Saturday, December 18, 2010

In Defense of Economists

It’s that time of the year, Christmastime. This is the time of year when people say that the spirit of Christmas should center on giving and not on receiving. Two of the top Classic Christmas cartoons are “A Charlie Brown Christmas” and “How the Grinch Stole Christmas.” They both have the same moral. Materialism is bad. They say that we should stop focusing on the stuff and look to the deeper, true meaning of Christmas.

It is at this point that economists get scorned. Many, too many, think that economics (and by default economists) is all about (and only about) stuff, and consuming stuff in particular. Economists have pointed out that many firms don’t break even until the first day after Thanksgiving. It is the day when many firms climb out of the red and into the black, hence “Black Friday.” The implication is that if we didn’t have Christmas and all the buying of (needless?) stuff that goes along with it, then many of our businesses would never see an annual profit. Furthermore, Keynesian economists have defined the size of the economy, GDP, in a way that emphasizes consumption. The formula for GDP is consumption spending + investment spending + government spending + spending on net exports. Of these factors, consumer spending is the largest and if that dips, then so does our measurement of GDP. Therefore, too many people conclude that we should spend, spend, spend, and economists are accused of being the chief cheerleaders for this. While there are some economists that in fact cheer on consumption for consumption’s sake, Austrian economists do not.

To an Austrian economist, economics is a value-free (or value-neutral) science. The Austrian economist should not care if the economy is rapidly expanding, slowly growing or even contracting. His job is to study the economy and try to figure out how it works. If someone asks the Austrian economist, “Will this policy enhance or diminish future growth,” the answer is not the economist injecting his own values into the debate. This is what Mises and Kirzner mean by economics being a “Wertfreiheit” or value-neutral science. As an individual, the economist can step out of his role as a value-neutral scientist and suggest goals such as economic growth or unemployment reduction. However as an economist, as a scientist, it really should not matter if a person or a society consumes at a high rate or saves at a high rate. So it is rather silly to assume that all economists are cheerleaders for materialism and ever expanding rates of consumption.

To an Austrian economist, economic growth does not mean that there has to be more stuff. Austrian economics has long taught that value is subjective and cannot be compared between individuals. Thus, an economy may be better off if it takes fewer resources and less time to make the same amount of stuff. This is certainly true for individuals. We call that free time, or leisure hours. If you got the same pay for working fewer hours, would you consider yourself better off? Now imagine that for the entire economy. We are clearly better off, but not consuming more stuff.

That being said, as an Austrian economist and as a thinking individual, I prefer higher rates of future economic growth. Although to an Austrian economist, expanding future economic growth does NOT mean expanding our rates of consumption today. In fact, it means exactly the opposite. For the economy to grow in the future, it will need capital. In order for capital to be freed up for more roundabout production methods, more resources must be invested instead of consumed. In other words, that means there must be an increase in savings, not consumption.

These new methods of production are more complex and more roundabout, but are used because they either cut down on the amount of resources needed, cut down on the amount of work hours needed, or both. This process frees us up to do more or allows us enjoy leisure time. It is a major benefit of growing economy. It allows us to take time off and enjoy the Christmas holiday. Without a market economy, our holiday might not be as cheery or bright.

So have yourself a very merry Christmas, and think about the benefits that a market economy provides. I know I will.

Thursday, December 16, 2010

Cwik Interview on Mises.Org

In yet another shamless promotion of myself, my interview by the Mises Institute has been posted to their web site.  I think they have done a nice job.

They started with some easy questions, but then there were some that I had to do some thinking about. 

The link is here

I hope you enjoy it.

Friday, December 3, 2010

The Terrible Red Line

I live in a town next to Raleigh: Garner, North Carolina.  For several decades the highway has looped around Raleigh and not unlike other growing cities, another loop has been planned for.  This outer loop has been planned for the past 20 years.  As a result, land has been set aside and businesses have planned for future traffic over these past decades.

It was much to everyone's surprise that at the beginning of September several other routes were added to the map for consideration.  These additional routes are known as the Red, Blue and Purple Lines.  Within a period of six weeks, the transit authorities met with communities and an overwhelming number of citizens stated that the original Orange Line was the one everybody preferred.  At the end of the initial six-week period, the Blue and Purple Lines were removed from the map.

The Red Line, the route that literally passes through my neighborhood, the route that will be about six or seven houses away from my house, was not removed as an alternate to the original Orange Route.


There is a mussel that lives in a river on the south side of the nearby lake.  It is on the endangered species list.  There is no sign of it on the streams and creeks on the north side of the lake.  (Nevermind that the mussel is found all along the eastern seaboard of the U.S.; where North Carolina is just the southern most edge of its habitat.)  As a result, thousands of homes could be destroyed so that the mussel isn't disturbed.

There are many things that an economist could use here for comment: the value of unowned mussels, the competing interests of dividing a town, the destruction of many, many homes and businesses, the diminution of private property rights and the ascension of "community/environmental" standards, the economics of urban planning, etc.

Instead of recapping any of those subjects, I want to describe last night's meeting. 

Last night there was a meeting with the Mayor, the engineering firm and my neighborhood.  (This was just one of a series of such meetings.)  What struck me was the absolute helplessness that my neighbors and I felt.  We were up against raw, naked power and there was nothing that we could do but talk, be upset and grow angry.

The people who have the ultimate authority in the decision were nowhere around.  We could only question the engineering firm that has no power or authority whatsoever.  The ultimate decision will be made be a small group of people, who I will never know.  The decision will be made without my knowledge.  The location will be unknown to me.  I am merely a pawn, and an inconvenient one at that.

This is the fate that happens whenever we place our faith and our fate into the hands of the government.  The bureaucrats have their rules and regulations and, to them, I am no longer a citizen or an individual.  I am merely something to be dealt with.

Such a dehumanizing system is not "bad" or "evil."  It is simply the nature of bureaucracy.  Mises wrote one of the best books on this subject, simply titled Bureaucracy.  It is found here.  I highly recommend chapter 2, "Bureaucratic Management."

The relationships between individuals is distinctly different between the market system and a system of bureaucracy.  In a market system of private property, I must treat the person with whom I wish to trade with respect, as an equal.  If I do not, there will be no trade. 

In a system of bureaucracy, there is no such relationship.  It is not a relationship between equals.  A bureaucratic relationship is one of power and powerlessness.  As we move toward National Health Care, as we move toward a increasing regulation over our finances, as we move toward the centralization of power in the hands of fewer and fewer people, we move away from a nation of equals.  We move toward a nation comprised of those who have power and those who do not.

I hope that we can recover our lost Liberty.  It was not too long ago that private property was at the top of the list of protected rights.  Now with the Kelo case, and other eminent domain cases giving power to governments, our Liberty is in increasing jeopardy.  

Finally, I am reminded of the Bugs Bunny cartoon, "No Parking Hare."  It is about building a freeway through Bugs Bunny's home.  After a series of fights, the road is moved because, as Bugs says, 'The sanctity of the American home must be preserved!'"

Tuesday, November 30, 2010

Adding to the Blog

As I learn more about the capabilities of this tool, I will add to this site.  You may have noticed a few additions.  On the left-side, I have added links to the lectures I presented at FEE this past summer.  Clicking on a link will take you to the page with the audio and PowerPoint presentations.  Below that are links to the popular posts and down further is a listing of subjects that the posts cover.

On the right-side, I have added two pages.  The first is the Economic Distress Index.  If one clicks on it, you can either look at the entire graph from 1967 or just the last 14 years.  There are also links to the data.  There is also a link to an explanation of the index.

