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.

A Review of Gary North's "What is Money?"

The inaugural installment of this collection of essays first appeared on LewRockwell.com on September 29, 2009 - fittingly, Ludwig von Mises' birthday. Dr. North is one of the foremost Austrian economists and economic historians working today, and has gained a wide following with his writing and lectures. These essays are virtually impossible to overrate; they clear up so much of what is misunderstood about money and banking.

Our civilization depends on sound money and honest banking. As North makes emphatically clear, we have neither.

A few excerpts should get my point across:

"The heart of the modern monetary system is fractional reserve banking. This system is based on fraud. At the very heart of the modern economy is fraud -- fraud on a gigantic scale. What is the nature of this fraud? Counterfeiting. Banks are government-licensed institutions that issue bogus IOUs. Because these IOUs function as money, they are counterfeit money. This is the heart, mind, and soul of all modern banking."

"Counterfeiting is universally condemned by civil governments. Wherever we go, a national civil government has passed a law imposing serious sanctions against anybody who would counterfeit the national monetary unit. Why do governments do this? Because they are all counterfeiters, and they deeply resent an invasion of their turf. Laws against counterfeiting in today's world are a form of gang warfare."

"To reform central banking is to perpetuate it. To perpetuate it is to accept the fundamental premise of modern economics: money is different. Money is not governed by the same laws of supply and demand that govern the rest of the economy. Money requires experts to administer it. Private contracts are not sufficient."

"Someday, perhaps, central banks will stop subsidizing their respective Treasury Departments. On that glorious day, governments will move rapidly toward bankruptcy, interest rates on government debt will rise, the markets will begin to crash, consumer prices will begin to fall, and the mother of all bank runs will begin. Get there early."

"The powers that be will cease to be powers if money dies. They have based their political control and their wealth on their control of digital money. This is the line to which the hook of state power is attached. To destroy the currency is to break this line. Better a new Great Depression than hyperinflation, if you are a central banker.

"If money dies, a lot more than money will die. This includes Bernanke's pension. He knows this."

I suppose one could be critical of the author for writing so informally about a subject that many would say cannot be translated into everyday language; that any attempt to translate it corrupts it and renders it misleading or just plain wrong.  But one of the hallmarks of Austrian School economics is the clarity of its expositors, a trait that seems to annoy the Keynesians who understand money only in the context of aggregates, equations, and central planning.  But if thought is to be a guide to individual action, then clarity of thought is indispensable, and North, in these essays, offers the reader a remarkable degree of lucidity.

There are other popular essays that delve into the nature of money.  Bastiat's What is Money? is instructive and entertaining, and Thomas Paine's attack on paper money lays bare what we've forgotten.

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.

Also highly recommended is Ron Paul's three-part lecture series, What is Money?

The sophisticated elites who run the monetary system proudly admit they don't know what money is, though they do concede that being unable to define money makes it difficult to manage. In a sense I can empathize with them.  Money - the commodity - was removed from the economy completely in 1971.  It is indeed hard to manage something that no longer exists, and if it did exist, would not require managing.  As Milton Friedman once wrote,

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. 356]

North, borrowing from Mises, tells us what money is in six words, then proceeds to build on it.  Not very sophisticated, but infinitely usable.

Securing Property Rights in the Absence of a State

Many Rothbardians are vowing not to vote in this or any election since voting only supports the State.  But I wonder if they could be persuaded otherwise if they knew one of the ballot choices were to dissolve the governments and replace them with voluntary market institutions.  Of course, we don’t have that choice, and most people would either laugh or be scared to death if it were proposed.   But with sovereign nations riding the Keynesian sled into the Abyss, the dissolution might fall in our laps anyway.  Preposterous as it might sound, we might need to consider organizing society around something other than the coercive monopolies driving us to extinction.

Fortunately, we have both experience and theory to draw upon.  In this article I want to touch on two sources from each: The classic study by Terry L. Anderson and P. J. Hill, An American Experiment in Anarcho-Capitalism: The Not So Wild, Wild West and Robert P. Murphy’s Chaos Theory.

