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Cyprus and the Unraveling of Fractional-Reserve Banking – Article by Joseph T. Salerno

Cyprus and the Unraveling of Fractional-Reserve Banking – Article by Joseph T. Salerno

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The New Renaissance Hat
Joseph T. Salerno
March 30, 2013
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[Originally posted on Circle Bastiat, the faculty blog of the Mises Institute. Read Circle Bastiat for Austrian analysis of current economic events from today’s top Misesian and Rothbardian economists.]

The “Cyprus deal” as it has been widely referred to in the media may mark the next to last act in the the slow motion collapse of fractional-reserve banking that began with the implosion of the savings-and-loan industry in the U.S. in the late 1980s.

This trend continued with the currency crises in Russia, Mexico, East Asia, and Argentina in the 1990s in which fractional-reserve banking played a decisive role. The unraveling of fractional-reserve banking became visible even to the average depositor during the financial meltdown of 2008 that ignited bank runs on some of the largest and most venerable financial institutions in the world. The final collapse was only averted by the multi-trillion dollar bailout of U.S. and foreign banks by the Federal Reserve.

Even more than the unprecedented financial crisis of 2008, however, recent events in Cyprus may have struck the mortal blow to fractional-reserve banking. For fractional-reserve banking can only exist for as long as the depositors have complete confidence that regardless of the financial woes that befall the bank entrusted with their “deposits,” they will always be able to withdraw them on demand at par in currency, the ultimate cash of any banking system.

Ever since World War Two governmental deposit insurance, backed up by the money-creating powers of the central bank, was seen as the unshakable guarantee that warranted such confidence. In effect, fractional-reserve banking was perceived as 100-percent banking by depositors, who acted as if their money was always “in the bank” thanks to the ability of central banks to conjure up money out of thin air (or in cyberspace).

Perversely the various crises involving fractional-reserve banking that struck time and again since the late 1980s only reinforced this belief among depositors, because troubled banks and thrift institutions were always bailed out with alacrity—especially the largest and least stable. Thus arose the “too-big-to-fail doctrine.” Under this doctrine, uninsured bank depositors and bondholders were generally made whole when large banks failed, because it was widely understood that the confidence in the entire banking system was a frail and evanescent thing that would break and completely dissipate as a result of the failure of even a single large institution.

Getting back to the Cyprus deal, admittedly it is hardly ideal from a free-market point of view. The solution in accord with free markets would not involve restricting deposit withdrawals, imposing fascistic capital controls on domestic residents and foreign investors, and dragooning taxpayers in the rest of the Eurozone into contributing to the bailout to the tune of 10 billion euros.

Nonetheless, the deal does convey a salutary message to bank depositors and creditors the world over. It does so by forcing previously untouchable senior bondholders and uninsured depositors in the Cypriot banks to bear part of the cost of the bailout. The bondholders of the two largest banks will be wiped out and it is reported that large depositors (i.e., those holding uninsured accounts exceeding 100,000 euros) at the Laiki Bank may also be completely wiped out, losing up to 4.2 billion euros, while large depositors at the Bank of Cyprus will lose between 30 and 60 percent of their deposits. Small depositors in both banks, who hold insured accounts of up to 100,000 euros, would retain the full value of their deposits.

The happy result will be that depositors, both insured and uninsured, in Europe and throughout the world will become much more cautious or even suspicious in dealing with fractional-reserve banks. They will be poised to grab their money and run at the slightest sign or rumor of instability. This will induce banks to radically alter the sources of the funds they raise to finance loans and investments, moving away from deposit and toward equity and bond financing. As was reported Tuesday, March 26, this is already expected by many analysts:

One potential spillover from the March 26 agreement is the knock-on effects for bank funding, analysts said. Banks typically fund themselves with some combination of deposits, equity, senior and subordinate notes and covered bonds, which are backed by a pool of high-quality assets that stay on the lender’s balance sheet.

The consequences of the Cyprus bailout could be that banks will be more likely to use contingent convertible bonds—known as CoCos—to raise money as their ability to encumber assets by issuing covered bonds reaches regulatory limits, said Chris Bowie at Ignis Asset Management Ltd. in London.

“We’d expect to see some deposit flight and a shift in funding towards a combination of covered bonds, real equity and quasi-equity,” said Bowie, who is head of credit portfolio management at Ignis, which oversees about $110 billion.

If this indeed occurs it will be a significant move toward a free-market financial system in which the radical mismatching of the maturities of assets and liabilities in the case of demand deposits is eliminated once and for all. A few more banking crises in the Eurozone—especially one in which insured depositors are made to participate in the so-called “bail-in”—will likely cause the faith in government deposit insurance to completely evaporate and with it confidence in the fractional-reserve banking system.

There may then naturally arise on the market a system in which equity, bonds, and genuine time deposits that cannot be redeemed before maturity become the exclusive sources of finance for bank loans and investments. Demand deposits, whether checkable or not, would be segregated in actual deposit banks which maintain 100-percent reserves and provide a range of payments systems from ATMs to debit cards.

While this conjecture may be overly optimistic, we are certainly a good deal closer to such an outcome today than we were before the “Cyprus deal” was struck. Of course we would be closer still if there were no bailout and the full brunt of the bank failures were borne solely by the creditors and depositors of the failed banks rather than partly by taxpayers. The latter solution would have completely and definitively exposed the true nature of fractional-reserve banking for all to see.

Joseph Salerno is academic vice president of the Mises Institute, professor of economics at Pace University, and editor of the Quarterly Journal of Austrian Economics. He has been interviewed in the Austrian Economics Newsletter and on Mises.org. Send him mail. See Joseph T. Salerno’s article archives.

The Deflationary Spiral Bogey – Article by Robert Blumen

The Deflationary Spiral Bogey – Article by Robert Blumen

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The New Renaissance Hat
Robert Blumen
February 23, 2013
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What is deflation? According to dictionary.com, it is “a fall in the general price level or a contraction of credit and available money.”

Falling prices. That sounds good, especially if you have set some cash set aside and are thinking about a major purchase.

But as some additional research with Google would seem to demonstrate, that would be a naïve and simple-minded conclusion. According to received wisdom, deflation is a serious economic disease. As the St. Louis Fed would have us believe,

While the idea of lower prices may sound attractive, deflation is a real concern for several reasons. Deflation discourages spending and investment because consumers, expecting prices to fall further, delay purchases, preferring instead to save and wait for even lower prices. Decreased spending, in turn, lowers company sales and profits, which eventually increases unemployment.

The problem with deflation, then, is that it feeds on itself, destroying the economy along the way. It is the macro equivalent of a roach motel: perilously easy to enter but impossible to leave. The problem, you see, is that deflation reduces consumption, which reduces production, eventually shutting down all economic activity.

Wikipedia explains it this way:

Because the price of goods is falling, consumers have an incentive to delay purchases and consumption until prices fall further, which in turn reduces overall economic activity. Since this idles the productive capacity, investment also falls, leading to further reductions in aggregate demand. This is the deflationary spiral.

Deflation is far worse than its counterpart, inflation, because the Fed can fight inflation by raising interest rates. Deflation is nearly impossible to stop once it has started because interest rates can only be cut to zero, no lower. For this reason, “The Ben Bernank” believes that monetary policy should be biased toward preventing deflation more than preventing inflation.

Economist Mark Thornton cites the prominent New York Times blogger Paul Krugman who compares deflation to a black hole, a type of astrophysical object whose gravitational field is so strong that no matter or energy that comes near it can escape. Krugman writes,

… the economy crosses the black hole’s event horizon: the point of no return, beyond which deflation feeds on itself. Prices fall in the face of excess capacity; businesses and individuals become reluctant to borrow, because falling prices raise the real burden of repayment; with spending sluggish, the economy becomes increasingly depressed, and prices fall all the faster.

