Murphy's Response to Paul Krugman

Very few people liked to be publicly criticized. One of the blessings, however, of having to answer pointed questions criticizing our perspective is that it forces us to reexamine our position and, if sound, to find a better, more clear and ultimately more convincing way to present our case. That is the thought that came to mind last week upon reading Bob Murphy's excellent response to Paul Krugman's criticism of Murphy and his exposition of Austrian business cycle theory.

It is quite possible that you have read it already, but in case anyone had not, I want draw your attention to it. Although Murphy's piece is a direct response to Krugman, it also proves to be an excellent introductory summary of Austrian theories of capital and business cycles. There are a number choice parts of Murphy's response that I will highlight as follows:

Murphy begins his essay with an introduction on Austrian capital theory in which be links to an article about Austrian Capital in which he uses a formal mathematical model in his exposition, just to show Krugman his bona fides. This is an excellent rhetorical disarming of the standard tiresome criticism of Austrian economists not knowing any math.

In a section on the Austrian theory interest, he explains why savings and investment is necessary for economic expansion.

How is it possible that the community as a whole can have more income in, say, 30 years? Obviously the households think it is financially possible, because their bank balances rise exponentially with the higher savings rate. But technologically speaking, this is possible because the composition of physical output changes. The households have cut back on going out to dinner, buying iPods, and so on, in order to double their savings rate. This means that restaurants, Apple stores, and other businesses catering to consumption will have to lay off workers and scale back their operations. But that means labor and other resources are freed up to expand output in the sectors making drill presses, tractors, and new factories.

In 30 years, the economy will be physically capable of much higher output (including the production of consumer goods), because at that time, workers will be using a larger accumulation of capital or investment goods made during the previous three decades. That is how everybody can have a higher standard of living, through savings.

He then presents an excellent summary of Austrian business cycle theory. He explains why, when governments try to fund investment with monetary inflation without an increase in voluntary savings, this sets in motion an unsustainable boom that must resolve itself in recession.

Unfortunately, at some point reality rears its ugly head. The central bank hasn't created more resources simply by buying assets and lowering interest rates. It is physically impossible for the economy to continue cranking out the higher volume of consumption goods as well as the increased output of capital goods. Eventually something has to give. The reckoning will come sooner rather than later if rising asset or even consumer prices makes the central bank reverse course and jack up interest rates. But even if the central bank keeps rates permanently down, eventually the physical realities will manifest themselves and the economy will suffer a crash.

 Murphy then turns his attention to responding to specific criticisms of Krugman. Krugman asks if Austrian theory is true, why can central banks cause an economic slow-down? Murphy responds in essense, "What do you mean why? That is part of the theory!"

[Krugman] asks, "Why is there overwhelming evidence that when central banks decide to slow the economy, the economy does indeed slow?" But because the Austrian theory says the bust occurs when the central bank backs off and allows interest rates to rise toward their "correct" level, this is hardly a problem. In fact, if central banks couldn't slow the economy, as an Austrian economist I would be worried about my theory.

Murphy writes an exceptionally good paragraph explaining why capital consumption occurs via malinvestment during an inflationary boom.

. . .during the boom period, entrepreneurs (led by false signals) invest in projects that are individually rational and "efficient," but that don't mesh with each other. In other words, it's not so much that a farmer forgets to plant some of the seed corn in order to have a future crop. Rather, it's that a farmer plans on expanding his output, and so he plants much more than he did in the past, but unbeknownst to him, the owners of the silos and railroads (needed to bring the harvest to market) aren't expanding their own operations at the same pace.

This is such a crucial point. Capital is consumed in plans that cannot be carried out, because their simply are not enough capital goods in existence to finish all investment projects. There are not enough capital goods, because there has not been enough voluntary savings to fund their production.

In respond to Krugman's complaint that there is no evidence that an economy's capacity is damaged during booms, Murphy makes the uncomfortable-for-modern-macroeconomists, yet true, point that

. . .there is no simple statistic to which we can point. Austrians are correct to say that "measured investment may not show what's really happening," and correct to say that production is much more complex than depicted in Krugman's models. This isn't "cosmic talk" but a statement of basic facts.