Thanks to Hollywood and popular literature, the American West [1830-1900] is often portrayed as violent and lawless.  As long as you had a fast gun and were willing to use it, you could get away with anything.  The reason: weak or nonexistent government.  In their literature search, though, Anderson and Hill found ample evidence to the contrary.  For example, W. Eugene Hollon, in his book Frontier Violence: Another Look found that “the Western frontier was a far more civilized, more peaceful, and safer place than American society is today [the early 1970s]."  Another researcher, Frank Prassel, writing in the mid-1930s, found that

if any conclusion can be drawn from recent crime statistics, it must be that this last frontier [the West] left no significant heritage of offenses against the person, relative to other sections of the country.

In the early West people protected their property and lives with private agencies.  Significantly, these agencies understood that violence was a costly method of resolving disputes and usually employed lower-cost methods of settlement such as arbitration and courts.  Nor was there a universal idea of justice common to these agencies.  People had different ideas of what rules they wished to live under and were willing to pay for.  Competition among the agencies provided a choice. 

Anderson and Hill looked at four institutions in the early West that approximated anarcho-capitalism (AnCap): land claims clubs, cattlemen’s associations, mining camps, and wagon trains.

Land Claims Clubs

Found throughout the Middle West, the land claims clubs or squatters’ associations showed how newly arriving pioneers joined together for common purposes without government assistance. 

Each claims association adopted its own constitution and by-laws, elected officers for the operation of the organization, established rules for adjudicating disputes, and established the procedure for the registration and protection of claims.

Though violence was an option to be used against those who didn’t follow the rules, at least one association used social ostracism to curtail or punish violators.  They formally resolved:

That we will not associate nor countenance those who do not respect the claims of settlers and further that we will neither neighbor with them . . . Trade barter deal with them in any way whatever.

Some claims associations were formed to oppose “speculators,” while others encouraged speculation, exemplifying how the clubs “developed rules consistent with the preferences, goals, and endowments of the participants.”

Cattlemen’s Associations and Mining Camps

Like the claims groups, cattlemen’s associations drew up formal rules governing their members, but their enforcement methods were often more violent.  As protection agencies, they hired gunfighters (stock detectives) to eliminate rustlers.  The mercenaries were not motivated by ethics, but by “the side which made them the first or best offer.”

Did the gunslingers ever form criminal associations of their own, selling protection and violating property rights as they wished?  There were a few loose associations of this kind, but they were “dealt with more quickly and more severely under private property protective associations than under government organization.”

The California gold rush of 1848 brought thousands of easterners west to seek their fortune, as did gold discoveries later in Colorado, Montana, and Idaho.  Many gold seekers organized before leaving home, and as with other private agencies the rules varied between organizations.  People had the choice of purchasing the set of rules they preferred.  Interestingly, many of the mining organizations prohibited lawyers from their districts and in one case specified no more than fifty nor less than twenty lashes for lawyers who were caught practicing law.

Anderson and Hill:

One early Californian writes, "We needed no law until the lawyers came," and another adds, "There were few crimes until the courts with their delays and technicalities took the place of miners' law.”

Miners courts provided a system of justice, and a judge and jury were selected from among the members.  Any law-abiding miner might serve as prosecutor or defender of the accused. 

In Colorado there is some evidence of competition among the courts for business, and hence, an added guarantee that justice prevailed.

Wagon Trains

Wagon trains rolling west in search of gold provide perhaps the best example of anarcho-capitalism in the American frontier.  Realizing they would be passing beyond the pale of the law, the pioneers “created their own law-making and law- enforcing machinery before they started.”  In many cases they created constitutions similar to the U.S. Constitution.  Once the travelers were beyond the jurisdiction of the federal government, they elected officers to enforce the rules laid out in the document. 

The constitutions also included eligibility for voting and decision rules for amendment, banishment of individuals from the group, and dissolution of the company. 

