Taxes and Smuggling

A fundamental principle of economics is that incentives matter. They do so because when forming their preferences people take into account their circumstances. That is why government intervention in the economy so often breeds what is often referred to as the underground economy. When supplying goods legally becomes more expensive due to taxes or regulation, the incentive to skirt the law so as to supply them more affordably is very powerful. For many the temptation is too great to resist.

An excellent illustration of this principle is the consequences of this summer's New York City cigarette tax hike. FoxBusiness reports that, "Sales of taxed cigarettes plummeted 27 percent since July, when state lawmakers raised the excise tax to $4.35 a pack on top of the city's tax of $1.50, making the average price of Marlboros in New York $11.60, with some shops charging as much as $14."

Now comes a story from the New York Post (HT: LewRockwell.com and Economic Policy Watch) reporting that several people are willing to risk being run in by the cops to sell illicit cigarettes--those not bearing a tax stamp--in Gotham. One underground entrepreneur drives to Delaware to pay $27 a carton and is able to make up to $160 a day by selling them for $8 a pack in Midtown NYC.

Engines of Prosperity: Entrepreneurship

A couple of weeks ago, I began a series explaining what economics teaches us about the causes of prosperity (see here, here, and here). Because capital accumulation increases productivity of land and labor, the size of the capital stock is positively related to economic expansion. In order for economic progress to continue over time, however, it is important not to waste capital that has already been accumulated. Capital must not be consumed by being sunk in unproductive uses. This is why entrepreneurship is the third major contributor to economic development.

If the capital stock is unwisely employed, it will shrink over time, resulting in a decline in the standard of living. Merely because a capitalist sits on a pile of capital that he is ready to invest does not guarantee that he will have an equivalent or larger pile of capital to invest a year from now. He could invest his present capital to produce goods that are unwanted and fail to reap enough revenue to maintain his capital stock.

Capital accumulation, per se, does not guarantee success in any business venture. As Austrian economist Ludwig von Mises explained in Human Action (p. 295),

Capital does not ‘beget profit’. Profit and loss are entirely determined by the success or failure of the entrepreneur to adjust production to the demand of the consumers. 

Capital is accumulated out of savings. Savings is income held back from consumption. If income declines, then savings declines, if there is not an accompanying decrease in time preference (and there is no reason to think that there would be merely due to economic losses).

Capital accumulation over time, therefore, also depends upon the wise use of capital. Waste is possible, because production decisions in the present are based on a forecast of uncertain future market conditions. If the producer forecasts incorrectly, he will use his capital to make something people do not want and he will not be able to sell his output at prices he anticipated would cover his costs. His income falls and his capital is consumed. Successful entrepreneurship is needed to reap profits that are the result of the wise use of capital.

Entrepreneurship is necessary because in the market division of labor people produce goods more for the market than directly for themselves. As my friend Jeff Herbener notes, they must therefore forecast the subjective values of other people. The entrepreneur performs the valuable social function of dealing with uncertainty, coordinating diverse land, labor, and capital goods owned by numerous people, and directing production into the most socially valuable ends. A society that wants to flourish economically, must embrace social and legal institutions that allow entrepreneurs to perform their function.

Charles M. Schulz: Economic Commentator

Friday was the birthday of Charles M. Schulz, creator of the Peanuts comic strip. I grew up on Peanuts and had several collections of his strips in paper back. His older material was very witty, sometimes biting in its commentary on life, but also generally uplifting. His A Charlie Brown Christmas is rightfully a classic with its straightforward telling of the Christmas narrative by Linus.

On occasion Schulz would write a strip that could be construed as at least tangentially related to an economic issue. In fact, I liked them so much I used five Peanuts strips in my book. One of the funniest is from May of 1987 and can be read by clicking here.

Would that every macroeconomist favoring monetary and fiscal stimulus would read and heed.

Auction of Apple-1 Computer Teaches Two Economic Lessons

This Tuesday, an original Apple-1 Computer sold at auction at Christie's of London for $213,600. The original 1976 sticker price for the computer when it was first released was $666.66. This recent sale illustrates two important economic lessons.

The first lesson is that value is subjective. People value goods according the the ends those goods satisfy. When acting, because economic goods are scarce, a person must rank his ends, choosing to obtain some while leaving others unfulfilled. This ranking is done by a process of subjective, or personal, valuation. As explained by Carl Menger in his Principles of Economics , it is this subjective value that determines the price of a good. Menger's theory that is derived from the reality of human action is in stark contrast with Karl Marx's labor theory of value and even Alfred Marshall cost of production theory of value. With an original price tag of $666.66, we know that the original cost of production was something less than that. It surely was not $213, 600. The reason the selling price for the Apple-1 was that high is that someone subjectively valued that particular computer more than $213,600. Value is subjective and the prices of goods are determined by the subjective valuations of all buyers and sellers in the market.

The second thing we learn from the story of the computer sale is that free enterprise, capital investment, and entrepreneurial drive result in economic development. The story about the Apple-1 auction reports that in today's dollars, $666.66, the original purchase price, is approximately equivalent to $2593.96 today. Spending that much money will buy you three top of the line iPads. It could also buy a personal computer that can do vastly more that the creators of Apple-1 (with its 8K bytes of RAM) ever dreamed a computer could do.

Books for Black Friday

Traditionally, the Friday after Thanksgiving is the beginning of what has become known as the Christmas shopping season. When I was in high school working at a retail store similar to Wal-mart, but on a smaller scale, I remember having to make sure our store was decorated for Christmas by November 10th. Now, of course, most stores begin trying to manufacture the happy holidays cheer the day after Halloween. Nevertheless, Black Friday is still seen as THE big day.

This year I decided to do my bit to help the puzzled Christmas shopper by providing a list of the most rewarding books you can give your loved ones who are thoughtful people interested in economics, theology, and perhaps even philosophy.

The following is a list of books that I've found important and have positively influenced my thinking in a number of areas.

Economics 

Heurta de Soto, Jesus, Money, Bank Credit, and Economic Cycles.