The second is a graph of yield curve inversions.  Again, you can look at the entire graph from 1953 or just look at the last 10 years.  Yield curve inversions are one of the best predictors of an on-coming recession.

My goal is to continue to improve this blog and post articles that tend to examine economic problems from an Austrian perspective. 

You are, as always, very welcome to post comments as you wish.

Friday, November 19, 2010

The Real Thanksgiving Story

The first Thanksgiving is not a story of dumb whites who came to the New World to conquer and spread disease amongst the idyllic, nature-loving natives.

It is, instead, a story of the triumph of Capitalism over Socialism.

There have been several retellings of the first Thanksgiving, I have linked to Richard Ebeling's recounting last year.  Thomas DiLorenzo writes an excellent account in the third chapter of his book, How Capitalism Saved America.

This year I found a nice YouTube version that does a good job.  It explains why private property rights saved the pilgrims and triumphed over the collectivist ideal.

I find Thanksgiving to be one of the best holidays for exactly that reason.

Since the posting of this video, I have found Reason.TV's version.  Very funny.

Thursday, November 11, 2010

Austrian Economics Forum Fall 2010 #5—MegaPost

Socialism is a failure, but why does it keep coming back? That’s the perennial question. In the latest Austrian Economics readings Group forum at NC State University, we discussed the final Hayek readings on socialism. In particular, "Socialist Calculation II: The State of the Debate (1935)" and "Socialist Calculation III: The Competitive 'Solution.'" These are chapters 8 and 9 in Individualism and Economic Order.

To Hayek, the problem that faces an economic system is one of coordination. How do individuals coordinate their actions with one another without the guidance of a central planner? And if there is a central planner, then will that system be able to incorporate all of the information necessary to not waste resources while satisfying the most intense wants and desires of the consumers? Will the people who live under a central planner still be able to choose their own consumer goods, or will goods just be rationed to them? Will workers get to choose where they work or will they simply be assigned their station in life?

Hayek begins by pointing out that the Russian experiment is a failure. The people are more impoverished than under the Czarist régime. Turning to the theoretical side of the debate, Hayek focuses on the mathematical approach to solving the production and distribution questions. In order to calculate the correct solution, the knowledge of opportunity costs is needed. More than mere “technical” knowledge is needed to run an economy. Just because we know how to build something does not answer the question of should it be built at all.

Furthermore, there is a need for the knowledge of consumer goods. Consumers’ tastes and preferences are continuously changing and the central planner, to be successful, will need some sort of feedback mechanism to incorporate the changes. Bureaucracies move too slowly to accomplish this task. The bottom line of this analysis is that the market processes the information that the central planners cannot. In order to achieve some sort of solution, consumer sovereignty has to be sacrificed. Consumers no longer can choose what they prefer; must simply take whatever goods and services that are placed before them.

In the conclusion, Hayek seems to have left the door open to the possibility of a workable socialist solution. Hayek states,

“that today we are not yet intellectually equipped to improve the working of our economic system by ‘planning’ or to solve the problem of socialist production in any other way without very considerably impairing productivity. What is lacking is not ‘experience’ but intellectual mastery of a problem which so far we have learned only to formulate but not to answer. No one would want to exclude every possibility that a solution may yet be found. But in our present state of knowledge serious doubt must remain whether such a solution can be found.”

I argued that unlike Mises, Hayek is leaving the door open. Cordato said that he thought the Hayek was being gracious towards his academic colleagues. While this may very well be the case, this is not how the debate progressed in the 1940s. The chief rivals to the Austrian challenge, like Lange, thought that Hayek was retreating from Mises’ position that socialism is impossible, even on paper.

It was at this point in our discussion that I read from an article that was published in 1948. The article, “Socialist Economics” was published by the American Economic Association in a collection of papers entitled, A Survey of Contemporary Economics. The article was written by Abram Berson, at that time he was a professor at Columbia University and earned a Ph.D. from Harvard. So his interpretation of the debate is not some fringe interpretation, it was, basically, the mainstream of the time. Furthermore, Bergson cites, not just the two articles that we read for the readings group, but he also cites “The Use of Knowledge in Society,” and Schumpeter and Mises as well.

Here is what Bergson says,

“To come finally to Mises, there are two questions to ask: What does he say and what does he mean?

“On the first question, let Mises speak for himself:”

Then there is a lengthy quote from Mises on how without private property there can be no market and no prices and then no economic calculation. Mises concludes, “Exchange relations between production goods can only be established on the basis of private ownership of the means of production.

[back to Bergson]

“As to what Mises means, there appear to be two views. According to that which seems to have gained the wider currency, Mises’ contention is that without private ownership of, or…a free market for, the means of production, the rational evaluation of these goods for the purposes of calculating costs is ruled out conceptually. With it goes any rational economic calculation. To put the matter somewhat more sharply than is customary, let us imagine a Board of Supermen, with unlimited logical faculties, with a complete scale of values for the different consumers’ goods and present and future consumption, and detailed knowledge of production techniques. Even such a Board would be unable to evaluate rationally the means of production. In the absence of a free market for these goods, decisions on resource allocation in Mises’ view necessarily would be on a haphazard basis.

“Interpreted in this way, the argument is easily disposed of. Lange and Schumpeter, who favor this interpretation of Mises, point out correctly that the theory is refuted completely by the work of Pareto and Barone. …

“According to the other interpretation of Mises, which has the authority of Hayek, the contention is not that rational calculation if logically inconceivable under socialism but that there is no practicable way of realizing it. Imputation is theoretically possible; but, once private ownership of the means of production has been liquidated, it cannot be accomplished in practice.

“Hayek’s own thinking and that of Robbins, seems to be along these lines. Lange, who interprets the views of Hayek and Robbins as being in reality a retreat from the original position of Mises, considers that his own analysis refutes their argument…”

In the second reading, Hayek argues that it is the Socialists who have changed their arguments. And it is he who is chasing after them. Hayek states, “[I]t is surely unfair to say, as Lange does, that the critics, because they deal in a new way with the new schemes evolved to meet the original criticism, ‘have given up the essential point’ and ‘retreated to a second line of defense.’ Is this not rather a case of covering up their own retreat by creating confusion about the issue?”

So each side accuses the other of retreating and shifting the debate because of the other side’s inability to respond to the criticism. Personally, I am less interested in who shifted first. What does interest me is the shift in the debate. I agree with the first Bergson interpretation of Mises that under Mises’ analysis, socialism is unworkable, even on paper. I think that Mises’ argument that grounds itself on the fundamental foundation of socialism—communal property—is the stronger argument, because it attacks the very core of socialism. There is simply no getting around it. Either there is private property and a market that guides production or there is a central planner who controls it all.

I find it amazing that Bergson so easily dismisses the first interpretation of Mises. Bergson, Lange, Taylor, etc, all say that Mises was answer by Pareto and Barone. However, in the second reading, Hayek cites Pareto and shows that Pareto “expressly denied” the mathematical solution. Bergson obviously read this article and makes no attempt to address this point. Why?!?

I liked the second article more than several other people in the group. In section 5 of the article, we can clearly see the famous phrase “the circumstances of time and place” appear before the “Use of Knowledge” article. We also see an early sketch of the “man on the spot” concept a few paragraphs later.