Precisely! The capital structure is, in fact, a complex, multi-stage, structure of heterogeneous capital goods. To deny this is to deny reality.
 
Murphy goes on, however, to point to statistics such as housing prices, the trade balance, construction employment and home vacancy rates, all of which support Austrian theory. As he notes

Because Krugman was the one who set up these two challenges, it is significant that the Austrian theory passed with flying colors. Furthermore, it is significant that Krugman's own theory cannot explain the actual sectoral shifts in the labor markets. Remember, Krugman wasn't at all embarrassed by the data when he (erroneously) thought the housing bubble had little to do with the unemployment problem.

This is very important, because it was Krugman who notoriously advocated (in 2002) and then defended (with caveats in 2006) the creation of a housing bubble.

 All in all a tremendous performance that should be read in its entirety. If you want a clear, concise, and brief exposition of Austrian business cycle theory, this is a good place to start.

Charles Hodge on Property

Charles Hodge (1797 - 1878)

One of the common themes of many of the posts in this blog is the Christian ethic of private property. I have previously discussed the views of St. Augustine, Francis Wayland, and Basil Manly. Charles Hodge, the towering Princeton theologian also provided an important theological argument for private property. In the third volume of his Systematic Theology, published in the 1870s, Hodge as a section in which he provides commentary on each of the Ten Commandments.  He argued that in the commandment "Thou shalt not steal" God has instituted a divine right to property. The opening three paragraphs of this section is an excellent summary of his position:

This commandment forbids all violations of the rights of property. The right of property in an object is the right to its exclusive possession and use.

The foundation of the right of property is the will of God. By this is meant, (1.) That God has so constituted man that he desires and needs this right of the exclusive possession and use of certain things. (2.) Having made man a social being, He has made the right of property essential to the healthful development of human society. (3.) He has implanted a sense of justice in the nature of man, which condemns as morally wrong everything inconsistent with the right in question. (4.) He has declared in his Word that any and every violation of this right is sinful.

This doctrine of the divine right of property is the only security for the individual or for society. If it be made to rest on any other foundation, it is insecure and unstable. It is only by making property sacred, guarded by the fiery sword of divine justice, that it can be safe from the dangers to which it is everywhere and always exposed.

How Ethanol Subsidies Make It Harder to Feed People

One fundamental economic fact of life is that we get more of whatever we subsidize. Since 2001 the U.S. Government has poured gobs (that is a technical term that means officially, a lot) of money into the production of ethanol as an alternative energy source. The Wall Street Journal has a brief, yet informative editorial explaining some of the consequences of such a policy. In 2009 the United States produced five times more ethanol than it did in 2000. To produce more ethanol, we use more corn. As the editorial documents:

In 2001, only 7% of U.S. corn went for ethanol, or about 707 million bushels. By 2010, the ethanol share was 39.4%, or nearly five billion bushels out of total U.S. production of 12.45 billion bushels. Four of every 10 rows of corn now go to produce fuel for American cars or trucks, not food or feed.

All of this for no net environmental benefit. Even Al Gore has admitted that he championed ethanol subsidies to get votes from farmers, not because ethanol really benefited the environment.
As the Wall Street Journal piece concludes:


Now if the demand for corn increases because more people are subsidized for producing ethanol, the price of corn will increase. Higher corn prices will raise costs of producing other goods like beef or tortillas that require corn as a factor of production. It would be one thing if ethanol was the use for corn people valued the most. Because this use is driving by subsidies, however, we know this is not the case.

At a time when the world will need more corn and grains, it makes no sense to devote scarce farmland to make a fuel that exists only because of taxpayer subsidies and mandates. If food supplies tighten and prices keep rising, such a policy will soon become immoral.

Is Inflation Much Greater Than We've Been Told?

Chris Martenson thinks so. In a piece published on Business Insider he provides data and analysis that corroborates what I've previously noted here, here, and here.  Martenson argues that the Consumer Price Index (CPI) now routinely understates the amount of price inflation we are experiencing. He attributes this inaccuracy to three adjustments the Bureau of Labor Statistics (BLS) makes to the data as they calculate the  CPI.