In case you’re not already scared straight, the deflationary doomsday has already happened in America when (according to the New York Times) it caused the Great Depression.

Japan, according to Bloomberg “has been battling deflation for more than a decade, with the average annual 0.3 percent decline in prices since 2000 damaging economic growth.” The New York Times reports that Japan’s new prime minister Abe “has galvanized markets by encouraging bold monetary measures to beat deflation.”

I hope that everyone is clear on this.

Now that you understand the basics, I have some questions for the people who came up with this stuff.

Why do falling prices make people expect falling prices?

The observation that prices are falling, means that in the recent past, prices have fallen.

One person noticing that the price of a good, that appears somewhere on their value scale has fallen for some time, might interpret that information and conclude that in the future, the price of that good will be lower. But a second individual might see the same thing and expect the price to level off and stay where it is, and a third might interpret falling prices as an indicator that in the future prices will be higher.

Why should a price having fallen indicate that it will continue to fall? That is only one of three possible future trends. Why should past trends continue indefinitely?

Why will the public mainly choose the first of these three outlooks, more than the other two?

According to economist Jeffrey Herbener, the assumption that falling prices create expectations of more of the same is a feature of certain popular macroeconomic theories in which price expectations are modeled as part of the theory. In his testimony to Congress, Herbener observes that “the downward spiral of prices is merely the logical implication of assumptions about expectations within formal economic models. If you assume that the agents operating in an economic model suffer from expectations that are self-reinforcing, then the model will produce a downward spiral.”

Are expectations self-reinforcing? It would make just as much sense to say that expectations are self-reversing—after people have seen prices go down for a while, they will expect prices to go up.

Are these formal models a good description of human action? Contrary to what these models say, there is no fixed response to an event. In my own experience, I can think of many times I, or someone that I know, jumped on a low price because we did not expect the opportunity to last.

But what about wages?

The postponement theory depends on the assumption that a fall in prices will benefit buyers who wait. This is true if we are talking about people who have lots of cash and can sit on it indefinitely. But most of us have ongoing monthly expenses and we depend on our wages to replenish our cash reserves. Our purchasing power, at the time when we want to make a delayed purchase, comes from our cash savings and our wages. A fall in wages, if substantial, would wipe out any gains in purchasing power realized from lower prices.

If consumers do not buy today because they expect lower prices tomorrow, then what are their expectations about their wages? Do they anticipate that their wages will be the same, higher, or lower? If lower, then by how much? As much as prices have fallen?

If consumers forecast lower prices and stable wages, then why are consumer prices included in the models, but wages are not? Does deflation only affect consumer goods prices, leaving all other prices untouched?

According to the deflationary death spiral theory, decisions not to buy drag the economy into a death spiral. Does anyone expect that could happen without affecting wages?

And what about asset prices?

In addition to cash savings and wages, individuals decide how much to spend and save taking into account the amount that they have already saved. Someone who is trying to save to meet their family’s future needs will feel less comfortable about spending.

Most people hold some of their savings in cash. That portion of their savings increases in purchasing power when prices fall. But people also save by purchasing financial assets, such as stocks and bonds, or real assets such as property, and rental housing. All of these assets have a price, which could rise or fall. Depending on the mix of cash and other assets that an individual holds, a fall in asset prices could wipe out any gains in purchasing power from the cash portion of their savings.

Do people take value of their past savings into account when deciding whether to buy or wait? Or do people form expectations about consumer prices only and ignore what might happen to their savings in a deflation?

If falling consumer prices generate expectations of more of the same, what impact do falling prices have on expectations about asset prices? Do buyers who delay purchases expect the prices of their saved assets to be lower as well? If not, then do they expect that consumer prices will be lower and asset prices will be higher?

If deflation causes the economy to disintegrate, will asset prices be spared?

Is it only buying behavior that is affected?

The deflation death star begins to destroy the earth when buying is postponed.

But is it only buying that is affected by expectations about the future? If buying is affected but not selling, then why not?

If consumers expect lower prices of most things, including things that they already own, it is equally logical that they would sell their possessions and their assets in order to buy them back later at a lower price. Selling your home and renting a similar one would be the place to start. Selling your car and leasing would be the next step. Finally, selling your assets for cash would be equally profitable. Expectations of lower prices should lead to a spiral of selling, driving prices down even faster, leading to more deflationary expectations and more selling until everyone has no possessions and no assets other than cash.

If this happened, then who would buy?

Do prices ever get low enough?

If buyers expect lower prices, then how much lower? Any number in particular? If a buyer expects a specific lower price, and the price reaches that level, will he buy? Or does he always expect prices to go even lower than they are today, no matter how far they have fallen already?

If expectations of lower prices turn out to be correct, and prices drop to even lower levels, then is there any point where a minority of contrarian buyers defect from the consensus and begin to see a bottom, or even an uptrend? Or do these expectations go on forever adapting to lower prices causing prices to drop indefinitely?

The point of delaying a purchase is so that you can make the purchase in the future and have some additional cash left over to make another purchase or to save. What is the point of delaying a purchase that you never make?

We have all had the experience of buying a new computer, or some other device, the day before the next version was released and it costs less and does more. If you knew would you have waited? Maybe, but maybe not. If you need a computer for work, then you will buy it sooner rather than later.

Many people delayed their purchase of the iPhone 4 in order to buy the iPhone 5, then when available they bought the iPhone 5. My iPhone4 was worn out by that time and I needed a new phone.

What about the Law of Demand?

According to the law of demand, a greater quantity of a good is demanded at a lower price than at a higher price. If that were true, then people would buy more, rather than postponing purchases.

What happens to the law of demand in a deflation? It turns out that the law of demand has a loophole: it requires that all other things remain equal. In a deflation death spiral, all things are not equal. Consumer preferences change in response to prices. Stationary supply and demand curves do not exist in such a world. For prices to fall and yet still fail to induce buyers to buy, the quantity demanded must always fall by more than enough to compensate for the lower asking price. The demand curve is always shifting downward faster than the price falls, to prevent an equilibrium price from ever forming. Economist W. H. Hutt calls this “an infinitely elastic demand for money.”

Does this describe the world that we live in, or any world that we could imagine? Do people really react in such a mechanical way to price changes? How do we explain, for example, shoppers competing to buy at low prices?

Why do sellers not lower prices?

Why is it only buyers whose expectations of lower prices are based on falling prices? Are the expectations of sellers included in the model?

If not, is that because the models assume that sellers do not have expectations? Or do the expectations of sellers not match the expectations of buyers?

If sellers have the expectations of lower prices, why do they not lower their prices immediately in order to sell inventory ahead of their competitors?

According to the deflation spiral theory, expectations frustrate market clearing. Yet, as Rothbard argues, speculation about future prices helps prices to converge to market clearing values. If buyers and sellers both expect future prices to be lower, why do market prices not converge upon this new, lower level immediately?

If customers are postponing purchases expecting lower prices in the future, but sellers do not cooperate, then inventories will accumulate. If this began to happen, then why would sellers not lower their prices immediately in order to clear out inventories?

All of us are both buyers and sellers, of different things at different times. To say that only the expectations of buyers are affected by falling prices, is to say that the same person, early in the day, has expectations about his own future purchases, but later the same day, does not have expectations about his own current and future sales. Does the model assume that we have all been lobotomized so the two sides of our brain do not communicate with each other?

Do producers have any control over their costs?

