Macroeconomics Explained

From Saturday Morning Breakfast Cereal. Thanks goes to my former student Anthony Oriti for pointing me to this.

Voluntary Exchange Is Mutually Beneficial Redux

Michel de Montaigne

Or when is a renaissance not a renaissance? If you are not already aware, Jason Jewell, Associate Professor at Faulkner University in Montgomery, Alabama, where he chairs the Department of Humanities, assigned a very brief essay by Montaigne for part of the weekly reading in his Great Books Project. Let us just say that it is a pity that Montaigne was such an influential writer in Renaissance France. The essay, "One Man's Profit Is Another Man's Harm" is reproduced in its entirety below:

DEMADES the Athenian condemned one of his city, whose trade it was to sell the necessaries for funeral ceremonies, upon pretence that he demanded unreasonable profit, and that that profit could not accrue to him, but by the death of a great number of people. A judgment that appears to be ill grounded, forasmuch as no profit whatever can possibly be made but at the expense of another, and that by the same rule he should condemn all gain of what kind soever. The merchant only thrives by the debauchery of youth, the husbandman by the dearness of grain, the architect by the ruin of buildings, lawyers and officers of justice by the suits and contentions of men: nay, even the honor and office of divines are derived from our death and vices. A physician takes no pleasure in the health even of his friends, says the ancient Greek comic writer, nor a soldier in the peace of his country, and so of the rest. And, which is yet worse, let every one but dive into his own bosom, and he will find his private wishes spring and his secret hopes grow up at another's expense. Upon which consideration it comes into my head, that nature does not in this swerve from her general polity; for physicians hold, that the birth, nourishment and increase of every thing is the dissolution and corruption of another:-- "For, whatever from its own confines passes changed, this is at once the death of that which before it was."

Jewell had this to say about Montaigne's essay:

In a short three paragraphs, Montaigne completely misconstrues the nature of trade without going so far as to condemn it. Or maybe it’s just the title of the essay that is misleading. Montaigne writes that no one would have an opportunity for profit if no one else were dissatisfied with anything. Of course, that’s not the same thing as saying that one’s profit harms another. It would be more accurate to say, “One Man’s Profit Comes from the Relief of Another’ Man’s Harm.” It’s too bad they didn’t know about marginal utility in the 16th century.

I agree with Jewell, but would perhaps go farther. Montaigne's statement that everyone's "private wishes spring and his secret hopes grow yup at another's expense" shows, I think, that he was not misleading with the title.

Good economists know that every voluntary exchange is mutually beneficial, because each party receives something they value more highly that what they trade away. This is true even in the midst of trying circumstances. A physician who receives income from treating a sick person is not benefiting by harming his patient. He receives income as he treats his patient who needs his services because he is ill.

That trade is mutually beneficial was known at least as early as Aristotle. And in the Summa Theologica, Aquinas has this to say: "Buying and selling seem to be established for the common advantage of both parties, one of whom requires that which belongs to the other, and vice versa. . ." This understanding was embraced and developed by the British Scholastic also at the the Unversity of Paris, Richard of Middleton and by the Franciscan Pierre de Jean Olivi. In the 14th Century in his Quaestiones, a commentary on Aristotle's Ethics, the French philosopher Jean Buridan de Bethune further developed the principle of mutually beneficial exchange (On all of this see Murray Rothbard's Economic Thought Before Adam Smith, and Alejandro Chafuen's Faith and Liberty. Montaigne really should have known better.

Of Marshmallows and Time Preference

Grove City College Psychology Professor Joseph Horton makes a very nice application of a classic study in his field to economic policy and its consequences. In "We Need to Stop Eating the Marshmellows" he describes the study and then uses it to make sense of our national debt disaster.

In a classic psychological study, hungry four-year-olds were offered a marshmallow. They were told that if they could wait about 20 minutes before eating, they could have two marshmallows instead of one.

 Only about one-third of the children successfully delayed gratification and got two marshmallows. This ability to delay gratification as children predicted success in life decades later. They were more likely to study, do well in school and in careers. In addition, they had more successful social relationships. The ability to sacrifice today for gains tomorrow can pay big dividends.

This study illustrates the fundamental economic principle of time preference. Other things equal, people prefer to have their ends satisfied sooner than later. Therefore, to be willing to put off present consumption, people must expect to be able to consume more in the future.