One last point in the article that needs attention comes at the end of section 6. Hayek points out that under central planning there will be no improvements made. He states, “Any improvement, any adjustment, of the technique of production to changed conditions will be dependent on somebody’s capacity of convincing the SEC (Supreme Economic Council) that the commodity in question can be produced cheaper and that therefore the price ought to be lowered. Since the man with the new idea will have no possibility of establishing himself by undercutting, the new idea cannot be proved by experiment until he has convinced the SEC that his way of producing the thing is cheaper. Or, in other words, every calculation by an outsider who believes that he can do better will have to be examined and approved by the authority, which in this connection will have to take over all the functions of the entrepreneur.”

Innovation and creation will die under central planning. There is no incentive for the bureaucrat to take a risk. Bureaucrats, are by their nature, the opposite of risk-takers. They are the opposite of entrepreneurs.

For more on this debate, I found an article written by Murray Rothbard. It is found here:

Wednesday, November 10, 2010

Hayek vs. Keynes Rap Sequel Preview

Earlier this year a rap video between Hayek and Keynes called "Fear the Boom and Bust" was posted on YouTube.  It was wildly successful.  You can find it here. With all good things, a sequel is in the works.  Here is a sneak peak of a live duel between Hayek and Keynes.

Tuesday, November 9, 2010

Ron Paul on the Fed

There was an article yesterday on "Fed Will 'Self Destruct,' Policy 'Deeply Flawed': Ron Paul." 

Ron Paul is very much in tune with the Austrian perspective of the economy.  He argues that the Fed's actions are in the wrong direction and that when he becomes chairman of the committe that oversees Monetary Policy, his approach will be very different.  He is in favor of opening up the dollar to domestic competition.  Competitive currencies would allow individual citizens the ability to escape from the mismanaged, inflationary policies of the Fed set forth in the post-gold standard era.

To read this article, it is here:

Wednesday, November 3, 2010

Twisting the Yield Curve--Again!

The more things change, the more they stay the same.

Today the central bank of the US, the Fed, has announced that it will buy 600 billion dollars worth of “longer-term” Treasuries. By the end of second quarter 2011, they are planning on buying $75 billion in 30-year bonds per month. (I suppose that 20-yr bonds would also fall under the heading of “longer-term” as well.) They again hope that this additional liquidity, “stimulus” will jump start economic growth.

The Fed also announced that they will target Fed Funds rates between 0.00% and 0.25%. This is eerily similar to an announcement they made on March 18, 2009. In that announcement they said that they were going to target Fed Funds rates between 0.00% and 0.25% and inject $850 billion into the economy. $300 billion were to go into the purchasing of longer-term Treasuries. I have already described how such a scheme is pure folly here.  In that article, I also pointed out that it didn’t work when they tried it in the Kennedy Administration. Have we started to notice a pattern forming?

It is odd to find that we have tried this before and have not achieved the desired result. The key to impacting the so-called “real economy” by using expansionary monetary policy is by catching people unaware. If businesses see how much is injected and when, then they will adjust in anticipation of the injection. In other words, the only effect that the monetary stimulation will have is the immediate devaluation of the currency.

Tuesday, October 26, 2010

Cwik in Polish

I just received an e-mail from the good people at the Fundacja Instytut Ludwiga von Misesa (the Polish Mises Institute,  They tell me that my article "Austrian Business Cycle Theory: Corporate Finance Point of View” is now translated into Polish!  How cool is that!?  (There is a comments page with a discussion (so far) on time preference and interest rates.) 

The new title is “Austriacka teoria cyklu koniunkturalnego z punktu widzenia finansów przedsiębiorstwa,” and it can be found here:

The pdf can be found here: 

The original can be found here:

Investing Social Security Funds arises from the Dead (Just in time for Halloween?)

Today I was listening to the radio and a story came up stating that Andy Stern, former President of SEIU (the state employees union), suggested that in order to keep Social Security solvent, a portion should be "invested" into the stock market.  So I looked for the story and sure enough it is found on the Huffington Post here.  (Okay the article is from the end of June, but I heard it today, hence the Halloween reference.)

As mentioned in the article, this idea was once proposed in the Clinton Administration.  This idea was bad then and it is bad now.  Fortunately in May 1999, I wrote an article on the dangers of "investing" Social Security funds into the stock market.  That article, "A Socialist Stock Market?" is found here.

Here are a few paragraphs...

Murray Rothbard once asked Ludwig von Mises at what point on the spectrum of statism can a country be designated as "socialist." To his surprise, Mises said that there was, indeed, a clear-cut delineation: the stock market.

Mises said, "A stock market is crucial to the existence of capitalism and private property. For it means that there is a functioning market in the exchange of private titles to the means of production. There can be no genuine private ownership of capital without a stock market: there can be no true socialism if such a market is allowed to exist."

A corollary to this idea is that if the government is allowed to "invest" in the stock market, then the economy can no longer be called market-based. President Clinton has proposed a plan to use up to one-fourth of new Social Security funds to buy shares in our stock markets. The danger of this plan may not be as obvious as his previous health-care plan, but they are just as serious. The justification for this argument is that the Social Security system is unstable and will face financial strains in about 2014 and will be exhausted by 2032. There are a few options that the Washington elite have deemed as "solutions." Most of these ideas are politically unpalatable. The first is an increase in taxes. Over time, the needs of the Social Security fund will be so high that it will stifle the entire economy. There have been some projections showing FICA taxes as high as 82 percent in forty years.

The second option is to reduce the "benefits" being paid out by the fund. This action is also politically unacceptable. The third alternative is to somehow increase the rate of return on the current surpluses to cover the future. The thinking in the Clinton administration is simplistic at best. The plan assumes (wagers) that the stock market will continue to increase (forever) at rates high enough to meet the projected needs.

The fundamental problem that the Clinton administration ignores is that the Social Security program is based on what is called a Ponzi Game or a pyramid scheme. You have probably seen this if you've ever received a chain letter that states, "Send money to the first five people on the list, remove the first person's name, and place yours at the bottom." In other words, the first people in the program (those at the top of the pyramid) are currently getting money from the new people enrolling (those who are at the lower stages of the pyramid).

Social Security works in the same way. Those who are retired are receiving money from those who are currently working. As long as the base of the pyramid is expanding at a geometric rate, the system will continue to function. However, U.S. demographics show that after the baby-boom generation, the base of the pyramid shrinks. It is mathematically impossible to continue the Social Security program indefinitely.

The best solution is to phase out the Social Security program by taking two steps.

The rest of the article is found here:

Thursday, October 21, 2010

Austrian Economics Forum Fall 2010 #4

This past Friday, the Austrian Economics Forum met for the fourth time this semester at North Carolina State University.  This week we covered the 7th chapter in Hayek's book, Individualism and Economic Order.  This chapter is actually the introductory chapter of Hayek's edited collection Collectivist Economic Planning.  It is called "Socialist Calculation I: The Nature and History of the Problem."  The other reading was written by our own Dr. Roy Cordato called, "Knowledge Problems and the Problem of Social Cost."  It was published in the Journal of the History of Economic Thought, Fall 1992.

Since Roy was with us that afternoon, we began with his article.  It is a critique of Ronald Coase's famous 1960 article, "The Problem of Social Cost."  The Coase article is important because it has given rise to the Chicago (University) Law and Economics program.