What made this arrangement work, according to the authors, was a profound respect for property rights.  Yet there was little mention of property rights in their constitutions.  The inviolability of property rights was so throughly ingrained that the pioneers rarely resorted to violence even when starvation was imminent.  Quoting John Phillip Reid from his study of the Overland Trail, the authors tell us:

While a few of those who were destitute may have employed tricks to obtain food, most begged, and those who were "too proud to beg" got along the best they could or employed someone to beg for them.

Certainly the transient nature of these rolling communities made them more adaptable to anarcho-capitalism.  The demand for “public goods” such as roads or schools never came up, for example, though they did have to protect themselves from Indian attacks without relying on the State.  For the most part, their arrangements worked.  People bought protection and justice, found competition among rules producers, and the result was an orderly society, unlike that generally associated with anarchy.

Murphy’s Case for Anarcho-Capitalism

In Chaos Theory, Robert P. Murphy sketches how market forces would operate to support the private production of justice and defense -- two areas that are traditionally conceded to be the sole province of the State.  Murphy contends that not only would the market be able to provide these services, but would do so much more efficiently and equitably than the system we have now.

Here, we’ll confine our discussion to a few key points he makes about the production of “justice” on the free market.

As with the western pioneers and the world today, no single set of laws or rules is needed to bind everyone.  People would enter into voluntary contracts that spell out the rules they agree to live by.   “All aspects of social intercourse would be ‘regulated’ by voluntary contracts.” 

Who makes the rules?  Private legal experts, who would draft laws under open competition with rivals.  The market deals with “justice” as it does with other services.  As Murphy notes,

“the market” is just shorthand for the totality of economic interactions of freely acting individuals. To allow the market to set legal rules really means that no one uses violence to impose his own vision on everyone else.

In an advanced AnCap society, insurance companies would play a major role.  People would buy policies, for example, to indemnify their victims if they were ever found guilty of a crime.  As they do now, insurance companies would employ experts to determine the risks of insuring a given individual.  If a person were considered too great a risk he might be turned down, and this would be information others would use in deciding if and how they wished to interact with him.

Critics say this might work for peaceful, rational people but what about incorrigible thieves and ax murderers?  How would market anarchy deal with them?

All Property is Privately Owned

Murphy reminds us that “wherever someone is standing in a purely libertarian society, he would be on somebody’s property.”  This allows for force to be used against criminals without violating their natural rights.  He cites the example of a person entering a movie theater, with an implicit contract such as the following:

If I am judged guilty of a crime by a reputable arbitration agency [perhaps listed in an Appendix], I release the theater owner from any liability should armed men come to remove me from his property.

In this way the use of force would have been authorized by the recipient himself beforehand.

But where do these armed men take the criminal?  On a free market, a high-security analog to jails would evolve.  These jails, though, would resemble hotels because they would be competing with each other for business, which in AnCap means both pleasing the criminal and guaranteeing his secure detention.  Unlike government prisons there would be no undue cruelty and virtually no chance of escape.  If a dangerous criminal escaped and killed again the insurance company would be held liable.  And a prisoner who didn’t like the way he was treated would have the option of switching to a different jail, as long as his insurance company was in agreement.

Would the Mafia Take Over?

People who support the State because they believe organized crime would take control of an AnCap society should consider that we’re already living  under the “most ‘organized’ criminal association in human history.”  Whatever crimes the Mafia has committed, they are nothing -- nothing -- compared to the wanton death and destruction states have perpetrated.   

We need to consider, too, that the mob gets its strength from the government, not the free market. 

All of the businesses traditionally associated with organized crime—gambling, prostitution, loan sharking, drug dealing—are prohibited or heavily regulated by the state. In market anarchy, true professionals would drive out such unscrupulous competitors.

