Government's Cold Reality -- Part 2

A really good article by Jon Sanders has appeared on the John Locke web site.  It follows up on the ridiculous new proposed policy to make cold medicine that contains pseudoephedrine accessible only with a prescription.  

The amazing thing pointed out in this article is that for each move the government makes, the drug-makers make counter-moves.  They stay a step or two ahead of the law.  Each time they do, the meth that they cook up is more dangerous and deadly.  Each time they revise their formula, they use less pseudoephedrine.  In fact, now they can make meth without any at all.  Here is the link.

New EconStories Video--Deck the Halls with Macro Follies

Our friends at EconStories have produced another hit: "Deck the Halls with Macro Follies."  Enjoy!

Government's "Cold" Reality

Warning: You may be reading the words of a criminal.  The rate at which the government is eroding our liberties is striking and by the time you read this post, you may be breaking the law.  You have been warned...

There may be some of you who have noticed that my postings are done this semester.  (If you haven't, that's not a big deal.)  The reason why my postings have dropped off is because I have been ill for most of the semester.  I think that I may have been well for 2 -- 2.5 weeks  over the past 15 weeks.  I think that there are several factors, like the children going to a school for the first time.  (Last year, we home schooled.)  Nevertheless, when one in the family is starting to begin the path of recovery, another of one picks up something new and then I catch it.  

Today, I have a nasty cough.  My son also has a persistent cough.  This weekend my wife has come down with something new--a sore throat and a fever.  (I am looking forward to getting that one next!)

As the least sick driver in the house, it is my duty to go out and get the medicine.  And here we come to it.  My state, North Carolina, has decided that we are not to be trusted to buy pseudophedrine HCL.  First, we must show IDENTIFICATION to be registered in a statewide system.  We don't have to show ID in Presidential elections where we choose who will be the most powerful man on the planet, but we have to present ID for a stuffy nose!  Second, the amount we are allowed to buy is limited.  There were two boxes I was considering.  The first was just straight up pseudophedrine.  The other box was a mix of pseudophedrine and a sinus pain reliever.  My wife frequently has sinus troubles and I thought that she might like that.  So I, as a normal consumer, chose both.  

And then the machine chimed.

I would be breaking the law to buy two boxes!  Oh heavens!  How dare I want something that deals with multiple symptoms and something else that only deals with a stuffy nose.  I know!  How dare I think that I shouldn't over-medicate myself while providing multi-symptom relief for my wife!

The government can explain how they are just looking out for me.  They can explain how through this law they are cracking down on Meth makers and users.

All of these reasons are really irrelevant.  What it comes down to is the relation between the individual and the state.  Who owns my body?  Am I sovereign over myself?  The Classical Liberal/Modern Libertarian says that as long as I am not violating another's rights, then I should be free.  I should have control over what I put into my own body.

The political landscape is changing.   For the past several years, it was argued that the U.S. is a Center-Right country.  I think that most people live their lives conservatively.  I think that most people want the national government to be fiscally responsible and fiscally sound.  I also think the perception on individual rights is on the rise.  In the last election (Nov. 2012), marijuana for recreational use has passed in a few states.  The traditional American position was a fairly Libertarian one.  Historically, we don't see government interfering with personal choices until the Progressive Movement joined with the Prohibitionists. 

The lesson learned in the 1920s was that while alcoholism is bad, making alcohol illegal was worse.  Being addicted to drugs is bad, but drug war is worse.  It is time to stop the Nanny State.

It is time to have a serious discussion on the fundamental nature of the relationship between the individual and the State.  Does the state derive its powers from the people?  Or do people derive their rights from the State?  Are individuals sovereign to be masters of their own lives?  Or is the State the master of us all?

The cold reality is that the state is force.  Before a government can ever do, it must first take.  It is either force in action or it is the threat of force.  It cannot make us better people.  It cannot make us a more moral people.  It cannot make us thrifty, hard-working and generous.  

The choice that every generation must answer is how much government shall we have.  To sit on the sidelines is to make a choice.  To not think about it, is to make a choice.  To not read and engage is to make a choice.  To conclude, I turn to the words of the great Austrian economist, Ludwig von Mises:

Everyone carries a part of society on his shoulders no one is relieved of his share of responsibility by others.  And no one can find a safe way for himself if society is sweeping towards destruction.  Therefore everyone, in his own interest, must thrust himself vigorously into the intellectual battle.  No one can stand aside with unconcern: the interests of everyone hang on the result.  Whether he chooses or not, every man is drawn into the great historical struggle, the decisive battle into which our epoch has plunged us.

I, Pencil: The Movie

Our friends at the Competitive Entreprise Institute has just put "I, Pencil: The Movie" up on YouTube.  I invite everyone to take a look.

Teaching Austrian Economic Theory

This weekend I had the pleasure to speak before the 12th Annual Economics Teaching Workshop co-sponsored by UNC-Wilmington and Cengage Learning.  My topic was "Teaching Austrian Economic Theory."  The attendees were professors and instructors (with a few grad students thrown in for flavor).  I was happily surprised to see several hands go up when I asked how many have heard of Austrian Economics.  

When I was asked to give the talk, I was given a wide latitude about what I could say.  While having such discretion is a wonderful thing, I found that I had very little idea who my audience would be.  After thinking about it, I realized that I had to do the following:

1. Introduce and explain what Austrian Economics is.
2. Show how it differs with the mainstream.
3. Show how to teach it.
4. Show why it is better.
5. Do it for enough topics to be relevant.  (I chose to cover value theory, capital theory and business cycle theory.)
6. And do it all in under an hour!

To be certain I talked quickly.  I don't think that I went too fast, however I did promise to post the PowerPoint presentation of the talk so that they weren't scrambling to write down a bunch of stuff. To fulfill that promise here are the PowerPoint notes.

Once again, I would like to thank my hosts for the event.  In particular Rob Burrus and Pete Schuhmann of UNC-W and John Carey of Cengage.

Business Cycle Talk at Furman University by Cwik

Recently, I had the pleasure to give a talk at Furman University to the group, "Conservative Students for a Better Tomorrow."  The talk was, "It Didn't Have to Be This Way: From the Great Depression to Financial Meltdown."

There were about 70 students in attendance and several sat without chairs.  I commend the group for gathering so many students to listen to an economics lecture on the night that competed with the first Presidential Debate.

As you can see, they are a good looking group...

Additionally, the lecture was recorded.  It was split into two parts.  Here is Part 1...

Here is Part 2...

Again, I want to thank Furman University and the student group, Conservative Students for a Better Tomorrow, for their hospitality.

Austrian Economics Forum Fall 2012 #1--Caldwell on Hayek

Sadly, this year started off with me getting rather sick, and as a consequence, I have not been able to update the blog as I would like.  Fortunately I am on the mend and new posts will be forthcoming soon.

The first AEF event at NC State University had Hayekian expert Bruce Caldwell as the speaker.  Unfortunately I was unable to attend, however Alex Gill, graduate student and coordinator of the AEF, was able to write up his notes of the event.  Here are his words...

Talk on "How to do Archival Research" with Caldwell's work on Hayek as the motivating example...

Caldwell began by explaining how his interest in methodology led to an interest in the Austrian school, which led to the Hayek's challenge project.  He became interested in the Austrians because disputes with socialism and positivism shaped their arguments.

