Mises Institute Daily Articles (Full-text version)

A Pro-Free-Market Program for Economic Recovery

Fri, 20 Nov 2009 03:15:00 -0600

[This talk was given at Economic Downturn: Cause and Cure (Mises Circle, Sponsored by Louis E. Carabini) Newport Beach, California, November 14, 2009.]

Good afternoon, ladies and gentlemen:

As you all know, we are in a severe economic downturn. The official unemployment rate now exceeds 10 percent and according to many observers is actually substantially higher. Within the last year or so, our financial system has been rocked to its foundations. The collapse of the housing bubble and the numerous defaults and bankruptcies connected with it brought down major financial institutions, such as Bear-Stearns, Lehman Brothers, and Merrill Lynch. It also brought down numerous small and medium-sized banks and threatened to bring down even such banking giants as Citigroup and Bank of America. The Dow Jones stock average fell from a high of 14,000 to about 6,500. Important retailers such as CompUSA, Circuit City, Mervyns, and Linens 'N Things went under, as did countless small businesses throughout the country. Practically every shopping mall gives testimony to the severity of the downturn in the form of vacant stores.

The collapse of the housing bubble and the massive losses and mounting unemployment that have resulted from it have unleashed a veritable firestorm of hostility against capitalism, in the conviction that it is capitalism and its economic freedom that are responsible. It is now generally taken for granted that any solution for the downturn requires massive new government intervention, to curb, control, or abolish this or that aspect of capitalism and its alleged evil.

Reflecting this view, in an effort to avoid financial collapse, the government's response was the enactment of an $800 billion "stimulus package" designed to boost spending throughout the economic system, and the pouring of more than $1.1 trillion of new and additional reserves into the banking system, along with the direct investment of capital in the country's most important banks and in major automobile firms, in order to prevent them from failing.

As a result of its so-called "investments," the government now owns a majority interest in the common stock of General Motors, once the flagship company of capitalism. There have been important extensions of government control over the economic system in other areas as well. For example, the stimulus package contains substantial funding for new bureaucracies to control healthcare and energy production.

The new and additional bank reserves, moreover, are not only massive, but almost all of them are excess reserves. Excess reserves are the reserves available to the banks for the making of new and additional loans, i.e., for new and additional credit expansion. They are the difference between the reserves the banks actually hold and the reserves they are required to hold by law or government regulation.

To gauge the significance of today's excess reserves, one should consider that total bank reserves as recently as July of 2008 were on the order of just $45 billion, and excess reserves were less than $2 billion. Those $45 billion of reserves supported a total of checking deposits in one form or another on the order of $6 trillion (a sum that included traditional checking deposits, so-called "sweep accounts," money-market mutual-fund accounts, and money-market deposit accounts insofar as checks could be written against them). That was a ratio of checking deposits to reserves in excess of 100 to 1, or equivalently, a fractional reserve of less than 1 percent.

Today, of the $1.1 trillion-plus of total reserves, all but approximately $62 billion of required reserves, are excess reserves. As of the week of November 4, excess reserves were $1.06 trillion.

Fortunately, for the time being at least, the banks are afraid to lend very much of this sum, but the potential is clearly there for a massive new credit expansion and corresponding increase in the quantity of money. Recognition of this potential is reflected in the current surge in the price of precious metals. Indeed, since $1.06 trillion of new and additional excess reserves are more than 22 times as large as the $45 billion of reserves that were sufficient not so long ago to support $6 trillion of checking deposits, they might potentially support checking deposits in excess of $132 trillion. In effect, what has happened is that our recent brush with massive deflation has turned out to be an occasion for a massive inflationary fueling period in the effort to avoid that deflation.

Inflation and Deflation: Credit Expansion and Malinvestment

The title of my talk, of course, is "A Pro-Free-Market Program for Economic Recovery." What this entails changes as the government adds new and additional measures that create new and additional problems. If I were giving this talk a year ago, my discussion would have been weighted somewhat more heavily toward deflation and somewhat less heavily toward inflation than is the case today.

A fundamental fact is that our present monetary system is characterized both by irredeemable paper money, i.e., fiat money, and by credit expansion. There is no limit to the quantity of fiat money that can be created. This is the foundation for potentially limitless inflation and the ultimate destruction of the paper money, when the point is reached that it loses value so fast that no one will accept it any longer.

The fact that our monetary system is also characterized by credit expansion is what creates the potential for massive deflation — for deflation to the point of wiping out the far greater part of the money supply, which in the conditions of the last centuries has been brought into existence through the mechanism of credit expansion.

Credit expansion is what underlay the housing bubble, and before that, the stock market bubble, and before that a long series of other booms and busts, running through the Great Depression of 1929 that followed the stock market boom of the 1920s, through the 19th and 18th Centuries all the way back to the Mississippi Bubble of 1719, and perhaps even further back.

Credit expansion is the lending out of money created virtually out of thin air. It is money manufactured by the banking system, always with at least the implicit sanction of the government, which chooses not to outlaw the practice. Since 1913, credit expansion in this country has proceeded not only with the sanction but also with the approval, and active encouragement of the Federal Reserve System, which, as I've shown, is now desperately trying to reignite the process as the means of recovering from the current downturn.

The new and additional money is created by the banking system through the lending out of funds placed on deposit with it by its customers and still held by those customers in the form of checking accounts of one kind or another. The customers can continue to spend those checking deposits themselves, simply by writing checks or using other, similar methods of transferring their balances to others.

But now, at the same time, those to whom the banks have lent in this way also have money. To illustrate the process, imagine that Mr. X deposits $1,000 of currency in his checking account. He retains the ability to spend his $1,000 by means of writing checks. From his point of view, he has not reduced the money he owns any more than if he had exchanged $1,000 in hundred-dollar bills for $1,000 in fifty-dollar bills, or vice versa. He has merely changed the form in which he continues to hold the exact same quantity of money.

But now imagine that Mr. X's bank takes, say, $900 of the currency that he has deposited and lends it to Mr. Y. Mr. Y now possess $900 of spendable money in addition to the $1,000 that Mr. X continues to possess. In other words, the quantity of money in the economic system has been increased by $900. Mr. Y's loan has been financed by the creation of new and additional money virtually out of thin air. This is the nature and meaning of credit expansion.

Now, nothing of substance is changed, if instead of lending currency to Mr. Y, Mr. X's bank creates a new and additional checking deposit for Mr. Y in the amount of $900. (This, in fact, is the way credit expansion usually occurs in present-day conditions.) There will once again be $900 of new and additional money. There will be altogether $1,900 of money resting on a foundation merely of the $1,000 of currency deposited by Mr. X.

The $1,000 of currency that Mr. X's bank holds is its reserve. If Mr. Y deposits his currency or check in another bank, it is the banking system that now has $1,000 of reserves and $1,900 of checking deposits. On the foundation of these reserves, it can create still more money and use it in the further expansion of credit. Indeed, as we have seen, the process of credit expansion is capable of creating checking deposits more than 100 times as large as the reserves that support them.

Credit expansion makes it possible to understand what caused the housing bubble and its collapse. From January of 2001 to December of 2007, credit expansion took place in excess of $2 trillion. This new and additional money made available in the loan market drove down interest rates, including, very prominently, interest rates on home mortgages. Since the interest rate on a mortgage is a major factor determining the cost of homeownership, lower mortgage interest rates greatly encouraged buying houses.

This artificially increased demand for houses, made possible by credit expansion, soon began to raise the prices of houses, and as the new and additional money kept pouring into the housing market, home prices continued to rise. This went on long enough to convince many people that the mere buying and selling of houses was a way to make a good living. On this basis, the demand for houses increased yet further, and finally a point was reached where the median-priced home was no longer affordable by anyone whose income was not far in excess of the median income, i.e., only by a relatively few percent of families.

In the middle of 2004, the Federal Reserve became alarmed about the situation and its implications for rising prices in general, and over the next two years progressively increased its Federal Funds interest rate from 1 percent to 5.25 percent. This rise in the Federal Funds rate signified a reduction in the flow of new and additional excess reserves into the banking system and thus its ability to make new and additional loans. This served to prick the housing bubble.

But before its end, perhaps as much as a trillion and a half dollars or more of credit expansion and its newly created money had been channeled into the housing market. Once the basis of high and rising home prices had been removed, home prices began to fall, leaving large numbers of borrowers with homes worth less than they had paid for them and with mortgages they could not meet.

The investments in housing represented a classic case of what Mises calls "malinvestment," i.e., the wasteful investment of capital in inherently uneconomic ventures. The malinvestment in housing was on a scale comparable to the credit expansion that had created it, i.e., about $2 trillion or more. That's about how much was lost in the housing market. When the money capital created by credit expansion was wiped out, the lending, investment spending, employment, and consumer spending that depended on that capital were also wiped out.

And, particularly important, as vast numbers of home buyers defaulted on their mortgages, the mounting losses on mortgage loans increasingly wiped out the capital of banks and other financial institutions, setting the stage for their failure.