Applying AnCap

Murphy discusses several applications of anarcho-capitalism in today’s world, one of which is medical licensing.  Almost everyone believes that without government regulation we would all be at the mercy of quacks.  “Ignorant consumers would go to whatever brain surgeon charged the lowest price, and would be butchered on the operating table.”  Therefore, we need the iron fist of government to restrict entry into the medical profession.

But this is pure fiction.  Since the demand for safe and effective medicine is universal, the market would respond accordingly with voluntary organizations that would allow only qualified doctors into their ranks.  Insurance companies, too, would only underwrite doctors who met their standards, since they would stand to lose millions in malpractice suits.

Regarding the ongoing controversy of gun control, Murphy sees legitimate points to both sides of the debate:

Certainly we cannot trust the government to protect us once it has disarmed us. But on the other hand, I feel a bit silly arguing that people should be able to stockpile atomic weapons in their basement.

How might AnCap resolve this?  Let’s say Joe Smith wants an insurance company to agree to pay $10 million to the estate of anyone Smith happens to kill.  “The company will be very interested to know whether Smith keeps sawed off shotguns—let alone atomic weapons—in his basement.”  In this way truly dangerous weapons would be restricted to those willing to pay the high premiums for owning them.

Though it’s hard to imagine any company willing to issue a policy to a holder of nuclear weapons, nevertheless, if someone wanted to, there would be no agency with the authority to prohibit owning them.  But without a policy, a person would be unable to guarantee his contracts with others and would find it virtually impossible to function in society.

Getting there from here

Establishing an AnCap society depends heavily on the history of the region.  North Korean market anarchists, for example, might have to use violence to curtail that brutal regime, while in the United States, “a gradual and orderly erosion of the State is a wonderful possibility.” 

The one thing all such revolutions would share is a commitment by the overwhelming majority to a total respect of property rights.

People already understand that rape and murder are crimes - even rapists and murderers.  The hard part is convincing people “that murder is wrong even when duly elected ‘representatives’ order it.”

We can build on intuitive notions of justice, just as newly arriving miners in California respected the claims of earlier settlers. 

To take a more modern example, even inner city toughs unthinkingly obey the “rules” in a pickup game of basketball, despite the lack of a referee.

As he explains in a footnote, the players in a pickup game still recognize the existence of a foul (and other rules), even if the offending player denies he committed one. 

Now, the market solution to such ambiguity and bias, for games deemed important enough to warrant the extra cost and hassle, is to appoint official referees to apply the “law” (which they too unthinkingly respect). Notice that at no point is a violent monopoly needed to achieve this orderly outcome. 

 Conclusion

Those who defend the State as necessary to protect  property rights should brush up on their history, from day one to the present.  As Murphy wraps up,

I ask that the reader resist the temptation to dismiss my ideas as “unworkable,” without first specifying in what sense the government legal system “works.”

George Ford Smith is the author of The Flight of the Barbarous Relic and two other books.  Robert P. Murphy is Libby Gadsen's scheduled guest for her radio show Gadsen Rising on Tuesday, October 16, 2012 from 4:30-6:00 P.M. ET.   His topic will be anarcho-capitalism.  Gadsen Rising is a www.FreedomizerRadio.com production.  Call 347-324-3704 to listen or participate.

Fiscal Cliffs and Monetary Mountains

On September 13, economist Frank Shostak had an article on Mises.org about the upcoming “fiscal cliff,” which he explains this way: 

The "fiscal cliff" refers to the impact of around $500 billion in expiring tax cuts and automatic government-spending reductions set for 2013 as a result of successive failures by Congress to agree on some orderly alternative method of reducing budget deficits.

The impact, according to the CBO, is that the federal deficit could fall by nearly half (43%), from $1.128 trillion in 2012 to $641 billion in 2013. 

How should we interpret this projection?  The IMF and CBO think it’s a looming disaster.  But the IMF and CBO are not staffed by Austrian economists.  Shostak:

Ultimately what matters for the economy is not the size of the budget deficit but the size of government outlays — the amount of resources that government diverts to its own activities. Note that, because the government is not a wealth-generating entity, the more it spends, the more resources it has to take from wealth generators. This means that the effective level of tax here is the size of the government and nothing else.