Essentially what Coase's article says is that the right to property is an important institutional factor in the efficiency of the market.  Coase argues that we should first set property rights and see if it creates an efficient solution.  If it does not yield an efficient outcome and when there are no transaction costs, then through trading by affected parties, the system will naturally move to an efficient system.  However if there are positive transaction costs that prevent these negotiations from taking place, then what is now called "the Coasian Judge" will step in and redistribute the property rights so that the highest valued use of the resources is obtained.  For Coase's system, property rights are a variable to be manipulated.  Manipulated how?  Well, the judge will simply look at the various prices and make an economic calculation and reassign the rights.

Cordato objects to this entire process.  He uses Hayek's arguments on knowledge to say that there is a fundamental flaw in this logic.  The flaw is this: The judge assumes that the prices that he is using are equilibrium prices.  Only equilibrium prices contain the correct information about the relative scarcity of goods and services.  Disequilibrium prices do not contain such information.  We can take the argument a step farther and say that if the economy is in general equilibrium and prices are truly equilibrium prices, then why is there a dispute in the first place?

It has been 18 years since this article appeared.  I asked Cordato whether he has seen much literature that condemns the Coasian approach from the Austrian point of view.  He said other than some work by Walter Block, he has seen very little.  So, what does Coase have to say about these criticisms?  Well, nothing.  To our knowledge, he remains silent on these issues.

A great paper topic was generated by this discussion: the application of Public Choice theory to judges.  In North Carolina, we elect judges, why should we not apply standard Public Choice theory to the so-called Coasian judge?

During the discussion I brought up a point to clarify what we mean by "prices contain information."  I posited that there is a parcel of land that is currently owned by the state.  Scenario A is that we suppose that it is given to one person.  Scenario B supposes that the plot of land is divided into 100 units and given to 100 individuals.  Wouldn't it be better to follow scenario B because it contains the "information" of 100 individuals instead of just one person?  Wouldn't Hayek like the second scenario based on his information and knowledge arguments?

The answers to these are "No."  Karen Palasek rightly pointed out that Hayek does not mean quantity of information, that more people's subjective preferences are better.  Hayek's focus is on the coordination of information.  Hayek is focusing on how well and how quickly the subjective information is incorporated.  The subjective preferences themselves and who is participating is a not the focus of the problem.

Unfortunately, Hayek did not have a fully articulated ethical system on which to rest the rights to property.  Unlike Rothbard or Rand who had articulated ethical systems, Hayek cannot make the same sorts of policy recommendations.  All that he can ground his arguments on are the efficiency of coordination.

The second article discussed was Hayek's introduction to the Socialist Calculation Debate to the English speaking world.  Hayek's retelling of the intellectual drift from laissez-faire to Marx is excellent.  The laissez-faire economists of the 19th century had a fundamental flaw, the labor theory of value.  The logical extension of the labor theory of value leads straight to Marx.  So, the economists of the Marginalist Revolution and immediately thereafter, put aside the popularization of economic's insights on competition and wealth generation, and instead concentrated on reworking the foundation of economics.  This foundational work, while absolutely necessary, was technical work which excluded the average reader.  As a result, the popular field was left wide open to the Marxists, the German Historical School, etc.

According to Marxist thought communism is inevitable.  It would come about by the "material productive" forces of history.  As a result, there was little questioning of how a communistic society would operate.  In fact, as Hayek points out, to raise such a question was to question "scientific socialism" and called for stigmatization of the questioner.  Hayek further argues that there is no predestination in the evolution of institutions and that institutions can certainly regress.

The article then sets up the collection for which it was originally written.  We had little discussion on the later sections of the article, and decided that we would get to the center of the arguments next time.

For the next meeting, we are to cover chapters 8 & 9 in the book.  They are "The State of the Debate (1935)" and "The Competitive 'Solution'" (1940).

Thursday, October 14, 2010

30-second Spots

Many of my students have approached me and have said something like, "Why don't you run for political office since you know all this stuff?"  (Usually, it is not said too sarcastically.)

My comment back is that I do not think there is any way to explain a complex economic topic in a 30-second commercial.  Nevertheless, I am curious about what could be condensed into a 30-second ad.  I am not thinking about political ads.  What I am most curious about is an economic ad.

I would like to ask for recommendations of ideas, topics, etc. that should be done.  Have you seen anything like on YouTube (or any other site) that achieves this goal?  Please send me the links.  If I find some good ones, I'll post them.

Thursday, October 7, 2010

Austrian Economics Forum Fall 2010 #3

The last readings group covered Hayek's articles "The Meaning of Competition" and "'Free' Enterprise and Competitive Order."  In my opinion the first is brilliant and the second, well, maybe it should not have been published.  The group also seemed to be of the same opinion--the second article made too many concessions. 

The first article, "The Meaning of Competition," was originally a lecture presented in 1946 at Princeton University.  If I am recalling correctly, in the late 1940s, Hayek was on a lecture tour of the United States for two reasons.  First, he was very popular due to his book The Road to Serfdom.  Based on the popularity of this book, he was asked to go on a speaking tour to promote it.  Also at this time, his home life was becoming increasingly unhappy.  He was moving towards a divorce and, as a result, he was looking for a new position outside of the LSE.  (He eventually moved to the University of Chicago, 1950-1962.)

"The Meaning of Competition" takes the model of perfect competition to task.  In fact, he completely trashes it.  He starts by examining the perfectly competitive model's assumptions.  He, of course, focuses his attention on the assumption of perfect or "complete" knowledge.  Hayek argues that by making this assumption, the economist has assumed away the very problem that he is to answer.  It is only through the competitive order that relative scarcities can be discovered.  It is only through a market price system that this knowledge can be communicated.  It is the price system that economizes on what and how much needs to be communicated to create a efficient economic system.

Hayek argues,
"The function of competition is here precisely to teach us who will serve us well: which grocer or travel agency, which department store or hotel, which doctor or solicitor, we can expect to provide the most satisfactory solution for whatever particular personal problem we may have to face."

During the group discussion, I presented the following argument.  For the economist, the relevant cost of any decision is always the opportunity cost.  In a world of perfect knowledge, the marginal cost is the opportunity cost of the resource.  When we remove the idea of perfect knowledge, opportunity cost and marginal cost are no longer the same.  In fact, the entrepreneur should completely set aside the Average Variable Cost curve, the Average Fixed Cost curve and the Marginal Cost curve, because they are not the relevant basis of decision. 

For example, suppose an entrepreneur is faced with the choice of project A and project B.  Suppose further that the expenditures for both projects are $100.  The revenue for project A is $150 and the revenue for project B is $120.  Since the rate of profit for A is higher (50% versus 20%), the entrepreneur will obviously pick project A.  What is the cost of this decision?  It's not the $100.  The cost, the opportunity cost, of his decision is not being able to get the 20% return from project B.  Now suppose that the expenses for project A climbs from $100 to $110.  The rate of profit falls to about 36%.  Now even though the entrepreneur's expenses have risen, the cost of the project (the opportunity cost) has remained exactly the same!  The cost is still the 20% that the entrepreneur is unable to get when he chooses project A.

(I'm not sure if everyone agreed with this line of thought or not, because they were fairly quiet.  I suppose that it might be something that people need to sit with and think through.)

Hayek then drops the assumption of homogeneous goods and states the obvious--we live in a world with a spectrum of unalike products.  For Austrians, products are substitutes or complements not because they look a certain way or have a certain physical similarities.  For example, helicopters and closed-circuit cameras can be substitutes.  How so?  When a news station wants traffic updates, it can either send out a helicopter to monitor the traffic or it can use the cameras that now watch traffic flow.  They are substitutes, not because cameras and helicopters look like each other, but because they are able to yield the same result.  In a world where goods are not homogeneous, in a world where cameras and helicopters can be substitutes, the perfectly competitive model is completely inadequate.