[T]here are three major statistical 'tricks' that the BLS imposes on the Consumer Price Index. They are hedonics, which tries to account for improving quality in products over time, substitution, which is the act of switching to lower-cost items when prices surge on preferred items, and weighting.

Martensen then uses how the BLS incorporates health care prices into the CPI as a case study illustrating why he thinks the CPI underestimates the impact on raising health care prices on inflation.

He conlcudes:

For the reasons above, inflation is much higher than proclaimed. Yet we are being told, on a near-daily basis, that the massive money printing and deficit spending activities of the Federal Reserve and federal government, respectively, are not stoking inflation. At least, 'not yet.' Since the Fed uses the CPI as a key indicator in its decision making, the big risk here is that Bernanke will not begin to turn the wheel on the monetary supertanker until after it is too late.

Why Not Private Roads and Highways?

That is the question considered by my friend and colleague Tracy Miller. He discusses the economics and history of private roads, noting:

The paucity of private roads cannot be taken as proof that such roads would not be built in the absence of government subsidies. Few private highways exist because they cannot compete with government subsidized highways. Given the choice between paying a toll to drive on a private highway driving on a government highway at no charge, most drivers would rather drive on government highways than private highways, even if private highways were better quality and had less congestion.The result is a very inefficient system of roads and highways that are more costly than necessary with serious congestion problems in many cities.

Another economist who has written hundreds of pages on the issue of road privatization is Walter Block.

A Compelling Preview of Tonight's State of the Union Address

Amity Shlaes provides a compelling preview of the economic policy portion of tonight's State of the Union Address by President Obama. She examines the coming claim by the President that in today's trying economic times government spending continues to be necessary to create private sector jobs. Shlaes does us all a valuable service by providing a digest of economic research by economists as diverse as Robert Barro, Price Fishback and Valentina Kachanovskaya, Lee Ohanian, and Robert Higgs.

The work of these economists all point to the fact that government spending is actually a job killer, not a job creator. "The research," Shlaes concludes, " also tells us that the best thing President Obama can do to help unemployment drop on his watch is to eschew more plans for spending altogether."

On this point Shlaes agrees with me. I conclude the chapter on macroeconomic policy in my Foundations of Economics with the following:

Putting our faith in fiscal stimulus such as increased government spending is likewise foolish. Increased government spending must be financed somehow. Clearly, paying for it by increasing the money supply does more harm than good. Paying for it by increasing taxes reduces the ability and incentive to save and invest because taxation reduces disposal income. Financing increased government spending by borrowing takes otherwise productive capital out of the private economy and redirects it into the hands of bureaucrats who consume it according to their statist ends. All of this tends to promote capital consumption and hampers the capital accumulation process necessary for the economy to get back on the path to prosperity.

China's Economy: Expanding and Overheating?

Last Wednesday's New York Times featured an article about Chinese economic expansion that is illustrative of a misconception all too common in economic journalism. The story is ostensibly about the apparent white hot Chinese economy that officials tell us "grew 10.3 percent in 2010." The annualized rate of Chinese economic expansion in the fourth quarter was 9.8%. "Both the quarterly and annual figures were significantly above what analysts had expected."

Now, given that economic expansion occurs as an economy produces more goods that people can use to achieve their various ends, one would think, assuming the numbers paint an accurate picture, that rapid economic progress would be greeted unequivocally as good news. However, the very next paragraph includes a definite caveat.

Taken together, the data and a number of other statistics in recent days supported the view of many economists who believe that the government will have to further tighten monetary policy, which could eventually lead the Chinese currency to appreciate against the dollar.

Now, if the Chinese economy was actually expanding, it must be that the Chinese have become more productive and that output has increased. If this is so, the supply of goods must have increased. Therefore, the prices of goods should be decreasing, not increasing. Economic progress results in overall prices that are lower than they otherwise would be, not higher than they otherwise would be.  If that is the case, there would be no necessary reason for the Chinese government to tighten monetary policy.