The finest economic treatise of the decade. Anyone who wants to do serious work on monetary or macroeconomic theory should begin here.

Hulsmann, Jorg Guido, Mises: The Last Knight of Liberalism.

A magisterial biography of the great economist. Well written and a tremendous scholarly achievement.

Mises, Ludwig von, Human Action.

Mises' magnum opus. The most important book written in the social sciences ever.

Mises, Planning for Freedom and Other Essays.

This is an excellent introduction to Mises' thought in the form of a collection of essays, the vast majority of which are written for the intelligent layman.

Rothbard, Murray N., Man, Economy, and State.

Rothbard's magnum opus in which he builds a grand edifice of economic theory upon the foundation laid by Ludwig von Mises.

Ritenour, Shawn, Foundations of Economics: A Christian View.

My own economics treatise written as an introduction to economic thought built upon the economics of Mises and Rothbard. It shows why and how sound economics develops out of a Christian view of creation and man. Tom Woods says that my book "is everything a textbook on economics should be: clear, well organized, easy to understand -- and interesting!"

Theology

Bavinck, Herman, Reformed Dogmatics

This is a massive and, as a colleague of mine put it, stirring systematic theology in four volumes. Bavinck maintains a wonderful mixture of outstanding scholarship, theological orthodoxy, and devotion to Christ.

Machen, J. Gresham, Christianity and Liberalism

Machen's trumpet blast against theological liberalism in which he conclusively demonstrates that liberalism is not merely a different, modern expression of the Christian faith. It is an entirely different religion.

Machen, The Christian View of Man.

Machen, The Christian Faith in the Modern World.

The above two works are what we could call Machen's popular theology. They are based on radio addresses he gave on parts of the Westminster Shorter Catechism.

Philosophy 

Carson, Clarence, Flight from Reality.

A profound mix of history, political thought, sociology, and philosophy. Carson attempts to explain how the drive to reform society in the Twentieth Century was largely the result of intellectuals turning their back on reality.

Clark, Gordon H., A Christian View of Men and Things.

An excellent and thorough introduction to philosophy from a Christian perspective. Clark devotes separate chapters on epistemology, history, politics, ethics, science, and religion. 

Schaeffer, Francis, The God Who is There.
Schaeffer, Escape from Reason.

Schaeffer, He is There and He is Not Silent.

The above three works make up Schaeffer's "philosophy trilogy." They may not be the last word on the subject, but they are pretty good first words.

Schlossberg, Herbert, Idols for Destruction.

A monumental critique of modern American intellectual culture from a Christian perspective. One of the great books written during the 1980s. Any Christian who is at all concerned about modern culture must read this book.

Scruton, Roger, An Intelligent Person's Guide to Modern Culture.


The title is very accurate in this case. In this relatively brief work, Scruton explains and critiques the various philosophies that underlie many aspects of modern culture. If one wants to make sense of our contemporary world, this is an excellent place to start.

Being Thankful for the Blessings of Property

Happy Thanksgiving! During the day we pause to thank the Lord for the many blessings he has bestowed upon us, I recommend the following essays by Richard J. Maybury and Gary Galles.Both explain the economic lessons to glean from the experience of the Pilgrims and both note that the primary reason for God's blessing them with relative prosperity after years of famine and hunger was a shift away from socialism and toward private property. In their essays, both authors draw upon William Bradford's History of Plymouth Plantation to get the straight scoop.

One misconception that is still with us is that the Pilgrims adopted socialism out of religious conviction. Galles notes that this is a misconception, but it is beyond the scope of his essay to provide the full historical back drop to that initial fateful economic design.

In fact, the Pilgrims did not desire to establish Christian communism. As I noted a couple of years ago in response to this essay, the Pilgrims original communal property arrangements were foisted upon them by their colonial sponsors. The sponsors did this after they learned that they would not be granted a monopoly of fishing rights in Cape Cod. The sponsors’ original agreement with the Pilgrims was such that the Pilgrims were to work for four days for the sponsoring company and then would have two days to work for themselves. The sponsors later changed their deal and told the Pilgrims that they would have to work all six days of the work week for the sponsors. At the end of seven years, the Pilgrims would be granted title to the property they worked. The Pilgrims were not happy with the change, several of them recognizing that the new arrangement would make them virtual slaves of the sponsors, but they went along with the deal because many had already made large investments toward the move and they were convinced that emigrating to the New World is what God wanted them to do.

Bradford’s establishing private property was not a repudiation of any belief they had that Christian charity requires communism. They had no intention of implementing such a system. The Pilgrims’ move to private property was, in fact, a move to a properly Christian ethic as it regards property. God blessed the Pilgrims with material plenty as they forsook their original socialist property arrangement and adopted one more in agreement with Christian ethics.

Engines of Prosperity: What About Technology?

Last week I began a series of posts discussing the sources of economic prosperity. I began the series because I think it absolutely necessary to understand these basic principles if we want to properly evaluate various policy suggestions about how to promote prosperity in less developed countries or how do we get out of the Great Recession. So far I have explained the importance of the market division of labor and capital accumulation.

Since the development of the Solow Growth Model by Robert Solow, it has been argued by many that capital is not the real source of economic expansion, but that technology is. This is so, it is argued, because capital, like labor, faces diminishing returns, so that as we increase capital investment, at some point total output reaches a maximum and then economic expansion resulting from increased capital will be exhausted. The source of sustained economic progress, therefore, must be technology, according to this view.

What are we to make of this argument? It is certainly true that new and better technology allows for more efficient production. As I note in my book, Foundations of Economics, according the the USDA, in 1987 it took the average American farmer 3 hours to produce 100 bushels of wheat, compared to 275 hours it took the average American farmer to do the same thing in 1830. Since the 1830’s there has been tremendous technological advance in the number and quality of tools, equipment, fertilizers, and pesticides available for farmers, greatly increasing farmer yields.