Hayek concludes the article with:
"Competition is essentially a process of the formation of opinion: by spreading information, it creates that unity and coherence of the economic system which we presuppose when we think of it as one market.  It creates the views that people have about what is best and cheapest, and it is because of it that people know at least as much about possibilities and opportunities as they in fact do.  It is thus a process which involves a continuous change in the data and whose significance must therefore be completely missed by any theory which treats these data as constant."

The second article was the last one written for this book.  It was written for the 1947 Mont-Pélerin conference and it was presented as the beginning of a discussion group.  As a result, it raises many questions and answers very few.  The conference was the first for what is now called the Mont-Pélerin Society.  The purpose of the group was to gather the few remaining classical liberals, draw a line in the sand and determine the best course of action to promote liberty and oppose collectivism.

I confess that I like the beginning of the article.  Hayek illustrates how there is this tendency for popular governments to cater to special interest groups, take over certain "responsibilities" of the citizens, gather power and control the masses.  Hayek argues that we need to take a long-term perspective.  A free society cannot be built overnight; people must be educated about liberty, responsibility and the importance of private property.  Hayek then argues that we cannot simply chant mantras of private property and liberty.  There needs to be more. 

It is after this point that the wheels fall off.

Hayek argues that we need to think about the extension of the traditional concept of property to areas such as patents, copyright, trade-marks "and the like."  Hayek then argues that maybe we shouldn't have patents and trade-marks.  At first, I thought that this is similar to today's controversy in Austrian circles on the topic of Intellectual Property (IP) Rights.  However, Hayek continues further along this line of reasoning.  By questioning the "blind" extension of property rights to areas such as IP, we should further question the "blind" extension of property rights and "freedom of contract" to other areas such as corporations and limited liability organizations.  Hayek then argues that it is the proper role of government to step in and limit corporations.  In fact, it is "the duty of government to protect the individual against organized groups [corporations]."  Hayek further states, "There may be valid arguments for so designing corporation law as to impede the indefinite growth of individual corporations....Hayek then argues that we should also scrutinize labor unions and their collective power.

In the final section, Hayek opens the discussion to taxation.  While he warns against the negative incentives that taxes cause, he also says, "I ought to add that inheritance taxes could, of course, be made an instrument toward greater social mobility and greater dispersion of property and, consequently, may have to be regarded as important tools of a truly liberal policy which ought not to stand condemned by the abuse which has been made of it."

I find these passages astonishing.  Maybe Hayek is attempting to be thought provoking to generate a discussion for a panel, but I doubt it.  Hayek is making these claims in front of the first Mont-Pélerin meeting, a meeting to stem the tide of collectivism, a meeting attended by the leading classical liberal thinkers.  I wonder what Mises thought of this paper.  I think that passages such as these may have been the cause for some to split Hayek into Hayek I (the good one) and Hayek II (the not-so-good one).

There is no question that Hayek was a champion for liberty.  His writings have done much for the promotion of free markets.  However, Hayek was only human and could make mistakes.  He regretted not reviewing Keynes' General Theory.  I suspect that he wouldn't place this article on a pedestal either.

Tuesday, October 5, 2010

Our National Debt, the Age of the Universe and Our Future

There has been a lot of controversy centered on the size of the U.S. National Debt and rightly so, because it has never been a larger number. Today, the national debt is approximately $13,550,000,000,000 dollars. Such a large number needs context. I could say that if we stacked a trillion $1 bills on each other that this stack would stretch around the Earth 2.72 times. Unfortunately, that boggles the mind, especially if I say that our debt is 13.55 times that. Clearly, we need another way to understand the vastness of this number.

Using the Hubble Space Telescope, scientists have a clearer picture of the origin of the universe. Scientists estimate that the universe is approximately 13.7 billion years old. When we compare the age of the universe with the size of our national debt, our national debt is a 1,000 times larger. In other words, if we had spent about $1,000 a year, every year, since the beginning of time, we would have a number about the size of our national debt. Or, suppose you had spent $2.71 a day, every day, since the universe began. You would have spent as much as our current national debt.

How did the debt get so large if there was a surplus in the Clinton years? It is true that the federal government collected more tax revenue than it spent in the late ’90s and national debt shrank, however the debt did not fall to zero. (The last time the national debt was zero was in 1836, under President Andrew Jackson.) We have since had budget deficits—with each borrowed dollar adding to the debt. With the TARP funds, bail-outs, stimulus injections, and other spending programs, there is little wonder that the resulting deficits are so large.

There are three ways that we can get ourselves out of this hole. The first is to monetize the debt. In essence, this means that we can convert the debt into dollars and pay everyone we owe. In fact, this can be done tomorrow. How? Quite simply, allow the central bank of the U.S., the Federal Reserve, to buy up all the existing debt. Let it buy up all the T-Bills, Treasury Notes and Bonds—all of it. Dollars would replace the outstanding debt. Where would the Federal Reserve get all this money? The answer is simply that the Fed would get it out of a big black hole of nothingness. The dollar isn’t backed by anything—not gold, not silver, nothing but the “full faith and credit” of the United States (whatever that is). That means the Federal Reserve can just create money at will. It can create an infinite supply. It doesn’t even need to print new bills. The Fed could simply type numbers into a computer account and it’s done.

What is the problem with monetizing the debt? When $13.55 trillion new dollars hit the economy, the banking system multiplies the new dollars by a factor of a little more than 9. That means the money supply will swell by more than $120 trillion. (The current size of the money supply, as measured by M2, is $8.7 trillion.) If we took this route, we would be well on our way to hyperinflation. There have been several historical instances of hyperinflation, which wipes out life savings and destroys resources that form capital. The most famous instance was the German hyperinflation of 1923. Prices were rising so fast that people had to be paid multiple times a day. When workers were paid mid-morning, the men would run to the gates to give the money to their wives so that they could buy something before the money became worthless. Inflation was so bad that the price of a cup of coffee tripled by the time one finished drinking it. And this was happening for all prices! Germany could not continue with this situation. It had to abandon the Paper Mark and eventually switched to the Reichsmark.

The second way out of this deficit is to increase the amount of tax revenue that flows into the Federal Treasury. This approach has failed miserably for two reasons. The first is that the politicians always seem to find ways to spend all the additional money brought in and leave us no better off. The second reason is that increasing taxes is like having the economy drop an anchor. Taxation slows the economy, stunts business activity and penalizes the behavior of entrepreneurs. As a result, the higher tax rates take a larger percentage from a smaller pie, leaving a small and short-term increase in the revenues flowing into the Treasury followed by a drop-off in tax revenue a year or two down the line leaving a large debt and a stagnant economy.

This leaves the third option: a cut in spending. By a cut in spending, I don’t mean what politicians have been calling a cut, “a reduction in the rate of spending.” I mean, “Stop the car, put it in reverse, and back it up.” We need to cut spending to levels that are below our revenues. This will constitute many broken promises and real pain. The federal government has made very large promises. In fact, the size of the Unfunded Liabilities for the federal government exceeds $110.7 trillion. In other words, just to fulfill the promises already made, another $110.7 trillion are needed in the bank collecting interest right now. (U.S. GDP is only $14.5 trillion.)