The projected decline in government spending for 2013 is $9 billion, which follows a projected decline of $40 billion for 2012.  You would think commentators would zero in on 2012’s decline rather than 2013, Shostak notes.

But wait - if it’s true government takes things out of the pot without putting anything in, why would so many people be afraid of a reduction in government outlays?  If the “pot” represents a snapshot of a society’s total wealth, with net revenue streams feeding it, wouldn’t it make sense to slap government’s hands for scooping up whatever it wants?  Yes, it would if the dominant economic theories were free market instead of Keynesianism.  In the Keynesian world, government doesn’t have to do anything useful to create jobs and prosperity, since, as Paul Krugman says, we’re in a liquidity trap.  By paying people to dig holes and fill them back up it puts real food on the table because those hole-workers will spend their money and induce farms and factories to grow more corn and produce more razor blades.  It’s not just the dirt diggers powering the recovery, either - it’s everyone they trade with, thanks to the Keynesian spending multiplier.  As economist George Reisman notes, “The multiplier and its benefits are allegedly restrained only by the disappearance of funds into the ‘leakage’ constituted by saving.”

Shostak then addresses the issue of expiring tax cuts - will we have less purchasing power in 2013?  You might think the answer is straight-forward: More for government means less for us.  But given the expected reduction in government outlays, Shostak argues, the tax increase will be “like a tight monetary policy.”

A tighter monetary stance in this respect should be seen as positive for wealth generators since it weakens various bubble activities that sprang up on the back of past loose monetary policies.

By this logic if you end up paying more in taxes next year you have reason to feel good, sort of.  You may not be able to save as much or go out to dinner as often, but on net you’re better off because the sub-group of market participants who qualify as wealth-generators will have a lighter economic burden because of the decline of certain bubble activities.

One supposes that if the tax increase were greater yet, more bubble activities would cease, and the result would be even more positive for wealth generators.  But if taxes continue to rise, at some point the monetary stance would become so tight it would strangle the process of wealth-generation.  The tax increase, therefore, is harmful to all economic actors, with the possible except of the government. 

Put another way: If the taxed individuals are wealth generators they will have less money with which to invest in capital goods.  Other things equal, they will produce less, not more.  Taxes may put the bubbles on the sidelines, but they also hurt the wealth generators.

It’s hard to see how a tax is a net positive, at least for the taxpayer.

Here Comes Hyperinflation?

Another issue to surface this past week was inflation, the scary kind, as in destruction of the currency.  On September 12 Greg Hunter published an interview with Shadowstats founder John Williams, who predicted a dollar sell-off leading to digital wallpaper by 2014.  When Ben Bernanke announced a day later that the Fed would run the printing presses until the unemployment rate improved, it seemed like fulfillment of a prophecy. 

But will Bernanke print until the currency is no longer money?  Does that statement square with Williams’ acknowledgement that the Fed’s primary concern was “propping up the banks”?  How does turning the U.S. dollar into wallpaper help Citibank or Bank of America?  How does it help businesses produce, hire, and innovate when money becomes so plentiful it is more profitable to use as toilet paper?

More likely Bernanke will print and print, and print some more, then stop.  He will stop short of killing the dollar.  The bankers want to be able to buy things with their billions.  He will stop, and by then smart investors will be perched atop foreign currencies and precious metals as they watch the politicians flog the lifeless horse that was once our economy. 

Bernanke may be acting suicidal but I don’t believe he’s thinking that way.  He’s merely thinking like the Keynesian he is.  More spending is the great panacea.  People will not sit on cash if they think it’s getting worthless.

Paul Krugman says Bernanke is behaving in a manner consistent with his advice to “credibly promise to be irresponsible.”  By this he means Bernanke cannot get people spending unless they expect higher prices.  Monetary policy, therefore, should seek to instill this expectation.  Promising to print an additional $40 billion a month indefinitely might get them shopping in a panic.