The idea that fast growth puts an economy in danger of price inflation due to "overheating" is a product of the Keynesian framework that views economic growth as synonymous with increases in national income made possible by increases in aggregate demand. If demand increases faster than supply, prices will increase, however, such a phenomena is not economic growth. It is merely an increase in spending. The caption under the accompanying photo reveals much: "Demand for consumer goods continued to fuel growth in China."

Consumption demand does not generate economic growth. We must produce in order to consume not consume in order to produce. Consumption does not fuel growth at all. If we directed all of our efforts toward consumption, we would very quickly consume all of the goods that exist and be left with nothing for future consumption. We only have goods to consume after they have been produced, which implies that it is saving and investment in production that fuel real economic expansion.

True economic progress should not generate fears of inflation. Unsustainable economic activity funded by monetary inflation should. If increased price inflation in China is a real threat, this indicates that recent increases in official Chinese income statistics are indicative of growth that is more apparent than real.

A Christian Speaks Up for Capitalism

I just recently came across the thought-provoking essay "A Christian Speaks Up for Capitalism" by James D. Gwartney, co-author of a very popular principles of economics text. The piece originally appeared in the August 1986 Freeman, but is as timely as today's headlines. Gwartney explains why Capitalism is an ally of Christianity, not a necessary enemy. He argues thus by stressing several points:

• Capitalism rewards and reinforces service to others.
• Capitalism provides for the masses, not just for the elites.
• Capitalism provides opportunity for achievers of all socioeconomic backgrounds to move up the economic ladder.
• Capitalism provides for minority views.

I think the first point is so important. Way too many Christians (and people in general for that matter) are under the mistaken impression that capitalism is a barbaric free-for-all in which the greedy eat the bread they have made with the ground up bones of the exploited working class. In a free capitalist society, however, the only way for a capitalist/entrepreneur to make a profit is to serve his customers better than anyone else. Not only does capitalism reward service, it provides an incentive to be the best servant possible. In fact, even if an entrepreneur was the epitome of the greedy capitalist pig, the only way for the pig to feed his desire for wealth is to serve others. It is the only economic system with the potential to turn a vice into something beneficial for someone.

Gwartney concludes:

Of course, capitalism does not impose the moral demands that Christianity does. But economic systems seeking to perfect human nature have more often led to tyranny than to bettering the human race. Christians would do well to settle for an economic system that reinforces Christian virtues, improves living standards, and provides for minority views. Capitalism is such a system.

Krugman on Baby Sitters and Depression Economics

In his blog post against Robert Murphy, Paul Krugman gently chides Murphy for using a fictional  story to explain capital theory and the business cycle, while noting that at least the baby-sitter co-op story he likes to use is based, as they say in Hollywood, on a true story. Krugman explains economic recessions using the tale of a baby-sitting co-op that ground to a halt due to members hoarding babysitting tickets.  He used this metaphor as the key explanatory tool in his book Return of Depression Economics, first published in 1998 and then re-issued with additional material discussing the most recent economic crisis.

The problem is that, while the baby-sitting co-op may have really existed, it is not a good metaphor for an economy supported by a vast, complex structure of heterogeneous capital. Interested parties can read my evaluation of the weaknesses of Krugman's paleo-Keynesian approach in this essay reviewing the first edition of Krugman's book..

Initial Thoughts on Krugman on Murphy

Paul Krugman has explicity criticized Robert Murphy's explanation of Austrian theory of capital and the business cycle. I have not had time to develop a full response to Krugman's argument, but my initial thoughts are below. The core or Krugman's criticism is as follows:

A short sample: If inflation is a case of too much money chasing too few goods, why aren’t slumps associated with accelerating rather than decelerating inflation, as the supply of goods falls? Why is there such a strong correlation between nominal and real GDP? Why is there overwhelming evidence that when central banks decide to slow the economy, the economy does indeed slow? And on and on.

Oh, and what evidence is there that the economy’s capacity is damaged during booms? Investment rises, not falls, during booms; yes, I know that Austrians take refuge in cosmic talk about the complexity of production and how measured investment may not show what’s really happening, etc., but where’s the positive evidence of what they’re claiming?

