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The Lesson of Warren Harding Revisited

February 10, 2010 Leave a comment

Though I have written extensively about the Recession of 1920, it is worth revisiting it per Glenn Beck’s show last night.  Beck rightly pointed out that the policies of decreased taxes and decreased government spending implemented by both Harding and Coolidge paved the way for the dramatic economic growth of the roaring 20s. What Beck didn’t mention was that prior to this period of unprecedented economic expansion, President Warren Harding had inherited one of the worst recessions in American history.   This Recession of 1920-21 is another one of the dirty secrets glossed over in the Progressive history books.

By late 1919, America was facing inflation in prices as measured by CPI of 20%.  Between 1920 and 1921, unemployment doubled from 5.2 to 11.7%.  During this same period, from their peak in June of 1920, prices declined by 15.8% on a year-over-year basis, a 50% greater deflation in prices than during ANY 12-month period during the Great Depression.  So what was Harding’s proposal to deal with this mess? To understand how to get out of recession, Harding looked towards how we got into it in the first place.

For America was coming out of World War I.  Government was controlling huge swaths of the economy, as it had mobilized land, labor and capital towards war production and away from normal commerce as dictated by consumer demand.  In addition to the mass of resources that needed to be reallocated according to market forces, the economy had been further distorted due to the policies of the Federal Reserve which had inflated the money supply by 71% from 1913-1919 (while the physical volume of business had only increased by 9.6%), and whose policies had led to an increase in prices of a staggering 234% between 1914 and 1920.  Prices needed to readjust according to the reallocation of resources.  In addition, not surprisingly, due to the costs of war, the federal budget had grown to $18.5bn.

One will note the parallels to our economic situation today.  Just as war led resources to be allocated away from where an unfettered economy would have directed them, so too did the artificial boom fueled by the Federal Reserve and various government policies lead resources to be misallocated towards assets such as houses and stocks during our most recent boom and bust cycle.  While unsustainable businesses and concomitant rises in prices developed in the private sector, the government too drastically increased.

Harding understood the root cause of recession.  As he noted in his inaugural address:

The economic mechanism is intricate and its parts interdependent, and has suffered the shocks and jars incident to abnormal demands, credit inflations, and price upheavals. The normal balances have been impaired, the channels of distribution have been clogged, the relations of labor and management have been strained. We must seek the readjustment with care and courage…All the penalties will not be light, nor evenly distributed. There is no way of making them so. There is no instant step from disorder to order. We must face a condition of grim reality, charge off our losses and start afresh. It is the oldest lesson of civilization.

And so what was his big Keynesian stimulus plan to bring the economy back from the abyss?  He argued during his Republican nomination speech:

Gross expansion of currency and credit have depreciated the dollar just as expansion and inflation have discredited the coins of the world. We inflated in haste, we must deflate in deliberation. We debased the dollar in reckless finance, we must restore in honesty. Deflation on the one hand and restoration of the 100-cent dollar on the other ought to have begun on the day after the armistice, but plans were lacking or courage failed. The unpreparedness for peace was little less costly than unpreparedness for war. We can promise no one remedy which will cure an ill of such wide proportions, but we do pledge that earnest and consistent attack which the party platform covenants. We will attempt intelligent and courageous deflation, and strike at government borrowing which enlarges the evil, and we will attack high cost of government with every energy and facility which attend Republican capacity. We promise that relief which will attend the halting of waste and extravagance, and the renewal of the practice of public economy, not alone because it will relieve tax burdens, but because it will be an example to stimulate thrift and economy in private life.

And so, shockingly Harding practiced what he preached.  Regarding deflation, the Federal Reserve jacked up interest rates from 4.75% in January 1920 to 7% in June 1920, and held this rate through the aforementioned major drop in prices through May of 1921.  Harding slashed the federal budget from $18.5bn in 1919 to $6.4bn in 1920 all the way down to $5.1bn in 1921.  Meanwhile, the government actually ran surpluses during these years, allowing them to pay down the debt by $300mm from 1920-21.  The Chief Economist of Chase National Bank of the era, Benjamin Anderson summed Harding’s philosophy and his attack on the recession as follows:

The idea that a balanced budget with vast pump-priming government expenditure is a necessary means of getting out of a depression received no consideration at all. It was not regarded as the function of the government to provide money to make business activity. It was rather the business of the US Treasury to look after the solvency of the government, and the most important relief that the government felt that it could afford to business was to reduce as much as possible the amount of government expenditure, which had risen to great heights during the war; to reduce taxes—but not much; and to reduce public debt.