Is technology, then, a separate component generating economic expansion? As the knowledge regarding how to do something, technology does set a limit on our production.  As Rothbard notes in Man, Economy, and State, however, capital is a narrower limit. For technology to be usable it must be bound up in actual capital goods. It does no good for a secretary to know that he could use an electronic device to type and edit written documents if programmed correctly, if he does not have access to an actual personal computer. In order to take advantage of technology, we must, consequently, have capital investment. Rothbard summarizes,

To expand production, the important consideration is not so much technological improvement as greater capital investment. At no time has invested capital exhausted the best technological opportunities available. Many firms still use old, unimproved processes and techniques simply because they do not have the capital to invest in new ones. They would know how to improve their plant if capital were available. Thus, while the state of technology is ultimately a very important consideration, at no given time does it play a direct role, since the narrower limit on production is always the supply of capital (p. 626).

Therefore, it turns out that capital is the relevant factor for economic expansion. Without capital investment, technology is of no use. With capital investment, technology will advance as entrepreneurs continually seek to use better, more efficient, capital goods.

Wages Sticky Downward?

One of the staples of Keynesian thought (whether paleo or new) is the premise that in a free market wages are nevertheless sticky downward. By 'sticky' they don't mean like Oakland Raider cornerback Lester Hayes' hands during the stickum era. They mean that, for some reason, wages do not fall when the demand for labor falls. Wages, therefore, stay above the market clearing rate, resulting in unemployment. That is why, Keynesians say we need fiscal or monetary stimulus to get us back to full employment.

Murray Rothbard has already refuted this notion in his treatise Man, Economy, and State by pointing out  that if wages can't fall legally because of minimum wage regulations, this is due to government intervention. On the other hand, if it is due to voluntary labor contracts, then any unemployment that results is not involuntary because workers and labor unions could always renegotiate a lower wage.

It turns out that this is exactly what is happens during times of economic downturn. For example, performing arts unions worked together with Broadway production companies and agreed to be paid lower wages for a period following the 9/11 terrorist attacks in New York City which caused the tourist trade to fall off for awhile.

Now it is reported that a number of labor unions are doing the same thing in response to the Great Recession. These workers and their unions recognize that sometimes one has to agree to a lower wage to keep one's job when the demand for labor falls. This is precisely how markets clear and one important way malinvestment is resolved in a recession.

Don't Polticize the Fed?

I remember from a review (having never seen the film) that at one point during Madonna's documentary Truth or Dare, she get's a telephone call from her father asking her not to be so immodest during her live concerts. She replies into the phone, "But Daddy, I have to keep my artistic integrity." When I first read that story, the first thought that came to mind was a question. In order to maintain something, doesn't one have to possess it first?

Treasury Secretary Tim Geitner recently provided a similar thought only in reverse. No doubt aware of the growing skepticism toward our central money printing machine, the Federal Reserve, Geitner has warned Congress not to remove the Fed's mandate to pursue full employment. To do so would be to politicize the Fed, which is a definite no-no.

Again a question comes to mind. Can we prevent something from happening after it has already happened? The fact is the Fed, by its very nature is politicized. It is chartered by the United States Congress, which Geitner surely understands, is filled with politicians. Whenever Ben Bernanke is asked by Ron Paul what in the Constitution gives the Fed the authority to create dollars, Bernanke appeals to the Fed's Congressional charter and says, in effect, we serve at the pleasure of Congress.

Bernanke has also recently began carrying water for the Obama Administration in criticizing China's perceived currency policy. The idea that the Fed is fiercely independent strains credulity. The Fed is already politicized up to its eyeballs. In fact, as Murray Rothbard showed over a decade ago in his Case Against the Fed, it was the product of politics from the beginning. The quickest and surest, indeed only, way to de-politicize the Fed is to end it.

Capital in Proverbs

There are many who think that there is a fixed wall of separation between faith and science in general and between the Scriptures and economic science in particular. Showing this dichotomy to be false is one of the great purposes of my book, Foundations of Economics. Because the Author of the Bible is also the maker of the created order, we should expect that there is no ultimate conflict between the special revelation constituted in Scripture and the general revelation we see manifest in creation.

I came across a simple case in point recently while reading in the book of Proverbs. Proverbs 14:4 reads,

Where there are no oxen, the manger is clean,
but abundant crops come by the strength of the ox.

Plowing in Nivernais by Rosa Bonheur (1822-1899)

Bible commentator Matthew Henry says the following about this verse:

Where no oxen are there is nothing to be done at the ground, and then nothing to be had out of it; the crib [the manger] indeed is clean from dung, which pleases the neat and nice, that cannot endure husbandry because there is so much dirty work in it, and therefore will sell their oxen to keep the crib clean; but then not only the labour, but even the dung of the ox is wanted.

Charles Bridge has a slightly different take on this verse. In his A Commentary on Proverbs he explains

Oxen are used in husbandry (Deut. xxv.4. 1 Kings, xix.19.) Where, therefore, no oxen are, to till the ground, the crib is clean. (Amos iv. 6) Because, where is no labour, there can be no food wherewith to supply it. God works by means not by miracles. There must be good husbandry, in order to an abundant harvest. let the ox be put to his work, and much increase will be by his strength. (Ps. cxliv.14.)

Regardless of whose particular interpretation regarding the meaning of the clean manger (or crib) is correct, here is a case where the author of this practical manual for living reminds the reader that, in his agrarian setting, oxen are powerful means for producing abundant crops. Yesterday I explained the importance of capital for economic prosperity. In this case, the ox is a great capital good used to produce a great harvest, which was a chief source of livelihood in that day. Without the use of an oxen, on the other hand, the farmer's lack of output would leave him wanting.

The Importance of Capital

Yesterday, I began a series of posts that will briefly explain the economic sources of prosperity. I discussed the nature and beneficial consequences of the market division of labor and how voluntary exchange is necessary for the division of labor to thrive. (By the way, an outstanding article on the topic is Murray Rothbard's masterful, "Freedom, Inequality, Primitivism, and the Division of Labor.")