Previously, I asked if sellers could anticipate lower prices as well as buyers. If the producers anticipated lower prices, why did they go ahead and produce the item, or order raw materials with such high costs that they could not make a profit?

If a single business firm is experiencing fewer sales, they may not be able to reduce their costs because a single firm is close to being a price taker in the markets for labor and capital. There are usually alternative uses for their factors that value them more highly, at or close to current prices. But if prices, and sales are falling everywhere, or if everyone expects this to be the case, then why will suppliers not lower their prices if they expect their costs to be lower?

What are people doing with the money that they did not spend?

Suppose that people postpone spending. What do they do with the money they did not spend? Are they increasing their cash holdings? Or are they spending on investment goods? Saving and investing is a form of spending, only the expenditure is for capital goods rather than consumer goods. In this case, there would be no general decline in total spending or employment. Workers would have to change jobs from the consumption industries to capital goods industries, as Hayek explains in his essay “The Paradox of Savings”; but production would continue during the transition.

How much lower prices are necessary to induce people to postpone purchases?

There is a return on the purchase of a consumption good that results in the services provided by the good. This must be balanced against the return on the cash by holding until prices are lower. As noted by the Center for Economic Policy Research (CEPR), a small price change is not much of a motivation to wait, if you need a new product:

[postponement of purchases] would be true for rapid rates of deflation, but Japan’s deflation has almost always been less than 1.0 percent a year. In 2011 its inflation rate was -0.2 percent. This means that if someone was considering buying a $20,000 car, they could save $40 by waiting a year. It is unlikely that this rate of deflation affected the timing of many purchases to any significant extent.

Why do quantities adjust but not costs?

If there is a generalized increase in money demand, then prices need to adjust downward. Why is it that all the quantity of goods bought and the quantity of labor employed can adjust, but prices cannot?

According to The Asia Times, when deflation strikes, factories lay workers off in order to cut costs. Why cannot producers lower their bid prices to their labor force and their suppliers in order to preserve production? If they could lower their costs, then they could produce profitably at a lower price level.

The general price level does not matter to business firms, so long as their costs are below their sale prices. Why does a deflationary meltdown assume that business can not operate profitably at any nominal price level? Why can business not lower costs?

Is this really what caused the Great Depression?

What about the credit bubble of the 1920s?

What about bank failures? The great contraction of the money supply?

The Smoot-Hawley tarrif?

What about regime uncertainty?

How about New Deal wage and price policies that prevented prices from falling, which would have allowed employment to recover?

Conclusion

The deflation death spiral is a theoretical description of a situation but it does not describe the reality of human action, for any number of reasons:

1. There is in reality always a diversity of expectations among the public. While some people will expect prices to continue in the same direction, others will form the opposite view. Everyone’s expectations will change not only in response to changes in the data, but taking into account their entire life experience, their own ideas, and their situation.

2. Expectations are not entirely driven by prices. A broad range of things influences our expectations about price.

3. Lower prices are not always sufficient motivation to delay purchases because everyone prefers to have what they want now, rather than later.

4. Expectations of buyers tend to be met by sellers, if not at first, then fairly soon. In some cases, buyers can hold onto their cash for a bit longer, but most businesses have no choice but to sell their inventories at what the buyer will pay. In other cases, buyers may not be able to delay purchases, or may not wish to, and will pay what they must in order to buy.

5. Everyone—buyers and sellers (and every one of us acts in both of these roles at different times)—has expectations not only about consumer prices, but about wages, employment prospects, even asset prices, the economy in general, the progress of our own life, and the future of our family. A coherent plan of saving and spending takes all of these things into account.

6. Expectations can be met. Buyers have a buying price. Even if not known in advance, they know it when they see it posted. Even if they do not know what they plan to buy in the future, a bargain price will be met by buyers.

7. People only need so much cash. Beyond that, they start to look around for either consumption goods, or investments.

Robert Blumen is an independent enterprise software consultant based in San Francisco. Send him mail. See Robert Blumen’s article archives.

This article was published on Mises.org and may be freely distributed, subject to a Creative Commons Attribution United States License, which requires that credit be given to the author.

Where Is the Inflation? – Article by Mark Thornton

Where Is the Inflation? – Article by Mark Thornton

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The New Renaissance Hat
Mark Thornton
January 30, 2013
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Critics of the Austrian School of economics have been throwing barbs at Austrians like Robert Murphy because there is very little inflation in the economy. Of course, these critics are speaking about the mainstream concept of the price level as measured by the Consumer Price Index (i.e., CPI).

Let us ignore the problems with the concept of the price level and all the technical problems with CPI. Let us further ignore the fact that this has little to do with the Austrian business cycle theory (ABCT), as the critics would like to suggest. The basic notion that more money, i.e., inflation, causes higher prices, i.e., price inflation, is not a uniquely Austrian view. It is a very old and commonly held view by professional economists and is presented in nearly every textbook that I have examined.

This common view is often labeled the quantity theory of money. Only economists with a Mercantilist or Keynesian ideology even challenge this view. However, only Austrians can explain the current dilemma: why hasn’t the massive money printing by the central banks of the world resulted in higher prices.

Austrian economists like Ludwig von Mises, Benjamin Anderson, and F.A. Hayek saw that commodity prices were stable in the 1920s, but that other prices in the structure of production indicated problems related to the monetary policy of the Federal Reserve. Mises, in particular, warned that Fisher’s “stable dollar” policy, employed at the Fed, was going to result in severe ramifications. Absent the Fed’s easy money policies of the Roaring Twenties, prices would have fallen throughout that decade.

So let’s look at the prices that most economists ignore and see what we find. There are some obvious prices to look at like oil. Mainstream economists really do not like looking at oil prices, they want them taken out of CPI along with food prices, Ben Bernanke says that oil prices have nothing to do with monetary policy and that oil prices are governed by other factors.

As an Austrian economist, I would speculate that in a free market economy, with no central bank, that the price of oil would be stable. I would further speculate, that in the actual economy with a central bank, that the price of oil would be unstable, and that oil prices would reflect monetary policy in a manner informed by ABCT.

That is, artificially low interest rates generated by the Fed would encourage entrepreneurs to start new investment projects. This in turn would stimulate the demand for oil (where supply is relatively inelastic) leading to higher oil prices. As these entrepreneurs would have to pay higher prices for oil, gasoline, and energy (and many other inputs) and as their customers cut back on demand for the entrepreneurs’ goods (in order to pay higher gasoline prices), some of their new investment projects turn from profitable to unprofitable. Therefore, you should see oil prices rise in a boom and fall during the bust. That is pretty much how things work as shown below.

As you can see, the price of oil was very stable when we were on the pseudo Gold Standard. The data also shows dramatic instability during the fiat paper dollar standard (post-1971). Furthermore, in general, the price of oil moves roughly as Austrians would suggest, although monetary policy is not the sole determinant of oil prices, and obviously there is no stable numerical relationship between the two variables.

Another commodity that is noteworthy for its high price is gold. The price of gold also rises in the boom, and falls during the bust. However, since the last recession officially ended in 2009, the price of gold has actually doubled. The Fed’s zero interest rate policy has made the opportunity cost of gold extraordinarily low. The Fed’s massive monetary pumping has created an enormous upside in the price of gold. No surprise here.

Actually, commodity prices increased across the board. The Producer Price Index for commodities shows a similar pattern to oil and gold. The PPI-Commodities was more stable during the pseudo Gold Standard with more volatility during the post-1971 fiat paper standard. The index tends to spike before a recession and then recede during and after the recession. However, the PPI-Commodity Index has returned to all-time record levels.