But if they shop for precious metals, their strategy will have backfired.

Conclusion

Keynesians have been running things since the 1930s.  They are blind to oncoming train wrecks and spin their chronic failures with “too little, too late.”  The business cycle is a mystery they blame on the market rather than past interventions.  For them, the heart of the economy is a government-supported banking cartel that proudly distorts prices and a profligate Congress that blows the roof off its debt limits.  They are the enablers of a government that is growing more intrusive in every area of our lives.  Keynesians are bringing civilization to its knees, while being called on to save it.

I occasionally find it helpful to recall the words of my instructor, Dr. Robert P. Murphy, as he concluded a Mises Academy course on Keynes, Krugman, and the Crisis last year:

Ask yourself: What would the world look like if Keynesians were totally wrong?

It would look like it is today.

Still propagandized after all these years

I got a call from a young friend the other day complaining of writer’s block.  It wasn’t that he couldn’t think of anything to write, exactly; he couldn’t think of anything to satirize. 

“You’re crazy,” I said.  “What’s not to satirize?”

Brief silence.  “I can see you don’t know a thing about satire.“  He sighed.  “Satire requires an audience who would appreciate it.  Look, you don’t tell jokes to yourself, right?  You tell them to others.  If no one gets them, they’re not jokes.”

“Well--”

“They’re not jokes -- trust me.  Satire’s a little more complicated.  You want them to laugh, but when they’re done you want them to see what or who you’re picking on and agree with you.  You want them to take action.  If it’s political satire, you want them to overthrow the government.  Satire’s serious business.  You need to know what’s right, to laugh at what’s wrong.  But that’s the problem.  People don’t know.”

“Oh, yeah?  Tell that to the cast of Saturday Night Live.  Or Jon Stewart.  You’re burned out, man.  Let the field lie fallow.  You’ll get your touch back.”

“It’s not a case of lost touch.  Suppose you wanted to lampoon this stuff that passes for money, the fiat outpourings of the central banks.  Among the commentariat money is an issue, at least since the crisis of 2008.  At least on the internet.  But it’s not an issue with the middle class.  They still don’t get it.  They’ve been savaged by the bankers and politicians but they still don’t understand how it happens.  They have no freaking idea of what role gold has traditionally played in keeping these guys off their backs and out of their wallets.  They hear bright people say it’s barbarous, that to support it is like calling for the return of the biplane, and that serious discussion centers around whether Bernanke should impose another QE.   And if a few of them do get curious about gold as money, crowned experts like Bernanke slam the door in their faces.  He tells them that in the 1930s, the smart countries dumped gold before the others did.  Or that all those infamous panics of the 19th century were gold’s fault, that it forced bankers to redeem their notes for something of value.  So what if they issued more notes than they had gold on deposit?  That was acceptable practice and always has been.  If only people would simply believe that paper issued under a monopoly arrangement with the government was something valuable, everything would be fine.  The fact that we’ve had perpetual inflation and war since paper was crowned king is a fact lacking visibility.  To the general population.”

“No, you’ve lost your touch.  The material for a spoof of fiat money is there in abundance.”

“You could spoof it only for a select few.  The rest would be bored.  Okay, let’s try this: Suppose you wanted to satirize the War on Terror.  A ripe topic, right?”

“Over-ripe.”

“So what do you do?  You might say we’re winning the war and show the number of terrorists we have locked up in prison.  Yea for our side!  We’re number one!  But wait -- these guys don’t look like terrorists.  They’re not al-Zawahiri or al-Umari or al-Salada or something -- they’re al-Johnson or al-Jones or al-Richardson.”

“Great!”

“No, it isn’t.  No one on main street would laugh.  Half these prisoners are drug users.  They may not know it but they fund terrorism.  Their partners are the real ‘als’ planning the next attack.”

“Nooo!”

“That’s what people believe.  If you’re in jail, you’re a bad guy.  Bad guys support terrorists.  So you can’t satirize the War on Terror.”