A highly developed division of labor would be impossible, however, without capital goods. Another engine of economic development, therefore, is capital. Capital goods are produced means of production: tools, machines, buildings, and intermediary goods.Capital is the sum of the monetary value of all a firm’s assets that are dedicated to that firm’s productive operations minus the sum of the monetary value of all of a firm’s liabilities . These assets may consist of land, physical plant, tools, machinery, goods-in-process, receivables, cash, etc.

The use of capital goods increases the productivity of the user, by allowing people to produce a greater quantity of output in the future. They also enable people to produce some goods that could not be had at all without capital goods, such as watches, automobiles, or iPads.

However, capital goods do not spontaneously spring fully developed from nature. Before capital goods can be used, they must be produced. Producing them takes time. In order to obtain capital goods it is necessary to save and invest these saved resources toward the formation of capital.

Additionally, because capital goods are perishable, they must be replaced with further investment. At any moment in time, therefore, each producer has the option of accumulating capital, maintaining capital, or consuming capital. Accumulating and maintaining capital requires a certain amount of saving. Consuming capital requires only that the producer use up his capital stock. As implied above, the choice regarding whether a producer is going to accumulate, maintain, or consume his capital depends upon how much that producer values present goods over future goods. It depends on his time preference.

The higher people’s time preferences are, the more present-oriented they are. They tend to consume more and save and invest less. With high enough time preferences they will consume capital, resulting in less productive labor. Output and real incomes will fall and society endures a lower standard of living.

The lower people’s time preferences are, the more they save and invest. Over time, people will have more capital goods and labor will be more productive. Output will increase and the general standard of living rises. Consequently, a chief determinant of whether an economy expands or contracts is the size of the stock of capital.

If we want a society that enjoys increased prosperity, therefore, we need to foster social institutions that encourage capital accumulation. Such an institution is private property. Unless an investor is secure in his property, he will remain uncertain whether he will be able to keep both his accumulated capital and any positive return on his investment. He will have little incentive to save and invest in further capital maintenance not to mention accumulation. Private property, the institutional setting of capitalism, is therefore a key that opens the door to prosperity. As Mises says in Human Action (p. 562):

The characteristic mark of economic history under capitalism is unceasing economic progress, a steady increase in the quantity of capital goods available, and a continuous trend toward an improvement in the general standard of living.

Engines of Prosperity: The Division of Labor

Much has been written recently on the efficacy of foreign aid for economic development. Before we can make sense whether foreign aid is affective in assisting less developed countries experience sustainable economic development, we need to understand what are the sources of prosperity to begin with. Only after we grasp what causes prosperity can we then evaluate whether foreign aid assists, hinders, or has no impact on the process of economic expansion and development.

Even before we do that, however, it is helpful to remind ourselves that for the bulk of human history, poverty was the norm for the masses. Mass prosperity is a relatively recent phenomenon. Therefore before we ask why some societies are poor, we should investigate why any societies are prosperous.

As I explain in the culminating chapter of Foundations of Economics, economic theory has much to tell us about how societies become prosperous. Economics identifies three sources of economic progress: the division of labor, capital accumulation, and entrepreneurship. Today I want to focus on the division of labor. It is so important that in Human Action (p. 157), Ludwig von Mises referred to the division of labor and the human cooperation inherent to it as “the fundamental social phenomenon.” The division of labor is socially fundamental in two senses. It has been with us since the beginning of human history and it is the driving force for the forming of societies. In the book of Ezekiel, for example we find a list of 37 different goods that were brought to the commercial center Tyre from 23 different cities or regions.

The division of labor contributes to prosperity, because people are more productive when they specialize in doing those tasks at which they are relatively most efficient. Instead of every person producing every good that he consumes himself, all of us are more productive if we specialize in producing those goods for which we are the low cost producer. This division of labor results in more total output and more goods available for society to consume using the same quantity of resources.

There are many reasons for this. God has created mankind with unequal abilities in human labors. He has also providentially distributed natural resources unequally over the earth. Capital goods are also unequally distributed. Different people have different quantities and kinds of tools, buildings, and machines with which to work. Because different people possess different human abilities, natural resources, and capital goods, they tend to be relatively more productive at certain tasks and relatively less productive at other tasks. These differences and the ability to produce more in certain lines of production create an incentive to specialize in production.

Given the differences in labor abilities resource and capital goods endowments, people find it in their interest to specialize in making those goods at which they are relatively better at producing. As everyone specializes in producing goods they can make at the lowest cost compared to anyone else, the total output of all members of society increases. As people exchange their output with others who have participated in the division of labor, they are also able to consume more than they could without the division of labor.

We can only benefit from the division of labor, however, if we can exchange what we produce. Voluntary exchange is necessary to open the door to the division of labor, because only the possibility for exchange allows us to produce goods for the market and not for merely our own use. If no exchange took place, everything each of us wants to consume would have to be made personally. By allowing for the development of the division of labor, exchange helps bring about economic progress, which allows for an increasing number of people to have dominion over the earth, not by killing or robbing one another, but by peaceful, mutually beneficial voluntary trade.

Easterly and Freschi on How Foreign Aid Supports Repression

William Easterly and Laura Freschi of AidWatch fame have a thought provoking blog post at the New York Review of Books that asks, "Why Are We Supporting Repression in Ethiopia?" It should be required reading for anyone interested in the consequences of foreign aid.

Their post does not pretend to be an exhaustive treatment of the consequences of aid. However, it does explain one of the likely negative consequences: propping up corrupt tyrants. Easterly and Freschi draw upon a new study published by Human Rights Watch which uses many interviews with Ethiopians, documenting that foreign aid to Ethiopia has been used by the Prime Minister of Ethiopia to "discriminate against non-party members and punish dissenters."

Such negative political consequences of foreign aid were also recognized many years ago by P. T. Bauer in his chapter on foreign aid in his excellent book, Reality and Rhetoric: Studies in the Economics of Development.

Did Raising the Reserve Requirments in 1936 and 1937 Prolong the Great Depression?