High prices seem to be the norm. The US stock and bond markets are at, or near, all-time highs. Agricultural land in the US is at all time highs. The Contemporary Art market in New York is booming with record sales and high prices. The real estate markets in Manhattan and Washington, DC, are both at all-time highs as the Austrians would predict. That is, after all, where the money is being created, and the place where much of it is injected into the economy.

This doesn’t even consider what prices would be like if the Fed and world central banks had not acted as they did. Housing prices would be lower, commodity prices would be lower, CPI and PPI would be running negative. Low-income families would have seen a surge in their standard of living. Savers would get a decent return on their savings.

Of course, the stock market and the bond market would also see significantly lower prices. Bank stocks would collapse and the bad banks would close. Finance, hedge funds, and investment banks would have collapsed. Manhattan real estate would be in the tank. The market for fund managers, hedge fund operators, and bankers would evaporate.

In other words, what the Fed chose to do ended up making the rich, richer and the poor, poorer. If they had not embarked on the most extreme and unorthodox monetary policy in memory, the poor would have experienced a relative rise in their standard of living and the rich would have experienced a collective decrease in their standard of living.

There are other major reasons why consumer prices have not risen in tandem with the money supply in the dramatic fashion of oil, gold, stocks and bonds. It would seem that the inflationary and Keynesian policies followed by the US, Europe, China, and Japan have resulted in an economic and financial environment where bankers are afraid to lend, entrepreneurs are afraid to invest, and where everyone is afraid of the currencies with which they are forced to endure.

In other words, the reason why price inflation predictions failed to materialize is that Keynesian policy prescriptions like bailouts, stimulus packages, and massive monetary inflation have failed to work and have indeed helped wreck the economy.

Mark Thornton is a senior resident fellow at the Ludwig von Mises Institute in Auburn, Alabama, and is the book-review editor for the Quarterly Journal of Austrian Economics. He is the author of The Economics of Prohibition, coauthor of Tariffs, Blockades, and Inflation: The Economics of the Civil War, and the editor of The Quotable Mises, The Bastiat Collection, and An Essay on Economic Theory. Send him mail. See Mark Thornton’s article archives.

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Copyright © 2013 by the Ludwig von Mises Institute. Permission to reprint in whole or in part is hereby granted, provided full credit is given.

Review of Gary Wolfram’s “A Capitalist Manifesto” – Article by G. Stolyarov II

Review of Gary Wolfram’s “A Capitalist Manifesto” – Article by G. Stolyarov II

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The New Renaissance Hat
G. Stolyarov II
January 5, 2013
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While Dr. Gary Wolfram’s A Capitalist Manifesto is more an introduction to economics and economic history than a manifesto, it communicates economic concepts in a clear and entertaining manner and does so from a market-friendly point of view. Wolfram’s strengths as an educator stand out in this book, which could serve as an excellent text for teaching basic microeconomics and political economy to all audiences. Wolfram is a professor of economics at Hillsdale College, whose course in public-choice economics I attended. The book’s narration greatly resembles my experience of Wolfram’s classroom teaching, which focuses on the essence of an idea and its real-world relevance and applications, often utilizing entertaining concrete examples.

The book begins with several chapters on introductory microeconomics – marginal analysis, supply, demand, market equilibrium, opportunity cost, and the effects of policies that artificially prevent markets from clearing. The middle of the book focuses on economic history and political economy – commenting on the development of Western markets from the autarkic, manorial system of the feudal Middle Ages, through the rise of commerce during the Early Modern period, the Industrial Revolution, the emergence of corporations, and the rise in the 20th century of economic regimentation by national governments. One of the strengths of this book is its treatment of the benefits of free trade, from its role in progress throughout history to the theoretical groundwork of Ricardian comparative advantage. Enlightening discussions of constitutionalism and the classical idea of negative liberty are also provided. Wolfram introduces the insights of Ludwig von Mises regarding the infeasibility of central planning in solving the problem of economic calculation, as well as Friedrich Hayek’s famous “knowledge problem” – the dispersion of information among all the individuals in an economy and the impossibility of a central planner assembling all the information needed to make appropriate decisions. Wolfram further articulates the key insights of Frederic Bastiat: the seen versus the unseen in economic policy, the perils of coercive redistribution of wealth, the immorality of using the law to commit acts which would have been unacceptable if done by private individuals acting alone, and the perverse incentives created by a system where the government is able to dispense special privileges to a select few.

The latter third of the book focuses on such areas as money, inflation, and macroeconomics – including an exposition of the Keynesian model and its assumptions. Wolfram is able to explain Keynesian economics in a more coherent and understandable manner than most Keynesians; he thoroughly understands the theories he critiques, and he presents them with fairness and objectivity. I do, however, wish that the book had delved more thoroughly into a critique of Keynesianism. The discussion therein of the Keynesian model’s questionable assumptions is a good start, and perhaps a gateway to more comprehensive critiques, such as those of Murray Rothbard and Robert Murphy. A layperson reading A Capitalist Manifesto would be able to come out with a fundamental understanding of Keynes’s central idea and its assumptions – but he would not, solely as a result of this book, necessarily be able to refute the arguments of Keynes’s contemporary followers, such as Joseph Stiglitz and Paul Krugman. Wolfram mentions critiques of Keynesianism by Milton Friedman and the monetarist school, the concept of rational expectations precipitating a move away from Keynesianism in the late 1970s, and the “supply-side” interpretations of the Keynesian model from the 1980s. However, those viewpoints are not discussed in the same level of detail as the basic Keynesian model.

More generally, my only significant critique of A Capitalist Manifesto is that it is too brief in certain respects. It offers promising introductions to a variety of economic ideas, but leaves some significant questions arising from those areas unanswered. Wolfram introduces the history and function of the corporation but does not discuss the principal-agent problem in large, publicly traded firms with highly dispersed ownership. To anticipate and answer (and perhaps partially acknowledge the validity of) criticisms of the contemporary corporate form of organization, commentary on how this problem might be overcome is essential. Wolfram explains the components and computation of Gross Domestic Product and the Consumer Price Index but devotes only a small discussion to critiques of these measures – critiques that are particularly relevant in an electronic age, when an increasing proportion of valuable content – from art to music to writing to games – is delivered online at no monetary cost to the final consumer. How can economic output and inflation be measured and meaningfully interpreted in an economy characterized partially by traditional money-for-goods/services transactions and partially by the “free” content model that is funded through external sources (e.g., donations or the creators’ independent income and wealth)? Moreover, does Wolfram’s statement that the absence of profit (sufficient to cover the opportunity cost) would result in the eventual decline of an enterprise need to be qualified to account for new models of delivering content? For instance, if an individual or firm uses one income stream to support a different activity that is not itself revenue- or profit-generating, there is a possibility for this arrangement to be sustainable in the long term if it is also justified by perceived non-monetary value.

Wolfram’s discussion of inflation is correct and forms a strong link between inflation and the quantity of money (government-issued fiat money these days) – but I would have wished to see a more thorough focus on Ludwig von Mises’s insight that new money does not enter the economy to equally raise everybody’s incomes simultaneously; rather, the distortion due to inflation comes precisely from the fact that some (the politically favored) receive the new money and can benefit from using it while prices have not yet fully adjusted. (This can be logically inferred from Wolfram’s discussion of some of the “tools” of the Federal Reserve, which directly affect the incomes of politically connected banks – but I wish the connection to Mises’s insight had been made more explicit.) Wolfram does mention that inflation can be a convenient tool for national governments to reduce their debt burdens, and he also discusses the inflationary role of fractional-reserve banking and “tools” available to central banks such as the Federal Reserve. However, Wolfram’s proposed solutions to the problems of inflation remain unclear from the text. Does he support Milton Friedman’s proposal for a fixed rate of growth in the fiat-money supply, or does he advocate a return to a classical gold standard – or perhaps to a system of market-originated competing currencies, as proposed by Hayek? It would also have been interesting to read Wolfram’s thoughts on the prospects and viability of peer-to-peer and digital currencies, such as Bitcoin, and whether these could mitigate some of the deleterious effects of central-bank-generated inflation.

