank, but so what?  To most analysts, GDP is GDP.

Ignoring the market’s signals

From the beginning of the depression in 1930, the free market had been willing to put people to work, but government wouldn’t let it.  Allowing wages to fall along with other prices was deemed cruel and unfair.  Almost 12 years later wages did fall for the men sent overseas, over a million of whom came back dead or wounded.   

Americans had a choice - the market’s way or the government’s way.  Unfortunately, they let government decide for them.

Politicians know that workers don’t take kindly to seeing their nominal income decrease, even if other prices are falling, and are likely to register their displeasure at the polls.  But there has to be more to it than political expediency, so officials announce that if wages fall, workers can’t buy as much and the economy goes downhill.   So they keep wages up to protect the workers, without whose spending they put themselves out of a job.

Keeping wages from falling did protect them - the ones who managed to hold onto their jobs.  Given the falling prices prior to Roosevelt’s gold heist, people with jobs found the dollars in their paychecks were buying more.  Predictably, high wages led to high unemployment, but Keynes considered this evidence of market failure, that Say’s Law no longer worked - there was a glut of labor but no one was hiring.  As Rothbard explains, however,

There is never any genuine unsold surplus, or "glut," whether specific or general over the whole economy, if prices are free to fall to clear the market and eliminate the surplus.

Keynes’s recommended policy - deficit spending and inflation - was far more politically palatable than leaving wage rates to the market.  With above-market wages, especially after passage of the Wagner Act in 1935, not only were people out of work, but those with jobs frequently worked reduced work weeks and lived in constant fear of getting fired.  By contrast, if you were stateside during the war you had no trouble at all finding a military contractor willing to hire you.

Government deficits and inflation didn’t cure unemployment in the 1930s, and they didn’t cure it during the war, either.  

When did prosperity return?  After Roosevelt died and the war ended, a new attitude prevailed in Washington that gave investors enough confidence to begin investing again.  Most of the wartime controls were removed, and consequently private investment soared even though official GDP plummeted.

As Robert Higgs tells us,

A minimum estimate of [economic] growth in 1946 was 30%.  There was never a year like that in our history.  Ever.  Not even half that good.  Ever.  Thirty percent in one year.  This was real growth. 

What looks like the second-worse year in history from the standard GDP data was, in reality, the best year ever in year to year performance of all time.  This was the real peace dividend.

Conclusion

Keynesianism instills the conviction that some combination of deficits and inflation will set things right again, that when one QE or stimulus package doesn’t do the job, another will, then another, then another.  We need to remember that it wasn’t more government that restored prosperity in 1946, but rather the release of productive energy made possible by significantly less government.

The Economic Superbowl: 1920-1921 versus 1930-1931

It’s been said there’s no such thing as a controlled experiment in the social sciences, including economics.  But we had something close to a laboratory experiment back in 1920-1921 and 1930-1931.*

In each of these periods there was a depression.  Unemployment was high - for awhile, it was higher in the 1920s than in the 1930s.  Prices were falling in both periods. 

In the 1920-21 depression, the Federal Reserve Bank of New York crashed the monetary base, thereby reducing the money stock, and jacked interest rates to record highs.

In the 1930-1931 depression, the federal reserve gradually increased the monetary base and lowered the interest rate. 

In the 1920-21 period the government slashed spending and allowed nominal wages to fall.

In the 1930-31 depression the government increased spending and deficits while pressuring industrial leaders to maintain wage rates.

Tax Policies

Coming out of World War I the highest marginal income tax rate was 77%.  First Harding, then Coolidge (following Treasury secretary Andrew Mellon’s advice) lowered tax rates steadily in the early 1920s.  By 1925 the highest tax rate was around 25%.  Tax receipts began to climb, as people stopped playing defense and looked for ways to grow their income.  As incomes increased, so did tax revenue in spite of the lower rates. 