Since the publication of Milton Friedman and Anna Schwartz's A Monetary History of the United States 1867-1960, the conventional answer has been yes. Richard Timberlake has called the Fed's raising the legal reserve requirements three times during 1936 and '37 a "debacle" that ushered in monetary contraction and a second recession within the Great Depression.

In his essay "Money and Gold in the '20s and '30s" originally published in The Freeman and reprinted in the new book Money Sound and Unsound, Joseph Salerno offers a different perspective. Salerno notes that "the money supply (M2) continued to grow from June of 1936 to June of 1937, the year the policy was implemented." Hardly a deflationary contraction.

Two other articles published in the Journal of Post Keynesian Economics also argue against the notion that the 1937-38 contraction was due to higher reserve requirements. The first is L. G. Telser's "Higher member bank reserve ratios in 1936 and 1937 did not cause the relapse into depression." The abstract reads as follows:

Examination of both sides of member banks' balance sheets reveals evidence that refutes the claim that higher member bank reserve ratios imposed by the Federal Reserve Board of Governors in 1936 and 1937 caused the re- lapse of the U.S. economy into depression. Member banks responded to higher reserves by selling some of their U.S. Treasury paper and did not reduce their loans to business.

Robert Stauffer draws on Tesler's work in his article, "Another Perspective on the Reserve Requirement Increments of 1936 and 1937." The abstract is as follows:

The purpose of this analysis is to investigate three issues surround- ing the Federal Reserve's doubling of reserve requirements between August 1936 and May 1937. First of all, arguments are offered that strengthen and complement L.G. Telser's analysis of how bank lending was affected by reserve ratio increases. Second, a unique money multiplier model is utilized to mea- sure the impact of these policy changes on excess reserves and the money sup- ply. Finally, the possible relationships between Fed policy changes and the recession of 1937-1938 are discussed, including the Friedman and Schwartz perspective.

The issue of increased legal reserve requirements is important because that is one avenue, and perhaps the best one, the Fed could take to exit from the aftermath of all the quantitative easing so as to avoid actual hyper-inflation.

James Grant on How to Make the Dollar Sound Again

Saturday's New York Times featured James Grant's excellent op-ed explaining what he would do to to recovering a sound dollar. (Hint: it does not include quantitative easing). He calls for a return to the gold standard. Notwithstanding official unpopularity of the idea, Grant makes a lot of sense and his analysis is well worth reading.

Grant makes one great point after another with his snappy prose. He notes that the classical golds standard was one of the most stable monetary systems we've had in history. He notes how simple it is to maintain. He notes that the pure paper money era is relatively recent, beginning in 1971. He notes that even the Fed was originally on an international gold standard. He even identifies some of the titles of irrelevant research pursued by Federal Reserve economists. Finally, and most importantly, he explains that under an honest gold standard, government bankers do not need to be clairvoyant, which is a good thing, because they can't be.

As Grant explains,

The intended consequences of this intervention include lower interest rates, higher stock prices, a perkier Consumer Price Index and more hiring. The unintended consequences remain to be seen. A partial list of unwanted possibilities includes an overvalued stock market (followed by a crash), a collapsing dollar, an unscripted surge in consumer prices (followed by higher interest rates), a populist revolt against zero-percent savings rates and wall-to-wall European tourists on the sidewalks of Manhattan.

As for interest rates, they are already low enough to coax another cycle of imprudent lending and borrowing. It gives one pause that the Fed, with all its massed brain power, failed to anticipate even a little of the troubles of 2007-09.

A government managed gold standard would certainly not be perfect and would only be as good as the vigilance of the powers that be to maintain it. We did, after all, once have a gold standard and the state walked away from it. An even better alternative would be a free market in money production in which no single entity, such as the Federal Reserve, has the official monopoly in printing money, and in which banks are not allowed to create checkbook money out of thin air via fractional reserve banking. Still, a gold standard would be much better than we have now and might be a tremendous step in the right direction.

Nota Bene: Lew Rockwell who made me aware of Grant's op-ed on his blog, will have Grant as a guest on The Lew Rockwell Show tomorrow. The program will be available as a podcast.

Cotton Subsidies Help Some Cotton Farmers, Hurt Others

BBC News has a provocative report about arguments over cotton subsidies. Trade negotiators from Chad, Mali, Benin and Burkina Faso claim that government subsides to US and British cotton farmers may help cotton farmers in those countries, but at the same time they harm cotton growers from the poorest nations. Subsidies do so by artificially increasing the amount of cotton grown in the U.S. and U.K. This artificially lowers the world price, making life more difficult for cotton farmers in Western Africa.

This is another example of the contradictory nature of our economic policies as they relate to economic development in poorer countries. In 2008, for example, the U.S. Government spent $35,899,000,000 (that's $35.899 billion)on foreign aid, ostensibly to assist less developed countries in getting out of poverty. At the same time, the U.S. government provides large subsidies to sugar and cotton subsidies which artificially lower world prices of these goods, making it harder for farmers in less developed countries to earn a living.

A more sensible plan for economic development that works according to economic law and not against it would be to free markets. This would include both stopping foreign aid and removing subsidies for domestic cotton farmers. Such a policy would encourage capital investment toward its most highly valued uses and would allow farmers in poorer countries the chance to compete on their own merits.

Government Regulation and Economic Destruction

On Friday I noted that government regulation of the economy was both economically destructive and violated the right to property. Yesterday, I mentioned that St. Augustine, one of the great fathers of the church, recognized the aggressive nature of the emperor the state was no better than a band of thieves when it violated God's moral law.

Twelve further examples of government aggression in the economy can be found here. Some are just ridiculous. In Milwaukee, for example, a business owner who wants to go out of business, must even apply for a license even to do that! In each of these examples mutually beneficial exchange is reduced and people are left worse off than they would be without the regulation. They add to the cost of doing business, which is the last thing we need when trying to get out of the Great Recession. And all of this regulation is the result of the violation of the ethic of property.

Augustine and Property Rights

According to Chambers' Book of Days, Saint Augustine of Hippo was born on this day in 354 AD . He is now well known for being a father of the Church and author of The City of God. A friend and colleague of mine recently drew upon his De Doctrina Christiana while investigating the "Dangers, Delights, and Dead Ends" of Christian scholarship.