 

As part of the Hayek's Challenge project, he went to the Hayek archives at the Hoover Institute at Stanford and met then current general editor for Hayek, Bartley and his partner Stephen Kresge.  He quickly learned the importance of personal relationships, both between the researcher and those he encounters as well as the relationships between the subject of research and the people the researcher interviews or otherwise encounters in the course of research.  

 

When Bartley died, the editorship of Hayek's collected works moved to Kresge, who soon requested that Caldwell take it over.  Caldwell's position changes from having to ask for permission to quote unpublished material to being in charge of who has said permission (and for what). 

 

Dr. Douglas Pearce at this point asked Caldwell to clarify rules on quoting from unpublished letters.

 

Caldwell explained that one can paraphrase unpublished material without the editor's permission, but to quote directly or extensively one needs the general editor's permission.

 

Prof. Caldwell went on to explain that being general editor requirs fundraising (for instance, to hire volume editors), a skill he learned by doing.  He credits part of his career success to fundraising talent.

 

Caldwell then began discussing Hayek's divorce, both to reinforce the point about personal relationships and to make a point about following through to correspondents' archives (to get the other halves of conversations).  He learned that Hayek's father (a medical doctor and botanist) was highly nationalistic and embraced many of the opinions associated with Nazism, as did Hayek's brother.  His mother blamed his father for making F.A. a liberal, as she believed said liberalism was a reaction to the father's nationalism.  Without following through to correspondents' archives, Caldwell never would have found this fact out (and others), which would have changed the story he will end up telling in the forthcoming biography, especially with regard to Hayek's family relationships.

 

Hayek's archives include notecards he made while studying the literature (where he would list quotes from others and citations, etc.)  Through the painstaking process of reading many boxes of these notecards, Caldwell gained insight into Hayek's thinking about his Nobel prize and the person he shared it with (Gunnar Myrdal).  Caldwell was previously curious about Hayek's apparent change of tone beginning in this period (from relatively passive and softspoken to more aggressive and willing to attack others), and he realized that Hayek in this period was incensed that he had to share the prize with Myrdal, and that furthermore Myrdal disparaged him (Hayek) and later Nobel recipient Friedman publicly, which to Hayek displayed a complete lack of class and professionalism.  Hayek was furthermore upset that his Nobel address was refereed when submitted to Economica, a journal Hayek used to edit while he was at LSE.  He was offended that it was not accepted as is without an editing process.  So in this period (1970s) Hayek struck back, and began, for instance, attacking Mill (unfairly, according to Caldwell's interpretation) and Mill's interpreters (more fairly, perhaps).

 

Caldwell met with Hayek's children Larry and Christine, and obtained much of interest from them.

 

Dr. Lee Craig then asked, "Were Hayek's children or wives ever interested in his work/economics?"

Answer (paraphrased): No

Dr. Roy Cordato asked, "Where did Hayek place himself intellectually among other Austrians?"

Answer: He was a student of Weiser, but called Mises his "mentor."  He wasn't too close personally with Mises and Popper, though intellectually these two were the closest to Hayek.

 

Dr.Roy Cordato then asked, "Are Hayek's mentions of public goods, welfare economics and the like an artifact of his studying under Weiser?"

Answer: Not that I see.

 

Tim G. then asked, "Is there a connection between Hayek's economics and The Sensory Order?"

Answer: There is not a connection between Sensory Order and Misesian economics.  There is a similarity between Hayek's capital and cognitive theories, though (both self-organizing systems).  Current science is  largely in accord with Hayek's psychological theories.  Read the book and see what you think (the book is hard to understand).

 

Secondary Consequences--Blackmailing Batman

One of the most important concepts that we stress in economics is that of secondary consequences.  Too often, we simply focus on the immediate, on the short-term, on what happens to a particular group.  Economics teaches us that we need to go beyond a narrow focus.  In the movie "Batman: The Dark Knight," an employee discovers Batman's secret identity and thinks that he should be paid $10 million a year for the rest of his life to keep quiet.  Here is the scene:

The reason why this scene is funny is because the extortionist has not thought his proposition through.  He hasn't looked beyond the immediate.  What will Batman's reaction be to someone who wants to release his secret?  What will happen to him?  Will he ever be able to enjoy that money?

Earlier this week I attended my Town's Council Meeting.  There was a proposition to limit Electronic Gaming Businesses by saying that these businesses had to stay at least a quarter mile away from each other.  What they are failing to do is think about the secondary consequences.  Let's set aside the issue of whether such a rule will achieve its purpose--to frighten away such businesses from the Town of Garner.  (It won't.  It's like preventing Burger King from locating near a McDonald's because we fear that people are getting too fat.) 

The secondary consequences of creating these spacial regulations is that the town is carving out islands of monopoly.  Each business gets its own territory and all competitors are prevented from encroaching on your business.  The cost of enforcing this rule is picked up by the government.  It's a sweet deal for those already in business.  As an island of monopoly, the business doesn't have to compete as hard and so the product to the consumers is inferior and at a higher price.

So if the Town Council hates competition and wants to stick it to the consumers, then by all means let's pass this rule.  Or perhaps, we should think it through before we go up against Batman.

Capitalism and The Godfather Movies

The History Channel recently broadcast a show called "The Godfather: Legacy."  It was a look at the three movies and was fairly informative.  Several of the key people who helped make the trilogy were interviewed, and of course, this included the director Francis Ford Coppola.  Unfortunately, Coppola said that what happened in the movie shows the consequences of capitalism.  ARGH!  Really?!?  No, no, no!  Wrong, wrong wrong!  This is wrong with wrong sauce.


While I like the movies and think that they are beautifully crafted, I cannot accept that if we had a pure capitalistic system it would look like the world of the Godfather.  A free market means that I am free to choose to buy or not to buy, hence the word "free."  A free market does not force or even threaten the use of force to get people to buy or not buy.  If there is such a threat, then we have a system other than that of a free market.  Making an offer one cannot refuse in a free market means a really good price, not the threat of being shot in the head.


A system that threatens or uses force to get its way is the opposite of the market.  Such a system is really the system of government.  Government cannot do anything without taking from someone first.  The government must take before it can do.  The only way it can take is through the use or threat of force.  So when we watch the Godfather movies do not think that this is a movie about capitalism.  If anything, they are movies about power and coercion. It is the use of power and coercion that is more closely connected to the actions of the state than to any market.

Competition vs. Conflict

Last week President Obama said that we do not live in autarky.  In other words, one person did not build a business, he had help.  Well, duh!  No one argues that we should each live in solitude, not even the more ardent Randian Objectivist.  


So what is he really getting at?  He is trying to emphasize that communities need to work together.  Fine.  However, his emphasis is on the public sector's "contribution" to society.  Here are a few thoughts on this...


First, before government can make any contribution to society, it must first take from society.  Just because the public sector has spent money on an area, e.g., roads, schools, etc., it does not mean that such things would not be produced if the private sector was left alone.  In deed, the public sector tends to crowd out the private sector whenever it does anything.  Additionally, the public sector is unable to determine whether it is spending money efficiently and thus is always more wasteful of resources than the private sector.


Secondly, autarky may be a starting point for economic theorizing, but it does not mean that we stay there.  Austrians almost always start with the assumption of a lone individual on an island when developing theories of capital and interest.  However, one of the most important insights of all of economics is the Law of Comparative Advantage, which Mises takes to the level of the individual and calls it the Law of Association.  It says that when we specialize and trade, we are made better off.