Nor did the government increase public employment with a view to taking up idle labor. There was a reduction in the army and navy in the course of these years, and there was a steady decline in the number of civilian employees of the federal government. This policy on the part of the government generated, of course, a great confidence in the credit of the government, and the strength of the gold dollar was taken for granted. The credit of the government and confidence in the currency are basic foundations for general business confidence. The relief to business through reduced taxes was extremely helpful.

According to Anderson, how did the recession end?

…we took our losses, we readjusted our financial structure, we endured our depression and in August 1921 we started up again. The rally in business production and employment that started in August 1921 was soundly based on a drastic cleaning up of credit weakness, a drastic reduction in the costs of production, and on the free play of private enterprise. It was not based on governmental policy designed to make business good.  (See Benjamin Anderson’s Economics and the Public Welfare or his gratisThe Return to Normal“)

Now we can debate fiscal and economic policy all day, but across the spectrum, it should be clear to all that a government that intervened and created the conditions for economic crisis will not be able to solve it.  If government’s can create prosperity when the private sector is imperiled, then why would Americans be against government central planning when all is rosy?  Do the rules of economics not apply during downturns?

If we can agree that recessions are the result of resources being improperly allocated, then we can also agree that the only way to return to economic health is to allow for their reallocation according to the market.  This involves allowing nonproductive business ventures to go belly-up, prices to naturally fall where they have unjustifiably risen and reduction in the size of government allowing resources to be released to entrepreneurs to reverse the ills of the artificial boom and spur growth.  All measures that impede the natural cleansing of an economy will only ensure pain and suffering like that witnessed over the last few decades in Japan.  Harding had things right and it would do our lawmakers good to follow his lesson: central planning and government control creates problems; innovative Americans are the only ones who can solve them.

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Democracy, Progressivism and Decivilization

February 1, 2010 1 comment

Over the last couple of days I came across two striking articles, one in the American Thinker and the other in the National Review on the destruction of our republic due to the concepts of democracy and progressivism.  The authors come to different conclusions.  On the one hand, Mark Hendrickson concludes in his AT piece that “The republic they gave us has been corrupted and possibly lost forever.”  Alternatively, Matthew Spaulding end his NRO piece: “The American people are poised to make the right decision. The strength and clarity of the Founders’ argument, if given contemporary expression and brought to a decision, might well establish a governing conservative consensus and undermine the very foundation of the unlimited administrative state. It would be a monumental step on the long path back to republican self-government..”  These are the two fates we face, and it is the job of conservatives, libertarians and regular Americans to determine which way we go.

On Mark Hendrickson’s piece, there is much fodder for any fan of The Law by Frederic Bastiat.  Hendrickson argues that there has grown a dichotomy in the notion of democracies since our founding:

The gulf between the founders and contemporary Americans stems from very different usages of the word “democracy.” Benign “democracy” connotes the empowerment of individuals and a corresponding freedom from tyranny and oppression.

Further according to Walt Whitman, government was to “make no more laws than those useful for preventing a man or body of men from infringing on the rights of other men.”

My interpretation of democracy is simply a system in which 50% + 1 of people can vote away the rights of the other 49% of individuals.  While this may be semantics, I would argue that Whitman believes in individual liberty, as opposed to democracy, secured by a severely limited and divided government.  Clearly, Hendrickson concurs, and argues that Whitman’s so-called democratic ideal is best served by a:

constitutional republic…premised on the primacy of individual rights. It sought to restrain governmental power in order to protect those rights…Democracy, by contrast, is a theory of power: What the majority wants, the majority gets. The founders — great students of history and human nature — understood that individual rights could be trampled by democratic majorities as readily as by individual tyrantsThe founders knew that if America’s constitutional republic ever degenerated into a formal democracy, then Americans’ rights and Whitman’s democratic ideal would be lost.