In 1932, Hoover pushed through one of the highest peacetime tax increases in U.S. history.  A person making above a million dollars in 1931 could keep 75 cents on the dollar; a year later the amount plunged to 37 cents on the dollar.  In the lowest bracket, rates more than doubled.  Along with this were countless taxes on items that had never been taxed.  From 1931 - 1933, revenue from the individual income tax dropped by more than half.  By 1933, the economy was at the depth of the Depression.

Roosevelt went further.  The top income tax rate had spiked from 24 to 63 percent under Hoover, and then to 78 percent in 1935 under FDR.  Capital gains taxes more than doubled, going from 12.5 percent during the 1920s and early 1930s to 32 percent by 1934-1935.  In 1936, the New Dealers decided to tax corporate savings, imposing a severe penalty on businesses that depended on profits to expand operations.  Called the Undistributed Profits Tax, it entrenched the bigger firms by keeping their smaller competitors from expanding.  It also pressured firms to use debt instead of equity to finance expansion.

Throughout the 1920s, the Coolidge administration ran a budget surplus every year.  Throughout the 1930s, first Hoover, then Roosevelt ran budget deficits every year.

Keynesians such as Christina Romer tell us Hoover tried to balance the budget, and then FDR ran deficits but they weren’t big enough.  It took the huge deficits of World War II to break the back of the Depression.  Whether fighting the war overseas or on the home front, Americans were anything but prosperous during this period.

Monetarists such as Milton Friedman tell us the Fed didn’t inflate enough after the Crash to offset the fall in the money supply.   People were pulling their money out of the banks, and the Fed failed to offset the deflationary effect this was creating. 

During previous crises in the 19th and early 20th centuries the Fed was subject to the same criticism.  The Fed really didn’t inflate enough before it existed, as economist Robert Murphy puts it.  Yet we recovered from those crises in two years, on average.

Gold takes the blame

Both Keynesians and monetarists blame the gold standard for restricting policy options.  When FDR confiscated the people’s gold in 1933 and outlawed contracts denominated in gold, the Fed went on a printing spree and the government stepped up its spending.  From 1933-1936, unemployment declined steadily while GDP increased.

But the gold standard in some form had existed for centuries prior to the the 1930s.  Why did it suddenly cause a massive depression?  It existed during the depression of 1920-21, yet that crisis was over in two years and was followed by one of the most prosperous periods in U.S. history.

And if the gold standard of 1929 did cause the depression, why didn’t going off gold end it?  Fed monetary inflation and government spending improved the statistics somewhat but the economy remained in a depressed state throughout the 1930s and beyond. 

Critics of gold rarely mention that the gold standard that failed was not the classical gold standard of the 19th century.  European governments ordered their banks to stop redeeming gold in 1914 so they could use the printing press to pay for the Great War.  The “gold standard” abandoned in the 1930s had been erected in 1922 at a conference attended by 34 countries in Genoa, Italy.  Called the gold exchange standard, its purpose was to keep gold “in the vaults” by redeeming currencies not in coins but in large bars.  Most European citizens were thereby disarmed of their means for keeping government spending under control.  U.S. citizens could still legally redeem bank notes for gold coins, but in practice it was rare. The gold exchange standard collapsed in 1931 when England went off gold completely because it couldn’t redeem France’s sterling holdings.

The monetarists’ slam-dunk: The double-dip of 1937-1938

According to monetarists, the Fed interrupted the New Deal’s recovery in 1936-1937 when it doubled the reserve requirements of its member banks, thus contracting the money stock and producing a double-dip or a “depression within a depression” in 1937-1938.  Unemployment spiked and GDP fell off.   

Let’s take a closer look at this period and the years preceding it.  Following passage of the Gold Reserve Act of 1934, the U.S. Treasury was under a legal mandate to purchase all the gold offered to it at the rate of $35 an ounce, a 69 percent increase over the classical rate of $20.67.  The Treasury was in effect mimicking the Fed’s inflationary open market operations by freely purchasing demonetized gold instead of government securities.  Gold flowed into the U.S. from abroad, increasing bank reserves and inflating the money supply by over 10% annually from 1934-1936.

When in 1937 the Treasury began sterilizing their purchases (i.e., selling securities to pay for the gold instead of printing money) it slowed the growth of the money supply.  Doubling the reserve requirements brought interest rates up a notch but they were still very low.  Cheap loans were still available for businesses that wanted them. 