In his magisterial history of economic thought, Murray Rothbard explains that Augustine was an early Christian source of some important ideas that under gird sound economic theory. Rothbard notes that in Augustine we find the roots of subjective value theory. Augustine recognized that people valued goods because they helped satisfy their subjective needs, not because of  any objective criteria. Augustine was also the first Church father to take an explicitly positive view of the merchant, noting that he provides the service of transporting goods over sometimes great distances to sell to buyers and therefore earns is remuneration. On this point, Augustine appealed to the teaching of Christ when he said "The laborer is worthy of his hire." Augustine further noted that any fraud or deceit that takes place in commerce is not in the nature of commerce itself, but is, rather, a product of sin.

Augustine also was a defender of private property, noting that rulers are not allowed to violate God's moral law merely because they are rulers. When the state acts to take what is not theirs to take, they are every bit as guilty of theft as a common thief. In a relatively well-known passage from The City of God Augustine explains:

Justice being taken away, then, what are kingdoms but great robberies? For what are robberies themselves, but little kingdoms? The band itself is made up of men; it is ruled by the authority of a prince, it is knit together by the pact of the confederacy; the booty is divided by the law agreed on. If, by the admittance of abandoned men, this evil increases to such a degree that it holds places, fixes abodes, takes possession of cities, and subdues peoples, it assumes the more plainly the name of a kingdom, because the reality is now manifestly conferred on it, not by the removal of covetousness, but by the addition of impunity. Indeed, that was an apt and true reply which was given to Alexander the Great by a pirate who had been seized. For when that king had asked the man what he meant by keeping hostile possession of the sea, he answered with bold pride, “What thou meanest by seizing the whole earth; but because I do it with a petty ship, I am called a robber, whilst thou who dost it with a great fleet art styled emperor.

Voluntary Exchange is Mutually Beneficial: Haircut Edition

One of the fundamental principles of exchange is that an exchange that is voluntary is mutually beneficial. This is because that when people voluntarily agree to trade their property, each demonstrates that they value what the receive more highly than what they trade away. Each party receiving a good he values more and, therefore, each party is better off after the trade. Even sociologists who like to point out the existence in perceived power structures agree that voluntary exchange benefits all participants.

This fundamental principle reveals some of the costs of government regulation in the economy. On his blog, John Steigerwald alerts us to the story of armed police raids of barbershops in Florida. The Orlando Sentinel reports that on two days in August and September at least nine shops were stormed and 37 barbers were arrested in front of their customers for the crime of unlicensed barbering. I guess now its, "Shave and a hair cut. . .two-to-five years." Government licensing of barbers and other service providers makes it harder for people to enter the regulated industries, driving up costs and reducing the quantity of services provided.

Such regulation also violates the ethic of property. If someone is willing to pay their own money to have their hair cut by someone without a license, that is because they choose that as their best grooming option. To take that option away is to force them to satisfy their desires in a more costly way. As I point out in Chapter 17 of my book, Foundations of Economics, such regulations reduce the quantity of mutually beneficial exchanges and therefore make people relatively worse off than they would be in a free society.

Money and Banking Quote of the Day

From pages 654-55 of Jesus Huerta de Soto's Money, Bank Credit, and Economic Cycles:

The system of financial planning which rests on the central bank cannot possibly eliminate recurring economic cycles. The most it can do is to delay their appearance by creating new liquidity and providing support to endangered banks in times of crisis, at the cost of aggravating the inevitable economic recessions. Sooner or later, the market always tends to spontaneously react and to reverse the effects of monetary aggression unleashed on it, and therefore deliberate attempts to prevent such effects via coercion (or the granting of privileges) are condemned to failure. The most these attempts can achieve is the postponement, and consequent worsening, of the necessary reversion and recovery, or economic crisis. They cannot prevent it.

Creating new liquidity and providing support to endangered banks in this time of perceived crisis is exactly what the Fed has been doing and continues to do with QE2.

Huerta de Soto Presenting the London School of Economics' Hayek Lecture

Here is the great Jesus Huerta de Soto presenting this year's Hayek Lecture at the London School of Economics (HT: Mises Institute).

LSE Hayek Lecture 2010: Professor Jesús Huerta de Soto from Cobden Centre on Vimeo.

His Hayek lecture entitled "Economic Recessions, Banking Reform and the Future of Capitalism"  is as timely as today's headlines. His magnificent Money, Bank Credit, and Economic Cycles is a book for the ages.

Thornton on Bernanke

A former graduate professor of mine, Mark Thornton, has an excellent essay on Mises.org explaining why Ben Bernanke's proposed solutions for the economic banana we are in are in fact the problem. In this essay, Thornton documents Bernanke's educational and professional pedigree, examines his truly dismal track record as economic prognosticator and policy maker, noting particularly that he was, "deeply involved in creating the housing bubble encouraging people to invest in toxic assets, and orchestrating the cover-up after the bubble collapsed."

I have written on Thornton's excellent analysis before and am happy to recommend another of his essays.

Jim Grant on Bernanke and QE2

On his blog Lew Rockwell posted November 3 appearance of James Grant on Bloomberg.



Grant provides his opinions about the Fed, its assumption of much more economic responsibility, and quantitative easing, or what we used to call, merely, inflation, or as Grant puts it, printing money. Grant is the best financial writer working today and everything he says is worth listening to. His remarks about deflation and Bernanke's being an expert on the Great Depression are alone worth the price of admission. Treat yourself to this.

Misguided Compassion Hurts the Poor

So says Theodore Dalrymple in an excellent article from the Spring 2010 City Journal. Dalrymple shows remarkable insight he begins his essay with the following:

To sympathize with those who are less fortunate is honorable and decent. A man able to commiserate only with himself would surely be neither admirable nor attractive. But every virtue can become deformed by excess, insincerity, or loose thinking into an opposing vice. Sympathy, when excessive, moves toward sentimental condescension and eventually disdain; when insincere, it becomes unctuously hypocritical; and when associated with loose thinking, it is a bad guide to policy and frequently has disastrous results. It is possible, of course, to combine all three errors.