This is essential.  Tyranny by the masses is no less evil than tyranny by a king.  Hendrickson rightly notes as I have argued that the socialists encouraged democracy as a means to their end.  He argues:

In The Communist Manifesto, Marx wrote that the way to attain socialism was to “win the battle of democracy.” The cold-blooded Lenin taught, “A democracy is a state which recognizes the subjection of the minority to the majority.” The democracy that the founders loathed and that the communists coveted is a political system in which government ceases to protect individual rights and instead annihilates them.

True enough.  Further,

In the words of British archeologist and historian Sir Flinders Petrie, “When democracy has attained full power, the majority without capital necessarily eat up the capital of the minority and civilization steadily decays.”

The end result of the push towards democracy has been decivilization, where various interests plunder various other interests overtly.  In our current system, the wealthiest financial interests (with all the capital) have stealthily (and sometimes not so stealthily) expropriated the wealth of the middle class in their bailouts and Fed-induced inflation and cartelization, whilst the lower classes have made use of the legislative branch and the courts through the unions and community organizing groups to further bilk the middle class.  Those with the most capital and those with the least have feasted on those in the middle.  Generally, as I have argued time and time again, the masses have been practicing legal plunder for well over a century.  The end result of this system however is that you run out of productive people to rob at the point of the legitimized gun of government.

Ultimately, Hendrickson laments that

politicians and jurists have ignored Washington’s wise counsel and undermined liberty by ignoring or defying (thus, usurping) the clear language of the constitution in pursuit of their ambitions.  The rule of law lies in tatters. Our political degeneration has progressed to the point where Speaker Pelosi and Senate Majority Leader Reid write major legislation behind closed doors and order their partisan minions to approve their proposals before they even read them. In the name of democracy, the national government has become blatantly undemocratic.

The founders’ misgivings about democracy were spot-on. The republic they gave us has been corrupted and possibly lost forever.

Matthew Spaulding recounts the systematic destruction of our rights over time which has left us in this predicament.  There is much worthy of analysis here.  Spaulding notes the incestuous relationship between government and society:

Americans are wrapped in an intricate web of government policies and procedures. States, localities, and private institutions are submerged by national programs. The states, which increasingly administer policies emanating from Washington, act like supplicants seeking relief from the federal government. Growing streams of money flow from Washington to every congressional district and municipality, as well as to businesses, organizations, and individuals that are subject to escalating federal regulations.

It makes you question, given the fact that our lives are so heavily regulated; that business seems to serve at the leisure of government – how there is any innovation and advancement…how the human spirit remains free when all around it the walls close in upon it.

Spaulding argues that this system has as its origin,

the theories of Thomas Hobbes, who wanted to replace the old order with an all-powerful “Leviathan” that would impose a new order, and Jean-Jacques Rousseau, who, to achieve absolute equality, favored an absolute state that would rule over the people through a vaguely defined concept called the “general will.”

While true, I might add that given Plato’s view of an ideal society growing not through organic spontaneous order, but under the direction of an elite class, we can trace the roots of the tyranny of elite control back much further.  This split is also embodied amongst the founders in the difference between Jefferson and Hamilton.

Progressives were the ones to implement a system completely anathema to that created by the founders.  As Spaulding puts well:

American “progressives,” under the spell of German thinkers, decided that advances in science and history had opened the possibility of a new, more efficient form of democratic government, which they called the “administrative state.” Thus began the most revolutionary change of the last hundred years: the massive shift of power from institutions of constitutional government to a labyrinthine network of unelected, unaccountable experts who would rule in the name of the people.

The great challenge of democracy, as the Founders understood it, was to restrict and structure the government to secure the rights articulated in the Declaration of Independence — preventing tyranny while preserving liberty. The solution was to create a strong, energetic government of limited authority. Its powers were enumerated in a written constitution, separated into functions and responsibilities and further divided between national and state governments in a system of federalism. The result was a framework of limited government and a vast sphere of freedom, leaving ample room for republican self-government.

Progressives viewed the Constitution as a dusty 18th-century plan unsuited for the modern day. Its basic mechanisms were obsolete and inefficient; it was a reactionary document, designed to stifle change. They believed that just as science and reason had brought technological changes and new methods of study to the physical world, they would also bring great improvements to politics and society. For this to be possible, however, government could not be restricted to securing a few natural rights or exercising certain limited powers. Instead, government must become dynamic, constantly changing and growing to pursue the ceaseless objective of progress.