As the study reveals, even doubling the payoff was not enough for two-thirds of the children to do so. This corroborates the observation of  the 13th century monk, Bartholomew the Englishman who wrote, “Children often have bad habits, and think only of the present, ignoring the future . . . They cry and weep more over the loss of an apple than over the loss of an inheritance . . . They desire everything they see, and call and reach for it.

Professor Horton notes in his essay that, when it comes to the American masses' approach to social policy, their behavior is way too childish.

The debt and unfunded liabilities at the federal level are simply astronomical. The debt is more than $16 trillion, or $50,000 for every citizen. This does not count unfunded liabilities for Social Security and Medicare. We are on the precipice of becoming the next Greece, except that no one will be there to bail us out.

Politicians are not the source of the problem. The problem lies in the voters who elect them. It seems more and more voters not only want to eat their own marshmallow right away, but they want to eat the marshmallows of others without regard of how to, or who will, pay for our collective inability to delay gratification.

Much better would be the way of Christ, given to us by His Apostle Paul. "Let the thief no longer steal, but rather let him labor, doing honest work with his own hands, so that he may have something to share with anyone in need" (Ephesians 4:28, ESV). Likewise, we should not willingly enter into financial slavery. As the writer of the Proverb warns, "The rich rules over the poor, and the borrower is the slave of the lender. (Proverbs 22:7, ESV).

Would Supply Side Economics End the Obama Recession

Michael Busler, an Associate Professor at Richard Stockton College, thinks so. He argues that

The correct supply side action needed today is to reduce tax rates, especially for the wealthy, reduce capital gain tax rates, remove the stifling regulations and inject a sense of freedom and opportunity. This would increase output, grow the economy, reduce unemployment, eventually increase tax revenue, put downward pressure on inflation and finally end the “Obama Depression.”

While Busler's instincts seem good, I am not as optimistic as he.While removing interventionist regulation of business is a very sound idea, cutting taxes by themselves is no guarantee of economic expansion. This is because government spending must be funded somehow. If not by taxes then by borrowing from the non-bank public or the inflationary banking system. Either way, purchasing power is taken away from people in society and capital is consumed, either directly or indirectly via malinvestment. At the same time scarce economic resources are still consumed be government bureaucrats.

The primary problem is government spending. That is what drastically needs to be cut. Contrary to conventional Keynesian wisdom, reducing government does not reduce economic prosperity. It may reduce statistical GDP, but it does not impoverish society. To the contrary, if the government spends less, resources are freed from government consumption to be used in productive investment. Such investment is a key source of economic prosperity. To truly increase economic output, therefore, we should cut government spending which would allow tax cuts to truly induce economic expansion.

Best Economics Blog Post on Huff Post. . . .Ever

Steve Mariotti has written what has to be the best article about economics to appear on Huffington Post. In "The Economic Philosopher's Outcast: Mises," Marriotti makes a compelling case for listening to Mises and economics in the Misesian tradition. Given the debt problems faced by several municipalities--not to mention our national govermnent--the time is long past for us to pay attention to Mises' arguments about the negative consequences of economic statism.

Mises, the modern day creator of the Classical Liberal movement (today also called libertarianism) destroyed the intellectual arguments of socialism by proving that it was impossible to allocate scarce resources effectively without private property and free-market prices. He showed that the more the state limited economic incentives to individuals, the greater the harm to low-income people and the general population. Centralized planning, something that was characteristic of all three types of socialism: the Nazis, the Fascists and the Communists, led to the ruin of an economy, and resulted in more and more tyranny and the rise of the totalitarian state. What economists failed to understand was that massive government spending and a authoritative centralized government would bring economic ruin to Germany, Russia, and many other countries.

Mariotti goes on to quote Peter G. Klein who gave the Mises Lecture at the most recent Austrian Student Scholars Conference.

"People are increasingly disenchanted with mainstream Keynesian views of the economy. Keynesians were blindsided by the housing bubble and the financial crisis. Their response was to pump the economy with cheap credit and huge government spending which has only prolonged the agony. The Austrians led by Mises offer a compelling alternative explanation in which booms and busts are caused by central-bank manipulation of interest rates in vain attempts to stimulate or stabilize the economy."