So where can we cut our spending? If we look at the amount that we have spent on national defense this year (and I mean all of it), add up the total money spent on all the branches of the military—including equipment, personnel, operations, the wars in Iraq and Afghanistan—we have a year-to-date total of a little more than $527 billion. That is a lot of money and there are certainly areas that could be cut. Yet, if we look at how much we have spent on Social Security over the same period of time, we see the total to be above $534 billion. Furthermore, if we look at Medicare and Medicaid, that number is nearly $604 billion. Unlike defense spending, Social Security, Medicare and Medicaid are currently considered “Non-discretionary” budget items, so radical structural changes are needed to fix this problem, as well as the courage to solve this deficit issue.

I recently heard a good analogy. Imagine that you received some terrible news: your child has an awful, horrible disease. This disease will cause a lot of pain and suffering and could possibly result in the child’s death. Any parent’s natural reaction would be to fall to one’s knees and pray to God, “Give it to me. I will take the pain. I will suffer the burden, but please spare my child.”

Our National Debt is that disease. Why are we so willing to pass on the pain and suffering to the next generation, to our sons and daughters? Why are we so unwilling to bear the burden of our past excesses? The country is already broke. At this point, we are simply piling on. We have to address this issue now; it is getting worse. We have to look in the mirror and ask ourselves, “What kind of a person am I? What am I willing to do? What am I willing to sacrifice?” It has come to the point where the only way to fix this problem is through a sacrifice in today’s comforts. Will we try to spare our children from this disaster or will we impose this debt on them for our own comfort today? What are we willing to sacrifice for our children? What are you willing to sacrifice?

Thursday, September 30, 2010

Mises' "Latest" Book

Bettina Bien Greaves is a living treasure.  She has worked for decades at the Foundation for Economic Education (FEE) and attended just about every lecture that Mises gave at FEE and at NYU.  She would take shorthand notes of all that he said.  Today she is converting those notes back into text.  She has recently come out with a synthesis of several Mises lectures.  It is called: Ludwig von Mises on Money and Inflation: A Synthesis of Several Lectures.  You can find the book here and for sale here.

I am so excited about this that I am posting a short chapter below.  It is called, "The Constitutional Side of Inflation."  Enjoy...

When we talk about these things we must not forget that they do not have only an economic side; they also have a constitutional side. You may say that government is the most important institution. The government is very important in many regards. Perhaps one overrates the importance of the government, but one does not overrate the importance of good government.

Modern constitutions, the political systems of all nations that are not ruled by barbarian despots, are based upon the fact that the government depends financially upon the people, indirectly upon the men that the voters have elected for the constitutional assembly. And this system means that the government has no power to spend anything that has not been given it by the people, through the constitutional procedures which make it possible for the government to collect taxes. This is the fundamental political institution. And it is a fundamental political problem if the government can inflate. If the government has the power to print its own money, then this constitutional procedure becomes absolutely useless.

Our whole political system is based upon the fact that the voters are sovereign, that the voters are electing Congress and other such institutions in the various states that rule the country. We call the United States a democracy because the rule of the country is in the hands of the voters. The voters determine everything. And this distinguishes the system, not only from the despotic systems of other countries, but also from the conditions as they prevailed in earlier days, in countries that already had parliamentary institutions and parliamentary government, at that time. However, there has developed, especially in the last decade, a problem of  constitutional law, that is whether the government must get the approval of the people through Congress when it wants to spend, or whether the government, because it is established and has at its disposal a number of armed men, is free to spend as it wishes, simply by increasing the quantity of money. People must realize that the question is “Who should be supreme? The parliaments elected by the voters, who can restrict government spending by refusing to grant the power to tax? Or institutions that want to override the interests of the people by increasing the quantity of money to expand government spending and so do away with the prerogative and independence of the individual voter?”

If we do not succeed in restoring the monetary system that makes the individual independent to some extent of the interference of government institutions, government banks, government monetary authorities, government price ceilings, and so on, we will lose all the achievements of the free market and of the free initiative of the individuals, whatever methods of constitutional law we follow. If the government can inflate whenever it wants to spend, it can take away from the people without their agreement everything, their purchasing power, their savings, and so on. From this point of view there disappears even the fundamental principle which everybody sees as the difference between a Communist government and a government based on the idea of individual freedom, the preservation of free markets and the ability of the people to control the government.

If you look at the constitutional history of England in the 17th century, you learn that the Stuarts had problems with the British Parliament. The conflict consisted precisely in the fact that the Parliament was not prepared to give to the King of England the money he needed for purposes of which the Parliament didn’t approve. The people disapproved of a great part of the government expenditures and Parliament was not anxious to impose taxes. The Stuart kings wanted to spend more than Parliament was prepared to give them. If the King at that time, in 1630 let us say, had asked one of those who are considered experts today in government finance, “What can I do? I don’t have the money!” the “expert” would have said, “Unfortunately, your family, the Stuarts, came too early to their position as rulers. Two hundred years, three hundred years later, it would be much easier for such a government as you want to rule the country. A printing press would have been sufficient to make it possible for your government to spend all the money it needed to have an army and the other things needed to protect the King against the people.” But the poor Stuarts were living in an age in which the technique of producing paper money had not been developed to a considerable extent. Charles I couldn’t inflate, you know. There was no solution for him; he could not engage in deficit spending. This was the undoing of the Stuart family and the Stuart regime. And in the conflict which originated out of this, one member of the Stuart family lost his life in a very disagreeable way—Charles I lost his head. (fn1) And the Stuart family as such lost the crown of England. What the poor Stuarts didn’t have was the facility of the printing press as it exists today.

The monetary problem we have to struggle with today is the problem of paying for government expenditures which are not accepted or, let us say, not approved, by the people. The conduct of government affairs, public affairs, is not different from the conduct of the financial and monetary conduct of private affairs. If the government wants to spend, it has to collect the money; it must tax the people. If it doesn’t tax, but increases the quantity of money in order to spend more, then it brings about an inflation. The difference between the conditions in 18th century England and the conditions in other countries, let us say for instance in Russia, consisted of the fact that the Russian government was free to take away from its subjects what it wanted while the British government was not. The British government had to comply with the provisions of a set of laws that limited the amount of money the government had the right to collect from its citizens. And it had to spend this money precisely according to the wishes of the people.

All our constitutional laws and our system of government are based upon the fact the government is not permitted to do anything that violates this system of laws representing the moral and actual ideas and philosophies of our people. But if the government is in a position to increase the quantity of money, all these provisions become absolutely meaningless and useless. If it is said that the government has to spend, is entitled to spend, a definite amount of money for keeping people in prisons, this means something. There is a definite reason for its spending. All our legal provisions are influenced to some extent by the fact that this is the amount of money which is given to the government for this purpose. But if the government is in a position to increase the quantity of money to use for its own purposes, then all these things become merely a theoretical expression of something which has practically no meaning at all. We must not forget that all the protection given to individuals through constitutions and laws disappears if the government is in a position to  destroy the meaning of every inter-human relation by undermining the system of indirect exchange and money which is called the market. And this is much more importantthan any other problems we talk about today. It is the interference of the government with violence that has spoiled money, that has destroyed money in the past, and that is perhaps destroying it again today.

Some years ago you could frequently read quotations saying that Lenin said that the best method to destroy the free enterprise system would be to destroy the monetary system. Now a professor in Germany has demonstrated that Lenin never said this. But if Lenin had said this, it would have been the only correct thing that he ever said.