This belief in an administrative state in my view is really just a nice way of saying a centrally planned or authoritarian state.  As we have seen, the results of states based upon these principles have always failed because central planning fails.  This process leads to chaos, bloodshed and decivilization.  There is also a major fallacy that somehow because there are rigid principles that confine the spheres that government can influence, and the extent to which it can influence them, that this stifles “change.”  In fact, only a system that constrains government and thus maximizes individual liberty, built on bedrock principles can create a fertile ground for dynamic development, technological progress, widespread prosperity and peace.  Government’s effort to create these outcomes ensures they can never be reached.  The progressives have halted progress, and will push us backwards as a people through moral debauchery and economic servitude due to their subversion of the Constitution through the legislative, judicial and executive branches of our Leviathan central government, with the help of the media and academia in brainwashing the American people into either blind ignorance or delusional belief in the fatherly state.  The great advances of man have always been attributable to the individual, never the collective.

Spaulding notes that in the permanent administrative class created by the Progressives,

bureaucrats would address the particulars of accomplishing the broad objectives of reform, making decisions, most of them unseen and beyond public scrutiny, on the basis of scientific facts and statistical data rather than political opinions. The ruling class would reside in the recesses of a host of alphabet agencies such as the FTC (the Federal Trade Commission, created in 1914) and the SEC (the Securities and Exchange Commission, created in 1934). As “objective” and “neutral” experts, the theory went, these administrators would act above petty partisanship and faction.

The progressives emphasized not a separation of powers, which divided and checked the government, but rather a combination of powers, which would concentrate its authority and direct its actions. While seeming to advocate more democracy, the progressives of a century ago, like their descendants today, actually wanted the opposite: more centralized government control.

So it is that today, many policy decisions that were previously the constitutional responsibility of elected legislators are delegated to faceless bureaucrats whose “rules” have the full force and effect of laws passed by Congress. In writing legislation, Congress uses broad language that essentially hands legislative power over to agencies, along with the authority to execute rules and adjudicate violations.

The objective of progressive thinking, which remains a major force in modern-day liberalism, was to transform America from a decentralized, self-governing society into a centralized, progressive society focused on national ideals and the achievement of “social justice.” Sociological conditions would be changed through government regulation of society and the economy; socioeconomic problems would be solved by redistributing wealth and benefits.

On this so-called ruling class of bureaucrats, there are a few things worthy of note.  First is the principle that there is a certain elite that should decide things for everyone else; that there are some who by the grace of G-d are preordained to rule, while the masses must follow.  This is an immoral and non-progressive principle.  Aren’t the progressives supposed to be all about freeing the oppressed from tyranny?  Further, the argument that the end goal was more centralized government control in my view merely touches on a means to an end which is power for the elite class.  Regardless of what they feel is the proper role of government vis-a-vis the masses, deep down control is about power and stoking one’s ego; the elites lust for power over their perceived intellectual subordinates.  Ayn Rand sums this relationship correctly: “where there’s sacrifice, there’s someone collecting the sacrificial offerings. Where there’s service, there is someone being served. The man who speaks to you of sacrifice is speaking of slaves and masters, and intends to be the master.”  It is no surprise then that Barack Obama so stresses service and sacrifice, and even seeks to make it a permanent requirement for all citizens.


Additionally, on the belief that “Liberty no longer would be a condition based on human nature and the exercise of God-given natural rights, but a changing concept whose evolution was guided by government,”  this again reminds me of Yuri Bezmenov’s video on ideological subversion.  He describes a condition in which the people are so numbed to morality, and the sanctity of their natural rights that they support causes completely averse to their livelihood.  In addition, as Hans Herman-Hoppe argues in his Democracy: The God that Failed, in a system in which definitions of essential principles constantly sway at the whim of public opinion, it becomes highly difficult for positive human action to occur.  Uncertainty and constantly changing rules and regulations again undermines progress.  As Spaulding notes, FDR adviser Charles Merrian argued that “The question is now one of expediency rather than of principle.”  Expediency over principle is a surefire way to destroy the rights of the people.