Dalrymple then proceeds to provide historical episodes from his own personal experience while living in the Gilbert Islands, Tanzania, and England to illustrate the negative psychological, moral, and cultural effects of the kind of income distribution that is commonplace in the welfare state.

Dalrymple's essay brought to mind Chapter 2 in Herbert Schlossberg's magnificent Idols for Destruction: The Conflict of Christian Faith and Culture. Early in this chapter, entitled "Idols of Humanity," Schlossberg, like Dalrymple after him, calls our attention to how humanism so quickly moves from sympathy to sentimentalism with devastating consequences. Scholssberg observes:

Humanism raises sentiment to a level of command that is wholly inappropriate to it nature. In so doing, it bases its ethical structure on sentimentality, which is the doctrine of the primacy of sentiment, its elevation into a principle of truth. Humanism thrives on sentimentality because few religions are more dishonest in their doctrinal expressions. Unable to withstand dispassionate analysis, which would reveal its lack of foundation, it stresses feeling rather than thought. That is what makes sentimentality so vicious. People can get good feelings from almost anything; "sadism" refers to a philosophy that elevates feeling into a moral principle.

After over forty-five pages of expert analysis, including that of the problem of poverty and the consequences of attempted statist solutions motivated from sentimentality, Schlossberg concludes that, instead of bringing freedom, humanism breeds tyranny.

The better educated he is, the more likely the humanist is to believe that people are like machines and need to be programmed, and the more likely he is to believe that he should be one of the programmers. Given their premises, the logic of their position is invincible: Gods without power and wealth are an absurd contradiction.

Humanitarianism is saviorhood, and ethic perfectly suited to the theology that divinizes man. But the theology that divisnizes man, it turns out, only divinizes some men. The objects of humanitarian concern becomes less than men, so that the humanitarian can exercise the prerogatives of a god.

That god that failed is man.

The moral of the story is that, if we truly want to help people who are poor, we must treat them as people, not things are as mere atoms in an abstract blob we call humanity. And we must do so accepting the whole counsel of Scripture. We must recognize that some people are poor because of their own actions, while some are because of the actions of others. We must also recognize that it is easy for poverty assistance to breed the negative social consequences of dependency and sloth.

We must also recognize that the Scriptures do not allow for engaging in theft in the name of caring for the poor. We cannot rob our neighbor to give to the poor. Neither can we hire elected officials and their bureaucratic friends to do so.True charity begins with our sharing our own time, money and selves with those in need.

Monumental Work by Salerno

One of the great living Austrian, causal-realist economists is Joseph T. Salerno. He has made significant contributions to a number of economic fields. In the history of economic thought, two of my favorite articles are his "The Place of Human Action in the Development of Modern Economic Thought" and "The Development of Keynes' Economics: From Marshall to Millennialism," the later being the definitive piece to read if you want to understand Keynes' economic vision.

He has also done very important work in monetary economics. Earlier this year the Ludwig von Mises Institute published Money, Sound and Unsound, a monumental collection of work showcasing this treasure trove. The first printing quickly sold out, but now it is available again! This book includes the most important articles Salerno has written on monetary theory and history. Anything Salerno writes is worth reading and his contribution to monetary economics is especially valuable.

Given what passes for analysis of the causes of our Great Recession and the myriad of policy advice that would merely put us back on the road to false prosperity, Salerno's work is more important than ever.

Monopoly Is 75 Years Old

Seventy-five years ago today Parker Brothers released its classic board game Monopoly. Since its release, 275 million of the games have been sold. The story of its origins is a fascinating tale of innovation and government granted monopoly via the patent. Parker Brothers bought the rights the game from Charles Darrow.

The roots of the game, however, come out of the economics of Henry George, who argued that land is a free gift to all, and, hence. "We must make land common property." George advocated a single tax on land rents with the revenues either funding the state or a social pension. A socialist subscriber to Georgist economics, Lizzy Maggie, developed The Landlords Game, which was a Monopoly proto-type. Maggie's goal was to use the board game to teach people how land rents made landlords rich and their tenants poor. You can read Rothbard's dismantling of Georgist economics in his essays, "The Single Tax: Economic and Moral Implications," and "A Reply to Georgist Criticisms."

One of drawbacks of the game is the impression that free market competition naturally leads to one super-successful capitalist attaining a monopoly in industry. An excellent critique of the world-view communicated by Monopoly written by Ben Powell and David Skarbek can be read here. As they note, Murray Rothbard pointed out "A monopoly price and a monopoly by any usable definition arise only through the coercive grant of exclusive privilege by the government."

Unemployment and the Minimum Wage

Economic theory teaches that in the best of times, if the state establishes a minimum wage above the market wage, unemployment will result. This is because at the artificially high wage, the quantity of labor workers are willing to supply is greater than the quantity of labor demanded by entrepreneurs. In a free market, the more eager workers--those willing to work for lower wages--would bid down the wage until everyone who wants to work at the prevailing wage can work. A minimum wage fixed above the market wage prevents this adjustment from happening and therefore generates unemployment.

The effect of a minimum wage is even more pronounced during economic recessions. During economic downturns labor demand in many industry wanes, making it even more likely that a government mandated wage floor will be above the market rate. The government most recently raised the minimum wage at the worst possible time. I said this very thing last July. Not surprisingly, a study sponsored by the Employment Policies Institute documents that the minimum wage increase had a strongly negative influence on employment in those labor markets most closely effected by the minimum wage--those for unskilled labor and teenagers.  The entire study, authored by economists William E. Even and David A. MacPherson can be read here,

What Has Quantitative Easing Wrought? Dollar for Dollar

American and Australian dollars trade one-for-one at Hullubullu stores in Newtown. This is because Australia's central bank is thinking of slowing the rate of growth in Australia's money supply while ours is doing everything it can to increase the supply of U.S. dollars. It is the great American dollar devaluation. This news comes, somewhat ironically at the same time the U.S. government is agitated at China's alleged devaluation of its currency in an effort to gain a trade advantage vs. American producers.