Wolfram does discuss in some detail the sometimes non-meritocratic outcomes of markets – stating, for instance, that “boxers may make millions of dollars while poets make very little.” Indeed, it is possible to produce far more extreme comparisons of this sort – e.g., a popular “star” with no talent or sense earning millions of dollars for recording-studio-hackneyed “music” while genuinely talented classical musicians and composers might earn relatively little, or even have their own work remain a personal hobby pursued for enjoyment alone. To some critics of markets, this may well be the reason to oppose them and seek some manner of non-market compensation for people of merit. For a defender of the unhampered market economy, a crucial endeavor should be to demonstrate that truly free markets (unlike the heavily politicized markets of our time) can tend toward meritocracy in the long run, or at least offer people of merit a much greater range of possibilities for success than exists under any other system. Another possible avenue of exploration might be the manner in which a highly regimented political system (especially in the areas of education) might result in a “dumbed-down” culture which neglects and sometimes outright opposes intellectual and esthetic sophistication and the ethic of personal productivity which is indispensable to a culture that prizes merit. Furthermore, defenders of markets should continually seek out ways to make the existing society more meritocratic, even in the face of systemic distortions of outcomes. Technology and competition – both of which Wolfram correctly praises – should be utilized by liberty-friendly entrepreneurs to provide more opportunities for talented individuals to demonstrate their value and be rewarded thereby.

Wolfram’s engaging style and many valid and enlightening insights led me to desire more along the same lines from him. Perhaps A Capitalist Manifesto will inspire other readers to ask similar questions and seek more market-friendly answers. Wolfram provides a glossary of common economic terms and famous historical figures, as well as some helpful references to economic classics within the endnotes of each chapter.  A Capitalist Manifesto will have its most powerful impact if readers see it as the beginning of their intellectual journey and utilize the gateways it offers to other writings in economics and political economy.

Disclosure: I received a free copy of the book for the purposes of creating a review.

Iterative Learning versus the Student-Debt Trap – Video by G. Stolyarov II

Iterative Learning versus the Student-Debt Trap – Video by G. Stolyarov II

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Mr. Stolyarov explains why the structure of formal schooling does not teach the ways in which real achievements are attained. The worst obstacle to true, iterative learning is student debt that locks people into a particular path for most of their lives.

References
– “Iterative Learning versus the Student-Debt Trap” – Essay by G. Stolyarov II – The Rational Argumentator. This essay was originally published on the as a guest post on the “Education Bubble and Scam Report” website.
– “Reasons Not to Pursue a PhD” – Video by G. Stolyarov II
– “Advice for Most Recent High-School and College Graduates” – Video by G. Stolyarov II
– “Commonly Misunderstood Concepts: Education” – Video by G. Stolyarov II