Spaulding adeptly notes the changing view that the progenitors of the welfare state like FDR began to take on under policies such as those enumerated in the

Second Bill of Rights” that would “assure us equality in the pursuit of happiness.” Roosevelt held that the primary task of modern government is to alleviate citizens’ want by guaranteeing their economic security. The implications of this redefinition are incalculable, since the list of economic “rights” is unlimited. It requires more and more government programs and regulation of the economy — hence the welfare state — to achieve higher and higher levels of happiness and well-being.

In other words, FDR, his predecessors and followers believed in legalized plunder to ensure “equality in the pursuit of happiness.”  Instead of ensuring a playing field in which all could seek to attain what they subjectively defined as the good life, or the happy one, under the guise of equality, FDR and the others believed that they could socially engineer the American people in order to provide “economic security.”  This economic security is nothing more than a system of wealth transfers that create moral hazard and cause the American people to cease to strive to create wealth; rather, it leads people to use politics to grab it.  The modern welfare state was an edifice created to make the people parasitic, lazy sheeple dependent upon the facilitator of expropriation of government.  If the people understood this they would surely not stand for it.

The genius of the progressives is that once they began to radically expand government, it became almost impossible to stop politically, especially when these expansions often occurred because of crises perpetuated by government that purportedly only government could fix.  A politician doesn’t want to alienate one constituency or another by scrapping it of its government-granted privileges.  In addition, entitlement programs in particular as laws are difficult to repeal, continuously grow and become politically almost impossible to defeat because the public has gotten so used to them as rightful fixtures of the state.  How can you expect the American people to accept at face value that they should no longer expect Social Security or Medicaire, even if you can rationally explain that in the long run a state devoid of these programs will prove better for them.  Immediately, opponents will say that you want old people to be broke in retirement, or sick children to die.

Yet again, Spaulding is optimistic.  He notes:

There is something about a nation founded on principles, something unique in its politics that often gets shoved to the background but never disappears. Most of the time, American politics is about local issues and the small handful of policy questions that top the national agenda. But once in a while, it is instead about voters’ stepping back and taking a longer view as they evaluate the present in the light of our founding principles. That is why all the great turning-point elections in U.S. history ultimately came down to a debate about the meaning and trajectory of America.

In our era of big government and the administrative state, the conventional wisdom has been that serious political realignment — bringing politics and government back into harmony with the principles of the Declaration of Independence and the Constitution — is no longer possible. Yet we are seeing early indications that we may be entering a period of just such realignment. Perhaps the progressive transformation is incomplete, and the form of the modern state not yet settled — at least not by the American people.

This creates a historic opening for conservatives.

Growing opposition to runaway spending and debt, and to a looming government takeover of health care, doesn’t necessarily mean that voters want to scrap Social Security or close down the Department of Education. But it may mean that they are ready to reembrace clear, enforceable limits on the state. The opportunity and the challenge for those who seek to conserve America’s liberating principles is to turn the healthy public sentiment of the moment, which stands against a partisan agenda to revive an activist state, into a settled and enduring political opinion about the nature and purpose of constitutional government.

To do that, conservatives must make a compelling argument that shifts the narrative of American politics and defines a new direction for the country. We must present a clear choice: stay the course of progressive liberalism, which moves away from popular consent, the rule of law, and constitutional government, and toward a failed, undemocratic, and illiberal form of statism; or correct course in an effort to restore the conditions of liberty and renew the bedrock principles and constitutional wisdom that are the roots of America’s continuing greatness.

The American people are poised to make the right decision. The strength and clarity of the Founders’ argument, if given contemporary expression and brought to a decision, might well establish a governing conservative consensus and undermine the very foundation of the unlimited administrative state. It would be a monumental step on the long path back to republican self-government.

If nothing else, this is an inspiring and hope-filled message.  While there are signs that the masses are awakening, I do not believe that a slowdown in the growth of government will set us straight.  The man on the street does not realize how rotten our system is to the core — that we require fundamentally transforming America by scrapping the entire welfare state and returning power to the people.

