Cwik in Polish

I just received an e-mail from the good people at the Fundacja Instytut Ludwiga von Misesa (the Polish Mises Institute, http://mises.pl).  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: http://mises.pl/blog/2010/10/22/p-f-cwik-austriacka-teoria-cyklu-koniunkturalnego-z-punktu-widzenia-finansow-przedsiebiorstwa/

The pdf can be found here: http://mises.pl/wp-content/uploads/2010/10/ATCK-z-punktu-widzenia-finansow-przedsiebiorstwa.pdf 

The original can be found here: http://mises.org/journals/qjae/pdf/qjae11_1_4.pdf

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: http://mises.org/freemarket_detail.aspx?control=27.

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).

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.

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.

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?