Iterative Learning versus the Student-Debt Trap – Article by G. Stolyarov II

Iterative Learning versus the Student-Debt Trap – Article by G. Stolyarov II

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The New Renaissance Hat
G. Stolyarov II
December 18, 2012
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This article was originally published as a guest post on the “Education Bubble and Scam Report” website.
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Contemporary formal schooling inculcates a counterproductive and often stressful fallacy into millions of young people – particularly the best and brightest. The fallacy, which undermines the lives of many, is that, when it comes to learning, productivity, and achievement, you have to get it absolutely right the first time. Consider how grades are assigned in school. You complete an assignment or sit for a test – and if your work product is deficient in the teacher’s eyes, or you answer some questions incorrectly, your grade suffers. It does not matter if you learn from your mistakes afterward; the grade cannot be undone. The best you can do is hope that, on future assignments and tests, you do well enough that your average grade will remain sufficiently high. If it does not – if it takes you longer than usual to learn the material – then a poor grade will be a permanent blot on your academic record, if you care about such records. If you are below the age of majority and prohibited from owning substantial property or working for a living, grades may be a major measure of achievement in your eyes. Too many hits to your grades might discourage you or lead you to think that your future prospects are not as bright as you would wish.
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But this is not how the real world works. This is not how learning works. This is not how great achievements are attained. It took me years to figure this out. I was one of those students who insisted on always attaining the highest grades in everything. I graduated first in my class in high school (while taking honors and Advanced Placement courses whenever they were offered) and second in college – with three majors. In high school especially, I sometimes found the grading criteria to be rather arbitrary and subjective, but I spent considerable time preparing my work and myself to meet them. While I did engage in prolific learning during my high-school years, the majority of that learning occurred outside the scope of my classes and was the result of self-study using books and the Internet. Unfortunately, my autonomous learning endeavors needed to be crammed into the precious little free time I had, because most of my time was occupied by attempting to conform my schoolwork to the demanding and often unforgiving expectations that needed to be met in order to earn the highest grades. I succeeded at that – but only through living by a regimen that would have been unsustainable in the long term: little sleep, little leisure, constant tension, and apprehension about the possibility of a single academic misstep. Yet now I realize that, whether I had succeeded or failed at the game of perfect grades, my post-academic achievements would have probably been unaffected.
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How does real learning occur? It is not an all-or-nothing game. It is not about trying some task once and advancing if you succeed, or being shamed and despondent if you do not. Real learning is an iterative process. By a multitude of repetitions and attempts – each aiming to master the subject or make progress on a goal – one gradually learns what works and what does not, what is true and what is false. In many areas of life, the first principles are not immediately apparent or even known by anybody. The solution to a problem in those areas, instead of emerging by a straightforward (if sometimes time-consuming) deductive process from those first principles, can only be arrived at by induction, trial and error, and periodic adjustment to changing circumstances. Failure is an expected part of learning how to approach these areas, and no learning would occur in them if every failure were punished with either material deprivation or social condemnation.
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Of course, not all failures are of the same sort. A failure to solve a math problem, while heavily penalized in school, is not at all detrimental in the real world. If you need to solve the problem, you just try, try again – as long as you recognize the difference between success and failure and have the free time and material comfort to make the attempts. On the other hand, a failure to yield to oncoming traffic when making a left turn could be irreversible and devastating. The key in approaching failure is to distinguish between safe failure and dangerous failure. A safe failure is one that allows numerous other iterations to get to the correct answer, behavior, or goal. A dangerous failure is one that closes doors, removes opportunities, and – worst of all – damages life. Learning occurs best when you can fail hundreds, even thousands, of times in rapid succession – at no harm or minimal harm to yourself and others. In such situations, failure is to be welcomed as a step along the way to success. On the other hand, if a failure can take away years of your life – either by shortening your life or wasting colossal amounts of time – then the very approach that might result in the failure should be avoided, unless there is no other way to achieve comparable goals. As a general principle, it is not the possibility of success or failure one should evaluate when choosing one’s pursuits, but rather the consequences of failure if it occurs.
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Many contemporary societal institutions, unfortunately, are structured in a manner hostile to iterative learning. They rather encourage “all-in” investment into one or a few lines of endeavor – with uncertain success and devastating material and emotional consequences of failure. These institutions do not give second chances, except at considerable cost, and sometimes do not even give first chances because of protectionist barriers to entry. Higher education especially is pervaded by this problem.
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At a cost of tens of thousands of dollars per year, college is an enormous bet. Many think that, by choosing the right major and the right courses of study within it, they could greatly increase their future earning potential. For some, this works out – though they are a diminishing fraction of college students. If a major turns out not to be remunerative, there may be some satisfaction from having learned the material, and this may be fine – as long as it is understood that this is a costly satisfaction indeed. Some will switch majors during their time in college, but this is often in itself an extremely expensive decision, as it prolongs the time over which one must pay tuition. For those who can afford either non-remunerative or serial college majors out of pocket, there is the opportunity cost of their time – but that is not the worst that can happen.
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The worst fate certainly befalls those who finance their college education through student debt. This was a fate I happily avoided. I graduated college without having undertaken a penny of debt – ever – largely as a result of merit scholarships (and my choice of an institution that gave merit scholarships – a rarity these days). Millions of my contemporaries, however, are not so fortunate. For years hereafter, they will bear a recurring financial burden that will restrict their opportunities and push them along certain often stressful and unsustainable paths in life.
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Student debt is the great disruptor of iterative learning. Such debt is assumed on the basis of the tremendously failure-prone expectation of a certain future monetary return capable of paying off the debt. Especially in post-2008 Western economies, this expectation is unfounded – no matter who one is or how knowledgeable, accomplished, or productive one might be. Well-paying jobs are hard to come by; well-paying jobs in one’s own field of study are even scarcer. The field narrows further when one considers that employment should not only be remunerative, but also accompanied by decent working conditions and compatible with a comfortable standard of living that reflects one’s values and goals.
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Money is ultimately a means to life, not an end for its own sake. To pursue work that requires constant privation in other areas of life is not optimal, to say the least – but debt leaves one with no choice. There is no escape from student debt. Bankruptcy cannot annul it. One must keep paying it, to avoid being overwhelmed by the accumulated interest. Paying it off takes years for most, decades for some. By the time it is paid off (if it is), a lot of youth, energy, and vitality are lost. It follows some to the grave. If one pays it off as fast as possible, then one might still enjoy a sliver of that precious time window between formal education and senescence – but the intense rush and effort needed to achieve this goal limits one’s options for experimenting with how to solve problems, engage in creative achievement, and explore diverse avenues for material gain.
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If you are in heavy debt, you take what income you can get, and you do not complain; you put all of your energy into one career path, one field, one narrow facet of existence – in the hope that the immediate returns are enough to get by and the long-term returns will be greater. If you wish to practice law or medicine, or obtain a PhD, your reliance on this mode of living and its hoped-for ultimate consequences is even greater. You may defer the payoff of the debt for a bit, but the ultimate burden will be even greater. Many lawyers do not start to have positive financial net worth until their thirties; many doctors do not reach this condition until their forties – and this is the reality for those who graduated before the financial crisis and its widespread unemployment fallout. The prospects of today’s young people are even dimmer, and perhaps the very expectation of long-term financial reward arising from educational debt (or any years-long expensive formal education) is no longer realistic. This mode of life is not only stressful and uncertain; it comes at the expense of family relationships, material comfort, leisure time, and experimentation with diverse income streams. Moreover, any serious illness, accident, or other life crisis can derail the expectation of a steady income and therefore render the debt a true destroyer of life. Failure is costly indeed on this conventional track of post-undergraduate formal schooling.
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It may be difficult for many to understand that the conventionally perceived pathway to success is in fact one that exposes a person to the most dangerous sorts of failure. The best way forward is one of sustainable iterative work – a way that offers incremental benefits in the present without relying on huge payoffs in the future, all the while allowing enough time and comfort to experiment with life-improving possibilities at one’s discretion. Diversification is the natural companion of iteration. The more you try, the more you experiment, the more you learn and the more you can apply in a variety of contexts.
***
Having avoided the student-debt trap, I can personally attest to how liberating the experience of post-academic learning can be. Instead of pursuing graduate or professional school, I decided to take actuarial and other insurance-related examinations, where the cost of each exam is modest compared to a semester of college – and one can always try again if one fails. In the 3.5 years after graduating from college, I was able to obtain seven professional insurance designations, at a net profit to myself. I have ample time to try for more designations still. My employment offers me the opportunity to engage in creative work in a variety of capacities, and I focus on maximizing my rate of productivity on the job so as to achieve the benefits of iterative learning and avoid the stress of an accumulated workload. I could choose where I wanted to live, and had the resources to purchase a house with a sizable down payment. Other than a mortgage, which I am paying ahead of schedule, I have no debt of any sort. Even the mortgage makes me somewhat uncomfortable – hence my desire to pay it off as rapidly as possible – but every payment gets me closer to fully owning a large, tangible asset that I use every day. In the meantime, I already have a decent amount of time for leisure, exercise, independent study, intellectual activism, and family interactions.
***
My life, no doubt, has its own challenges and stresses; anyone’s situation could be better, and I can certainly conceive of improvements for my own – but I have the discretionary time needed to plan for and pursue such improvements. Moreover, the way of iterative learning is not fully realizable in all aspects of today’s world. Comparatively, I have fewer vulnerabilities than debt-ridden post-undergraduate students of my age, but I am not immune to the ubiquitous stressors of contemporary life. We continue to be surrounded by dangers and tasks where it is truly necessary not to fail the first time. As technology advances and we come to life in a safer, healthier world, the sources for life-threatening failure will diminish, and the realm of beneficial trial-and-error failure will broaden. The key in the meantime is to keep the failure points in one’s own life to a minimum. Yes, automobile accidents, crime, and serious illnesses always have a non-zero probability of damaging one’s life – but even that probability can be diminished through vigilance, care, and technology. To avoid introducing vulnerability into one’s life, one should always live within one’s present means – not expectations of future income – and leave oneself with a margin of time and flexibility for the achievement of any goal, financial or not. Productivity, efficiency, and skill are all welcome assets, if they are used to prevent, rather than invite, stress, anxiety, and physical discomfort.
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Learning absolutely anything of interest and value is desirable, as long as the cost in time and money – including the opportunity cost – is known and can be absorbed using present resources. This principle applies to any kind of formal schooling – or to the purchase of cars, major articles of furniture, and electronic equipment. If you enjoy it, can afford it out of pocket, and can think of no better way to use your time and money – then by all means pursue it with a clear conscience. If you cannot afford it, or you need the money for something more important, then wait until you have the means, and find other ways to use and enjoy your time in the interim. With the Internet, it is possible to learn many skills and concepts at no monetary cost at all. It is also possible to pursue relatively low-cost professional designation programs in fields where sitting in a classroom is not a requirement for entry.
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Remember that success is attained through many iterations of a variety of endeavors. Try to make each iteration as inexpensive as possible in terms of time and money. Except in times of acute crisis where there are no other options, avoid all forms of debt – with the possible exception of a mortgage, since it is preferable to the alternative of renting and giving all of the rent away to another party. Do not put all of your time and energy into a single field, a single path, a single expectation. You are a multifaceted human being, and your job in life is to develop a functional approach to the totality of existence – not just one sub-specialty therein. Remember, above all, never to lose your individuality, favored way of living, and constructive relationships with others in the pursuit of any educational or career path. You should be the master of your work and learning – not the other way around.
Are We Destroying the Earth? – Article by Sanford Ikeda

Are We Destroying the Earth? – Article by Sanford Ikeda

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The New Renaissance Hat
Sanford Ikeda
October 3, 2012
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People often complain that mankind is destroying the earth: that insatiable consumption and relentless production have laid waste to irreplaceable swaths of our planet, and that these activities have to stop or someday it will all be gone.

Which raises the question: What does it means to “destroy” something?