One of the principle institutions symptomatic of our problems both in terms of the increase in government and the diminution of the individual is the Federal Reserve.  It facilitates infinite government growth in part through wars, robs people of their income and savings and allows government to stealthily tax.  But try to explain to the average person why they should care about the Fed and most Americans (likely with good reason) will probably either stop listening or be unable to comprehend the magnitude of its evilness.  Amongst the “elite,” they will default to either Keynesian arguments or ad hominem attacks.  They can’t imagine that the foundation of the economy is a mirage.  They can’t imagine that a group of unelected Fed governors has such a great effect on our prosperity, liberty and peace.  They can’t believe that much of our government is pure fraud.

In general, people do not want to believe that government efforts to help people almost always end up hurting them, and that institutions that have been for a long time may be inherently corrupt and/or cease to be (just look at the investment banking houses).  People pray at the altar of the status quo because it is easier to accept things as they are instead of critically questioning and radically reevaluating the world.  It took me until these last few years to do so myself.

It is our job if we are to revive the tattered law, refound the relative paradise of republicanism that Hendrickson mourns and realign the country according to the principles that Spaulding espouses to open the eyes of the public to our view.  Ironically, progress requires a radical return to “reactionary” principles.  Civilization hangs in the balance.

The Recession of 1920 – Causes, Responses and Insights

January 11, 2010 Leave a comment

In my study of political economy, one of the most overlooked yet fascinating historical episodes I have come across is the Recession of 1920-21. A handful of free-market economists have tackled this crisis, and I decided to throw in my lot with them and pursue the subject further myself.

Below is the abstract for my critique of the acutely sharp downturn (so you know what you’re getting into) and the embedded paper in Scribd format. Scribd however is a bit screwy in its formatting of the paper, failing to capture various diagrams for example, so I strongly suggest instead reading the Word doc downloadable HERE.

Enjoy!

Abstract: Many attribute our current recession to the evils of unbridled capitalism. In response, our leaders have embarked on the typical Keynesian recession prescriptions in order to stimulate the economy and lead the nation out of the economic doldrums. Unbeknownst to most Americans however, prior to the Great Depression, policymakers used different tools to help guide the country out of recessions. Herein we examine the causes, responses and insights gleaned from the Recession of 1920-21, the last downturn in which leaders relied on the age-old policy of laissez-faire, combined with massive reduction in government and encouragement of deflation.

Debunking the Myth of the Keynesian Government Boost

January 13, 2009 Leave a comment


As the recession has deepened, many of our economists (namely Krugman, Summers and the like) and elected officials have continuously argued that given the current dire circumstances, the only way to get the economy going is for the government to create demand by spending. The logic is that in a recession, the problem is that we have underconsumption; the magic pill for increasing consumption is government spending, generally in the form of public works projects. If resources like laborers are sitting on the sidelines (having been laid off), why not employ them in jobs building tangible public goods, enabling them to earn a living? Then, the government-spending multiplier will kick in, and the economy will grow again.

Robert Murphy in his refreshingly simple but thorough manner goes about picking apart the Keynesian argument in a recent Mises article. Murphy neatly sums up the Krugmanite point that “putting unemployed resources to work can only help, since prodding workers into producing even items of dubious value is better than letting them sit around watching Let’s Make a Deal.” He cites blogger Mark Thoma’s drawn-out explanation of the logic here. In debunking the Keynesian “idle resources” thesis, Murphy notes,

Even on its own terms, Thoma’s scenario fails because it is unrealistic. It is absurd to think that the government could come up with spending programs that would draw only on unemployed resources. Keynesian “macro” thinking ignores the complex capital structure of an economy. To build a bridge (as in Thoma’s example) requires a lot more than cranes and generic laborers. For example, gasoline will be burned in order to transport the newly employed workers to and from the work site. Nails, screws, steel, lumber, and other resources will be channeled into the new bridge, and at least some of these inputs will be diverted away from other private-sector uses, rather than simply leaving a state of idleness. Within the broad category of “labor” we find a similar situation, once we actually contemplate doing this project for real. If the city of Houston wants to build a new bridge, is it really the case that every last person even remotely involved with the project, will come from the ranks of the unemployed who are within commuting distance of the Houston bridge site? Surely the project will draw on engineers, construction foremen, and other skilled workers, who were still gainfully employed even amidst the recession, and who therefore will not be able to work on as many private-sector projects as they otherwise would have.

