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.