The current plight of the economic system is the result of credit expansion and the malinvestment it engenders. Capital in physical terms is the physical assets of business firms. It is their plant and equipment and inventories and work in progress. As Mises never tired of pointing out, capital goods cannot be created by credit expansion. All that credit expansion can do is change their employment and shift them into lines where their employment results in losses. The empty stores and idle factories around the country are very much the result of the loss of the capital squandered in malinvestment in housing.

Other Consequences of Credit Expansion

The plight of the economic system is also the result of other consequences of credit expansion, namely, the encouragement it gives to high debt and dangerous leverage. This is the result of the fact that while credit expansion drives down market interest rates, the spending of the new and additional funds it represents serves to drive up business sales revenues and what the old classical economists called the rate of profit. This combination makes borrowing appear highly profitable and greatly encourages it. Individuals and business firms take on more and more debt relative to their equity. They expect borrowing to multiply their gains.

In addition, credit expansion is responsible for many business firms operating with lower cash holdings relative to the scale of their economic activity, in many cases, dangerously low cash holdings. Many businessmen develop the attitude, why hold cash when credit expansion makes it possible to borrow easily and profitably? Instead, invest the money.

"Why hold cash when credit expansion makes it possible to borrow easily and profitably? Instead, invest the money."

Thus, when credit expansion finally gives way to the recognition of vast malinvestments and the accompanying loss of huge sums of capital, the economic system is also mired in debt and deficient in cash. Thus, it is poised to fall like a house of cards, in a vast cascade of failures and bankruptcies, first and foremost, bank failures.

The Road to Recovery

The road to recovery from our economic downturn can be understood only in the light of knowledge of credit expansion and its consequences. The nature of credit expansion and its consequences imply the nature of the cure.

The prevailing — Keynesian — view on how to recover from our downturn totally ignores credit expansion and its effects. It believes that all that counts is "spending," practically any kind of spending. Just get the spending going and economic activity will follow, the Keynesians believe.

This conception of things, which underlies the support for "stimulus packages" and anything else that will increase consumer spending, is mistaken. It rests on a fundamental misconception. It ignores the fact that the fundamental problem is not insufficient spending, but insufficient capital due to the losses caused by malinvestment. It ignores the further facts that credit expansion has brought about excessive debt and, however counterintuitive this may seem, insufficient cash. Too little capital, too much debt, and not enough cash are the problems that countless business firms are facing today as a result of the credit expansion that generated the housing bubble.

Just as a reminder: the way that credit expansion brings about a situation of too little cash while itself constituting a flood of cash is that it makes it appear profitable to invest every last dollar of cash in the expectation of being able easily and profitably to borrow whatever cash may be needed.

What this discussion implies is that an essential requirement of economic recovery is that the widespread problems in the balance sheets of business firms must be fixed. Business firms need more capital, less debt, and more cash. When they achieve that, business confidence will be restored.

Ironically what could achieve at least less debt and more cash in the hands of business, and thus actually do some significant good is if when people received government "stimulus" money, they did not spend very much of it, or, better still, any of it at all. To the extent that all people did with money coming from the government was pay down debt and hold more cash, they would be engaged in a process of undoing some of the major damage done by credit expansion. They would be reducing their burden of debt and increasing their liquidity, thereby increasing their security against the threat of insolvency. Such behavior, of course, would be regarded by Keynesians as constituting a failure of their policies, because in their eyes, all that counts is consumer spending.

The 100-Percent Reserve

The most important single step on the road to economic recovery is the establishment of a 100-percent reserve system against checking deposits. Ideally, the 100-percent reserve would be in gold. And that's ultimately what we should aim at, for all of the reasons Rothbard explained. But even a 100-percent reserve in paper would do the job of totally preventing all future credit expansion and, equally important, all declines in the money supply.

(Because the 100-percent gold reserve standard is the long-run ideal of advocates of sound money, I cannot help but feel a sense of great satisfaction in the fact that a major step toward its achievement is what turns out to be urgently needed as a matter of sound current economic policy.)

In the simplest terms, to establish a 100-percent-reserve system in terms of paper, the government would simply print up enough additional paper currency so that when added to the paper currency the banks already have, every last dollar of their checking deposits would be covered by such currency. (Strictly speaking, a significant part, and for some months now the far greater part, of the reserves of the banks are not in actual currency but in checking deposits with the Federal Reserve. For the sake of simplicity, however, we can think of the checking deposits held by the banks with the Federal Reserve as a denomination of currency, since, for the banks, they are fully as interchangeable with currency as $50 bills are with $100 bills and vice versa.)

To illustrate the process of achieving a 100-percent reserve, imagine that total checking deposits are $3 trillion. In that case, the Fed would give the banks new and additional reserves that when added to their existing reserves would bring them up to $3 trillion. Through various programs, such as purchasing bad assets, the Fed has in fact already brought the total reserves of the banks up to over a trillion dollars, but almost all of those reserves, as we've seen, are excess reserves, a ready foundation for a massive new credit expansion, since excess reserves can be lent out.

What my example implies is adding to the $1.1 trillion of reserves the banking system now has, a further $1.9 trillion and making all $3 trillion of reserves required reserves. This would mean that the banks could not engage in any lending of these reserves and thus would be unable to finance credit expansion or any increase in the supply of checking deposits on the strength of them. The money supply in the hands of the public and spendable in the economic system would thus not be increased. That would happen only if and to the extent that the 100-percent reserve principle were breached.

Under a 100-percent reserve, checking depositors could simultaneously all demand their full balances in cash and the banks would be able to pay them all. Depositors' demand for cash would not create a problem and no amount of losses by the banks on their loans and investments would prevent them from honoring their checking deposits immediately and in full. Thus the checking deposit component of the money supply could not fall and nor, of course could its other component, which is the paper money in the hands of the public, usually described as the currency component. Thus, there could simply be no deflation of the money supply. And, as I've said, because all reserves would be required reserves, there would simply be no reserves whatever available for lending out, and thus no credit expansion whatever. The expression "killing two birds with one stone" could not have a better application.

"The most important single step on the road to economic recovery is the establishment of a 100-percent reserve system against checking deposits."

In a addition, a significant byproduct of a 100-percent reserve system would be that the FDIC would no longer serve any purpose and thus could be abolished.

Now an essential prerequisite of the 100-percent reserve is knowing the size of checking deposits, so that it will be known how much the 100-percent reserve needs to cover. At present, when one allows for such things as "sweep accounts," money-market mutual funds, and money-market deposit accounts, the magnitude to which the 100-percent reserve would apply can plausibly be argued to range from about $1.5 trillion to $8 trillion. It is very solidly $1.5 trillion, but does in fact range up to $8 trillion in that checks can be written on the additional sums involved, at least from time to time and for some large minimum amount.

To clearly establish the magnitude of checking deposits, bank depositors should be asked if their intention is to hold money in the bank, ready for their immediate use and transfer to others, or to lend money to the bank. In the first case, their funds would be in a checking account, against which the bank would have to hold a 100-percent reserve. In the second case, their funds would be in a savings account, against which the bank could hold whatever lesser reserve it considered necessary. In this case, the bank's customers could not spend the funds they had deposited until they withdrew them from the bank.

As I've said, the long-run goal in connection with the 100-percent reserve would be ultimately to convert it to a 100-percent gold reserve system. At that time, following the ideas of Rothbard further, the gold reserve of the Fed would be priced high enough to equal the currency and checking deposits of the country and be physically turned over to the individual citizens and the banks in exchange for all outstanding Federal Reserve money. The Fed would then be abolished. But this is a distinct and much later step in pro-free-market reform.

The 100-Percent Reserve and New Bank Capital

It should be realized that a major consequence of the establishment of a 100-percent-reserve system could be a corresponding enlargement of the capital of the banking system and thus an ability to cover even very great losses and thereby avoid such things as government bank bailouts and takeovers.

Consider the balance sheet of an imaginary bank. It's got checking deposit liabilities of $100. Initially, it has assets of $105, which implies that on the liabilities side of its balance sheet it has capital of $5 in addition to its checking deposit liabilities of $100.

Now unfortunately, malinvestment has resulted in a loss of $20 in the banks' assets, in the part of its assets consisting of loans and investments. As a result, its total assets are reduced from $105 to $85 and its capital is completely wiped out and becomes negative in the amount of $15.

However, on its asset side the bank still has some cash reserve, say, $10. If $90 of new and additional reserves were added to these $10, to bring the bank's reserves up to 100-percent equality with its checking deposits, the bank's asset total would also be increased by $90. This $90 increase on the bank's asset side would have to be matched by a $90 increase on its liabilities side, specifically by a $90 increase in its capital. Its capital would go from minus $15 to plus $75.

Applying this to the banking system as a whole in transitioning to a 100-percent reserve, we can see that the creation of such a vast amount of new bank capital would be entailed as easily to overcome whatever losses the banks might have suffered in their loans and investments.