This issue is essential to understanding the way that the economy works. As I have mentioned before, no bureaucrat can ever plan for productive economic activity because he lacks the specialized knowledge, the ability to coordinate the activities and the profit motive of the business people who provide goods and services. He does not understand the capital structure of the economy. In the end, his central planning as always will fail.

As Murphy notes however, the Krugman’s of the world admit that during downturns, government spending is not about generating efficient economic activity, but rather acting on the assumption

that normal rules don’t apply. Ordinarily we’d welcome an increase in private saving; right now we’re living in a world subject to the “paradox of thrift,” in which private virtue is public vice. Normally we want to be careful that public funds are spent wisely; right now the crucial thing is that they be spent fast. (John Maynard Keynes once suggested burying bottles of cash in coal mines and letting the private sector dig them up — not as a real proposal, but as a way of emphasizing the priority of supporting demand.) [Emphasis added]

I just cannot understand this logic that when things get bad, somehow the laws of economic do not apply anymore. If the government can be so productive in using resources when times are bad, why not use resources when times are good as well? Can a country not prosper without a government boost? As we have seen, this is patently false given the success of all of the nations that have shed the yoke of socialism. Just look at Eastern Europe. In addition, if we as individuals were in financial trouble, would we spend money fast, or be careful in how we spent our funds, if we spent them at all? The same logic that applies to a man applies to the nation. During rough economic times, we need to ENCOURAGE SAVINGS, CUT SPENDING AND LOWER ALL BARRIERS TO POSITIVE ECONOMIC ACTIVITY (NAMELY TAXES). This will pave the way for real economic growth when the market corrects.

Murphy goes on to explain to the recalcitrant Keynesians that it is important to remember how we got into this situation, if we are to figure out the best way out of it. As Murphy puts it, following the low-interest-rate-fuelled boom, which created a mirage of wealth-generating activities ending in bust,

Once people in the private sector realized they had made horrible decisions during the boom years, they needed to stop business as usual and figure out how to make the best of a bad situation. Homeowners who had skimped on their savings for years (relying on booming house prices) had to slash spending to compensate for years of overconsumption, while entrepreneurs needed to decide which activities were likely to be profitable going forward, in light of the new information.

What had to happen is that workers and other resources that had been misallocated into housing construction and Wall Street investment banks, needed to be moved into other sectors. To repeat, this was and is a fantastically complex reshuffling, because even something as simple as producing a pencil requires the contributions of thousands of workers all over the world.

It’s not a simple matter of moving unemployed builders and hedge-fund managers into “booming” sectors X, Y, and Z, because (as we’ve seen above) these newly employed workers will require complementary tools and resources that were not laid off to the same extent. So the issue is, what is the best new outlet for all of these laid-off workers, such that — all things considered — the final mix of output goods best satisfies consumer desires? How can we be sure that channeling them into occupation X won’t actually do more harm than good?

This Austrian analysis of the problem shows that there was a major misallocation of resources that need to be channeled into productive sectors. However, the government is not the best authority to determine how to do this. According to Murphy,

In practice, the people in a market economy solve this fantastically complex problem by making profit-and-loss calculations, which in turn rely on market prices. For example, it is clear that a former Wall Street quant isn’t doing anybody a service by cranking out models that give mortgage-backed securities a gold star for safety. But what should this PhD do now? Should he go into academia and teach thermodynamics (which may very well have been the subject of his dissertation)? Or is his impressive education really a complete waste, and he would — at this point, given the economic realities — provide the most service by working the register at Wal-Mart?

Nobody knows the answer to this question. What happens during the recovery process is that the unemployed whiz kid initially looks for a job paying his former salary. As the months pass, he realizes that this is unrealistic, and he begins lowering his minimum price. Eventually, he finds an employer with compatible desires, and the two agree to a mutually beneficial arrangement.

Imagine that, letting the markets sort out the problems brought about by the government-created boom-and-bust cycle. Murphy notes that the Keynesians are wrong to assume that it is simply an issue of scared consumers causing the economy to contract. He argues:


On the contrary, the economy’s capital structure really was thrown into an unsustainable condition during the boom years, and it takes time for the mess to be sorted out. When the government runs up a deficit to fund “stimulus” projects, all that really means is that it is forcing taxpayers to pay for projects that they wouldn’t buy with their own money.