“You just did!”

“Then why didn’t you laugh?”

“Your readers will, once you polish it.”

“They won’t.  My readers are the ‘als’ in prison.”

“Then dig deeper.  Hit the War on Drugs.”

“How?  By writing about soccer moms signing out kiddie aspirin at their local pharmacy, all the while chattering about their latest trip to the shore?”

“That’s a start.”

“Or a hospital scene depicting a shriveled old guy strapped to his mattress, his face a rictus of pain, while a canned video plays on his overhead TV detailing the evils of marijuana?”

“That’s good.  Dark, but good.”

“Of course there’s the old standby, cops armed with controlled substances to plant on troublemakers they want to send up.”

“That’s satire?”

“It might be if a cop’s kid gets hold of the stuff and is collared by some dick in another city.”

“You’re on a roll, man.  You need to hang up and get this stuff down.”

“You still don’t understand.  You know that puzzle about a tree falling in a forest with no one there -- would it make a sound?  I would be like that tree.  It’s not that there’s no one around.  They’re here but they’re lobotomized.  Regular people no longer think critically about the government.  Today’s normal is yesterday’s outrage, with the outrage removed.  Satire would play on that outrage, but it’s not there.  They’ve made peace with it in a psychotic sort of way.  They live in Huxley’s world without knowing it.  They love their servitude and call it freedom.  They still have their ball games and fishing trips, their malls and sitcoms.  Water still runs downhill, the sun rises and sets.  They can even speak freely, because their words are powerless.  In this blissful metamorphosis Julian Assange is the problem, not the corrupt governments.  You satirize that, they won’t laugh.  Satire’s not just humor, it’s an instrument of change.  Its fuel is outrage.”

“You’ve overlooked the elephant in the living room, my friend.  People have been screaming about the banks and Wall Street for at least four years.  They may not understand gold, but anti-Fed sentiment is all over the place!”

“Someone’s already tested the water on your elephant, buddy.  In this case a Brazilian elephant.  You say such animals don’t exist?  I say they’re invisible -- to the middle class.  They’re invisible to the middle class because they believe in the rightness of central banking.  Which, as I said earlier, is why they’re going broke.

“No satire I could ever write could top this.  It seems the staff of Brazil’s central bank is on strike.  They’re demanding a 23 percent pay increase.  Why?  Because of inflation.  They want the pay increase to cover the inflation they’ve created since 2008.”

“You’re making that up.”

“The Brazilian bank violated the first law of institutional counterfeiting: It didn’t take care of its own.  But who noticed?  No one.  Who cares?  No one.  Stand at the entrance to your local grocery store on a Saturday morning and ask the SUVs and mini-vans coming in if they’ve even heard of the strike . . or the central bank . . . or if they know what a central bank is.  Or if they have heard of a central bank, ask them if they think it’s an inflation fighter.  They’ll probably say yes.  ‘Thank God we have a central bank in the U.S., keeping a lid on inflation.  Unlike those boobs in Brazil.’  And if you stand there too long the store manager will order you off the premises, because he noticed you’re not selling girl scout cookies.”

“Look, you can’t expect political satire to ignite a revolution among everyday grocery shoppers.  If you were to conduct a survey you’d scare half of them and leave the rest thinking you’re a kook.  There’s an audience for your satire.  Not everyone’s been cleansed of outrage.  You need to find those people.”

“Yeah.  I believe they’re called ‘the choir.’  By definition you can’t change them.”

“That’s right -- and for the rest you need to be a teacher.  Satire isn’t a good teaching tool.  You build outrage with sound arguments.  Satire coaxes that outrage to the surface in the form of humor.  But you have to build it first.”

“But they’re lobotomized.”

“A better word would be ‘propagandized.’  It’s treatable.”

Then quietly, “Yeah,” followed by another silence so long I started to wonder if the connection broke.  Finally, to my surprise: “Yeah.  Yeah, that might work.  Talk to you later.”