What strikes me first is that these criticisms seem to demonstrate a marked ignorance of the literature on Austrian business cycle theory. I am happy that he has decided to finally engage Murphy in print. However, he still gives the impression that instead of honestly engaging the theory and then refuting it, he merely dismisses it. That is the only interpretation one can get his associating the validity of the phlogiston theory of fire with Austrian business cycle theory.

Additionally evidence of his dismissal is his failure to cite any of the scholarly literature. Many of his questions have already been answered in works such as Jesus Huerta De Soto's Money, Bank Credit, and Economic Cycles, Roger Garrison's Time and Money, Murray Rothbard's Man, Economy, and State, and America's Great Depression, Guido Hulsmann's "Toward a General Theory of Error Cycles," Anthony P. Mueller's "Financial Cycles, Business Activity, and the Stock Market," and Roger Garrison's "The Austrian Theory of the Business Cycle in Light of Modern Macroeconomics."  Not to mention the seminal works by Mises and Hayek. Both Mises and Hayek, for example, explain why, when the central bank slows the rate of growth of the money supply at the height of an inflationary boom, a recession ensues. This would not be a mystery to one who has read the Austrian literature.

Krugman also asks for evidence that capacity is damaged during "a boom." It should be noted that he does not distinguish between sustainable economic expansion resulting from investment fully funded by voluntary saving and an unsustainable boom funded by monetary inflation via credit expansion. There is a very real and important difference between those two phenomena. Assuming, for the sake of argument, that Krugman is referring to the boom made possible by monetary inflation, I would think that the tremendous amount of scarce producer goods sunk in housing projects that failed to come to fruition should count as evidence.

The materials used in this wasteful malinvestment cannot be used in more valuable production. If Krugman wants to see evidence of damaged capacity, perhaps he should watch this video:

Prices Are Rising Somewhere

Wholesale prices, especially those of food and energy, are on the rise. So says the BLS in there most recent release. Asha Bangalore of Northern Trust breaks down the numbers here. These higher prices should make Ben Bernanke sleep more easily. Indeed he is happy and said the economy is moving "in the right direction" with the threat of deflation falling. Thanks to Ben we are back to continually higher prices. By the way, consumer prices are rising too.

January in Paris

Three days ago I was honored to present a truncated version of the ideas in the first chapter of my book Foundations of Economics to the Austrian Research Seminar hosted by Guido Hulsmann. In addition to Professor Hulsmann, there were seven bright Austrian scholars in attendence, all of which contributed valuable suggestions and lively discussion.

My presentation, entitled "Christian Foundations of Economic Analysis," sought to briefly and broadly demonstrate that the Scriptural view of man presents us a picture of man that encourages us to embrace economic laws developed with a praxeological method. It was this understanding of economics as a science of human action that convinced me that economics was a calling worth pursuing for life.

As I explained the connection between the Biblical view of man and economic method:

Christian anthropology characterizes man as a being who a free rational agent who engages in purposeful behavior. In doing so, man applies means according to ideas to achieve ends. Such allocation of means require choice which itself necessitates preferring one thing to another. Such preferences are made according to the subjective values of the human actor. Man undertakes action in the face of incomplete knowledge in the present and must speculate about an uncertain future. Hence, praxeology is a method especially in agreement with the Christian view of man. When one looks at Scripture for information regarding the nature of human action, he finds that God’s revealed Word tells the reader that man is created in God’s image with the ability to think and act purposefully, by making choices based on subjective evaluations determined by his own value scale. Praxeology, therefore, is the economic method most reflective of reality as described in the Scriptures.

The Government Cannot Grow the Economy

Caroline Baum has written an excellent essay explaining why the government cannot "grow the economy." She is rightly put off by the very nature of the metaphor and further explains why, even if we accept the phrase "grow the economy" it is a fantasy to think that the state can accomplish such a feat.  "In the real world, of course, the more you “grow the economy,” the less you have to show for it." She even quotes the wise and pithy Henry Hazlit,

How marvelous is the Keynesian world! The more you spend the more you save. The more you eat your cake, the more cake you have.”