The entire article is highly recommended. My only quibble is Mariotti's closing in which he directs those wanting to learn more to the Mises Institute in Auburn, Alabama and to Hillsdale College that houses Mises' personal library. There is certainly nothing wrong with that. The Ludwig von Mises Institute has especially been the beacon for Misesian economics over the past 35 years.

My concern is what Mariotti failed to mention--that Grove City College houses the archive of Mises' American correspondence and papers. Five years after Mises' passing, his widow made Grove City College the permanent home to his papers, at the request of Mises' student and chairman of the Grove City College economics department, Hans Sennholz.

Additionally, Grove City College remains a leading institution for students to learn Austrian economics where they can study under Jeffrey Herbener and myself. At GCC the entire curriculum is rooted in Misesian Praxeology. Required reading includes my own Foundations of Economics for Principles of Microeconomics, Principles of Macroeconomics, and Foundations of Economics; Sections of Rothbard's Man, Economy, and State in Intermediate Microeconomics; Rothbard's The Mystery of Banking in Money and Banking, Rothbard's Power and Market in Public Finance, Sections from Mises' Human Action in Foundations of Economics and Money and Banking, Huerta de Soto's Money, Bank Credit, and Economic Cycles in Intermediate Macroeconomics, Hoppe's A Theory of Socialism and Capitalism in Comparative Economic Systems, Holcombe's edited Great Austrian Economists in Austrian Economics; and various supplemental articles by Roger Garrison, Jeffrey Herbener, Guido Hulsmann, and Joseph T. Salerno, and Rothbard just to name a few.  Finally, as alluded to above, Grove City College hosts the annual Austrian Student Scholars Conference. All in all it is a veritable cornucopia of causal-realist economics no interested student would want to miss. 

Who Is Pre-Copernican and Will Never Understand Monetary Policy?

In what has to be some of the weakest commentary in quite some time, Christopher T. Mahoney, a former Vice Chairman of Moody’s, mixes awkward metaphor with unfounded claims in his post, "Protestants Will Never Understand Monetary Policy." In his brief missive he strings together a series of mere assertions with very little actual analysis.

In doing so, the product he offers could be characterized as "Krugman-lite." Here is a sample:

"There are powerful forces arrayed against growth in the world today: the Dallas Fed, the Bundesbank, the ECB, the Ron Paul family, the entire German nation, Obama’s monetary ignorance, and the editorial board of the Wall Street Journal, the official organ of the orthodox right."

Additionally, Austrian economic philosophy of hard money, no central bank, and zero inflation is dismissed as

"pre-Copernican. The earth is not flat, and money matters. Yes, it would be a better universe if the earth were flat, and the sun revolved around the earth on a daily basis, and money didn’t matter. But it just ain’t so." 

Here Mahoney follows one of Krugman's favorite tactics in argumentation (if one can call it that). Instead of attempting to explain why an opposing theory is incorrect, merely claim that it is so old as to be pre-modern and, ergo, we can dismiss it.

He ends with this moralistic barrage where he implies that the key to economic progress is reflation:

Why is the Right so in love with hard money, low inflation, and high unemployment? Here is my answer: because they do not believe that there is such a thing as a free lunch. You could spread out a smorgasbord of caviar, salmon, lobster and Dom Perignon, and they would turn their heads and eat a cheese sandwich. Reflation is easy and thus sinful. It’s that Protestant thing.

This is another Krugmanesque tactic: dismissing an argument with a claim that it is moralistic or religious in nature.

There are a number of problems with this method. Nowhere does Mahoney get around to explaining why hard money, a free market in money production, and zero price inflation hinders economic progress. It is a mere assertion. It is, as Joseph Salerno notes, Mahoney himself and others like him are "the narrow-minded dogmatists . . .who insist against all reason and experience that the creation of money miraculously begets real goods and services and ushers in an earthly paradise of plenty." In fact, because economic prosperity requires a market division of labor made possible by capital investment coordinated by wise entrepreneurial decisions, it is imperative that the government not monkey around with our monetary system, destroying purchasing power and leading entrepreneurs astray through artificially low interest rates.