This is an aspect of the stimulus that really makes my blood boil. If it isn’t bad enough that the government is going to use precious resources inefficiently, and prolong the market-based recovery needed to start real economic growth again, the taxpayers funding these projects also don’t have really any say in them. Sure, we can vote out our elected officials. But as we have seen with all of the bailouts and the TARP money, even when sizable amounts of the populace have opposed government policies, we have not been able to stop them. It is immoral that the politicians can determine how best to use our hard-earned cash, and how much to burden our future generations with debt for these false stimuli. Let’s hope that we can not only vote out the bums during the midterm elections, but supplant them with people that have a sound understanding of economics and the Constitution.

Obama’s Job Creation In the Abstract

January 5, 2009 8 comments


The latest iteration of President-Elect Obama’s stimulus plan calls for 3 million jobs to be created or saved, of which approximately 20% will go towards government positions. For an example of how this has worked out at the state level, see Bill McGurn’s recent editorial on my home state of New Jersey. As usual, no economist or even rational, thinking human being could give sanction to a plan like this in good faith. If giving out jobs to people in government is a good solution to the unemployment problem in bad times, then shouldn’t the government “create” these jobs in good times too? But there is an even more fundamental question than this. Why should government create jobs for the sake of employment in the first place?

It is this question that underpins almost all of the government intervention in our lives over the last hundred years or so. The government is acting as if it is a divine central planner, with the ability to provide ample housing, healthcare (soon universal), credit, flatten market cycles and provide every type of moral-hazard-inducing insurance possible. It is in many respects one big Ponzi scheme where money is taken from the productive and paid out to a wide variety of special interests. The people in response have acted as complacently as the SEC in the case of Mr. Madoff.

If the government can carry out all of these functions in addition to fixing unemployment by simply creating government jobs, then why even have private industry? After all, the government has already monopolized its control of the money supply, and partially nationalized commercial and investment banks and automobile manufacturers. Why let the evil private businesses with their risk-taking, competition and potential failure ever enter into the equation? No, let’s sacrifice the free market to save the economy. Let’s have the government determine how labor should be optimally allocated, determine how much food, clothing and shelter each person should receive and which industries should grow and contract. After all, historically this has worked out quite well in the Soviet Union, Nazi Germany, fascist Italy and even relatively more liberal post-war Japan.

Sarcasm aside, this is something on which F.A. Hayek proved quite prophetic. Granted, I am no expert on Hayek, but having read The Road to Serfdom, it is clear that the problem of economic calculation is the reason the government cannot provide full or optimal employment, or any of its other ridiculous services without leading to utter economic ruin and ultimately revolution. No bureaucrat can figure out how to optimally produce and allocate goods and services, not only because he lacks the specialized knowledge, but because he is not subject to the price-setting mechanism of the market, nor is he held responsible by profit or loss. The government does not need to produce the best good or service at the lowest price to survive. In our particular mixed economy, the government’s economic calculus in attempting to socialize losses, pick winners and losers and “stimulate” the economy sows the seeds of its own destruction because it counters the very forces that led us to prosperity.

Legally, all one has to do is look at the Constitution to see that there is 0 justification for the government to be in the majority of the businesses it is now in. We are supposed to have a government with limited powers, created to protect individual liberty. It is for this reason that the government’s primary positive power granted by the Constitution is the power to defend (though incidentally we do have private defense companies that help with this function). The document is mainly however one of explicitly negative powers (to constrain government), in which without the clauses regarding “promoting the general welfare,” of the citizens, “the power to regulate commerce” amongst the states and the complicit loose-interpretationist judges, there is no way that the politicians could ever twist the language to fit their whims.

One of the little-spoken-of negative provisions in Article I, Section 10 of the Constitution should be given more attention by our elected officials. It reads “No State shall…make any Thing but gold and silver Coin a Tender in Payment of Debts. How much more attractive would those muni bonds be if we were actually paid in gold or silver, as the founders, who understood the problems associated with fiat money intended? Ultimately, the politicians in our current malaise could do right by their constituents by spending more time reading the Constitution, and less time listening to Keynesians. For it is paper money and government we have, and sound currency and liberty we lack.