I lectured on the very topic of economic expansion two days ago in a course I was invited to co-teach with Guido Hulsmann at the University of Angers. I gave the first lecture explaining the mechanisms of economic progress. In order to obtain more and better goods that allow us to satisfy more of our ends, obviously we need to increase our production. Because of the law of returns, gains from increasing our labor face certain constraints. Therefore, we need to take advantage of the use of capital goods which requires more roundabout production processes. Because capital goods need to be produced before they can be used, we must restrict our consumption (engage in saving) in order to sustain ourselves during the time we are making the capital goods that we can then use to produce more consumer goods. Consequently, saving and investment is necessary for economic progress.

Additionally, more roundabout production processes open more opportunities for the division of labor, which further increases our productivity. Because in the market division of labor, however, people are producing for other people, this raises the problem of coordinating all of the economic activity undertaken by the many different specialized producers at the various stages of production. Therefore, wise entrepreneurship is necessary to see that previously accumulated capital is not wasted.

The state can do none of the above. In fact it is worse than useless, the government is positively destructive. Baum's only less-than-bright spot in her essay is when she makes a concession that "Attempts to grow the economy by government spending can only provide support in the short run." In fact, government spending cannot even do that. Any support given is not temporary, it is merely apparent--an illusion. Increasing government spending can make nominal GDP look better, because government spending, after all, is a chief component of GDP. In fact, if GDP is increasing only due to government spending, the economy is actually regressing because capital is being consumed producing things people in society value less than their cost of production.

Lord Acton

Lord Acton (1834 - 1902)

Lord John Dallberg-Acton was born on this date in 1834.  He was an important historian and classical liberal. His most famous statement is most likely "Power corrupts and absolute power corrupts absolutely." During his life he paid close attention to the development of the United States with great interest and was saddened by the decline of federalism and states rights.

A good quick digest of Acton on liberty and government has been prepared by Gary Galles. His lecture on the American Revolution given at the turn of the 20th Century can be read here. To those who are looking for a larger helping, I recommend his Lectures on Modern History.

Women and Pay: Here We Go Again.

For years we have heard of the gap between the earnings of the average man and the average women as prima facie evidence of discrimination. The claim was raised again by Jeffrey Lewis and Janet Petersen, noting that an increasing number of women are finding themselves in officially-defined poverty.

The statistics they cite are as follows:

Working women are paid just 77 cents for every dollar their male counterparts receive. Although women earn 57 percent of bachelor's degrees and 60 percent of master's degrees, they continue to represent a meager 3 percent of CEOs in Fortune 500 companies, hold just 15 percent of the board seats of those companies and fill only 6.3 percent of top-earning executive posts.

I wrote about this issue back in 1999 in an essay entitled, appropriately enough, "Women and Work." Drawing on economic theory, contemporary labor statistics, and earlier work done by Thomas Sowell in his Civil Rights: Rhetoric or Reality?, and , I concluded

[T]he performance of women's earnings over time is not the result of systematic discrimination. Whether egalitarians like it or not, for the "average" woman her family life trumps other concerns on the margin. Employers and employees are merely recognizing this fact of nature: women and men are not equal in the sense of being identical. They are different and have different comparative advantages when it comes to work outside the home versus child rearing.

Of course, both men and women would like to work for much more than what they are getting paid, other things equal. But then, the other things are never equal. That fact serves as a useful devise for egalitarian politicians and bureaucrats. Social engineers use the persistence of inequality of income as the warrant for never-ending regulation.

I have no reason to conclude differently this time around.

Hulsmann on the Potential for Hyper-Inflation and More

Guido Hulsmann, Professor of Economics at the University of Angers, France and author of Mises: The Last Knight of Liberalism, was a recent guest on the Lew Rockwell Show. On the show he discussed the Fed's quantitative easing, monetary inflation, the potential for hyper-inflation and the beneficial aspects of deflation.