As explained, if checking deposits were $3 trillion, the Fed would give the banks new and additional reserves that when added to their existing reserves would bring them up to $3 trillion. If this had been done in September of 2008, bringing reserves up to $3 trillion would have required adding $2.955 trillion of new and additional reserves to the $45 billion or so of reserves the banks already had. This vast addition on the asset side of the banks' balance sheets would have implied an equivalent addition to the banks' capital on the liabilities side. No matter how bad the banks' assets were, I think it's virtually certain that an additional sum of this size would have been far more than sufficient to cover all the losses that the banks had incurred in their bad loans and investments. Their capital would have ended up being increased to the extent that the additional reserves exceeded the losses in assets under the head of loans and investments.

The government's bailout program of stock purchases in the banks would have been avoided, along with all of its subsequent interference in matters of bank management.

Now, as we've seen, in fact the Fed has already supplied a vast amount of reserves, about $1.1 trillion, to the banks through various programs, such as purchasing bad assets. If the 100-percent reserve principle were adopted now, many or most of those assets could be taken back, and the programs that created them cancelled.

Thus, what I've shown here is how transitioning to a 100-percent reserve would guarantee the prevention both of new credit expansion and of deflation of the money supply. It could also provide additional capital to the banking system on a scale almost certainly far more than sufficient to place it on a financially sound footing. To avoid what would otherwise likely be an excessive windfall to the banks, it would be possible to match a more or less considerable part of the increase in their assets provided by the creation of additional reserves, with the creation of a liability of the banks to their depositors, perhaps in the form of some kind of mutual-fund accounts. Thus, the newly created reserves might provide a financial benefit to the banks' depositors as well as to the banks.

Toward Gold

Of course, a 100-percent reserve system in which the reserves are fiat money does not address the problem of preventing inflation of the fiat money. It would still be possible for the government to inflate the fiat money without restraint. That is why it is necessary to have gold in the monetary system, serving as a restraint on the amount of currency and reserves.

Thus, an important ancillary measure in connection with the transition to a 100-percent paper-reserve system would be for the government to demonstrate a serious intent to move to a gold standard. Obliging the Federal Reserve to carry out a program of regular and substantial gold bullion purchases might accomplish this. In any event, it would be an essential prerequisite for someday achieving gold reserves sufficient to make possible the establishment of a 100-percent-reserve gold system. Along the way, this measure should lead to the day when purchases of gold bullion were the only source of increases in the supply of currency and reserves.

Establishing the Freedom of Wage Rates to Fall

Along with stabilizing the financial system through the adoption of a 100-pecent reserve, it's absolutely essential to establish the freedom of wage rates and prices to fall. This is what is required to eliminate mass unemployment. Whatever the level of spending in the economic system may be, it is sufficient to buy as much additional labor and products as is required for everyone to be employed and producing as much as he can.

Nothing could be more obvious if one thinks about it. Assume, as is the case today, that there is 10 percent unemployment, with only 9 workers working for every 10 who are able and willing to work. The same total expenditure of money that today employs only 9 workers would be able to employ 10 workers, if the average wage per worker were 10 percent less. At nine-tenths the wage, the same total amount of wages is sufficient to employ ten-ninths the number of workers. It's a question of simple arithmetic: 1 divided by 9/10 equals 10/9.

(Obviously, this is an overall, average result. In reality, some wage rates would need to fall by less than 10 percent and others by more than 10 percent.)

Of course, total wage payments are not fixed in stone. They can change. And in response to a fall in wage rates to their equilibrium level, to eliminate mass unemployment, they would increase. This is because prior to their fall, investment expenditures have been postponed, awaiting their fall. Once that fall occurs, those investment expenditures take place.

Finally, with debt levels sufficiently reduced and cash holdings sufficiently high, and thus business confidence restored, there is no reason to believe that a fall in wage rates could abort the process of recovery as the result of already employed workers earning less and thus spending less before new and additional workers were hired. The cash reserves and financial strength of business firms would enable them easily to ride out any such situation. And thus mass unemployment would simply be eliminated.

What stops wage rates from falling, what makes it actually illegal for them to fall, and which thus perpetuates mass unemployment, is the underlying pervasive influence of the Marxian exploitation theory. That doctrine is responsible for the existence of such things as minimum-wage laws and coercive labor unions and their above-market wage scales.

The most important fundamental requirement for achieving a free market in labor is the total refutation of the exploitation theory and its complete discrediting in public opinion. Such a refutation will show that it is not government and labor unions that raise real wages but businessmen and capitalists, and that essentially, all that unions do is cause unemployment and a lower productivity of labor and thus prices that are higher relative to wage rates. This knowledge is what is required to make possible the repeal of minimum-wage and pro-union legislation and thus achieve the fall in wage rates that will eliminate mass unemployment

Summary

In summation, my pro-free-market program for economic recovery is a provisional 100-percent-paper-money-reserve system applied to checking deposits, accompanied by a demonstrable commitment to ultimately achieving a 100-percent-gold reserve system. The 100-percent reserve in paper would put an end to all further credit expansion and at the same time make the money supply incapable of being deflated. Its establishment would also greatly increase the capital of the banking system. It would do so by more than enough to cover all the losses on loans and investments incurred in the aftermath of the collapse of the housing bubble and thus make possible the elimination of government ownership of common stock in banks and its interference in bank management. What it would not do is control the increase in paper currency and paper-currency reserves. That will require a 100-percent gold reserve system.

$95 $80

Finally, the freedom of wage rates and prices to fall must be established through the repeal of pro-union and minimum-wage legislation, and more fundamentally, the education of the public concerning the errors of the Marxian exploitation theory and their replacement with actual knowledge of what determines wages and the general standard of living. To say the least, this will certainly not be an easy agenda to follow, inasmuch as it must begin in the midst of a Marxist occupation of our nation's capital.

Thank you.

George Reisman, Ph.D., is Pepperdine University Professor Emeritus of Economics and the author of Capitalism: A Treatise on Economics (Ottawa, Illinois: Jameson Books, 1996). His web site is www.capitalism.net. His blog is at www.georgereisman.com/blog/. Send him mail. (A PDF replica of the complete book Capitalism: A Treatise on Economics can be downloaded to the reader's hard drive simply by clicking on the book’s title, immediately preceding, and then saving the file when it appears on the screen. ) See George Reisman's article archives.

This talk was given at Economic Downturn: Cause and Cure (Mises Circle, Sponsored by Louis E. Carabini) Newport Beach, California, November 14, 2009.

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Good Inflation

Fri, 20 Nov 2009 02:10:00 -0600

Last week a student in my MBA-level intermediate-macro seminar raised a provocative question. We were discussing the various kinds of (price) deflation and which kinds, according to Austrians, are benign and accommodate consumer preferences, and which are malignant and conflict with consumer preferences.

In view of the Austrian emphasis on inflationary monetary policy as the primary cause of the business cycle and the current financial crisis in particular, the student asked if Austrians considered any kind of inflation as "good" for the economy. I gave a short response in the affirmative and then thought about it more over the weekend. Here is the note on the subject that I wrote up for discussion in class tomorrow. (The last two paragraphs on free banking were not part of the original note.)

One kind of "good" inflation typically results when innovations and changes occur that permit people to economize on the amount of money they need to hold in their cash balances. For example, the introduction and increasing availability of credit cards bring about a decrease in the demand for money, which, all other things being equal, causes a general rise in prices. Credit cards operate as an alternative means of payment for many transactions and therefore reduce the amount of money people need to hold in currency and bank deposits in order to finance their anticipated exchanges at the prevailing level of prices.

These "excess" cash balances produce an increase in the demands for goods, the supplies of which have not increased. The result is that overall prices rise. But inflation here performs an important function: it reduces the buying power of the dollar to the point where money no longer is in excess supply, because people are now content to hold the total supply of money in existence in order to finance planned transactions at the new, higher level of prices. Another way of putting this is that the "real" money supply, that is, its total purchasing power in terms of goods, has been reduced to exactly the level desired by consumers.

What we might call "cash-economizing" inflation tends to occur as a result of any financial innovation, including the invention of money-market mutual funds, ATM machines, PayPal accounts, and so on. It may also result from organizational or technical innovations in business that promote vertical integration of operations, where capital goods previously exchanged between two independent firms are now produced and employed within the same firm.

Note that cash-economizing inflation is benign precisely because it is an outcome of individuals striving to optimize their property holdings through the voluntary exchange process. It is also noteworthy that this kind of inflation involves a one-shot increase in prices: once the new payment method or invention becomes broadly adopted, the decline in the demand for money ceases and prices stop rising. Lastly, inflation caused by people responding to opportunities to economize on their money holdings has no systematic effect on credit markets and the interest rate and therefore does not precipitate the business cycle.

"Note that cash-economizing inflation is benign precisely because it is an outcome of individuals striving to optimize their property holdings through the voluntary exchange process."