So what caused the plunging economic indicators?

As economist Joseph Salerno points out, money wages shot up 13.7% in the first three quarters of 1937.  The Supreme Court had recently upheld the National Labor Relations Act of 1935, and unions were cashing in.  With labor productivity remaining constant, unemployment began to rise. 

As business profits were squeezed by the run-up of labor costs and the economy slipped into recession, banks prudently began to contract their loans and pile up liquid reserves to protect themselves against prospective loan defaults and bank runs. To offset this uncontrolled decline of the money supply, beginning in mid-1938 the Fed (and the Treasury) once again resorted to an inflationary policy, reversing the reserve requirement increase and allowing gold inflows to once again pump up bank reserves.

Between June 30, 1937 and June 30, 1938 the money supply did in fact decrease, but this was a result, rather than a cause, of the recession, Salerno concludes.

And the winner?

Experts from the leading schools of economics today - the Keynesian and monetarist - tell us the Great Depression could’ve been avoided.  They know the depression of 1920-21 was followed by the Roaring Twenties.  They know the depression of 1930-31 turned into the Great Depression and is one of the reasons the world went to war in the 1940s.  So, do these experts take the government/Fed response to the 1920-21 depression as their model?

Perhaps because it would put them out of work, their answer is a resounding No.

That these same experts never see a crisis on the horizon should not dissuade us from trusting them.

* I strongly recommend a careful reading of Robert P. Murphy’s The Politically Incorrect Guide to the Great Depression and the New Deal.

Who Are the Revolutionaries in a Free Market Revolution?

On the dedication page of Ron Paul’s The Revolution: A Manifesto we find these words:

To my supporters:
I have never been more humbled and honored than by your selfless devotion to freedom and the Constitution.

The modifier “selfless” is intended as a moral tribute.  Imagine instead if he had written “selfish.”  Would that kill the Paul freedom movement?  Certainly there would be many who would question his choice of words, though most would probably shrug it off as an unfortunate typo. 

But if he had written “selfish” quite intentionally, how many people would regard that as a moral tribute?

What are the facts?  Can we really say that people who fight for freedom are acting in self-denial?  Wouldn’t freedom be an infinitely better condition to live under than the controlled society we now have or the totalitarian slave state we’re edging towards?  And if this is true, wouldn’t it be correct to say Paul’s supporters act in their conscientious self-interest, and therefore their support should be considered selfish?

So why didn’t he use that word?

As authors Yaron Brook and Don Watkins argue in their stimulating book, Free Market Revolution: How Ayn Rand’s Ideas Can End Big Government, it is the widespread inability to affirm the self that accounts for the continuing decline of freedom.  And since political freedom implies economic freedom, traditional selfless morality becomes capitalism’s greatest enemy, as they discuss in detail.

The Triumph of Greed?

When the financial crisis arrived in 2007-2008, capitalism’s enemies had no trouble spotting who they believed were the culprits: greedy businessmen and speculators.  Once again, the government had trusted them with freedom, and once again their insatiable greed brought the economy to its knees.  But Brook and Watkins point out what should be obvious, that freedom in economic affairs had been increasingly restricted for decades:

[B]ecause the conventional view of selfishness remained entrenched, it was not the “public servants” in Washington who took the blame . . . .

The true lesson of the financial crisis is exactly the opposite of what the pundits concluded.  The conventional view is that the free market failed.  In fact, it was the unfree market that failed, and it is more freedom that is the solution. [p. 58]

As they tell us later in discussing soaring health care costs,

It’s no accident that we don’t have a computer crisis, or a hair salon crisis, or a veterinary crisis.  Nor is it an accident that we did have a housing and financial crisis.  Along with housing and finance, medicine is one of the most regulated industries in the United States . . . [p. 194; emphasis added]

