The Division of Labor and Social Order

Mises University is in full swing at The Ludwig von Mises Institute this week. A couple of days ago my department chair, Jeffrey Herbener gave the following lecture on the importance of the division of labor for society.



This is the quality of economic education students at Grove City College receive every day.

Rothbard University!

This week I will be joining an illustrious faculty lecturing at Rothbard University offered by Mises Institute Canada. The event will be held on the campus of the University of Toronto. On the schedule are lectures by professors such as David Howden, Glenn Fox, and Pierre Derochers. I will be lecturing on the topics of entrepreneurship, money, economic development, income redistribution, and labor unions. These are topics that I teach about at Grove City College and that I have written about in my book, Foundations of Economics. I trust a good time shall be had by all.

The Fed and Moral Hazard

I have written on the topic of moral hazard before. It occurs when we adopt a policy to protect us from the consequences of certain behaviors, but the policy encourages the very behavior causing the problems.

It has been noted by others that the central bank, by having a monopoly on issuing money and by serving as the lender of last resort, ostensibly to promote and maintain financial stability, actually promotes less measured and more risky behavior on the part of banks, which causes the very financial instability the Fed was created to remove.

A new paper by Mark A. Carlson and David Wheelock, in a new working paper at the St. Louis Federal Reserve Bank, affirm this conclusion. The abstract is as follows:

As a result of legal restrictions on branch banking, an extensive interbank system developed in the United States during the 19th century to facilitate interregional payments and flows of liquidity and credit. Vast sums moved through the interbank system to meet seasonal and other demands, but the system also transmitted shocks during banking panics. The Federal Reserve was established in 1914 to reduce reliance on the interbank market and correct other defects that caused banking system instability. Drawing on recent theoretical work on interbank networks, we examine how the Fed’s establishment affected the system’s resilience to solvency and liquidity shocks and whether these shocks might have been contagious. We find that the interbank system became more resilient to solvency shocks but less resilient to liquidity shocks as banks sharply reduced their liquidity after the Fed’s founding. The industry’s response illustrates how the introduction of a lender of last resort can alter private behavior in a way that increases the likelihood that the lender will be needed.

That Carlson and Wheelock find that the Fed made the interback system more resilient to solvency shocks should not surprise. A central bank providing reserves to banks in trouble will reduce insolvency problems, almost by nature. What I find most interesting is the evidence that the Fed serving as a last resort did in fact seem to encourage behavior that increased liquidity problems, thereby creating a demand for the Fed's services. In this instance of government granted monopoly privilege, it is almost as if we have a case of the straw man view of Say's Law: the supply of emergency loans create their own demand. You can read the entire paper by Carlson and Wheelock by clicking here.

Recurrences of such financial crises' was the main ostensible reason the Fed was created. I write about the sharp contrast between Federal Reserve rhetoric and the real consequences of the Fed in the book The Fed at One Hundred. 

My Thoughts on the Fourth of July

When I was a boy, one of my favorite holidays was Independence Day. I was an enthusiastic student of the War for Independence. My favorite book was the How and Why Wonder Book of the American Revolution by Felix Sutton. I spent a lot of my childhood reading about the colonial era, the lives of people like Sam Adams, Paul Revere, Thomas Jefferson, Patrick Henry, and George Washington. I learned all about our American forefathers’ struggle for liberty against a king who merely treated them as revenue-generating pawns. I was nine years old when the US celebrated its bicentennial and my mother wallpapered my room with a red, white, and blue colonial American themed paper and I had various prints of famous revolutionary war scenes hanging on the walls. I looked forward every year to the day celebrating the signing of the Declaration of Independence.

Over the years, alas, my enthusiasm became dampened so that now, if I am exposed to any mainstream media celebrations of Independence Day, I do not feel the joy I once did. Instead I feel more like Charlie Brown at the beginning of A Charlie Brown Christmas. Remember in that childhood classic how, when Christmas approaches, Charlie Brown tells Linus that he knows he should be happy, but instead he always ends up feeling depressed. I increasingly get the same feeling as people gear up for 4th of July celebrations.

Now, much older and perhaps wiser, when I hear the popular media gushing about our freedoms, the Declaration of Independence, the Liberty Bell, Celebrate America concerts, and all the rest on the Fourth of July, instead of being happy, I feel a tinge of sadness. I like celebrating the Fourth of July by, say, gathering with friends, teaching my children about the Founding Fathers, reading the Declaration, and watching fireworks, but when I think about where we started and what we have become, like Charlie Brown I end up melancholy. This is because the politicians and the media talking heads clearly have no idea what they are talking about. Most seem to not even know what liberty really is. The only politician at the national level who spoke about freedom and the Constitution with actual conviction was Ron Paul and they laughed him off the stage. Instead, popular journalists and pundits try to make us believe that we are free because we are allowed to have other people vote away our liberties.

At the beginning of every major sporting event, Americans pay lip service to “the land of the free and the home of the brave,” but everywhere they are in economic chains. Last year total government spending was $6.4 trillion. That is $6.4 trillion with a t. That number amounts to over 36 percent of GDP. The Federal budget deficit the past fiscal year was $438 billion. Over the past eight years, our government debt has skyrocketed. By the end of this fiscal year, gross Federal government debt is expected to be over $19 trillion. That will be 106 precent of GDP.

Now, the important point to remember with respect to our freedom is that every single penny of government spending represents government control. When you spend money to purchase a loaf of bread, a tank of gas, or a pair of pants, you become owners of these economic goods and can use them as you see fit. When the government spends money, its bureaucrats gain control of economic resources. And the more of our resources under their control, the less free we become. . . .

Read the rest here

Mark Thornton on the Natural Interest Rate in the WSJ

My friend and former professor, Mark Thornton, has a letter to the editor published in the Wall Street Journal commenting on the importance of the natural rate of interest for business cycle theory. He notes that all the FED needs to do to foster discovery of the natural rate of interest is to cease manipulating the money supply and, hence, the interest rate. Thornton writes:

The Fed cannot “see” the natural rate of interest, but it is right before its eyes. You can achieve the natural rate by simply not increasing the money supply and withdrawing from interest-rate manipulation altogether.

Mark Thornton is now a Senior Fellow at the Ludwig von Mises Institute. He is one of the leading contemporary scholars in Austrian economics.