A second type of good inflation is one that occurs as a result of a reduction in the supplies of goods and services caused by natural disasters, the depletion of natural resources, or increases in people's preferences for leisure (causing a decline in labor-force participation) or for present consumer goods (causing the nonreplacement or "consumption" of capital goods). All of these events bring about, sooner or later, a greater scarcity of exchangeable goods in the economy.

The reduction in the supplies of goods in the market, all other things being constant, including the stock of money, causes an excess demand for goods to emerge. Overall prices will naturally rise to restore equilibrium in goods' markets. This rise in prices both indicates the greater scarcity of available goods and ensures that they are allocated to the uses most highly valued by consumers.

Conversely, it may be said that there is a fall in the "exchange" demand for money, which is constituted by the goods offered for exchange. The decrease in the demand for money in exchange, with the supply of money unchanged, initially produces a surplus of money, because at the low prices prevailing, the supply of money offered exceeds the supplies of goods brought to market. Eventually, the buying power of the dollar adjusts downward, goods' prices are bid up, and all dollars offered are absorbed in exchange for the now-higher-priced goods.

Once again we note that, unlike the ongoing price inflation that is typically caused by central-bank expansion of the money supply, the inflation generated by diminished supplies of goods is a one-shot affair. Prices stop rising as soon as the supplies of goods and services stop decreasing and stabilize at the lower level consistent with the change in the economic data.

"Scarcity" inflation is thus socially beneficial because it facilitates economic calculation and smoothly operating markets in a situation in which people's preferences or their production opportunities have undergone a radical change. History has shown time and again — during wars, revolutions, sieges, and crop failures — that any attempt to repress scarcity inflation via price controls or centralized distribution of necessities results in calculational chaos, widespread poverty, and social disorder.

Our conclusion is, thus, that a rise in general prices driven by the demand for money always improves economic welfare as Austrians understand that term.

In the interest of full disclosure, I note that most modern Austrians who support free banking, while agreeing with me on scarcity inflation, would strongly disagree with me that cash-economizing inflation is benign. Writers such as Larry White, George Selgin, and Steve Horwitz insist that any change in total spending caused by shifts in the demand for money must be promptly undone by a change in the supply of money in the same direction. Thus under our current fiat-money system, if financial innovations occur that induce people to reduce their demand for cash balances and to exchange money more rapidly, then according to "free bankers," the central bank must contract the money supply in order to prevent the increase in prices that corresponds to people's voluntary choices.

"The free bankers claim to be in favor of a freely competitive monetary system, but presume to know in advance what outcome the entrepreneurs operating in this system will bring about."

This is a direct implication of the free bankers' "productivity norm," according to which the central bank must actively suppress "meaningless" changes in prices. Meaningless changes in prices include those caused by shifts in what free bankers characterize — misleadingly in my opinion — as "the velocity of money." Thus, free bankers become cheerleaders for a monetary deflation engineered by the central bank as a means of stifling a pattern of freely chosen exchanges of property that expresses consumer preferences for higher prices.

The position of free bankers is not only erroneous but paradoxical as well. They accuse Austrians of the neo–Currency School, created by Mises and Rothbard, of viewing deflation and inflation asymmetrically, favoring deflation while condemning inflation. But as I tried to demonstrate above, Austrians of the neo–Currency School are perfectly consistent in their attitudes toward rising and falling prices: both "inflation" and "deflation" are benign as long as they are in accord with the voluntarily expressed preferences of consumers. Not so the free bankers, who claim to be in favor of a freely competitive monetary system, but presume to know in advance what outcome the entrepreneurs operating in this system will bring about, namely, complete stability of a particular macroeconomic variable.

Thus, the real point at issue between the free bankers and their neo–Currency opponents is whether the productivity norm should be invoked to encourage the central bank to use its power to manipulate the money supply in order to stabilize "total spending," a meaningless, ex post macroaggregate. The free bankers answer, "Yes." Neo–Currency School Austrians accept Mises's dictum that rising and falling prices per se are meaningless in assessing the soundness of a monetary regime. As Mises wrote,

$30 $15

The notions of inflation and deflation are not praxeological concepts.… They impl[y] the popular fallacy that there is such a thing as neutral money or money of stable purchasing power and that sound money should be neutral and stable in purchasing power.…

However, those applying these terms are not aware of the fact that purchasing power never remains unchanged and that consequently there is always either inflation or deflation.[1]

Joseph Salerno is academic vice president of the Mises Institute, professor of economics at Pace University, and editor of the Quarterly Journal of Austrian Economics. He has been interviewed in the Austrian Economics Newsletter and on Mises.org. Send him mail. See Joseph T. Salerno's article archives.

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Notes

[1] Ludwig von Mises, Human Action: A Treatise on Economics (Auburn, AL: Ludwig von Mises Institute, 1998), p. 419.

The Myth of the "Old Right"

Fri, 20 Nov 2009 02:08:00 -0600

[This article is excerpted from chapter five of Why American History Is Not What They Say: An Introduction to Revisionism.]

In 1932, according to John T. Flynn, there were no federal "subsidies to farmers, … handouts to the indigent, [or] support [for] schools." The federal government did not "build hospitals [or] provide medical care."[1] And though it did undertake national defense, it did so much more cheaply than Americans of today are accustomed to seeing.

"The U.S. had the sixteenth largest army in the world" in 1932, William Manchester reports, "putting it behind, among others, Czechoslovakia, Turkey, Spain, Romania, and Poland." And most of those in uniform "were committed to desk work, patrolling the Mexican border, and protecting U.S. possessions overseas." What remained to defend the United States from anyone other than Mexico was "30,000 troops — fewer than the force King George sent to tame his rebellious American colonies in 1776."[2]

In constant dollars, this army cost about 0.0125 percent of what today's military costs the US taxpayer. In 1932, the federal government was seizing less than 5 percent of our national income, so it had to be a good deal more frugal than the federal government of 2005, which claims a fraction more than five times that much.

The Great Depression was underway in 1932, of course — it had been for three and a half years. Around a quarter of the workforce was out of work, banks were failing, times were hard. And President Hoover had only made matters worse. Flynn saw the "Hoover New Deal" as an effort to virtually nationalize the US economy, an effort "to organize every profession, every trade, every craft under [government] supervision and to deal directly with such details as the volume of production, the prices, the means and methods of distribution of every conceivable product."[3]

Fortunately, however, from the liberal point of view, President Hoover had been voted out of office after a single term in the White House. The American electorate had repudiated his approach to fighting the depression and had elected the Democratic candidate, Franklin Delano Roosevelt, a man who stood for small government and fiscal responsibility.

This was evident from the platform on which Roosevelt had run — a platform that called for

An immediate and drastic reduction of governmental expenditures by abolishing useless commissions and offices, consolidating departments and bureaus and eliminating extravagance, to accomplish a saving of not less than 25 percent in the cost of Federal government.…

Maintenance of the national credit by a Federal budget annually balanced .…

A sound currency to be maintained at all hazards.[4]

Nor was this platform meant to be taken as mere empty rhetoric of the sort people today tend to assume is characteristic of virtually all public statements by politicians. No. As Garet Garrett of the Saturday Evening Post pointed out in 1938, "Mr. Roosevelt pledged himself to be bound by this platform as no president had ever before been bound by a party document. All during the campaign he supported it with words that could not possibly be misunderstood." He said, for example,

I accuse the present Administration of being the greatest spending Administration in peace time in all American history — one which piled bureau on bureau, commission on commission, and has failed to anticipate the dire needs or reduced earning power of the people. Bureaus and bureaucrats have been retained at the expense of the taxpayer.… We are spending altogether too much money for government services which are neither practical nor necessary. In addition to this, we are attempting too many functions and we need a simplification of what the Federal government is giving to the people.[5]

Roosevelt was particularly adamant on the subject of government borrowing.

Toward the end of the campaign he cried: "Stop the deficits! Stop the deficits!" Then to impress his listeners with his inflexible purpose to deal with this prodigal monster, he said: "Before any man enters my cabinet he must give me a twofold pledge: Absolute loyalty to the Democratic platform and especially to its economy plank. And complete cooperation with me in looking to economy and reorganization in his department."[6]

True, Roosevelt's political track record was somewhat worrisome, for "as governor he took New York State from the hands of Al Smith with a surplus of $15,000,000 and left it with a deficit of $90,000,000." Still, "there was nothing revolutionary in" what he was now telling the voters.

It was … actually an old-time Democratic platform based upon fairly well-accepted principles of the traditional Democratic party. That party had always denounced the tendency to strong central government, the creation of new bureaus. It had always denounced deficit financing. Its central principle of action was a minimum of government in business.[7]

By contrast, since the time of Lincoln, the Republican party had always stood for strong central government, top-heavy bureaucracy, and hefty handouts to big business. The fact that the voters had evicted a Republican from the White House and elected a Democrat surely meant that American public opinion was leaning in a more liberal direction.

"In 1932, the federal government was seizing less than 5 percent of our national income, so it had to be a good deal more frugal than the federal government of 2005, which claims a fraction more than five times that much."