But wait - Bernie Madoff was selfish, was he not?  He was trusted and left free to gain as much money as he could, which for him meant cheating his clients through a fantastic Ponzi scheme.  Could it not be argued that the combination of freedom and selfishness cost his clients billions?  One of his clients, a French aristocrat named Rene-Thierry Magon de la Villehuchet, was so heavily invested he was found dead of an apparent suicide after Madofff was arrested for fraud.  Ask almost anyone to name an example of a selfish person and Madoff becomes a prime candidate.  “To be selfish is to be like Madoff,” the authors write, “to screw anyone, even family and friends, in order to get more, more, more for me, me, me.  Madoff is just the latest poster boy for the evil of selfishness.” [p. 63]

But there’s a problem with this portrayal of selfishness - it includes people who don’t swindle others to get ahead.  It includes people who make a lot of money by producing goods that others value.  It includes people like Steve Jobs, “who was routinely derided as selfish” and was condemned for focusing on profit rather than philanthropy.  A Wired magazine commentary in 2006 described him as “nothing more than a greedy capitalist who’s amassed an obscene fortune.  It’s shameful,” adding that “he skates away from the responsibilities that come with great wealth and power.”

Brook and Watkins reject this analysis:

Does it really make sense to equate producers like Jobs with criminals like Madoff - to accuse them of the same dark motive and the same moral crime (in spirit, if not in scale)?  One creates wealth; the other steals it.  One thrives by trading with other people; the other destroys the lives of everyone he touches.  One works incredibly hard to build a product or company he can be proud of; the other spends his time trying to cover up the fact that he has nothing to be proud of. [p. 65]

 Anyone who takes the time to look at how businesses actually succeed will find, in most cases,

not ruthless exploitation but mutually beneficial production and trade; an Apple economy, not a Madoff economy.  [p. 67]

This runs counter to the conventional notion of trade as a zero-sum (win/lose) game.  Yesterday I bought groceries at a local supermarket.  If trade is a zero-sum game, then one of us lost.  I came home with the groceries I wanted, and the supermarket had the money it wanted - a win/win exchange.  What we each gave up in trade, we gave up voluntarily.  I didn’t have to settle on that supermarket; I could have gone elsewhere.  No one forces the supermarket to stay in business; if it can’t make a profit, it will close.  Right now it’s mutually beneficial for me to shop there and for the store to stay open.  In this sense, each of us was pursuing his rational self-interest, what Ayn Rand defined as selfish.  The store doesn’t sell groceries under cost as a matter of charity, nor do I shop there to do it a favor.

Should the supermarket do more than offer goods I want at prices I can afford?  Should it be “skating” toward other goals that certain others regard as its “social responsibilities”?

To get them to swallow the idea that it’s their duty to serve and sacrifice, the altruistic push for corporate “social responsibility” has taught businessmen that their choice is either some monomaniacal focus on the “bottom line” - one that involves ignoring many of the factors that determine a company’s bottom line - or a mawkish pursuit of a “service” agenda. . .

Any company that achieves productive success [such as my local supermarket or Apple] should self-confidently reject calls to “give back.”  It created wealth - it has nothing to atone for.

As the authors conclude, “the path to profits is paved in principle,” not chicanery or crime - something the skaters of this world will likely never understand.

The morality of sacrifice vs. the morality of rights

The authors note that the “dictatorial mentality that seeks power over others does not preach selfishness but self-sacrifice.”  As a character in The Fountainhead pointed out, sacrifice implies that someone will be collecting the sacrificial offerings.  The morality of sacrifice, of exploiter and exploited, underlies Big Government.

Free Market Revolution offers many refreshing insights on long-standing issues.   Following Rand, for instance, it tells us that “a right is a moral principle defining and sanctioning a man’s freedom of action in a social context,” then by way of elaboration says, “A society of rights is one in which you are as free as you would be alone on an island.”

Think of Tom Hanks in Cast Away, the authors suggest - he had no “right” to a survival manual even though he needed one, no “right” to dental care, no “right” to matches for starting a fire.  His only right was the freedom to figure out all those things for himself.  The notion of “a hungry man is not free” didn’t go over well on the uninhabited island.  He either learned to catch crabs or starved.  He even had to solve the problem of companionship on his own, by drawing a face on a volleyball and engaging in "conversation."  Unfortunately for the purveyors of sacrifice, there was no one around that the Hanks character could serve, other than himself.  If he wanted to live, he had to be selfish, he had to make a profit, in the best sense of those words.