The monetary problem which we have in this country, which you have in every country today, is the same—to keep the budget in equilibrium, to balance income and outgo, revenue and expenditure without printing an additional quantity of banknotes, without increasing the quantity of the monetary units. This is not only a problem of economics. It is also the fundamental problem of constitutional government, you know.  Constitutional government is based upon the fact that the government can only spend what it has collected in taxes. And it can only tax the people if the people accept it by the vote of their representatives in parliament. And in this way the voters are the sovereigns. The problem of monetary management in a modern country cannot, therefore, be separated from the constitutional problem, from the doctrine that says that all problems of government, all governmental matters are decided ultimately by the vote of the people. Whether you call this democracy or popular government doesn’t make any difference. But there is no monetary or budgetary problem that can be separated from the constitutional problem of who rules the country, who determines ultimately what has to be done in the country.

Fn 1 Charles I was beheaded on January 30, 1649.

Tuesday, September 28, 2010

Recessions and Recoveries

Two weeks ago the National Bureau for Economic Research (NBER) announced that we are out of the recession and have been since June 2009.  So, how does this recession compare to previous recessions?

The earliest date that the NBER uses is 1854.  The average length of a U.S. recession between 1854 and 2010 is 17 months.  If one uses post-WWII data, the average length of a business contraction is 10 months.

If we compare the current recession, which started in December 2007, with that of previous recessions, we see that the duration is longer than either average.  Now that the NBER says we hit bottom in June 2009, we have had 19 official months of recession.

We are now entering the 34th month since the beginning of the recession and many are questioning whether we have truly hit bottom.  While I believe that we have stopped falling, I think that the so-called recovery has started yet.  In fact, there are signs that the recovery is still far off.  For example, private investors are unwilling to make a move until they have a clearer understanding of the government's next regulatory moves.  This situation precisely mirrors investors' sentiments in the 1930s.

The Bush administration reigned over the first 14 months of this recession.  By historical averages, we should have been recovering by inauguration.  What does this tell us?  It says very clearly that the Bush administration made the wrong move by bailing out banks and propping up failing businesses.

It  is now more than 20 months since the Bush administration has left office, and the current government has also done much to hamper any prospect of recovery.  The Obama administration has not unleashed the economy (and reverse the Bush agenda), but instead, it has further shackled it.  By supporting TARP and the Bush bank bail outs and adding to the situation the GM bail out, the ineffective stimulus package, a new health care burden and more financial regulation, the Obama administration has set us on a path towards economic stagnation.  The looming fear is whether the stagnation will be coupled with Jimmy Carter style inflation.

It is time to recognize that taxing, spending and regulating are not the instruments for economic recovery. Money creation, artificially lower interest rates and government accumulation of debt are sending us down the wrong road.

Governments at all levels are stalling the recovery and it seems that no one trusts the market enough to let it do its job.

Perhaps we should listen to our 30th President Calvin Coolidge:

“The people cannot look to legislation generally for success. Industry, thrift, character, are not conferred by act or resolve. Government cannot relieve from toil. It can provide no substitute for the rewards of service. It can, of course, care for the defective and recognize distinguished merit. The normal must care for themselves. Self-government means self-support.”

Tuesday, September 21, 2010

Austrian Economics Forum Fall 2010 #2

It seems as though I am running a little behind in my updates for our discussion group.  At the last meeting we discussed Chapters 2 & 4 of Hayek's Individualism and Economic Order

The first article we covered was "Economics and Knowledge."  The article comes from a Presidential address before the London Economic Club in November 1936.  It was reprinted in Economica in 1937.  This article is significant because it is the first attempt he makes in describing the role and importance that prices play in our economy.  He addresses the question, "With the absence of a central planner, how is it that people cooperate?"  How do we coordinate our actions?  And more fundamentally, how do economists view and model this process?

Hayek focuses on what the economist assumes, and particularly, what the economist assumes the people in the economy know.  There is knowledge, data, which needs to be conveyed from one corner of the economy to the other.  Can knowledge be assumed to be "perfect" and known by all?  Hayek answers that knowledge is limited and divided.  This article sets him on the path of developing his concept of "spontaneous ordering."

There is one aside that I'd like to point out with regard to this article.  Hayek is questioning whether markets tend to equilibrate.  At the end of section 9, I think that we can see that Hayek agrees with market equilibration.  However during these years 1936-37, Ludwig Lachmann was Hayek's student at LSE.  I think that it is clear that he was influenced by this thinking and led him down the path of rejecting market equilibration.

The second article is one of Hayek's most famous articles, "The Use of Knowledge in Society."  It was published in the American Economic Review in 1945.  Here Hayek expands on his earlier question by asking,

"What is the problem we wish to solve when we try to construct a rational economic order? On certain familiar assumptions the answer is simple enough. If we possess all the relevant information, if we can start out from a given system of preferences, and if we command complete knowledge of available means, the problem which remains is purely one of logic."

Then he forcefully argues,

"This, however, is emphatically not the economic problem which society faces.  ...  The reason for this is that the 'data' from which the economic calculus starts are never for the whole society 'given' to a single mind which could work out the implications and can never be so given."

In this article, Hayek argues that knowledge is dispersed and must be that way.  He refers to the knowledge of "time and place."  There is no manner to communicate to a central planner all the knowledge that is necessary to have an efficient economy. 

There is no substitute for simply reading this very short article.  It is found here.  Nevertheless,...

The first thing that Hayek discusses is the different types of knowledge.  He says that there are scientific knowledge and the knowledge of the particular circumstances of time and place.  He argues that not all knowledge is something that can be communicated to a central planning board.  While Hayek is absolutely correct and he is not saying that he has a complete taxonomy of knowledge categories, I think that the category of tacit knowledge should also have been included in his discussion.  Tacit knowledge is the "learning-by-doing" knowledge that is easily seen in the world of art and music.

The next big thing that Hayek demonstrates is the economy of knowledge that is found in a price and that this information moves the economy.  Hayek uses an example of a Tin Mine.  Suppose that you use tin in your production process and the price of tin increases.  What do you do?  You cut back on your use of tin and look for substitutes.  But not only does the price tell the entrepreneur in which way to move, but it also tells him the magnitude.  If the price of tine goes up 3-cents, it's no big deal.  If the price of tin goes up 300%, then it is a big deal.  All of these actions are done without evening knowing what the root cause was.  The only thing that is known is that tin is relatively more scarce and the economy needs to adjust.

The next point that Hayek makes is that prices allow the individual to link himself into the greater economic order.  The price system sends to him enough information to make decisions and those decisions have effects on present and future price formation.  It is through this process that prices lead to coordination.  Paris gets fed!  How?  Through each individual, acting in his own self-interest, making decisions on what and how much to buy, and what and how much to sell, we get food to major population centers.  The best short story that illustrates this point is "I, Pencil" by Leonard Read of FEE.

Finally, I think that one of the most neglected points that Hayek makes is the fact that without prices, civilization could not exist.  Paris would starve without prices.  There is no other substitute for prices.  The Russians, under Lenin, tried it and it was a disaster.

There is no substitute for reading this article.  It's short--only 11 pages in the AER.  So get reading!

Monday, September 20, 2010

It's official! The Recession is over...Just in time for the second dip?

The National Bureau of Economic Research (NBER) has long ago deemed itself as the official determiner of recessions--when they begin and when they end.  Today, they have announced--that which I have been saying since at least March 2010 is true--that the recession ended in June 2009.  Here is the link.