When you burn a log, the log is destroyed but heat, light, smoke, and ashes remain.  It’s in that sense that physics tells us that matter is neither created nor destroyed.  Similarly, cutting down a forest destroys the forest but in its place are houses and furniture and suburbs.

The real question is: Is it worth it?

Value Can Be Both Created and Destroyed

What people usually mean when they say mankind is destroying the earth is that human action causes a change they don’t like.  It sounds odd to say that my wife, by eating a piece of toast for breakfast, is “destroying” the toast.  But if I wanted that toast for myself, I might well regard her action as destructive.  Same action, but the interpretation depends on purpose and context.

When a missile obliterates a building and kills the people in it, it may serve a political purpose even though the friends and family of those killed and the owners of the building are harmed.  The perpetrator’s gain is the victim’s loss.  In the political realm, one person’s gain is necessarily another person’s loss.  You rob Peter to pay Paul; you kill Jack to appease Jill.  It’s a “zero-sum game.”

In the economic realm, however, a thing is destroyed to the extent that it loses its usefulness to somebody for doing something.  Someone may want to bulldoze my lovely home just for fun.  If she pays me enough I may let her do it and be glad she did.  When not physically coerced, a trade won’t happen unless each side expects to gain.  If it does happen, and if the people who traded are right, then all do in fact gain.  Each is better off than before. The trade has created something–value.  If they are wrong they destroy value and suffer a loss, which gives them an incentive to avoid making mistakes.

Profits and Losses Help to Minimize the Destruction of Value

In free markets gains manifest themselves in profit, either monetary or psychic.  (In the short run, of course, you can sustain a monetary loss if you think there’s a worthwhile nonmonetary aspect to the trade that will preserve the profit.)  Now, the free market is not perfect, despite what some economics professors say about the benefits of so-called “perfect competition.”  People don’t have complete or perfect knowledge and so they make mistakes.  They trade when they shouldn’t, or they don’t trade when they should.  Fortunately, profits and losses serve as feedback to guide their decisions.

There’s another source of market imperfection.  People may be capable of making good decisions but they don’t trade, or trade too much, because the property rights to the things they would like to trade aren’t well-defined or aren’t effectively enforced.  In such cases their actions or inactions create costs they don’t bear or benefits they don’t receive.  The result is that their decisions end up destroying value.

If I free-ride off the oceans, if for example I don’t pay for dumping garbage into it, then the oceans will become more polluted than they should be.  If there is a cleaner, more efficient source of energy than fossil fuels, but no one can profitably use it because the national government prevents anyone from doing so (for example by prohibitions or excessive taxation), then again the value that would have been created will never appear.

Aesthetics or Economics?

Our esthetic sense of beauty is part of what makes us human.  If we wish to protect a lake or a valley from development because we think it beautiful, how do we do that?

To some extent it’s possible to do what the Nature Conservancy does, and purchase the land that we want to protect.  But that’s not always possible, especially when the land is controlled not by private persons but by the national government, which makes special deals with crony capitalists in so-called public-private developments.  In any case, even the free market is not perfect.  Economic development and material well-being mean that some beautiful landscapes and irreplaceable resources will be changed in ways not everyone will approve.

Remember, though, that economics teaches us that an action is always taken by someone for something.  There are no disembodied costs, benefits, and values.  In a world of scarcity, John believes saving rain forests is more important than saving the whales.  Mary believes the opposite.  If we are to get past disagreements on esthetics–essentially differences of opinion–that can turn into violent conflict, we need to find some way to settle our differences peacefully, some way to transform them into value-creating interactions.

Imperfect though it may be, the free market has so far been the most effective method we know of for doing that.

Sanford Ikeda is an associate professor of economics at Purchase College, SUNY, and the author of The Dynamics of the Mixed Economy: Toward a Theory of Interventionism.

This article was published by The Foundation for Economic Education and may be freely distributed, subject to a Creative Commons Attribution United States License, which requires that credit be given to the author.

Gold is Good Money – Article by Ron Paul

Gold is Good Money – Article by Ron Paul

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The New Renaissance Hat
Ron Paul
October 1, 2012
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Last year the Chairman of the Federal Reserve told me that gold is not money, a position which central banks, national governments, and mainstream economists have claimed is the consensus for decades.  But lately there have been some high-profile defections from that consensus.  As Forbes recently reported, the president of the Bundesbank (Germany’s central bank) and two highly respected analysts at Deutsche Bank have praised gold as good money.

Why is gold good money?  Because it possesses all the monetary properties that the market demands: it is divisible, portable, recognizable and, most importantly, scarce – making it a stable store of value. It is all things the market needs good money to be and has been recognized as such throughout history.  Gold rose to nearly $1800 an ounce after the Fed’s most recent round of quantitative easing because the people know that gold is money when fiat money fails.

Central bankers recognize this too, even if they officially deny it.  Some analysts have speculated that the International Monetary Fund’s real clout is due to its large holdings of gold.  And central banks around the world have increased their gold holdings over the last year, especially in emerging market economies trying to protect themselves from the collapse of Western fiat currencies.

Fiat money is not good money because it can be issued without limit and therefore cannot act as a stable store of value. A fiat monetary system gives complete discretion to those who run the printing press, allowing national governments to spend money without having to suffer the political consequences of raising taxes.  Fiat money benefits those who create it and receive it first, enriching national governments and their cronies.  And the negative effects of fiat money are disguised so that people do not realize that money the Fed creates today is the reason for the busts, rising prices and unemployment, and diminished standard of living tomorrow.

This is why it is so important to allow people the freedom to choose stable money.  Earlier this Congress I introduced the Free Competition in Currency Act (H.R. 1098) to permit people to use gold as money again. By eliminating taxes on gold and other precious metals and repealing legal tender laws, people are given the option between using good money or fiat money. If the federal government persists in debasing the dollar – as money monopolists have always done – then the people would be able to protect themselves by using alternatives such as gold that are both sound and stable.

As the fiat money pyramid crumbles, gold retains its luster.  Rather than being the barbarous relic Keynesians have tried to lead us to believe it is, gold is, as the Bundesbank president put it, “a timeless classic.”  The defamation of gold wrought by central banks and national governments is because gold exposes the devaluation of fiat currencies and the flawed policies of the national government.  National governments hate gold because the people cannot be fooled by it.

Representative Ron Paul (R – TX), MD, was a three-time Republican candidate for U. S. President. See his Congressional webpage and his official campaign website. 

This article has been released by Dr. Paul into the public domain and may be republished by anyone in any manner.

Interest Rates Are Prices – Article by Ron Paul

Interest Rates Are Prices – Article by Ron Paul

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The New Renaissance Hat
Ron Paul
September 28, 2012
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One of the most enduring myths in the United States is that this country has a free market, when in reality, the market is merely the structural shell of formerly free institutions.  The federal government pulls the strings behind the scenes.  No better illustration of this can be found than in the Federal Reserve’s manipulation of interest rates.

The Fed has interfered with the proper function of interest rates for decades, but perhaps never as boldly as it has in the past few years through its policies of quantitative easing.  In Chairman Bernanke’s most recent press conference he stated that the Fed wishes not only to drive down rates on Treasury debt, but also rates on mortgages, corporate bonds, and other important interest rates.  Markets greeted this statement enthusiastically, as this means trillions more newly-created dollars flowing directly to Wall Street.

Because the interest rate is the price of money, manipulation of interest rates has the same effect in the market for loanable funds as price controls have in markets for goods and services. Since demand for funds has increased, but the supply is not being increased, the only way to match the shortfall is to continue to create new credit. But this process cannot continue indefinitely. At some point the capital projects funded by the new credit are completed. Houses must be sold, mines must begin to produce ore, factories must begin to operate and produce consumer goods.