Finally, many on the left simply do not understand how a free society works.  At the center of the economic system all they see is one person trying to out-compete all rivals--doing whatever it takes to get resources for that dollar of profit.  This conception of the market economy is a skewed envisioning by Marx and the left.  


While there is competition, to be sure, the market cannot operate at odds with itself.  The market is less about competition than it is about harmony.  Consumers have preferences that are subjective and unknown to the producers of goods and services.  Manufacturers have resources and plans to make goods, but do not know which goods to make and in what quantity or quality.  The problem that faces every society is to convert the resources into  goods and services, but not just random goods and services.  They need to make items that satisfy the most intense wants and desires first, and then work down the consumers' preference list.  The market coordinates the conversion of these resources through the use of the price system.  The result is a harmony of action.  Different firms, through trial-and-error, through profit and loss, through competition discover the best combination of resource blends.  The result is that more people are served with less waste than any other system ever.


The reason why the left, Marxists in particular, focus on the single aspect of competition is that they view the world through the lens of conflict.  Marxism is born from Hegelianism.  Hegel saw the world in terms on conflict.  There is a thesis, which is today's mainstream.  Through time, a reaction builds in opposition to it, the antithesis.  A conflict eventually ensues and a synthesis emerges.  For Marx, the Monarchy was the thesis and the exploited were the antithesis.  The result that emerged from the French and American revolutions were the rise of Capitalism.  Capitalism is the new thesis, in which the proletariat will rise up against the bourgeoisie.  The result of this conflict will be Communism.  To the Marxists, the totality of history is conflict, so why should the internal workings of a free society be any different?


What a horrid way to look at the world--conflict, fighting and death!  A vision of a free society is one of liberty and one of individual responsibility.  In this vision, I need you and rely on you so that I can better myself.  When I trade with you, we are not in conflict, we are mutually helping each other.  We are both made better off by the trade.  A free society is the furthest thing from autarky.  If, in college, our President read Bastiat instead of Marx,  I doubt he would be able to make such foolish statements.

Austrian Economics Forum Spring '12 #6--Fractional Reserve Banking?

The final session of the Spring Semester Austrian Economics Forum at NC State University cover the topic of Banking.  There are basically two camps in the Austrian School when it comes to banking—100% reserve banking and free banking with fractional reserves.  For this session we covered the article “Fractional Reserve Free Banking: Some Quibbles” by Philipp Bagus and David Howden in The Quarterly Journal of Austrian Economics (2010, vol. 13, no. 4, pp. 29-55) and Selgin’s response found here or here.

Personally, I am in the free banking camp, but I think that there are strong economic arguments for getting close to 100% reserves.  As I will explain below, it might be the case that while the objections to Fractional Reserve Free Banking (FRFB) are true, they might be so small that the positives outweigh the negatives.

Overall, I cannot express how disappointed I was with the Bagus and Howden article.  We have already covered Bagus’ book, The Tragedy of the Euro, in the first session this semester (here) and I thought the sections that we read were thin.  While there is a decent underlining argument there, the scholarship was weaker than what I was expecting.  Unfortunately, this article proved to have the same flaw—weak scholarship.  Furthermore, Howden gave a named lecture at the Mises Institute’s Austrian Scholar’s Conference.  He explained what he meant by a “quibble.”  He meant that the argument for free banking was so weak that to argue in favor of it is a mere quibble!  [Wow!] 

When presenting an argument of an opponent, one should always give the benefit of the doubt, define the terms in the most generous manner and cast it in the most favorable light.  If you can still destroy the argument, then your case is solid.  Unfortunately, this is not the approach that Bagus and Howden take in their article.  They assume narrow interpretations and unfavorable conditions.  Simply put, they are not generous to their opponents.  As a result, the FRFB side can point out that the overly narrow case does not apply and that the argument was misconstrued.  In the session, the criticism actually fell less on Bagus and Howden and more on the editorial staff and reviewers at the QJAE.  Basically, the sentiment was, “How did this article see the light of day?”

Due to the poor scholarship, Selgin is able to destroy their argument and make them look ridiculous and arrogant, which is too bad because Bagus and Howden are not dumb guys.  Let’s take a quick look at the exchange, from Selgin…

According to Bagus and Howden (2010, p. 36), “Selgin starts his analysis by assessing changes in the demand for money, not distinguishing between the demand for commodity money (money proper) and money substitutes.” Actually, my chapter concerning how free banks deal with changes in the demand for money is titled “Changes in the Demand for Inside Money” (my emphasis), where “inside money” means more or less the same thing as Bagus and Howden’s “money substitutes.”

It is simple points such as these that allow Selgin to skewer Bagus and Howden.  It is as if they simply did not take the time to understand Selgin’s argument.  If this was an isolated incident, maybe we can let that slide by, but it is unrelenting.  Bagus and Howden are simply misrepresenting the FRFB argument. 

Last summer, I finished reading Rothbard’s Conceived in Liberty, which is a history of the American Revolution.  From there I was propelled into reading Rothbard’s A History of Money and Banking in the United States.  Then in the Fall I had to teach a Money and Banking Class and so I reread and then assigned Rothbard’s The Mystery of Banking, The Case Against the Fed, The Case for a100% Gold Dollar, and What Has Government Done to Our Money?  To round myself off for this year, I read through White’s Free Banking in Britain, Selgin’s The Theory of Free Banking and Sechrest’s Free Banking.  (I also read, a while ago, Horwitz’s Microfoundations and Macroeconomics.)  So I have been getting myself grounded for the 100% Reserve versus FRFB roundtable panel at FEE’s Introduction to Austrian Economics Summer Seminar (link here).

So here is my analysis (take away) from the ongoing exchange.  First, I think that those who support the Free Banking position are better debaters than those on the 100% Reserve side.  I say this because it seems that the 100%ers are willing to fall back to the moral argument as opposed to fighting on economic ground.  While there is nothing inherently wrong in arguing against the legitimacy of converting a bailment into a deposit (an asset for the bank), my point is that it is not an economic argument.

The Bagus and Howden article does identify the weak points of the FRFB position, but they discredit their position against FRFB with their sloppy scholarship.  There are two major (economic) weaknesses in the FRFB position and it is due to these weaknesses that I have strong reservations on the FRFB position.

Before we can get into these points, we first need to make the distinction between the different types of credit.  A problem in the literature is that it seems that each author has his own way of defining credit and thus the arguments become confusing.  I will use the definitions Machlup uses in The Stock Market, Credit and Capital Formation (1931).  He distinguishes between transfer credit and created credit.  (While there is a third category, we don’t need to worry about it here.)

Transfer credit is the sort that stems from my placing money into a loaning institution and it is borrowed by another.  This form of a loan matches the deposit banking that Rothbard outlines in The Mystery of Banking.  The second type of credit is the sort that materializes out of nowhere.  An example of this is when the Federal Reserve buys a bond and credits the sellers account.  Where did that new money come from?  It came from a big, black hole of nothingness.  The money (credit) was created.

So the first weakness in Selgin’s presentation of the FRFB system is that he starts his analysis with an economy, and a banking system, that is fully loaned up.  In other words, he is starting with banks balancing their “average net reserve demand” equal to zero. (Selgin 1988, p. 73)  I think that this is a weakness, not because of the logic that Selgin engages in, but because that this assumes way a major point of credit fueled inflation—the process to get to a fully loaned up system.  I think that it is true that if we start with a fully loaned up banking system with no malinvestments, then yes, the system is fairly stable.  However, if in the process of getting to this fully loaned up state, we create malinvestments along the way, then the system is not stable.  There will be the classic Austrian Boom/Bust Cycle.