Does the Fed really monetize government debt?

If monetizing debt is understood to mean printing money to pay for government deficits, then the Fed is guilty.

The basics are quite simple.  The federal government issues and the Fed buys interest-bearing debt certificates.  The Fed pays for these securities by creating digits on a computer that represent dollars.  In this Age of Ron Paul, more people are learning that the digits do not represent savings borrowed from the public.  The Fed is not a financial intermediary; it is a money factory.  And while factories under capitalism produce for the benefit of the masses, this factory cranks out dollars for the politically-favored, to the detriment of the masses.   The Fed is thus an anti-capitalist, anti-free market institution.  The 12 members of the FOMC decide how much money they need and create the digits on-the-fly, from nothing.  The idea of Bernanke or other Fed chairmen printing money is a metaphor, but an accurate one.  It’s simply more convenient for the Fed to create digits than to print money. 

It might be objected that this is not the equivalent of printing money because fiat money is not an interest-bearing asset.  By purchasing government bonds, the argument runs, the Fed collects interest from the Treasury, thus providing an additional windfall for the central bank, which also collects the principal.  The government would’ve been better off issuing a service order to its “money factory” and having it print the amount demanded and avoid the interest payments.  In other words, instead of Bernanke creating digits, have Geithner create them.

Simply printing money to pay one’s debts, though, even when done by a legitimate government, runs the risk of being seen as such.  Even eight-year-olds know a counterfeiter is a crook who prints money then spends it.  It’s always possible kids today would survive government schools to adulthood, still believing the emperor is stark naked, and that could lead to revolution.  Most adults, of course, have little interest in where money comes from as long as it buys things at the mall, and most economists have a habit of not biting the hand that feeds them, and thus lend support for an “independent” Fed.

If cheating is the goal, what’s needed is a circuitous means of printing money to keep the public befuddled and indifferent, and this is the reason for having a central bank.  It’s true, the Fed collects interest on the government securities it holds, but it gives most of it back to the Treasury.  After deducting for operating and other expenses, it pays member banks a 6% dividend on the stock they hold in their reserve banks, which in 2010 amounted to $1.5 billion.  (By law, member banks must subscribe to stock in the Federal reserve bank of their district equal to 3% of their capital, at a fixed rate of $100 per share, with another 3% subject to call of the Board of Governors.  See here.)  The remaining balance of the Fed’s interest receipts, including interest from assets other than U.S. bonds, is remitted to the Treasury at the end of each fiscal year.  In 2010, this amounted to $79.3 billion.  (See the 2010 annual report, pg. 130, Table 4 for details.)  Thus by giving the Treasury all the revenue it receives after deducting for expenses and dividends, the Fed in effect is granting the government loans at nearly zero interest.  As for the principal, the Fed simply keeps it on their books.  It could demand payment from the government, but so far it hasn’t.  If the Fed ever decides to defend the value of the dollar, unrestrained government as we've known it is doomed.

As we can see the government, in issuing bonds, is getting money for virtually nothing, then spending it.  As kings of old did when they literally ran the printing presses to pay for expenses beyond what they collected in taxes, today’s government does the same but through the esoteric world of central banking.

Why would bankers agree to such an unprofitable arrangement?

The commercial banks make their profits through the protection afforded by the government cartel of central banking.  Fractional-reserve banking has been the norm in banking for thousands of years, but while it can be very profitable it is also subject to instant disaster when banks over-inflate.  Under central banking in a fiat paper money regime, member banks inflate at a uniform rate and thus avoid currency drains from other banks and runs from the public.  And since money is paper or digits representing paper, the central bank, with its monopoly of the note issue and commodity money outlawed, can generate as much money as needed should problems arise.

As cozy as this arrangement is, most bankers don’t seem to recognize that central bank inflationary policies (“easing” or “accommodative”) will eventually bring an end to their scheme.  The money will become so worthless people stop using it.

The solution is to separate money and banking from the government, completely and permanently.