The interview lasts about 15 minutes and is well worth the time.  You can download it as an mp3 file by clicking here.

We Don't Even Know How Bad the Federal Finances Are

After pouring over the U.S. Government Accountability Office's 2010 Financial Statements, Doug French reports that

the U.S. Government Accountability Office says it can’t render an opinion on the federal government’s financials “because of widespread material internal control weaknesses, significant uncertainties, and other limitations.”

Remember when even an unsubstantiated hint of impropriety at accounting titan Arthur Andersen sent it packing? Well, let us see what the Comptroller General of the United States has to say about our national government's financial statement:

Our report on the U.S. government’s consolidated financial statements is enclosed. In summary, we found the following:

• Certain material weaknesses in internal control over financial reporting and other limitations on the scope of our work resulted in conditions that prevented us from expressing an opinion on the fiscal years 2010 and 2009 accrual-based financial statements.1 About 32 percent of the federal government’s reported total assets as of September 30, 2010, and approximately 25 percent of the federal government’s reported net cost for fiscal year 2010 relate to three agencies’ fiscal year 2010 financial statements that, as of the date of our report, either received disclaimers of opinion or were not audited.

• Because of significant uncertainties, as discussed in our report, we are unable to, and we do not, express an opinion on the 2010 Statement of Social Insurance. About $22.8 trillion, or 74 percent, of the federal government’s reported total present value of future expenditures in excess of future revenue for 2010 relate to the Department of Health and Human Services’ 2010 Statement of Social Insurance, which received a disclaimer of opinion. In our opinion, the Statements of Social Insurance for 2009, 2008, and 2007 present fairly, in all material respects, the financial condition of the federal government’s social insurance programs, in conformity with U.S. generally accepted accounting principles.

• Material weaknesses resulted in ineffective internal control over financial reporting (including safeguarding of assets).

• Our work to test compliance with selected provisions of laws and regulations in fiscal year 2010 was limited by the material weaknesses and other scope limitations discussed in our report.

These sort of irregularities are not uncommon in a bureaucratic institution that, by its very nature, is unconstrained by profit and loss. When an entity can force people to give it money or it can legally print money itself, what does it matter if no one establish the extent of its solvency? It must be solvent because it simply must be.

Of Saxaphones and Heterogeneous Capital

While attending one of my college's annual Christmas concerts, I was reminded once again of one of the most underrated contributions to economics by the Misesian economic tradition--the idea that capital is heterogeneous. The first half of the Christmas concert was performed by the Grove City College Saxophone Quartet. The musicians were all quite capable and earnest in their music making, but it quickly became apparent that there was a clear difference between the success of the up-tempo jazzier pieces and that of the more lyric pieces.  Saxophones are great at swinging and bopping, but they are simply not designed for communicating sustained pathos. They are not equally serviceable for both lines of musical production. What is true in woodwind instruments it true for most other capital goods as well.

Capital is not a homogeneous blob of K, or as Peter Klein puts it in chapter 4 of his The Capitalist and the Entrepreneur, "shmoo." As such when thinking about how capital is allocated in an economy, we need to recognize that quantity of capital alone is not all that matters. Capital must be invested in the right places at the right time in the complex structure of production.The heterogeneity of captial is another reason that trying to resuscitate a recessionary economy via monetary inflation or fiscal stimulus is unwise and why focusing on maintaining stable nominal GDP spending is to focus on the wrong thing.

Top Posts of 2010

Foundations of Economics Year in Review:

The most popular posts of 2010:

1.   Who's Afraid of the Big Bad Inflation?

2.   Making the Economy Worse Through Mortgage Subsidies

3.   Responding to Economic Recession: Like Japan, Like the United States

4.   Inflation and Government Spending Do Not Provide Prosperity

5.   Don't Politicize the Fed?

6.   Instructor's Manual and Study Guide Now Available

7.   Bernanke: Apoplithorismosphobist-in-Chief

8.   Fighting Poverty with Capitalism

9.   Augustine and Property Rights

10. Voluntary Exchanges and the Free Market

Thanks to my readers, commenters, and correspondents.

Happy New Year!