The next weakness that is found in the FRFB system centers on the precautionary reserves.  If the banking system is fully loaned up, it is vulnerable to any fluctuations in people’s willingness to hold on to cash (or not hold onto cash).  Thus, each bank will hold onto some reserves to insulate itself from the day-to-day fluctuations and from any unforeseen changes in market conditions.  The bank will lose money if it holds onto too much cash reserves and put itself at risk if it holds onto too few.  So far, so good.  This choice is an entrepreneurial one and markets should be able to handle this. 

So here is my concern.  Suppose that for whatever reason there is an increase in the demand to hold onto cash.  This holding onto cash is deferred consumption.  In other words, it is saving.  Now, if nothing else happens there is a decrease in the demand for the goods and services that the cash holders are choosing not to buy.  This change in demand will then spread throughout the economy and the relative price changes will signal to entrepreneurs how to re-coordinate the economy. 

Many who support FRFB system (like Selgin and Horwitz) argue that this savings can be converted into transfer credit.  If the cash holders are holding onto an additional $1,000 per time period (e.g., each month), then the banks can loan out that additional sum of $1,000.  They argue that this is merely transfer credit and not created credit.  Therefore, this is not a problem to worry about.  While, it is true that this is not created credit, because the cash holders are indeed saving, there are, however, a few concerns.

First, as soon as these cash holders revert to their prior spending/cash holding patterns, then the banks need to call in those loans.  In the example above, the banks need to call in the $1,000.  Calling in loans may create a large disruption in the economic patterns.  If a business started a project and the loan is called in, there is no effective difference between liquidating this sort of a project and liquidating a malinvestment from an artificial boom.

Secondly, when the loan is made, there are nonneutral economic effects that stem from this loan.  When businessman A gets the loan, he will create a spending pattern that is unique.  New equilibria are generated.  This pattern will necessarily be different from the pattern generated by the reduction in demand by the saver.  While this may not seem to big a major problem to a well functioning economy, it is a point of concern to the extent that these patterns are at odds with the savers.  Most likely, the extent of concern on this point seems to be an empirical matter. 

The 100%ers are assuming that prices are flexible and will quickly adjust.  The FRFB supporters are assuming that prices are not quite as flexible and so they convert the savings into transfer credit.  However, to me this seems to be compounding the problem instead of solving it.  If prices adjust slowly, then why are we creating a second pattern to overlay which will reinforce or offset the prior pattern generated from savings?  I think that prices are stickier as we get closer to consumers.  While gasoline prices change by the penny each day, most consumer items target price points (e.g., $9.99, $29.99, etc.).  As we move further away from the consumer, we see less fixation on price points, but we do see more longer term contracts.  Again, this is a call for further research.  I suspect that there is some economic research on this, but since the other schools of economic thought tend to ignore the structure of production, I doubt that the answers are readily available.  If someone has a suggestion of where to look, I would be interested in these sources.

Problems and Prices on FEE TV

Hollywood is known for making "magic," likewise the staff at FEE TV should also be congratulated for making me look presentable. Thank you guys.

FEE--Introduction to Austrian Economics Summer Seminar 2012

For the week of June 4^th – 9^th, the Foundation for Economic Education (FEE) held the first seminar for the summer in Atlanta.  This is the 50^th anniversary for FEE to host a summer seminar.  I am honored that this has been my 10^th year to lecture to students for FEE.

This past week was an introduction to Austrian Economics.  Steve Horwitz and I suggested a schedule for this year and we are grateful that it was accepted without revision.  I am really pleased with how well the lectures were integrated.  I can’t really think of any particularly unique issue that we didn’t at least mention.  The lectures were videoed and FEE will be posting them later this summer.  When they come out, I will link to them on the left-side of this blog. (You can see some earlier lectures posted there now.)

I gave four lectures for FEE and participated in a roundtable discussion on the controversy between fractional reserve free banking and 100% reserve banking. 

My first lecture was “Menger and the Early Austrians.”  In it, I talk about four major contributions Menger made.  Since I covered issues of capital and interest in a later lecture, I focused on Böhm-Bawerk’s approach to value theory and his refutation of Marx.  Then, I walked through the books that Wieser wrote, with (of course) some analysis of each.  And I finished by covering some of the insights made by David Green, Philip Wicksteed, and William Smart.  The PowerPoint to the “Menger and the Early Austrians” lecture is found here.

The second lecture was “Praxeology, Supply and Demand.”  Here I began by comparing the methodology of the Austrians with the mainstream.  I presented the mainstream’s approach to methodology and critique it.  In contrast, I presented the Austrian methodology and build up the Laws of Demand and Supply from first principles.  We then built a model of the market.  I finished the lecture by comparing the manner in which the mainstream derives demand curves using indifference curve analysis.  The mainstream’s approach suggests that there is an income effect and a substitution effect for each price change.  The Austrians tend to think that policies that are derived from this thinking are equivalent to hocus-pocus.  The bottom-line is that when the mainstream derives demand curves in this fashion, they are comparing two levels of total utility and looking at the marginal rate of substitution.  When the Austrians derive demand curves, we are looking at the marginal utility derived from the next unit.  While both approaches use marginal analysis, they are not the same.  The PowerPoint to the “Praxeology, Supply and Demand" lecture is found here.

The third and fourth lectures really build upon each other.  The third was “Capital and Interest” and the fourth was “Business Cycles.”  In “Capital and Interest,” I criticize the mainstream’s approach of allowing objective factors to control the interest rate and also the notion that capital can be represented by a homogeneous pool.  In contrast, the Austrians hold that interest rates are determined by subjective time preference for both the supply of loanable funds (savings) and the demand for loanable funds (borrowing).  Furthermore, Austrians hold that capital is mostly complementary.  As a result, capital has a structure that cannot be ignored.  If we do so, we miss some significant aspects to economic theorizing.  The PowerPoint to the “Capital and Interest” lecture is found here.

The last lecture was on “Business Cycles.”  I began by developing Garrison’s three interlocking graph model.  It contains the Loanable Funds Market, the Production Possibilities Frontier Curve, and the Structure of Production.  We then walked through how the model works for various macroeconomic fluctuations and finished with working through the stages of the Austrian Theory of the Business Cycle.  The lecture finished with examining how the other modern macroeconomic theories explain the boom and bust of a business cycle.  The PowerPoint to the “Business Cycle” lecture is found here.

The last activity was a roundtable on 100% reserve banking vs. fractional reserve free market banking.  All four of the faculty participated in this discussion.  We started by first explaining why the current system of fiat banking with a Central Bank was a terrible system.  Then we explained how 100% reserve banking would work and then how fractional reserve free banking (with competitive note issuance) would work.  We then voiced our concerns about each system and then took questions from the students.  Since this was the last time we were talking before the group, we opened the last 15 minutes up to any question the students had on Austrian Economics.  There are no PowerPoint slides associated with this so I cannot link to anything right now.  However, when FEE posts it on the web, I’ll be sure to link to it.

I want to thank FEE for hosting another very good summer seminar.  The students asked some of the best quality questions we have heard for quite some time.  And the FEE staff did a marvelous job.  I appreciate the fact that the supporters of FEE have been able to keep this program going and also to be able to do it at such a high quality level.  Thanks!