But of course Franklin Roosevelt dashed all such liberal hopes within the first hundred days of his administration. In effect, once elected, he tossed the Democratic platform of 1932 into the trashcan and proceeded to show the electorate that he could play the conservative game better than any Republican. First he took Hoover's Hamiltonian policies and enormously expanded them; then, astonishingly, he had the effrontery to describe himself and his stolen program as "liberal."

John T. Flynn, a journalist and commentator and a noted liberal spokesman since the 1920s, wrote in 1940 that "I see the standard of liberalism that I have followed all my life flying over a group of causes which, as a liberal along with all liberals, I have abhorred all my life."[8] Nor was Flynn alone in this feeling.

A number of prominent liberals, many of them writers and intellectuals, had enthusiastically supported FDR in the 1932 election, believing that he meant to adhere to the classically liberal Democratic party platform for that year. In addition to Flynn, these included H. L. Mencken, editor of the American Mercury; Isabel Paterson, iconoclastic editor and columnist at the New York Herald Tribune Sunday "Books" section; and Garet Garrett, chief editorialist at the Saturday Evening Post.

They were joined in their bitter opposition to the Roosevelt New Deal by other writers and intellectuals who, irrespective of the candidate they had supported in the 1932 election, were also old-fashioned liberals appalled by what FDR was doing under the once-good liberal name. These included Albert Jay Nock, former editor of the Freeman and regular contributor to the American Mercury, the Atlantic Monthly, and Harper's; Rose Wilder Lane, prolific freelance journalist and author; Henry Hazlitt, Mencken's successor as editor of the American Mercury and later writer on economic issues for The New York Times and Newsweek; and Felix Morley, editor of the Washington Post from 1933 to 1940 and winner of a Pulitzer Prize for distinguished editorial writing.

Certain students of American intellectual history — Murray Rothbard is among them, unfortunately — have dubbed this group of writers and intellectuals, along with the handful of politicians who adopted a similar hostility toward New Deal domestic and/or foreign policy during the 1930s and early '40s, the "Old Right." "The Old Right," declares Internet pundit Justin Raimondo in his 1993 book Reclaiming the American Right, "was that loose grouping of intellectuals, writers, publicists, and politicians who vocally opposed the New Deal and bitterly resisted US entry into World War II."[9]

"The 'Old Right' was born," writes Jude Blanchette of the Foundation for Economic Education,

in protest to Roosevelt and the New Deal. Its leaders were H.L. Mencken, Albert Jay Nock, Garet Garrett, John T. Flynn, Suzanne La Follette and Felix Morley. It is notable that what one finds in their writings one can still find in the work of most libertarians today. In fact, it could be argued that the modern libertarian movement has more in common with conservatives of the 30s and 40s than do contemporary conservatives. The ideas of the Old Right conservatives (skepticism of government planning, isolationist foreign policy and a general belief in the free market) have taken a back seat to the modern conservative emphasis on domestic pragmatism and international interventionism.[10]

"The intellectual leaders of this old Right of World War II and the immediate aftermath," Rothbard wrote in 1964,

were then and remain today almost unknown among the larger body of American intellectuals: Albert Jay Nock, Rose Wilder Lane, Isabel Paterson, Frank Chodorov, Garet Garrett. It almost takes a great effort of the will to recall the principles and Objectives of the old Right, so different is the current Right-wing today. The stress, as we have noted, was on individual liberty in all its aspects as against state power: on freedom of speech and action, on economic liberty, on voluntary relations as opposed to coercion, on a peaceful foreign policy. The great threat to that liberty was state power, in its invasion of personal freedom and private property and in its burgeoning military despotism. Philosophically, the major emphasis was on the natural rights of man, arrived at by an investigation through reason of the laws of man's nature. Historically, the intellectual heroes of the old Right were such libertarians as John Locke, the Levellers, Jefferson, Paine, Thoreau, Cobden, Spencer, and Bastiat.

"In short," Rothbard wrote, "this libertarian Right based itself on eighteenth and nineteenth century liberalism, and began systematically to extend that doctrine even further."[11]

But if they were extending the doctrine of liberalism even further, they must have been liberals, right? They must have been men and women of the Left, not the Right — right? John Moser reports of John T. Flynn that "to the end of his life he never referred to himself as anything but a liberal.… Flynn claimed that it was the American political climate that changed during his lifetime, not he. Indeed, he believed that the very term liberal had been hijacked."[12]

"The very term liberal had been hijacked."

Flynn was correct. The writers and intellectuals who made up the most visible contingent of the "Old Right" were in no meaningful sense on the Right at all. They were on the Left, where they had always been. They were liberals. The term liberal had in fact been hijacked. The "two-party system" in the United States now consisted of two conservative parties and no liberal party.

A great many of the liberals who had been left in the lurch by the Democratic party's sudden, more or less official adoption of conservatism in liberal clothing made the mistake of joining (or, at any rate, supporting) the Republican party — presumably in the belief that the opposition party, whatever its fundamental character, was where they now belonged.

As Rothbard acknowledges, the "Old Right" was a coalition, in which the libertarians and individualists — the true liberals — were not dominant. Nevertheless, he writes, they

set the tone, since individualist and libertarian rhetoric provided the only general concepts with which New Deal measures could be opposed. The result, however, was that hack Republican politicians found themselves mouthing libertarian and antistatist slogans that they did not really believe — a condition that set the stage for a later "moderation" and abandonment of their seemingly cherished principles.[13]

More important, a great many of the liberals who had been driven into the GOP, though "at first properly scornful of their newfound allies, soon began to accept them and even to don cheerfully the formerly despised label of 'conservative.'"[14]

And so it was that

the Libertarians, especially in their sense of where they stood in the ideological spectrum, fused with the older conservatives who were forced to adopt libertarian phraseology (but with no real libertarian content) in opposing a Roosevelt Administration that had become too collectivistic for them, either in content or in rhetoric. World War II reinforced and cemented this alliance; for, in contrast to all the previous American wars of the century, the pro-peace and "isolationist" forces were all identified, by their enemies and subsequently by themselves, as men of the "Right." By the end of World War II, it was second nature for libertarians to consider themselves at an "extreme right-wing" pole with the conservatives immediately to the left of them; and hence the great error of the spectrum that persists to this day. In particular, the modern libertarians forgot or never realized that opposition to war and militarism had always been a "left-wing" tradition which had included libertarians; and hence when the historical aberration of the New Deal period corrected itself and the "Right-wing" was once again the great partisan of total war, the Libertarians were unprepared to understand what was happening and tailed along in the wake of their supposed conservative "allies." The liberals had completely lost their old ideological markings and guidelines.[15]

The irony of all this was that the New Deal, the program of the fraudulent "liberals" of the Roosevelt administration, was, at heart, a profoundly conservative program. "Almost everything done during the Hundred Days," Robert Higgs reminds us, "relied on the emergency rationale and the wartime analogy. Many programs employed during World War I were resurrected."

Moreover, "the administrators of the programs came largely from the ranks of the veterans of the wartime mobilization. The rhetoric and the symbols harkened back to that glorious occasion of extraordinary national solidarity."[16] In effect, then, the First New Deal, as FDR's program during 1933 and 1934 is generally called, was merely a rebirth of the policies of Woodrow Wilson — policies which were virtually indistinguishable from the Hamiltonian conservatism of Theodore Roosevelt.

"The 'two-party system' in the United States now consisted of two conservative parties and no liberal party."

It is sometimes asserted that the so-called Second New Deal, the package of policies FDR pushed during the period from 1935 to 1938, shifted the federal government's emphasis away from legislation aimed at "cartelization and other suppressions of market competition" to benefit big business and big labor and toward legislation aimed at "helping the underdogs and building the welfare state." It is further asserted that such welfare-state legislation was opposed by the big-business interests that most benefited from conservative policymaking.