But because consumption patterns have either remained unchanged or have become more present-oriented, by the time these new capital projects are finished and begin to produce, the producers find no market for their goods. Because the coordination between savings and consumption was severed through the artificial lowering of the interest rate, both savers and borrowers have been signaled into unsustainable patterns of economic activity. Resources that would have been used in productive endeavors under a regime of market-determined interest rates are instead shuttled into endeavors that only after the fact are determined to be unprofitable.  In order to return to a functioning economy, those resources which have been malinvested need to be liquidated and shifted into sectors in which they can be put to productive use.

Another effect of the injections of credit into the system is that prices rise.  More money chasing the same amount of goods results in a rise in prices.  Wall Street and the banking system gain the use of the new credit before prices rise.  Main Street, however, sees the prices rise before they are able to take advantage of the newly-created credit. The purchasing power of the dollar is eroded and the standard of living of the American people drops.

We live today not in a free market economic system but in a “mixed economy”, marked by an uneasy mixture of corporatism; vestiges of free-market capitalism; and outright central planning in some sectors.  Each infusion of credit by the Fed distorts the structure of the economy, damages the important role that interest rates play in the market, and erodes the purchasing power of the dollar.  Fed policymakers view themselves as wise gurus managing the economy, yet every action they take results in economic distortion and devastation.

Unless Congress gets serious about reining in the Federal Reserve and putting an end to its manipulation, the economic distortions the Fed has caused will not be liquidated; they will become more entrenched, keeping true economic recovery out of our grasp and sowing the seeds for future crisis.

Representative Ron Paul (R – TX), MD, was a three-time Republican candidate for U. S. President. See his Congressional webpage and his official campaign website. 

This article has been released by Dr. Paul into the public domain and may be republished by anyone in any manner.

Why the Deflationists Are Wrong – Article by Gary North

Why the Deflationists Are Wrong – Article by Gary North

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The New Renaissance Hat
Gary North
August 23, 2012
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An inflationist is someone who believes that price inflation is the result of two things: (1) monetary inflation and (2) central-bank policy.

A deflationist is someone who believes that deflation is inevitable, despite (1) monetary inflation and (2) central -bank policy.

No inflationist says that price inflation is inevitable. Every deflationist says that price deflation is inevitable.

Deflationists have been wrong ever since 1933.

Milton Friedman is most famous for his book A Monetary History of the United States (1963), which relies on facts collected by Anna Schwartz, who died recently.

It is for one argument: the Federal Reserve caused the Great Depression because it refused to inflate.

This argument, as quoted by mainstream economists, is factually wrong.

I often cite a study, where you can see that the monetary base grew under the Federal Reserve, 1931 to 1932. This graph is from a speech given by the vice president of the Federal Reserve Bank of St. Louis. You can access it here.

Figure 1
I posted this first in early 2010.

We can see that there was monetary deflation of the money supply, beginning in 1930. This continued in 1931 and 1932, despite a deliberate policy of inflation by the Fed, beginning in the second half of 1931 and continuing through 1932.

Depositors kept pulling currency out of banks and hoarding it. They did not redeposit it in other banks. This imploded the fractional-reserve-banking process for the banking system as a whole. M1 declined: monetary deflation.

The Fed could not control M1. It could only control the monetary base.

The argument of Friedman and Schwartz was picked up by mainstream economists. It is his most famous and widely accepted position. Bernanke praised him for it on Friedman’s 90th birthday in 2002.

Why was the argument wrong, as applied to 1931–33? I must tell the story one more time. Four letters tell it: FDIC. Well, nine: FDIC + FSLIC. They did not exist.

Franklin Roosevelt froze all bank deposits in early March 1933, immediately after his inauguration. This calmed the public when the banks reopened a few days later. He verbally promised people that the banks were now safe.

The US government created federal bank-depositor insurance in 1933. The Wikipedia article describes the Banking Act of 1933, which was signed into law in June:

  • Established the FDIC as a temporary government corporation
  • Gave the FDIC authority to provide deposit insurance to banks
  • Gave the FDIC the authority to regulate and supervise state non-member banks
  • Funded the FDIC with initial loans of $289 million through the U.S. Treasury

That stopped the bank runs. The money supply reversed. It went ballistic. So did the monetary base.

The key event was therefore the Banking Act of 1933. After that, the money supply never fell again. After that, prices never fell again by more than 1 percent. That was in 1955.

All it took for prices to reverse and rise was this: an expansion of the monetary base coupled with bank lending.

Yet deflationists ever since 1933 have predicted falling prices. They die predicting this. Then their successors die predicting this.

They never learn.

They do not understand monetary theory. They do not understand monetary history. They therefore do not learn. They do not correct their bad predictions, year after year, decade after decade, generation after generation.

They still find people who believe them, people who also do not understand monetary theory or monetary history.

I have personally been arguing against them for four decades.

Price deflation has nothing to do with the fall in the price of stocks.

There can be monetary deflation as a result of excess reserves held at the Fed by commercial banks. But this is Fed policy. The Fed pays banks interest on the deposits. Even if it didn’t, there would still be excess reserves. But by imposing a fee on excess reserves, the Fed could eliminate excess reserves overnight. Then the money multiplier would go positive, price inflation would reappear, and the Fed would get blamed. So, it maintains a policy of restricting the M1 multiplier.

Every inflationist says that monetary inflation will produce hyperinflation unless reversed by the central bank. There will be a return to low prices after what Ludwig von Mises called the crack-up boom. The classic example is Germany in 1934. That was a matter of policy. The central bank substituted a new currency and stopped inflating.

John Exter — an old friend of mine — argued in the 1970s and 1980s that monetary deflation has to come, despite Fed policy. There will be a collapse of prices through deleveraging.

He was wrong. Why? Because it is not possible for depositors to take sufficient money in paper-currency notes out of banks and keep these notes out, thereby reversing the fractional-reserve process, thereby deflating the money supply. That was what happened in the United States from 1930 to 1933. If hoarders spend the notes, businesses will redeposit them in their banks. Only if they deal exclusively with other hoarders can they keep money out of banks. But the vast majority of all money transactions are based on digital money, not paper currency.

Today, large depositors can pull digital money out of bank A, but only by transferring it to bank B. Digits must be in a bank account at all times. There can be no decrease in the money supply for as long as money is digital. Hence, there can be no decrease in prices unless it is Fed policy to decrease prices. This was not true, 1930 to 1933.

Deflationists never respond to this argument by invoking either monetary theory or monetary history. You can and should ignore them until one of them does answer this, and all the others publicly say, “Yes. That’s it! We have waited since 1933 for this argument! I was blind, but now I see! I’m on board! I will sink or swim with this.”

Let me know when this happens. Until then, ignore the deflationists. All of them. (There are not many still standing.)

The fact that a new deflationist shows up is irrelevant. Anyone can predict inevitable price deflation. They keep doing this. Look for the refutation of the inflationists’ position. Look for a theory.

If you do not understand the case I have just made, you will not understand any refutation. In this case, just pay no attention to either side. If you cannot follow economic theory, the debate will confuse you. It’s not worth your time.

For background, see my book Mises on Money.

See also Murray Rothbard’s book What Has Government done to Our Money?

Gary North is the author of Mises on Money and Honest Money: The Biblical Blueprint for Money and Banking. He is also the author of a free 20-volume series, An Economic Commentary on the Bible. Visit his website: GaryNorth.com. Send him mail. See Gary North’s article archives.

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Copyright © 2012 by the Ludwig von Mises Institute. Permission to reprint in whole or in part is hereby granted, provided full credit is given.