Austrian Economics Forum Spring '12 #5--Efficiency in an Open-Ended Universe

The fifth Austrian Economics forum centered on Roy Cordato's book, Efficiency and Externalities in an Open-Ended Universe.  In particular we focused on Chapter 3, "Catallactic Efficiency: Welfare Economics."  


In traditional welfare economic analysis, we make judgments about net effects of policy.  Does this policy help more people than it hurts, or is it the reverse?  Usually, this means that the economist must make a comparison between people's subjective utilities.  This analysis is called "interpersonal utility comparisons."  Since values are subjective, such a feat is impossible.  There is no way we can judge how much a person values something, and nearly all economists agree on this point.  However, this is where the Austrians an the neoclassicals part company.


The neoclassical economists will waive their hands and say that interpersonal utility comparisons are impossible, but then they do exactly that; they make interpersonal utility comparisons.  There are some theoretical constructs that confront the problem head-on, like the Pareto Optimality measure of efficiency.  However, these sorts of approaches have very little real world application.  For example, the Pareto condition says that a policy is good if, and only if, at least one person is made better-off while no one is made worse-off.  In the real world, this is never the case.  And so, as a mental exercise, such methods are fine, but the reality is that these end up calling for maintaining the status quo.


Cordato's chapter avoids this problem.  


The first thing that needs to be made clear is the distinction between positive and normative economics.  Positive economics is pure theory.  Normative economics is a value judgement made by the analyst.  For example, positive economic analysis says that whenever the price is below the market clearing price, there will be a shortage.  An example of a normative judgment is the statement that we should set the price below the market clearing price.  Normative economics deals with "should statements."  We should do policy X but should not do policy Y.  Cordato's chapter sets positive economics aside and focuses exclusively on normative economics.


The next thing that we need to examine is the concept of an open-ended universe.  So what's that?  The opposite of a closed universe, duh.  (I know, not helpful, but I couldn't resist.)   A closed universe is one that has a final state of rest, an equilibrium point toward which the market tends.  The neoclassical position tends to start in this state, which is fine for positive analysis.  However, we are dealing with normative analysis for the real world and the real world is definitely not in equilibrium.  Even if the real world does manage to get itself into an equilibrium, it would only be there for a moment.  This is because the demand curve is based upon things like tastes and preferences and the supply curve is based upon things like expectations.  When any of those factors change, the curves shift and a new market clearing relationship emerges.  


Kirzner's approach says that we are constantly chasing these market clearing prices.  It is the entrepreneurs' actions that coordinate the economy and move us closer to market equilibria.  Cordato argues that for normative economic analysis, we should jettison the very notion of equilibrium.  Let me be clear, Cordato is not saying we should jettison equilibrium altogether.  In fact, he does say that it is perfectly legitimate to still use it for positive economic analysis.  (Personally, I like the concept of "harmony" better, but that is a different discussion.)  


It is when we deal with normative economics that we should discard equilibrium.  The reason is that we have no idea where such an equilibrium would be.  We cannot argue that in the real world that each transaction moves us closer to an equilibrium, because each transaction adds new information into the system--information that was unknown before.  As new information is added into the system, the theoretical equilibrium changes.  Thus, it is impossible to determine (either before or even after the fact) whether a trade moves us "closer" to an equilibrium or not.  So an open-ended universe says that we cannot know where these equilibria are and whether a transaction moves us closer to or further from any of these points.


While this analysis is close to the Lachmann/Shackle position of economic kaledics, it is not the same.  The difference is that Cordato says that the use of equilibrium is legitimate when doing positive economics.  Lachmann and Shackle reject the concept of equilibrium for both normative and positive economics.


So then how are we to judge which policy is better, or in economic jargon, which policy is welfare enhancing?  Cordato proposes that we use a standard of "Catallactic Efficiency."  Catallaxy is an alternate word for the economy/economics.  It comes from the Greek root "katallasso" (καταλλάσσω), which means trade or exchange.  It also means "to befriend."  


Anyway, Cordato argues that methodological individualism holds that each person has his own set of goals and his own set of information.  "[Efficiency] is to be judged by the extent to which the catallaxy encourages individuals existing in a social context, to pursue their own goals as consistently as possible." (page 62)  Cordato continues,

By its very nature, then, questions of catallactic efficiency must focus on the institutional settings in which individual actors operate.  In particular there are two overriding issues.  The first centers around the institutional settings that will best facilitate the use and discovery of information, the appropriateness and relevance of which can only be known by those who need to discover and use it.  The second concerns the institutional setting that will allow individuals to gather the necessary physical resources [and use them].  pages 62-3.

So there are two conditions to be met: the first is the ability to discover information and the second is the ability to use resources to achieve the goals sought.  The conclusion is that a laissez-faire policy is best for enhancing the welfare of the community.


Such an approach, I believe, fits well with Mises' conception of Interventionism.  Mises argued that there were three manners in which the government could intervene in an economy.  The first is the role of the impartial judge and enforcer of private property rights. When there is a dispute, the government can resolve the dispute.  Mises thought that this was a normal and healthy function of government.  The second manner is when the government buys items from the market.  Suppose that the government wants to publish its annual budget.  To do so, it needs paper.  The government taxes people and then spends that money on paper.  While there are distortionary effects that result from the governmental action, the normal market process is intact.  The demand curves for the items that the taxed people would have purchased are reduced and the demand curve for paper is increased.  The market mechanism operates normally.  


The third type of intervention is where the government stops or hinders the market mechanism from operating normally.  In this form, the government prevents trades to take place by rules, regulations, or price controls.  For example, if the government passes a law that says all toys need to be tested for lead before they can be sold, this interferes with the normal market process.  If the government says that during "a state of emergency" prices can only rise above the 30-day average by 10% interferes with the normal market process.  In the first example, people will not be able or willing to sell toys and in the second, the goods  will not be rationed according to price.  Long lines will emerge and shortages will persist.


Cordato's "Catallactic Efficiency" standard and Mises' third type of interventionism go hand-in-hand.  They both focus the analyst's attention to the coordination process of the market.  How is new information generated and incorporated into the greater social order?  When obstacles restrict the market's ability to do this, we have catallactic inefficiency and interventionism.

Austrian Economics Forum Spring '12 #4--Kirzner & Cwik

For our fourth meeting, it was decided that we would discuss the paper that I presented at the Austrian Scholars' Conference in Auburn.  While I love to talk about myself, I decided to include a paper by Kirzner as well. 

The Kirzner paper is "The alert and creative entrepreneur: a clarification."  Basically, this is Kirzner responding to supporters and critics of Capitalism and Entrepreneurship, and then telling them that they are all wrong.

Kizner says that his work is not about how to become a successful entrepreneur.  Rather his work focuses on how the market process is set in motion be entrepreneurial decisions.

The interesting points he puts forward is an almost rewritting of his stance on Schumpeter.  He says that everyone knows of Schumpeter's creative-destroyer and so he did not want to dwell on that aspect of entrepreneurship.  He wanted to show how entrepreneurship coordinates the economy.

He then argues that many misinterpreted his writings to say that the entrepreneur was a passive noticer of opportunities.  He says that a false tension was created between the Schumpeterian "bold, disruptive, innovators or [the] passively alert, harmony-restoring responders to changes that have already occurred."  He then states,

[T]here must be scope for both a creative ("Schumpeterian") entrepreneur (one who generates pure profit) and a "passive," alert ("Kirznerian") entrepreneur (one who snuffs out given profit opportunities by promptly exploiting them.) p. 149 (italics in the original)

Cordato argued that his own work tends to connect the two positions.  He argued that we live in an "open-ended universe."  He means that there is no such thing as a final equilibrium to strive for.  In fact, as new information is added, the equilibrium point changes. 