But this view of what happened in the mid to late 1930s is unduly simplistic. Much of the legislation supposedly designed during the Second New Deal to help "underdogs," like the National Labor Relations Act of 1935 and the Fair Labor Standards Act of 1938, was anticipated by one of the First New Deal's key creations, the National Recovery Administration (NRA), launched in June of 1933. As Higgs notes, the "minimum wages, maximum hours, and working conditions" stipulated by the Fair Labor Standards Act were "much like those required under the NRA's codes of fair competition." On the whole, laws like the Second New Deal's Fair Labor Standards Act should properly be regarded as the "progeny" or "spawn" of the earlier NRA.[17]

Moreover, the minimum wage, maximum hour, and working conditions provisions of the National Industrial Recovery Act of 1933 (NIRA), the enabling legislation that created the NRA, were neither intended to benefit the downtrodden, nor imposed on big businessmen against their will. As Ronald Radosh argued, back when he was a New Left Historian, the provisions in question were actually intended to benefit the big businessmen, who could use them to increase costs for their smaller competitors. In the minds of these big businessmen, their smaller competitors were competing "unfairly by cutting costs through wage reductions."[18]

Radosh approvingly quotes John T. Flynn's 1934 remark that, when it came to the NRA, "industry wanted not freedom from regulation, but the right to enjoy regulation." And in fact, as Arthur Ekirch points out, "it was industry itself that had largely prepared the regulations governing prices and production" enforced by the NRA.[19]

Taken as a whole, Radosh maintains, "the New Deal was conservative. Its special form of conservatism was the development of reforms that modernized corporate capitalism and brought corporate law to reflect the system's changed nature."[20] Or, as Rothbard puts it,

After a bit of leftish wavering in the middle of the late thirties, the Roosevelt Administration recemented its alliance with big business in the national defense and war contract economy that began in 1940. This was an economy and a polity that has been ruling America ever since, embodied in the permanent war economy, the full-fledged State monopoly capitalism and neo-mercantilism, the military-industrial complex of the present era. The essential features of American society have not changed since it was thoroughly militarized and politicized in World War II — except that the trends intensify, and even in everyday life men have been increasingly moulded into conforming organization men serving the State and its military-industrial complex.[21]

The libertarian historian Leonard Liggio takes a similar position, arguing that

the pre-war New Deal benefited big business through government privileges and concentration of economic power as much as had Hoover's policies, of which the New Deal was basically a continuation. However, the most significant result of the war economy was the increased concentration of economic power which big business derived from government contracts, and the establishment of a close relationship between big business and the military .…[22]

The New Deal was, as John T. Flynn insisted while it was happening, "a form of conservatism dressed up as liberalism."[23] The "liberals" who pushed it were actually conservatives. And the members of the "Old Right" who opposed it were actually liberals. In his brief history of "the 'Old Right' Jeffersonians," Sheldon Richman acknowledges this. "That the movement was placed on the right or called 'conservative' has to be regarded a quirk of political semantics," he writes.

In a superficial sense it qualified as right-wing because it seemed to be defending the status quo from the state-sponsored egalitarian change of the New Deal. But in a deeper sense, the New Deal actually was a defense of the corporativist status quo threatened by the Great Depression. Thus the Old Right was not truly right-wing, and since that is so, it should not be bothersome that some palpable left-wingers, such as Norman Thomas and Robert La Follette, Jr., seemed at home in the Old Right.[24]

Nor was the opposition to the New Deal primarily a Republican phenomenon. Rothbard notes that Democratic politicians like Representative Samuel Pettingill of Indiana, "Governor Albert Ritchie of Maryland, who was a candidate for the Democratic presidential nomination in 1932, and Senator James A. Reed from Missouri" were prominent in the movement against the New Deal.[25]

Ronald Radosh adds the names of Senators "Burton K. Wheeler (D. Mont.) … and Hugo Black (D. Ala.)."[26] Sheldon Richman suggests "Senators Carter Glass of Virginia, Thomas P. Gore of Oklahoma, and Harry Byrd of Virginia," as well as such "Cleveland Democrats" as "Bennett Champ Clark of Missouri, Patrick McCarran of Nevada, and David I. Walsh of Massachusetts."[27]

In fact, it was members of the Democratic party, not the Republican party, who mounted the first organized offensive against the New Deal, which they regarded as a betrayal of the liberal principles that had long served as their party's ideological foundation. The first national organization opposed to the New Deal, the American Liberty League, was founded in 1934 by a group of prominent Democrats.

There was Jouett Shouse, former Democratic congressman from Kansas, former Assistant Secretary of the Treasury in the Wilson administration, former chairman of the Democratic National Executive Committee, and former president of the predominantly Democratic Association Against the Prohibition Amendment. There was John J. Raskob, former Democratic National Committee chairman and executive of the Du Pont company and General Motors. There was John W. Davis, the 1924 Democratic presidential candidate and a J.P. Morgan & Company attorney. And there was Al Smith, former governor of New York and 1928 Democratic presidential candidate. Sheldon Richman reports that "Raskob, a good friend and fellow Catholic of Al Smith, did the bulk of the early organizing and thinking about the League."[28]

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There were serious opponents of the New Deal in the GOP, too, of course. But, despite Rothbard's preposterous claim that they were "the soul of the [Republican] party," and represented "majority sentiment in the party," the fact is far otherwise. Rothbard seems actually to have believed that the only reason the so-called "Old Right Republicans" perennially "managed to lose the presidential nomination" is that said nomination was "perpetually stolen from them by the Eastern Establishment–Big Banker–Rockefeller wing of the party," which relied on "media clout, as well as hardball banker threats to call in the delegates' loans." Rothbard seems actually to have believed that "Senator [Robert A.] Taft [of Ohio] was robbed of the Republican nomination in 1952" in precisely this way — "by a Rockefeller-Morgan Eastern banker cabal, using their control of respectable 'Republican' media."[29]

But if the "Eastern Establishment–Big Banker–Rockefeller wing of the party" was so powerful, why was it never able to put its own man, Nelson Rockefeller, in the White House — or even win him the GOP nomination? It's not as though he didn't try for it time and again. The fact is that, as Clyde Wilson puts it, the "Old Right" members of the Republican party simply "never had sufficient strength" within the party "to nominate a presidential candidate or prevent very many evils."[30]

Jeff Riggenbach is a journalist, author, editor, broadcaster, and educator. A member of the Organization of American Historians, he has written for such newspapers as The New York Times, USA Today, the Los Angeles Times, and the San Francisco Chronicle; such magazines as Reason, Inquiry, and Liberty; and such websites as LewRockwell.com, AntiWar.com, and RationalReview.com. Drawing on vocal skills he honed in classical and all-news radio in Los Angeles, San Francisco, and Houston, Riggenbach has also narrated the audiobook versions of numerous libertarian works, many of them available in Mises Media. Send him mail. See Jeff Riggenbach's article archives.

This article is excerpted from chapter five of Why American History Is Not What They Say: An Introduction to Revisionism.

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Notes

[1] John T. Flynn, The Decline of the American Republic (New York: Devin-Adair, 1955), p. 113.

[2] William Manchester, The Glory and the Dream: A Narrative History of America, 1932–1972 (Boston: Little, Brown, 1974), p. 5.

[3] John T. Flynn, The Roosevelt Myth (Garden City, NY: Garden City Publishing, 1949 [1948]), p. 38.

[4] Garet Garrett, The People's Pottage (Caldwell, ID: Caxton, 1953), p. 27.

[5] Ibid.

[6] Flynn, The Roosevelt Myth, p. 37.

[7] Ibid., pp. 37, 36.

[8] Quoted in John E. Moser, Right Turn: John T. Flynn and the Transformation of American Liberalism (New York: NYU Press, 2005), p. 3.

[9] Justin Raimondo, Reclaiming the American Right: The Lost Legacy of the Conservative Movement (Burlingame, CA: Center for Libertarian Studies, 1993), p. 52.

[10] Jude Blanchette, "Libertarianism, Conservatism, and All That." November 16, 2004.

[11] Rothbard, "The Transformation of the American Right."

[12] Moser, Right Turn, p. 3.

[13] Murray N. Rothbard, "Life in the Old Right." August 1994.

[14] Rothbard, Left and Right.

[15] Ibid.

[16] Robert Higgs, Crisis and Leviathan: Critical Episodes in the Growth of American Government (New York: Oxford University Press, 1987), p. 194.

[17] Ibid., p. 191.

[18] Ronald Radosh, "The Myth of the New Deal," in A New History of Leviathan: Essays on the Rise of the American Corporate State, ed. Ronald Radosh and Murray N. Rothbard (New York: Dutton, 1972), p. 191.

[19] Arthur Ekirch, The Decline of American Liberalism (New York: Longmans, 1955), p. 276.

[20] Radosh, "The Myth of the New Deal," p. 187.

[21] Rothbard, Left and Right.

[22] Leonard P. Liggio, Why the Futile Crusade? (New York: Center for Libertarian Studies, 1978), p. 14.

[23] Moser, Right Turn, p. 113.

[24] Sheldon Richman, "New Deal Nemesis: The 'Old Right' Jeffersonians." Independent Review, Fall 1996, p. 203.

[25] Murray N. Rothbard, "Life in the Old Right." See also Murray N. Rothbard, "The Life and Death of the Old Right," Rothbard-Rockwell Report September 1990.

[26] Radosh, "The Myth of the New Deal," p. 167.

[27] Richman, "New Deal Nemesis," p. 211.

[28] Sheldon Richman, "A Matter of Degree, Not Principle: The Founding of the American Liberty League." Journal of Libertarian Studies Vol. 6, No. 2 (Spring 1982), pp. 146–147.

[29] Rothbard, "Life in the Old Right."

[30] Clyde Wilson, "Save America! Vote Republican!" September 30, 2003.

Taxes

Thu, 19 Nov 2009 04:12:00 -0600

[From "That Which Is Seen, and That Which Is Not Seen," 1850]

Have you never chanced to hear it said, "There is no better investment than taxes. Only see what a number of families it maintains, and consider how it reacts upon industry: it is an inexhaustible stream, it is life itself."