Bank in the summer of 2001 my wife and I took a tour of Italy for our 10th Anniversary. We met a coupld from Australia with whom we are still good friends. At the time they told us that it to two Australian dollars to trade for one U.S. dollar. In other words the price of an Australian dollar was fifty cents American. We went to visit our friends in Australian in 2006 and the dollar was still worth about one and a half Australian dollars, so that the price of an Australian dollar was about 75 cents American. Now the price of an Australian dollar has risen to close to one dollar a piece.

This is exactly what we get for the Fed increasing the U.S. money supply faster than other central banks increase theirs. This is the sort of inflation that Bernanke delights in.

What Happened to the $800 Billion Stimulus Money?

That is the question asked by Jonny Dymond to several people in Chicago for this story from yesterday's Business Daily on the BBC. The segment provides an interesting take on the lack of effectiveness of the Obama fiscal stimulus plan. What I find refreshing is that most of the interviewees seem to intuitively understand the vanity of Keynesian fiscal stimulus. Casey Mulligan, economist at the University of Chicago is particularly good. The union boss and Lapham-Hickey Steel president Bill Hickey are not so good. You can listen to the 18 minute segment by clicking here. These segments are usually available in streaming audio for 7 days after its original broadcast.You can download the episode by clicking here.

Wicksteed and the Anatomy of Criticism

A week ago I briefly made note of the influence of Philip Wicksteed on 3rd and 4th generation Austrian economists. It turns out that Wicksteed's price theory also had an impact on the literary criticism of Henry Hazlitt.  Hazlitt, of course, went on to be an excellent economist and write the best seller Economics in One Lesson. His first career, however, was as a literary critic. In the 1930s Hazlitt spent three years writing criticism for The Nation and then left to succeed H. L. Mencken at American Mercury.

In 1933 he wrote his own treatise on the subject, Anatomy of Criticism. It is in the form of a trialogue between three critics, each with different aesthetic theories. One, named Young, is a hyper-subjectivist, an objectivist named Elder, and a third, cleverly-named Middleton, who seeks to convince the others that the truth lies somewhere in between. To solve the problem of aesthetic value, he posits what he calls the social mind. The social mind serves as sort of the universal  judgment of the civilized, thoughtful members of society. Using the concept of the social mind, Hazlitt sought to avoid the pitfalls of pure subjectivist aesthetics, while at the same time not being forced to accept a purely objective aesthetic standard that was transcendent above the minds of men. The concept of the social mind is proposed by Middleton.

We are now ready to consider the question of values. Values are determined by the social mind. The value of a good is not inherent in that good; it is not independent of the mind and desires of men. But it is in large degree independent of the mind and desires of any particular man. This fact is most clearly seen in the economic field, if only because values there are expressed quantitatively, and with mathematical precision, in monetary prices. To a given individual in the market, the economic value of a good is a fact as external, as objective and stubborn, as the weight of an object. A man may attach no value whatever to a diamond bracelet; so far as he is concerned such baubles could sell at $5 and he would not buy one; but this fact does not prevent diamond bracelets from selling in the market for, say, about $3,000 each. On the other hand, if the same man should step on a rusty nail, he might be willing, if forced, to pay several hundred dollars for carbolic acid or iodine rather than run the risk of infection, yet he would probably get his iodine for less than a dollar at the nearest drugstore.

Young. But from what I know of economics, the relative market value of diamond bracelets and iodine is not determined by any "social mind", but by relative costs of production.

Middleton. If I argued that question at length it would carry us too far afield. It would be better to refer you to some good economic textbook. Not even all economists, of course, think clearly on the subject, but you will find an excellent discussion of this particular point in Wicksteed's "Common Sense of Political Economy." It is enough to say here that what a thing has cost to produce cannot determine its value, but what it will cost may determine whether or not it will be made. There is therefore a constant tendency to equality between price and cost o£ production, though not because the latter directly determines the former. However, all this applies merely to reproducible commodities. Suppose we take something that is not reproducible. As a connoisseur of art you might personally prefer Rivera to Gainsborough, yet if you wished to acquire for yourself a painting by either artist, you would find that you would have to pay a staggering sum for the Gainsborough but that you could acquire the Rivera for a relatively moderate figure. Regardless of your personal likes and dislikes, you are obliged to adjust yourself to the values placed on goods by the community as a whole, in its organic functioning.

Hazlitt's theory is that while the aesthetic value of a work of art is not determined by something outside of the minds of men, and hence subjective, it is not the product of the mind of any one specific man, and hence, from the perspective of each individual in society, objective.

Ultimately I think Hazlitt fails in his attempt to desubjectivize aesthetics by appealing the the social mind because the concept still relies on the aesthetic judgements of subjectively evaluating people. Nevertheless it is an ingenious application of Wicksteed's price theory to aesthetics.

I think Hazlitt is closer to the mark when his character, Elder the aesthetic objectivist posits

We must assume the existence of God, or reinstate Him, if only that we may have a hypothetical standard for assessing literary and aesthetic accomplishment. For only on the assumption of His existence and His infallible judgments is it at all possible to think of absolute values and an absolute standard.

Unfortunately, Hazlitt rejects this when he has Middleton say,

I do not see that your hypothesis gains you anything after all. For even if your God or your Absolute Valuer exists, He will never reveal to mortals the real standing of the classics. No, Elder, criticism will have to reconcile itself to the fact that it has human limitations. The literary opinions of your God will remain forever inscrutable, and humanity—or, if you wish, posterity—must be both for the author and his critic the court of last appeal. But the concept of a social mind and of its valuations at least clears the air.

It seems to me that Elder is closer to the truth, except we do not have to merely assume the existence of a God to have a consistent aesthetic theory. However, we can, by faith, recognize that according to the Scriptures the Creator made all things very good and that the things he made are both useful and beautiful.