As the authors note, “a society of rights is one that removes coercion from human affairs.”  [p. 131] Modern “rights” are claims to certain outcomes, not freedom of action.  What makes modern rights possible is the state, which forces some people to provide for others.  “Rights” in the modern sense increase coercion rather than remove it.  The result is bigger, more expensive, more intrusive government.

What about the workers?

It’s frequently asserted that workers need protection from the ravenous clutches of big business and therefore beneficent coercion on government’s part is required.  Notwithstanding the moral implications of this claim, how does this square with the facts?  Brook and Watkins tell us that real wages doubled between 1860 and 1890, a period in which the population was exploding.  Not only were workers making more, they were working less, with the average annual hours worked dropping from 3,069 in 1870 to 2,632 by 1913.  Because we didn’t have a central bank inflating the money supply and thereby imposing an unseen tax on dollar holders, the cost of living was going down.  Gently falling prices were the norm. 

In this century, by contrast, real median household income has been stagnant since 1968, due to policy-induced inflation (cheaper dollars) and the cost of government (taxes).  And it takes twice as many people (husband and wife both working) to maintain that stagnation today. 

The Invisible Austrians

My one serious complaint with Free Market Revolution is the authors’ claim that

Perhaps the most notable defense of capitalism in recent years is Arthur Brooks’s The Battle, a book that has received endorsements and accolades from political heavyweights, from Paul Ryan to Newt Gingrich to Karl Rove. . . .

But for all its virtues, The Battle suffers from two major problems: It doesn’t actually advocate capitalism, and it cannot defend the pursuit of happiness.

First, the political heavyweights the authors name are neoconservatives, who are as far-removed from free markets as the political left.  It’s hardly surprising they would endorse a book that speaks in “vague generalities” about liberty and limited government, and that “never explains what capitalism is.” [p. 212]  No politician today became a heavyweight by supporting limited government, free markets, and sound money, though of course neocons are obliged to pay lip service to the foregoing to keep their conservative credentials.

More important than this, however, is the absence of any mention of the rise of the Austrian school of economics in recent years, especially since 2007.  What about Tom Woods’ books - Meltdown: A Free-Market Look at Why the Stock Market Collapsed, the Economy Tanked, and Government Bailouts Will Make Things Worse, The Politically Incorrect Guide to American History, Rollback: Repealing Big Government Before the Coming Fiscal Collapse, Nullification: How to Resist Federal Tyranny in the 21st Century - not to mention his Liberty Classroom, which purports to teach “real history and economics” while you’re driving your car?   We could add books by Thomas DiLorenzo (How Capitalism Saved America, Hamilton’s Curse), Robert Higgs (Delusions of Power, Against Leviathan: Government Power and a Free Society), Robert P. Murphy (Lessons for the Young Economist, The Politically Incorrect Guide to the Great Depression and the New Deal, The Politically Incorrect Guide to Capitalism), Peter Schiff (The Real Crash: America's Coming Bankruptcy---How to Save Yourself and Your Country, How an Economy Grows and Why It Crashes) and yours truly (The Flight of the Barbarous Relic, The Jolly Roger Dollar: An Introduction to Monetary Piracy) to the mix as well.  Why is there no mention of the proliferation of free market analysis at Mises.org or of the Mises Academy that offers on-line studies in economics, political economy, history, and even a course on Atlas Shrugged?  And of course Ron Paul, about whom the writers are silent, has become capitalism’s champion in recent years, especially among young people and political activists.  Could it be that mentioning the Austrians - especially Ron Paul - is forbidden because of their foreign policy of peace?

If so, perhaps the authors can explain in a revised edition how maintaining a military empire worldwide and invading countries without provocation are compatible with free markets and the nonaggression axiom.

George Ford Smith is the author of three books, available on Amazon.  Visit his website.