In order to combat this doctrine, I must refer to my preceding refutation. Political economy knew well enough that its arguments were not so amusing that it could be said of them, repetitions please. It has, therefore, turned the proverb to its own use, well convinced that, in its mouth, repetitions teach.

The advantages which officials advocate are those which are seen. The benefit which accrues to the providers is still that which is seen. This blinds all eyes.

But the disadvantages which the taxpayers have to get rid of are those which are not seen. And the injury which results from it to the providers is still that which is not seen, although this ought to be self-evident.

When an official spends for his own profit an extra hundred sous, it implies that a taxpayer spends for his profit a hundred sous less. But the expense of the official is seen, because the act is performed, while that of the taxpayer is not seen, because, alas, he is prevented from performing it.

You compare the nation, perhaps to a parched tract of land, and the tax to a fertilizing rain. Be it so. But you ought also to ask yourself where are the sources of this rain, and whether it is not the tax itself which draws away the moisture from the ground and dries it up?

Again, you ought to ask yourself whether it is possible that the soil can receive as much of this precious water by rain as it loses by evaporation?

There is one thing very certain, that when James B. counts out a hundred sous for the tax gatherer, he receives nothing in return. Afterwards, when an official spends these hundred sous, and returns them to James B., it is for an equal value in corn or labor. The final result is a loss to James B. of five francs.

It is very true that often, perhaps very often, the official performs for James B. an equivalent service. In this case there is no loss on either side; there is merely an exchange. Therefore, my arguments do not at all apply to useful functionaries. All I say is — if you wish to create an office, prove its utility. Show that its value to James B., by the services which it performs for him, is equal to what it costs him. But, apart from this intrinsic utility, do not bring forward as an argument the benefit which it confers upon the official, his family, and his providers; do not assert that it encourages labor.

When James B. gives a hundred sous to a government officer for a really useful service, it is exactly the same as when he gives a hundred sous to a shoemaker for a pair of shoes.

But when James B. gives a hundred sous to a government officer, and receives nothing for them unless it be annoyances, he might as well give them to a thief. It is nonsense to say that the government officer will spend these hundred sons to the great profit of national labor; the thief would do the same; and so would James B., if he had not been stopped on the road by the extralegal parasite, nor by the lawful sponger.

Let us accustom ourselves, then, to avoid judging of things by what is seen only, but to judge of them by that which is not seen.

Last year I was on the Committee of Finance, for under the constituency the members of the opposition were not systematically excluded from all the commissions: in that the constituency acted wisely. We have heard M. Thiers say, "I have passed my life in opposing the legitimist party and the priest party. Since the common danger has brought us together, now that I associate with them and know them, and now that we speak face to face, I have found out that they are not the monsters I used to imagine them."

Yes, distrust is exaggerated, hatred is fostered among parties who never mix; and if the majority would allow the minority to be present at the commissions, it would perhaps be discovered that the ideas of the different sides are not so far removed from each other; and, above all, that their intentions are not so perverse as is supposed. However, last year I was on the Committee of Finance. Every time that one of our colleagues spoke of fixing at a moderate figure the maintenance of the President of the Republic, that of the ministers, and of the ambassadors, it was answered,

"For the good of the service, it is necessary to surround certain offices with splendor and dignity, as a means of attracting men of merit to them. A vast number of unfortunate persons apply to the President of the Republic, and it would be placing him in a very painful position to oblige him to be constantly refusing them. A certain style in the ministerial saloons is a part of the machinery of constitutional governments."

Although such arguments may be controverted, they certainly deserve a serious examination. They are based upon the public interest, whether rightly estimated or not; and as far as I am concerned, I have much more respect for them than many of our Catos have, who are actuated by a narrow spirit of parsimony or of jealousy.

But what revolts the economical part of my conscience, and makes me blush for the intellectual resources of my country, is when this absurd relic of feudalism is brought forward, which it constantly is, and it is favorably received too:

"Besides, the luxury of great government officers encourages the arts, industry, and labor. The head of the state and his ministers cannot give banquets and soirées without causing life to circulate through all the veins of the social body. To reduce their means would starve Parisian industry and consequently that of the whole nation."

I must beg you, gentlemen, to pay some little regard to arithmetic, at least; and not to say before the National Assembly in France, lest to its shame it should agree with you, that an addition gives a different sum, according to whether it is added up from the bottom to the top, or from the top to the bottom of the column.

$50 $44

"Dear me! how much trouble there is in proving that two and two make four; and if you succeed in proving it, it is said 'the thing is so plain it is quite tiresome,' and they vote as if you had proved nothing at all. "

For instance, I want to agree with a drainer to make a trench in my field for a hundred sous. Just as we have concluded our arrangement the tax gatherer comes, takes my hundred sous, and sends them to the Minister of the Interior; my bargain is at end, but the minister will have another dish added to his table. Upon what ground will you dare to affirm that this official expense helps the national industry? Do you not see, that in this there is only a reversing of satisfaction and labor? A minister has his table better covered, it is true; but it is just as true that an agriculturist has his field worse drained. A Parisian tavern keeper has gained a hundred sous, I grant you; but then you must grant me that a drainer has been prevented from gaining five francs. It all comes to this — that the official and the tavern keeper being satisfied, is that which is seen; the field undrained, and the drainer deprived of his job, is that which is not seen. Dear me! how much trouble there is in proving that two and two make four; and if you succeed in proving it, it is said "the thing is so plain it is quite tiresome," and they vote as if you had proved nothing at all.

Frédéric Bastiat was the great French proto-Austrolibertarian whose polemics and analytics run circles around every statist cliché. His primary desire as a writer was to reach people in the most practical way with the message of the moral and material urgency of freedom. See Frederic Bastiat's article archives.

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Economists Can Be Hilarious

Thu, 19 Nov 2009 03:12:00 -0600

We economists have a reputation for being dry and boring. That's why Ben Stein's scene in Ferris Bueller's Day Off works so well — and why this guy is such a novelty. Given our dismal reputation, I am happy to report that some economists' recent defenses of the efficient-markets hypothesis are laugh-out-loud funny. Outside Cirque du Soleil, you will not see such contortions as when these economists try to defend their theory from either refutation or triviality.

Krugman Launches the Attack

The efficient-markets hypothesis (EMH) comes in many forms of varying strength. Much like evolution, it is difficult to debate the issue because people can switch the definition in mid-argument. In evolution, not even a TV evangelist would deny that "organisms evolve over time," while on the other hand, many biologists would recognize that Richard Dawkins goes too far when he thinks that the theory of evolution by itself virtually disproves the existence of God.

This same problem exists when it comes to the EMH. In its weakest form, it simply means that new information tends to get incorporated quickly into stock prices, meaning that there can't be any obvious arbitrage opportunities lying around (since someone would have exploited them already). However, the most fanatical EMH advocates come close to saying that financial bubbles are literally impossible.

The EMH is associated with the Chicago School of economics. It has been understandably condemned after the financial crisis — especially since the statists have done a good job pinning the blame on "deregulated free markets." Paul Krugman summed up the anti-EMH view nicely in this pop article in the New York Times magazine.

In response to Krugman and other critics of neoclassical economics, the mainstream defenders have left their ivory castles to repel the invaders. Although Austrian readers are naturally sympathetic to anyone who picks a fight with Paul Krugman, we should be careful in choosing our allies. Elsewhere I have pointed out the serious flaws (from an Austrian perspective) in John Cochrane's response to Krugman. In the rest of this article, I'll highlight some of the sillier defenses offered by other neoclassical apologists of the EMH.

Robert Lucas

In a lengthy and very serious piece, Nobel laureate Robert Lucas defends mainstream economics (and the EMH in particular) from the scurrilous charges:

Macroeconomists in particular were caricatured as a lost generation educated in the use of valueless, even harmful, mathematical models, an education that made them incapable of conducting sensible economic policy. I think this caricature is nonsense and of no value in thinking about the larger questions: What can the public reasonably expect of specialists in these areas, and how well has it been served by them in the current crisis?

One thing we are not going to have, now or ever, is a set of models that forecasts sudden falls in the value of financial assets, like the declines that followed the failure of Lehman Brothers in September. This is nothing new. It has been known for more than 40 years and is one of the main implications of Eugene Fama's "efficient-markets hypothesis" (EMH), which states that the price of a financial asset reflects all relevant, generally available information. If an economist had a formula that could reliably forecast crises a week in advance, say, then that formula would become part of generally available information and prices would fall a week earlier.

Lucas's arguments here are typical in this debate. He offers a seductive mixture of assertion and non sequitur to make his case. First, the EMH is itself under dispute, so it hardly helps to cite the EMH and its implications. (This is akin to a Christian quoting the Bible to an atheist to prove the authority of Scripture.)