It was based upon this point that we decided that the next week would center on Cordato's book, Efficiency and Externalities in an Open-Ended Universe.  And so we tabled further discussion on this point for the next week.

****************************************************************************
Then the discussion turned to my paper, "Greed in Public and Private Institutions."

My paper, as is too often the case, was based upon frustration.  There is a general attitude that anything that happens in the private sector is due to greed, but when we switch to the nonprofit sector, motives are now made of pure light.  Indeed!

Of course people in every walk of life are greedy.  (As an aside, economists throw out the word "greed" because it cannot be precisely defined.  A typical definition of greed is the wanting of something too much.  However, what is "too much"?  Who decides?  As a result, economists use levels of self-interest.)  Self-interest is omnipresent and it propels Adam Smith's butcher, brewer and baker to serve others.  On the other hand, we have a separation of self-interest and the interest(s) of the overall organization.  It is a question of aligning incentives.  In other words, we are examining a principal-agent problem.  What if Bernie Madoff, Ken Lay or other suitable villain was in charge of the State Department or the US Treasury?  Would we even know what they would be up to?

My paper suggests that two questions arise: Can the institution efficiently allocate resources to satisfy the most intense wants and desires of consumers?  And can the principal-agent problem be overcome to ensure that the leadership will carry out its intended purpose or will the leadership use the entity as a means to a selfish (greedy) end?

In my paper, I looked at three institutional settings: for-profit companies, bureaucracies and nonprofits.  I conclude that the for-profit sector can answer both of the questions.  The bureaucracies cannot calculate efficiency, but it does issue rules, orders and regulations to control and guide the behavior of beaucrats.  It is in this way that bureaucracies have a chance of overcoming the principal-agent problem.  The nonprofit sector, on the other hand, is incapable of answering either question.

Overall, the discussion was friendly and supportive.  During the course of the discussion, Cordato asked a good question, "When it comes to bureaucracies, who are the principals?"  I did not have a ready answer for him.  When I wrote the paper, I had Mises' Bureaucracy in the back of my mind.  In it, he uses the model of a king that basically is in charge issuing orders.  And so in my mind, the king was the principal and the bureaucrat was the agent.  How that translates into a representative government is much more complex.  Although, the point that there is a potential solution remains.

Additionally, a student suggested that when it comes to the nonprofit organizations, we can split them into two groups.  The first group is primarily donation driven, while the second is endowment supported.  The first group "has its feet to the fire."  They must be very aware of what the donors expect, otherwise the funding disappears.  The second group is insulated from today's donors because an endowment has been built up.  (For example, think of colleges and universities that have large endowments.)  They are able to upset today's donors because they have the resources in place for tomorrow.  Of course, such an institution cannot upset significant donors forever, but they have a lot more room to be independent.  This insight certainly adds to the discussion that I make in separating the true-believers from the careerists.

US Debt Limit Analogy

Here is a short 3-min video making an analogy to the US Debt.  Just because we raised the limit last year, it does not mean that the problem has gone away.  If anything it has and will continue to get worse.

Enjoy.  For my thoughts on what to do to solve the debt problem, I have advocated partial repudiation of the national debt.  It is found here: http://tillmanspeaks.blogspot.com/2011/07/repudiation-should-we-repudiate.html

FEE TV

In the world of stranger things have happened, FEE has decided to post the following video of me.  In it I talk about the foundational difference between Austrian Economics and the mainstream.  I believe that they have done a good job (especially given what they had to work with!)

The Joys of Homeschooling

This year, we have been homeschooling my six-year old son.  Next year will probably be different, but after today I might just rethink it all.

Yesterday was Easter and so the story from the Last Supper through the Resurrection has figured prominently at our house.  And so at lunch, the boy was thinking about Judas' betrayal.  He asked, "Was Judas a tax-collector?"  I said that he wasn't.  And then the boy said, "But I thought he was a thief." 

Just when one thought it couldn't get better...

We were returning home after spending some time at the park and eating hot dogs.  He started telling me about his next entrepreneurial venture.  He wants to have a restaurant and live above it.  He will have a garden (where he grows the food for the restaurant), a park, a baseball field, play equipment, a pool, etc.  To me, it sounded like a chateau on an estate.  Anyway, we stopped at a red light where a guy with a sign was asking for money.  My son asked why he wanted money.  I asked my son didn't he also want money.  As he thought about it, I asked him how he could earn money.  He told me that when he gets older he could cut grass, fix things, build cars, etc.  (He's fairly entrepreneurial.)  I agreed with him by saying that if he wants money, he must think of how he could serve other people.  I explained that work is making things more useful (better) for others.

He then asked if he could make his own money.  I told him that he could, although no one else would want it.  He thought for a moment and said, "What if I make it out of gold?"  [Nice!]  I explained that he could as long as it was novelty money and not legal money.  Only the government is allowed to make "legal" money.  He then said that was completely wrong and that everyone should be allowed to make their own money!  YES!  A laissez-faire monetary system!  From the mouths of six-year olds! 

A Note on Price Gouging

Of course, there is no economic definition of "price gouging," but let's set that issue aside for a moment and focus on a particular objection in favor of price controls I recently came across.

Suppose that a storm knocks out water in the city and the price for water jumps from $1 to $10 for a single 16 oz. bottle.  If the government imposes price controls that limit the increase to 10% above the 30-day moving average, as many states do, then there will be a shortage. 

So the economist argues that the price spike is good because it reduces use of water and encourages suppliers to bring more in.

The objection runs like this, if you are a poor guy, you can't afford the $10 price and so you go without.  Alternatively, if we have to stand in line for rationed water, he has a chance to get some water.

This scenario is a false dichotomy.  Regardless of the method of distribution (by price, by 1st come/1st served, etc.), some people will be without water.  The reason is that a storm has knocked out the water supply. 

The correct question to ask is, "Which system gets water to the damaged area faster, so that the time is minimized for those who are without water?"

The correct answer is the price system.  High prices send a signal, to all, that water is needed in the area and rewards those who are there first with high revenues.  As the water comes "flooding" in (yes, a pun), the price falls and then even the "poor guy" will be able to get water.

Disasters are horrible situations to live through.  I remember the eye of a hurricane passing overhead.  It was an interesting experience.  The point is which system puts into place a system of incentives that gets the most relief to the most people in the shortest period of time.  And the best answer we have is the open and free market.

The South Sea Bubble

I recently finished reading a book on the South Sea Bubble. I was surprised at how fascinating it was. I have heard of the South Sea Bubble before, but I couldn’t really tell you much about it. I knew that it happened in the early 1700s and there was also something called a Mississippi Bubble. However, I couldn’t make a distinction between the two, until now.

The book is The South Sea Bubble: An economic history of its origins and consequences by Helen J. Paul (2011). She is an economic historian interested in Cliometric analysis (the application of statistical techniques to history). Using statistical analysis to analyze history is, from the Austrian point of view, entirely appropriate. In fact, it is really the only legitimate use of statistics.