It  should also be noted that the Austrian view that hard money is conduce to economic prosperity while government monetary inflation is useless at best and destructive at worst is, in fact, positively Copernican! As Murray Rothbard documents in his Economic Thought Before Adam Smith, Copernicus himself was the first "to set forth clearly the 'quantity theory of money.'" In his 1526 essay Monetae cudendae ratio, Copernicus, while discussing an increase in overall prices, wrote,

'We in our sluggishness do not realize that the dearness of everything is the result of the cheapness of money. For prices increase and decrease according to the condition of the money.' 'An excessive quantity of money should be avoided.'

  So it turns out that Copernicus himself was pre-Copernican. Who knew?

Fractional Reserve Banking is Inherently Unsustainable without Government Privilege

That is the thesis of this provocative lecture by Joe Salerno at the most recent Mises University.



Salerno explains how the Fed manipulates the entire money creation process as the central bank and then commercial banks make money out of nothing.

In my book, Foundations of Economics, I make the case that fractional reserve banking is inherently inflationary and generates the business cycle. Building on the monetary theory of Ludwig von Mises, Murray Rothbard, and Jesus Heurta de Soto, I explain how, in a fractional reserve setting (especially if it is backed by a central bank) increases in bank reserves are multiplied leading to increased prices, a decreasing purchasing power, and artificially lower interest rates that induce capital malinvestment and its consequential recession.

For those who want more, I highly recommend the collection of his writings on monetary theory and policy, Money Sound and Unsound. It is even available for no charge in pdf format.

Economic Expansion Requires Saving: R & D Edition

Goldman Sachs' Robert Boroujerdi has co-authored a report "The Search for Creative Destruction" that reveals an empirical relationship between research and development spending, sales revenue growth, and stock price returns. On the face of it, these results are not surprising. With more and better technology, we can be more productive and utilize our scarce resources more efficiently.

It is important to remember however, that taking advantage of technological development requires saving. It does so for two reasons. First, as I say in my book, Foundations of Economics, in order to take advantage of technology, it must be bound up in actual capital goods, which must be produced. Such production must be funded by savings.  Additionally, investment in research and development itself must also be funded by savings. Some neo-classical growth theorists downplay the importance of saving and investment and play up technology as engines of prosperity. It is important not to forget, however, that even R & D requires savings. 

Best New York Times Economic Analysis. . . . .Ever

Well that might be hyperbole. Henry Hazlitt used to write economic commentary for the New York Times. But still Casey Milligan's post "Consumer Spending and Economic Growth" is very impressive.

He takes Jared Bernstein to task, for which I am glad, because I do not have time right now to do it. Bernstein asserted in vulgar Keynesian fashion that consumer spending is what drives the economy, which is why he trumpeted President Obama's most recent speech on the economy.

Mulligan is right on the money when he counters that economic growth is the product of investment not consumption. As he says, "High levels of consumer spending are a consequence of economic growth, not a cause of it."

Mulligan later turns to the received economic wisdom of economic growth textbooks:

I went back to check the economic growth textbooks. My favorite was written by Robert Barro and Xavier Sala-i-Martin; I also looked at the latest editions of three books recommended by Tyler Cowen of George Mason University.

All of the books look closely at investment. All of them note the three flavors of investments: physical, human and ideas. None of them say that a high marginal propensity to consume might be a way to create sustained economic growth.

Alas, Mulligan did not consult of my Foundations of Economics, but he might have. The final chapter of my work is devoted to applying various economic principles to answering the question how do we have dominion and fill the earth in a world of aggravated scarcity without either killing one another or starving to death. As I explain, economic expansion and prosperity is the result of an extensive division of labor in which accumulated capital is invested wisely by entrepreneurs.

This conclusion of sound economic theory has strong implications for social institutions. As I explain in my book:

Our survey of the engines of economic development allow for drawing some conclusions regarding conditions necessary for such development. Institutionally, there must be a market economy. Even in a market economy hampered by various government interventions there can be some amount of economic expansion. The freer the market is the more economic expansion it can achieve. In order for economic expansion to be realized, people must be able to engage in social cooperation based on private property. Private property is necessary for voluntary exchange, and it is voluntary exchange that opens the door for the division of labor to develop. Private property also reduces the risk of saving and investment because in an environment of private property rights investors can keep whatever positive return they earn without fearing that it will be confiscated. Additionally, private property allows for the development of money and results in money prices that entrepreneurs use to calculate profit and loss. Hence, private property makes possible the productive use of factors of production.