Now, in what sense has it "been known for more than 40 years" that it's impossible to predict sudden falls in asset values? Didn't Mark Thornton and others warn us that the housing bubble was too good to be true several years before the crash? What more could an Austrian cynic do to disprove the EMH, than to predict that "the market" was all wrong when it came to housing prices, risk premiums, and so forth? Investors who heeded the warnings of Thornton and others got out of the stock market, didn't buy houses to flip in 2005, and, otherwise, managed to outperform other people who were caught up in the euphoric boom. If that's not "beating the market," what is?

Notice, there is a flaw in Lucas's argument. He is saying that if an economist could reliably predict a crash in a week, then everyone would know it now and the crash would happen immediately. There are two problems here. First, an economist can accurately predict a crash, but it doesn't follow that everyone else will automatically follow suit. In the real world, some economists are bullish and some are bearish at the same time. So, which way is the market supposed to move?

The EMH fan would probably say, "Aha! That just proves how right the EMH is. We don't have any reason to suspect the market will go up or down, because the current price reflects all available theories and information." Yet, the market price will go up or down, showing that at least one forecaster was wrong. (The other one might have just been lucky, so we can't say for sure that his prediction was really correct in the grand scheme.)

The second major flaw in Lucas's neat little demonstration, is that he assumes the formula for an impending crash must be very time specific. But what if someone like Mark Thornton says, "This situation is unsustainable. Housing prices cannot continue to rise at these rates"? That is still an accurate prediction. It is definitely useful to investors, especially if the forecaster gives a broad period, within which the move will occur.

In this situation, where some forecasters make qualitative predictions, Lucas's quick argument falls apart. We are back in the conventional world, where different forecasters rely on different theories to make different recommendations. The investors who listen to the bad ones lose money, while the investors who heed the more accurate theories make money. You can "beat the market" if you invest based on more accurate predictions. Is this really that strange a concept?

Lucas goes on to argue that the EMH is not a mere tautology; empirical testing backs it up:

Mr Fama arrived at the EMH through some simple theoretical examples. This simplicity was criticised in The Economist's briefing, as though the EMH applied only to these hypothetical cases. But Mr Fama tested the predictions of the EMH on the behaviour of actual prices. These tests could have come out either way, but they came out very favourably. His empirical work was novel and carefully executed. It has been thoroughly challenged by a flood of criticism which has served mainly to confirm the accuracy of the hypothesis. Over the years exceptions and "anomalies" have been discovered (even tiny departures are interesting if you are managing enough money) but for the purposes of macroeconomic analysis and forecasting these departures are too small to matter. (emphasis added)

Wait a second. Lucas has now considerably weakened his defense. Earlier he said that beating the market was an impossibility; moreover, an impossibility that had been known for 40 years. Yet in his discussion of the falsifiable tests, he admits that there are departures from the theory. So, now we have Lucas himself admitting that the EMH fails in the microscopic particulars. I still maintain that it failed spectacularly in the recent housing bubble, as well as the earlier dot-com bubble (which many Austrians also called, before it popped). What would it take for Lucas to admit that the EMH isn't true?

Before moving on, let's quote one more gem from Lucas:

The Economist's briefing also cited as an example of macroeconomic failure the "reassuring" simulations that Frederic Mishkin, then a governor of the Federal Reserve, presented in the summer of 2007. The charge is that the Fed's FRB/US forecasting model failed to predict the events of September 2008. Yet the simulations were not presented as assurance that no crisis would occur, but as a forecast of what could be expected conditional on a crisis not occurring. Until the Lehman failure the recession was pretty typical of the modest downturns of the post-war period. There was a recession under way, led by the decline in housing construction. Mr Mishkin's forecast was a reasonable estimate of what would have followed if the housing decline had continued to be the only or the main factor involved in the economic downturn. After the Lehman bankruptcy, too, models very like the one Mr Mishkin had used, combined with new information, gave what turned out to be very accurate estimates of the private-spending reductions that ensued over the next two quarters. When Ben Bernanke, the chairman of the Fed, warned Hank Paulson, the then treasury secretary, of the economic danger facing America immediately after Lehman's failure, he knew what he was talking about.

Mr Mishkin recognised the potential for a financial crisis in 2007, of course. Mr Bernanke certainly did as well. But recommending pre-emptive monetary policies on the scale of the policies that were applied later on would have been like turning abruptly off the road because of the potential for someone suddenly to swerve head-on into your lane. The best and only realistic thing you can do in this context is to keep your eyes open and hope for the best. (emphasis added)

Let's put aside Lucas's funny defense of Mishkin and Bernanke, which says they're very good at predicting economic conditions, except for those pesky financial disasters. Beyond that side splitter, Lucas is simply making stuff up in the excerpt above. Ben Bernanke, most assuredly, did not convey that he had any inkling of what lay ahead for the US economy. Watch this incredible compilation of Bernanke's consistent errors from 2005 to 2007, where at every stage he either failed to see the coming storm, or predicted that the trouble would soon end.

Again, I ask Mr. Lucas, What would Bernanke have to say for him to be guilty of what his critics accuse? Would we have to have Bernanke on tape saying, "I am 100 percent certain that no financial crash will occur"? It seems Lucas has set the bar really low for our Fed chairman.

David K. Levine

In an open letter to Paul Krugman, David Levine offers physics as an analogy to exonerate his macro colleagues:

The predictive failure is not a problem of the field — it is a problem for those who are under the impression that we should be able to predict crises. Do you number yourself in this bunch? Do physicists get it wrong because their theory says that they cannot predict where a photon shot through a sufficiently narrow slit will land? Economic models are like models of photons going through slits. Just as those models predict only the statistical distribution of photons, so our models only predict the likelihood of downturns — they do not predict when any particular downturn will occur. Saying "most economists failed to predict the downturn" is exactly like saying most physicists failed to predict the impact of the twelfth photon passing through the slit.

Anyone familiar with the incredible precision — and experimental confirmation — of the forecasts of quantum physics should recognize the absurdity of Levine's analogy. It's a bit like comparing a Euclidean proof to a closing argument by Johnny Cochrane. A better analogy for Levine would be a bunch of particle physicists inviting you over to look at their super collider, and then calling you the next week to say they exposed you accidentally to a lethal dose of radiation.

Jeremy Siegel

In a recent WSJ op-ed, Jeremy Siegel defends the honor of the EMH. Like any fanatic, he manages to transform vice into virtue:

The EMH, originally put forth by Eugene Fama of the University of Chicago in the 1960s, states that the prices of securities reflect all known information that impacts their value. The hypothesis does not claim that the market price is always right. On the contrary, it implies that the prices in the market are mostly wrong, but at any given moment it is not at all easy to say whether they are too high or too low. The fact that the best and brightest on Wall Street made so many mistakes shows how hard it is to beat the market. (emphasis added)

Siegel is to be congratulated for his masterful stroke here. During the bubble, when investment bankers were earning multimillion-dollar bonuses, the defender of the EMH would have said, "It's crazy for an average investor to try to beat the market. Some of the brightest minds in the world have enormous computers and an army of mathematicians at their service, squeezing every ounce of mispricing from the market. Don't bother trying to compete with those experts. Put your money in an index fund instead."

Yet, after many Austrians (and others from different schools of thought) predicted that the market would crash, and that investors should get into cash, Siegel points to the monumentally incompetent investment bankers as proof of the wisdom of "the market."

William Easterly

I've saved my favorite for last. The Queen of England famously asked why none of the economists had seen the crisis coming. Here's what William Easterly said in reply:

[E]conomists did something even better than predict the crisis. We correctly predicted that we would not be able to predict it. The most important part of the much-maligned efficient-markets hypothesis (EMH) is that nobody can systematically beat the stock market. Which implies nobody can predict a market crash, because if you could, then you would obviously beat the market.

Now c'mon — that's just plain funny.[1]

$20 $16

Murphy's Guide to Mises

Conclusion

The efficient-markets hypothesis comes in various forms. There is, indeed, a large empirical literature, in which Fama and others conducted falsifiable tests. However, as I hope I've demonstrated with the quotations above, in practice the efficient-markets hypothesis is actually a tautology, or a way of viewing the world.

There's nothing wrong with using a priori mental frameworks to parse economic reality; indeed that is one of the defining characteristics of Misesian praxeology . However, as the quotes show, many of the EMH apologists think they're independently confirming the EMH, when, in fact, their goggles simply force all evidence into conformity with their presuppositions.

Robert Murphy, an adjunct scholar of the Mises Institute and a faculty member of the Mises University, runs the blog Free Advice and is the author of The Politically Incorrect Guide to Capitalism, the Study Guide to Man, Economy, and State with Power and Market, the Human Action Study Guide, and The Politically Incorrect Guide to the Great Depression and the New Deal. Send him mail. See Robert P. Murphy's article archives.

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Notes

[1] In fact, Tyler Cowen told me by email that he thought Easterly was joking. Given that the rest of it sounded perfectly serious — and was not apologetic about the state of mainstream macro — I thought he was being serious. (Unfortunately Easterly's column is no longer at the URL where I originally read it, so all I have is the quotation I have put in the text above.)