So with this incredibly after-the-fact announcement, we find ourselves with national unemployment at 9.6% and North Carolina at 9.7%.  Additionally, we are seeing that the housing market is collapsing (again).  More importantly, we see that firms are expecting the other shoe to fall soon.  The Fed has done more than most thought they would.  The stimulus has now proven to be a failure.  The national debt is sky high.  Social Security, Medicaid and Medicare are unsustainable.  In the face of this, the federal government is burdening the economy with more rules, regulations and taxes.

I am certain that we are in a pause between two painful economic episodes.  Many expect the next election will sort everything out.  I am not quite so hopeful.  The country does need to turn back toward that which works--markets.  However, I do not see that turn any time soon. 

Initially, the Great Depression was merely a bad economic downturn.  In fact, it wasn't even as bad as the initial drop in 1920.  In stepped Hoover and made a bad situation worse.  He turned the country away from markets and sent us down the wrong path.  FDR campaigned against Hoover's crazy spending, but unfortunately not only did he not keep his promise, he increased spending and regulations! 

If we can survive FDR's National Recovery Act, we can survive the current federalization of the economy.  The question is how long will it be until we realize that this path leads us to failure.  How long will it take until we turn back to markets and prosperity?

Thursday, September 9, 2010

Is There Another Recession Around the Corner?

The best indicator of a recession has been the Term Structure of Interest Rate, better known as the “yield curve.” When the yield curve inverts, the economy slips into a recession approximately 4 - 6 quarters later. For my explanation of why this occurs, you can read my article here: or you can read the full dissertation here:

The yield curve has been making some troubling signs. Typically, the yield curve has an upward slope, and it looks like this:

However, when the economy reaches the upper turning point and is poised to fall into a recession, the short-term end rises relative to the long-term end. When this happens, it is called an inverted yield curve. We can plot the slope of the yield curve by simply taking the difference between the long and short ends. When the yield curve is upward sloping, the difference is a positive number. When the yield curve inverts, we have a negative number.

Here is a chart illustrating this difference over the past ten years:

(You can click on this picture for a close up.)

As we can see, the difference is falling again. The 10 year – 3 month spread dropped more than a 110 basis points from a recent high of 3.69 in April to 2.54 in August. The 10 year – 1 year spread dropped almost a 100 basis points from a recent high of 3.40 in April to 2.44 in August. The 20 year – 3 month spread dropped 101 basis points from a recent high of 4.37 in April to 3.36 in August. And the 30 year – 3 month spread dropped almost a 100 basis points from a recent high of 4.53 in April to 3.64 in August.

Each of these indicators fell by about 100 basis points in only 5 months, from April to August. This is a very sharp decline. The Fed has been absolutely flooding the market with as much money as the market can take. Many economists think that the Fed is running out of room to maneuver. 3-month T-Bills are under .20% and have been since April of 2009. 1-year T-Bills are now under .25% and with the Fed stimulant, there is a continuing downward trend. The question on the table is how long will this untenable situation remain?

When we see short-term interest rates start to rise, we will not the long-term rates follow suit. I am expecting to see the yield curve continue to flatten. If trends continue as they are, we are staring at a potential second dip in this recession.

Tuesday, September 7, 2010

Austrian Economics Forum Fall 2010 #1

August 25th was the kick-off to a new season of Austrian Economics readings! (Did you expect me to say football? Hardly!) This semester we are reading Friedrich A. Hayek’s Individualism and Economic Order. The first two readings were: “Individualism: True and False” (Chapter 1) and “The Facts of the Social Sciences” (Chapter 3).  (The book is found here:

There were about a dozen students attending the session. Professor Margolis and I were also there, but unfortunately Roy Cordato and his wife Karen Palasek were out of town. The session started slowly and found its footing as we got moving. I noticed that several of the students received their copy of the book when they arrived that afternoon, so I suspect that many of the students had not read the articles for discussion. I am hoping that the next session will have more student participation.

In the first chapter “Individualism: True and False,” Hayek begins by stating that there are really two definitions of individualism. At their root, they each have the word “equality” in common, but from this point the two branches of thought diverge and lead to positions that are not merely incompatible with each other, but are in direct conflict.

Readers of Hayek will recognize the first strand of thought as the traditional classical liberal view of the individual who has the same equal rights as any other individual. This individual has the liberty and the responsibility to chart his own life’s course. Such a position has been demagogued and characterized as one where the individual lives in isolation and must be completely self-sufficient. While some individuals choose to live this way, this lifestyle is not what Hayek is trying to explain. Hayek attacks this argument as the straw man for which it is. Instead, Hayek argues that in order for a society to work, individuals must be free to pursue their own goals. In fact, he contends that civilization itself would collapse if people were not able to freely choose their associations and their methods for achieving their goals.

The second strand of thought comes from the Descartes/Rousseau tradition. They exalt the individual and praise “Reason.” For them, “Reason” is superior to all other forms of human thought. As a result, we should be able to rationally plan society and free ourselves from many pitfalls. Hayek argues that before we start to tear down the institutions that hold society together, we must first understand their role.

A basic tenant in economics is to look beyond what is seen. The economist and social scientist must also look for and think about the unseen. In the unseen parts of institutions, there is knowledge and information that is essential to a well functioning society. To tear down these institutions also tears apart these unseen aspects. Hayek states, “the great lesson which the individualist philosophy teaches us on this score is that, while it may not be difficult to destroy the spontaneous formations which are the indispensable bases of a free civilization, it may be beyond our power deliberately to reconstruct such a civilization once these foundations are destroyed.”

My take on these two world views comes down to the manner in which we see ourselves. Do we see ourselves as fallen beings or as risen apes? When the Age of Reason was ascending, the Western world viewed mankind as fallen beings. “We are imperfect and each capable of great evil. This sinful side of our human nature needs to be checked and balanced.” Thus, the constitutional framers sought to prevent the gathering of power into any one institution’s or person’s hands.

The Descartes/Rousseau world view is that mankind is perfectible. With the rise of Darwinism in the 19th century, we see the push for a collectivism that is perversely (and paradoxically) based on individual reason. “Mankind grew up from the primordial ooze and rose above all other creatures. Why it only stands to Reason that there is no limit to the perfectibility of our nature and society. Every social ill can be cured if we put enough power into the hands of a person who has the ‘right Reasoning.’”

The second article was probably a little too technical for the students who did not have a chance to read it before hand. It wasn’t something that one could pick up as we went along. I found that the article fit well with Mises’ praxeology despite Hayek’s pleas to consider the empirical. I think that the characterization of the Praxeologist deducing the whole of economics from an armchair in an ivory tower to be a straw man. In praxeology, empirical observations are absolutely necessary. For example, we need to know if the society has money or a central bank. These assumptions are based on empirical observation.

In the course of the discussion of the article, there arose the point of whether we can know what another is thinking. And the answer is that of course, we cannot; but that is okay. I, as a social scientist, don’t have to know that person ate breakfast because he was hungry. I can reasonably infer that. In fact, technically, I don’t know that when I see the color red that another person also sees exactly what I see. All that is necessary for understanding is that we agree that the color is “red.” In the same way, I can never know what another is thinking, feeling or experiencing, but I can come “close enough.” In fact, if no one could ever come “close enough” then language would be impossible. The discussion then centered on: how an economist, as a social scientist, is supposed to do his job.

The next readings are Chapters 2 and 4 in the book: “Economics and Knowledge” and “The Use of Knowledge in Society.” These two articles have helped made Hayek famous to economists and social scientists. I look forward to this upcoming discussion group. I just hope that more people will be willing to discuss it.