Anyway, to the story…

Imagine a country that has been in and out of wars year after year. As a consequence, an enormous debt has accumulated and is difficult to pay off. (Stretches the imagination doesn’t it?) This was the situation that both England and France found themselves in the early 1700s. In England, some of the debt could be paid-off early, but not all of it and not without the permission of the creditor. Furthermore, this debt was between the King and the individual and could not be traded. In other words, if the King borrowed £1000 from you, he owed you. You could not sell that debt to another, and if the King died then the debt was cancelled. With all this debt hanging overhead, how does a King borrow more money to fight more wars? The solution came in three forms: the conversion of the King’s debt into the nation’s debt, the creation of paper money and with it the establishment of the Bank of England (as a central bank), and the chartering of a monopoly company.

The monopoly company was the South Sea Company. It offered equity shares in exchange for the previously untradeable debt. A creditor could exchange £1000 in government debt for shares in the company. These shares were tradable and the value would fluctuate on the open market. This allowed creditors to reduce their risk exposure to a government default or other inability to pay.

The company would collect the government debt from the creditors in exchange for shares. The company would then be the recipient of the government’s debt payments. As a result, the company was “guaranteed” a minimum amount of income each period. Furthermore, the South Sea Company was granted the exclusive right to trade in virtually all of South America. (Of course, other nations traded in South America so the grant of monopoly only stopped other English firms from competing with the company.) Additionally, the Spanish Asiento was granted to the company. The Asiento was a grant of monopoly to import African slaves into the Spanish colonies. (The agreement also allowed a limited number of “permission” ships to also trade in other goods.) So the South Sea Company would get the slaves from the Royal African Company, ship the slaves across the Atlantic under the full protection of the Royal Navy, and sell them in the Spanish Americas.

To try to put this into today’s terms, imagine if the US government sets up a company to buy up all the national debt. The company will have a positive cash flow as the US government pays the debt, and the company has a grant of monopoly to ship oil out of the Middle East, which is backed by the full power of the US Navy. The owners of the shares will collect the profits either through dividends or increased valuations of the stock. Many people thought that this arrangement was a good deal and sold their debt for shares.

But wait there’s more! The South Sea Company allowed owners of the stock to borrow money and use the stock as collateral. So, if I have £1000 in government debt, I could convert it into company stock and then borrow £1000 and use the stock as collateral. If the stock price falls, I could just walk away and let the company keep its stock while I pocket the cash.

But wait there’s even more! If you decide to purchase the stock, you could pay in installments. So if the price of the stock falls low enough, you could just stop paying the installments and forfeit the lower valued stock. Now combine this with the fact that you could borrow against the stock! You could purchase the stock and decide to pay in installments, borrow against it, and if the price falls, you could just walk away from it. What a deal!

No wonder there was a tremendous run up in the price of the South Sea Company! The result was a bubble that popped in September 1720. The French, under the direction of John Law, had a similar scheme. It was called the Mississippi Company. It, too, had a tremendous run up in price and also popped in the Spring of 1720.

For those history of economic thought buffs, you might recalled that John Law had a right-hand man that was able to get out of the Mississippi Company right before the collapse and walk away a rich man. He wrote a book about the experience and made other insights on the financial world and the economy in general. He was later murdered in London and his house set afire to cover up the treachery. His name was Richard Cantillon. Rothbard called him, “The Founding Father of Modern Economics.” Alas, that discussion is for another post.

Austrian Economics Forum Spring '12 #3--Calculus and Consent

After a few years of attending the AEF, the third meeting was my first disappointment with this group.  (I suppose it was bound to happen.)  Yes, there was basketball that diverted some; and yes, there was severe weather; and so attendance was very low, but the real reason was that the topic really just did not fit our group.  It was on Chapters 4-6 of Buchanan and Tullock's The Calculus of Consent (1962). 
For me, the discussion went around and around in a large circle.  The problem actually stems from the last sentences in Chapter 2.

It seems futile to discuss a "theory" of constitutions for free societies on any other assumptions than these.  Unless the parties agree to participate in this way in the ultimate constitutional debate and to search for the required compromises needed to attain general agreement, no real constitution can be made.  An imposed constitution that embodies the coerced agreement of some members of the social group is a wholly different institution from that which we propose to examine in this book.  pp. 19-20.  (emphasis added)

Which political entity, then, could they be talking about?  Even my Home Owners Association fails to fit this definition!  Government is different than another human institution in this sense: it is the only institution that has the legal right to coerce and use force.  Without this definition at the heart of the analysis, the rest is fluff. 

To me the problem with government is the imposition of rules and regulations on groups that do not agree with the "choices" made by government.  We were to discuss the groupings of external costs that Buchanan and Tullock divided into a ("expected costs resulting from purely individualistic behavior"), b ("expected costs of an activity embodying private contractual arrangements designed to reduce [internalize] externalities") and g (total costs imposed by collective decision-making).  But if we agree that there is no coercion to keep people in the constitution, then why would I not just veto everything that I disagree with?  Now repeat that reasoning for everyone.  The result is that groupings fall apart.  Thus, the discussion went in circles and my disappointment.

Austrian Economics Forum Spring '12 #2--Emerging Rules

At our second AEF meeting, we discussed the work of one of the NC State University's Graduate Students, Richard Hammer.  He presented his work, "Life Grows Through Discovery of New Social Rules." 

He argues that life is thermodynamic.  If we start with some simple assumptions about basic life needs (rules to exist), he wants to know how far can we get with this line of analysis.  Can it circle around to be useful for analyzing our own behavior? 

He starts with single cell organisms (SCOs).  They need food and water.  If they lack enough food or water, they will die.  If food and water are distributed homogenously, then we really do not get interesting results, because there is no reason to act--other than simply consume. 

The interesting results begin when we assume that there are pockets of food and water that the SCOs have to go to.  If the food and water are too far apart, the SCOs die.  If they can travel back and forth, then they can survive. 

A fundamental law in economics, The Law of Comparative Advantage (Mises called it The Law of Association), is based upon specialization and the division of labor.  It says that when we trade, we can benefit.  We have certain advantages over others.  It might be that our skill set or natural talents are better than another's.  It might be as simple as being closer to a natural resource than another.  The point is that it is our differences that allow up to benefit.

So if we posit that food and water is irregularly distributed, then some SCOs will have a comparative advantage over others.  Some SCOs will be closer to the food and the others will be closer to the water.  This means that if they cooperate, both groups will be better off than if they opertated in autarky. 

So far, so good.  I agree, but I didn't really see much benefit to this line of analysis.  However, others did.  They asked, "Why do cells in our bodies perform particularized functions for the benefit of the overall body?"  Their reasoning followed along these lines...

When SCOs start to cooperate, they are able to specialize.  When they specialize, they give up other functions and become dependent upon other SCOs.  Thus, we see the inklings of the transformation from SCOs to multi-cellular organisms.  Additionally, a side discussion of meme theory took place.

All-in-all, it was an interesting disucssion, but I fail to see how such theories can circle back and inform economic theory.  Why make an argument by analogy?  Why not just make the argument?

I am reminded of a quote by Böhm-Bawerk, where he attacks arguing by analogy.  It took place in his debates on Capital and Interest theory with John Bates Clark.  He says,

There seems to dwell in the human heart an enervating proneness for playing the poet in matters of science, and for placing by the side of the common natural things and forces with which we have to do in the world of prose visionary doubles in the form of all sorts of mystical beings and powers, to which a semblance of reality is imparted by means of an ‘elegant’ abstraction. I hold this practice to be fraught with greatest danger to science. If one departs from the bare truths of nature by only a hair’s breadth, scientific accuracy of thought is irretrievably lost the sway of truth gives place to that of words and sounding phrases.

Until next time...

Austrian Economics Forum Spring '12 #1--Tragedy of the Euro

We kicked off the latest round of the Austrian Economic Forum at North Carolina State University on January 27th, 2012.  It was well attended and everyone seemed excited to get the semester under way.  This semester is going to be a little different for us in that for each meeting a different Graduate Student will be either presenting his own work or a reading which interests him. 

The first session's reading was selected by Alex Gill.  He picked chapters 8 and 9 in Philipp Bagus' Tragedy of the Euro (2010).

The European Central Bank (ECB) has powers that are slightly different than those of the US Federal Reserve System.  The difference we focused on was the ability of the ECB to expand the money supply. 

The system works by the ECB loaning money to banks, which use national governments' bond as collateral.  Suppose a national government (e.g., Greece) decides that it must spend more than it takes in from tax revenues; it has a budget deficit.  (Hard to imagine I know, but hang in there.)   The Greek Government cannot simply create new money to cover its budgetary shortfall.  So it borrows the money by selling bonds.  The bonds are (either directly or indirectly) purchased by banks.  These banks then go to the ECB and ask for a loan.  The ECB accepts the Greek government bonds as collateral and credits Euros to the banks' accounts.  Where did this money come from?  It comes from a big, black hole of nothingness.  It is simply brought into existence by the recording of Euros in the banks' accounts.

Bagus also illustrated another difference.  The Treaty of Maastricht said that no bail-outs are allowed.  If a government overexpands and cannot meet its spending "obligations" then that's its own problem.  The national governments were allowed deficits of no more than 3% of GDP and Total Debt to not be greater than 60% of GDP.  Clearly, politicians care little about such restrictions.  

Today's situation reminds me of the addage that if you borrow $1 million from your banker and cannot pay if back, you are in trouble.  However, if you borrow $1 billion from your banker and cannot pay it back, then he is in trouble! 

No one who agreed to the treaty should have been under any illusion that these clauses would have been tossed aside in the midst of a crisis.  Austrian (or any decent economic) insight into the incentives of a crisis should have led one to this conclusion.  Bagus takes a slightly different approach to this analysis.
 
Bagus argues that the Euro Zone is analagous to the Tragedy of the Commons.  Since each country can run a deficit, and then monetize it, they will exploit the "common" value of the currency before others can.  Some governments spend more than their revenue and cover the deficit spending with bonds.  The governments that run deficits are able to exploit the "commons."  The value of the common resource, the Euro, is diminished for the rest of the users of the Euro. 

The analogy is a bit of a stretch.  The problem with the commons analogy is that "the commons" are unowned resources.  When a fisherman catches a fish, he is privatizing it for his own use.  The "Tragedy" is that the resource is overused and depleted.  The problem with this analogy is that all of the money is always owned by someone.  There is not some unowned resource, a pool of value, that then gets exploited when the Greek government runs a deficit.  I see what Bagus is trying to do, which is argue that the first to print new money is the winner.  But if this is the case, why not just make the standard Austrian non-neutral money argument and be done with it?  I think that making the argument on the grounds of non-neutral money is better because it is direct.  However, perhaps, Bagus' approach opens Austrian insights and arguments to an audience that otherwise would reject the Austrians out-of-hand. 

A conclusion that falls out of this analysis is that Greece will not reduce its deficit.  It has no incentive t0 do so.  It has been benefitting from the monetary might (stability) of other countries, such as Germany.  As a result, the Germans are upset with the Greek.  (See Chapter 9)  Will it lead to the collapse of the common market, balkanization, or even war?  Unfortunately, that is a question that cannot be answered.

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There is another point on theory that I think needs to be addressed. I think that Bagus is conflating the property rights argument in money production with that of some right to a value of money. In Chapter 8, Bagus contends that money production has external effects, and that the costs and benefits to money production are skewed due to these external effects. So far so good.

However, now he states, "Private gold money with clearly defined property rights was replaced by public fiat money. This money monopoly itself implies a violation of property rights." (p. 79) Hmmm… The problem is that in one sense this is true, but there is a second sense where it is not true. In the first sense, when we switch to a fiat money system, I can no longer demand gold in exchange for my labor services. Thus, this law violates my ability to freely contract on my own terms. However, the negative externality of the loss of value of the gold-in-my-pocket due to demonetization is not a violation of property rights. Nor is it a violation of property rights when there is monetary expansion that leads to a loss in purchasing power for the dollars-in-my-pocket. As my friends who deny intellectual property rights are fond of pointing out, there is no right to the value of anything. All value is subjective.

I think that Bagus is leaning toward the second sense when he says, "By giving fiat money a privileged position and by monopolizing its production, property rights in money are not defended and the costs of money production are partially forced upon other actors." (p. 79)

It would have been better if Bagus stuck to the traditional Hoppean/Rothbardian property rights argument that says that fractional reserve banking assigns the right of the same dollar to two different individuals. but he doesn’t. Instead, Bagus goes after Selgin and White, in footnote #8, for missing the property rights argument. He states that they “do not see any property rights violation in the issuance of fiduciary media.” Then, in addition to citing Hoppe, Hülsmann and Block, he cites entirety of the nearly 900 page book Money, Bank Credit, and Economic Cycles by Jesús Huerta de Soto. Why relegate such an important, and unproven, assertion to a footnote? The way I see it, expanding the money supply, even if it is 100% pure fiat money, is not a violation of my property rights. To claim otherwise means that I have a right to the value of my money, which is simply untrue.

Regardless, I think that the property rights argument is weak and a better case against fiat money and a central bank can be made on pure economic grounds.

Next, I want to address Bagus’ discussion of the "quality" of money, pages 79-80. This line of reasoning makes sense when a country is on a pure commodity standard, but makes little sense when we are talking about fiat money, which is only exchange value. If he simply means seigniorage, then okay, why not just say that? But if he is making a larger assertion, he needs to come out and say what he means and then differentiate it from seigniorage. Especially puzzling are statements like, “In contrast to fiat paper situations, where an increase in the supply of money dilutes the quality of the currency, there is no dilution in the quality of the currency by gold mining.” (p. 80.) He is using “quality” to mean “purchasing power” the first time, but means “percentage of content” in the second. Puzzling and troubling, indeed.

Finally, Bagus misses the big reason there is a check on the overexpansion of the money supply (beyond extent of the money multiplier) in a free banking system. The threat of bankruptcy in a free banking system does not have to come from a bank trying to drive a competitor into the ground. (See pages 83-84.) As Rothbard demonstrates in The Mystery of Banking (Chapter 8, page 114+), we can suppose that all economic actors are fully wanting fractional reserve banking to expand as much as they can. The check on bank expansion comes from the fact that some people have deposits at different banks. Suppose that I bank at Bank A and you bank at Bank B. When I get a check from you, I will deposit that check in my bank so I can access the funds. When I do so, Bank A asks Bank B for the money. That's the check against infinite bank expansion. Bank B had better have the money available for my bank and me or it will go out-of-business. The check is not because a bank might be trying to drive its competitor out of business, instead the check comes from the fact that I want to access my money from my bank.

Overall, it was a good discussion and a good beginning to another semester of thoughtful Austrian Economic Analysis. The next session will cover the idea of using artificial intelligence as an analogue for economic theorizing. The session that follows that will cover The Calculus of Consent by Buchanan and Tullock.