Chapter 4 of 61 · Making Economic Sense by Murray N. Rothbard
Making Economic Sense 1 IS IT THE “ECONOMY, STUPID”?
One of the persistent Clintonian themes of the 1992 campaign still endures: if “it’s the economy, stupid,” then why hasn’t President Clinton received the credit among the public for our glorious economic recovery? Hence the Clintonian conclusion that the resounding Democratic defeat in November, 1994, was due to their failure to “get the message out” to the public, the message being the good news of our current economic prosperity.
Some of the brighter Clintonians realized that the President and his minions had been repeating this very message endlessly all over America; so they fell back on the implausible alternative explanation that the minds of the voting public had been temporarily addled by listening to Rush Limbaugh and his colleagues.
So what went wrong with this popular line of reasoning? As usual, there are many layers of fallacy contained in this political analysis. In the first place, it’s crude economic determinism, what is often called “vulgar Marxism.” While the state of the economy is certainly important in shaping the public’s political attitudes, there are many non-economic reasons for public protest.
The public is particularly exercised, for example, about crime, gun control, the flood of immigration, and the continuing wholesale assault by government and the dominant liberal culture upon religion and upon “bourgeois” as well as traditional ethical principles.
Other non-economic reasons: a growing pervasive skepticism about politicians keeping their pledges to the voters, a skepticism born of hard-won experience rather than of some infection by a bacillus of “cynicism.” A fortiori removed from economics is an intense revulsion for the president, his wife, and their personal traits (“the character question”), a visceral response that made a powerful impact on the election.
But even apart from the numerous non-economic motivations for political attitudes and actions by the public, the common “it’s the economy” argument even leaves out some of the important features of economic-based motivation in politics. For the famous Clintonian slogan does not even begin to focus on all the relevant features of the economy.
Instead, to capture the Clintonian meaning, the sentiment should be rephrased as “it’s the business cycle, stupid.” For what the Clintonians and the media are really advocating is “vulgar business-cycle determinism”: if the economy is booming, the ins will be reelected: if we’re in recession, the public will oust the ruling party.
The “Business cycle” may at first appear to be equivalent to “the economy,” but in fact it is not. There are vital aspects of the economy felt by the voters that are not cyclical, not part of a boom-bust process, but that rather reflect “secular” (long-run) trends. What’s happening to taxes and to secular living standards, and among such standards the intangible, unmeasurable but vital concept of the “quality of life,” is extremely important, often more so than whether we are technically in the expansion or contraction phase of the cycle.
Indeed, the major economic grievance agitating the public has little or nothing to do with the cycle, with boom or recession: it is secular and seemingly permanent, specifically a slow, inexorable, debilitating decline in the standard of living that grinds down the people’s spirit as well as their pocketbooks. Taxes, and the tax bite into their earnings, keep going up, on the federal, state, county, and local levels of government. Semantic disguises don’t work any more: call them “fees,” or “contributions,” or “insurance premiums,” they are taxes nevertheless, and they are increasingly draining the people’s substance.
And while Establishment economists, statisticians, and financial experts keep proclaiming that “inflation has been licked,” that “structural economic factors preclude a return to inflation,” and all the rest of the blather, all consumers know in their hearts and wallets that the prices they pay at the supermarket, at the store, in tuition, in insurance, in magazine subscriptions, keep going up and up, and that the dollar’s value keeps going down and down.
The contemptuous charge by economic “scientists” that all this experience by consumers is merely “anecdotal,” that hard quantitative data and their statistical manipulations demonstrate that economic growth is lively, that the economy is doing splendidly, that inflation is over, and all the rest, doesn’t cut any ice either. In the end, all this “science” has only succeeded in convincing the public that economic and statistical experts rank up there with lawyers and politicians as a bunch of—how shall we put it?—“disinformation specialists.”
If everything is going so well, the public increasingly wants to know, how come young married couples today can no longer afford the standard of living enjoyed by their parents when they were newlyweds? How come they can’t afford to buy a home of their own? One of the glorious staples of the American experience has always been that each generation expects its children to be better off than they have been. This expectation was never the result of mindless “optimism”; it was rooted in the experience of each preceding generation, which indeed had been more prosperous than their parents.
But now the reality is quite the opposite. People know they are worse off than their parents, and therefore they rationally expect their children to be in still worse shape. Everywhere you turn you get a similar answer: “Why couldn’t you construct a new building with the same sturdy qualities as this (50-year old) house? . . . Oh, we couldn’t afford to build it that way today.”
Even official statistics bear out this point, if you know where to look. For example, the median real income in dollars, (that is, corrected for inflation) of American families is lower than it was in 1973. Then, if we disaggregate households, we get a far gloomier picture. Family income has not only been slightly reduced; it has collapsed in the last 20 years because of the phenomenal increase of the proportion of married women in the workforce.
This massive shift from motherhood and the domestic arts to the tedium of offices and time clocks has been interpreted by our dominant liberal culture as a glorious triumph of feminism in liberating women from the drudgery of being housewives so that they can develop their personalities in a fulfilling career. While this may be true for some occupations, one still hears on every side, once again, that the “reason I went to work is because we could no longer afford to live on one salary.”
Again, since there is no way to quantify subjective motivations, we can’t measure this factor, but I suspect that the great bulk of working women, i.e., those in non-glamorous careers, are only working to keep the family income from falling steeply. Given their druthers, I suspect they would happily return to the much-maligned “Ozzie and Harriet” family of the Neanderthal era.
Of course, there are some sectors of the economy that are indeed growing rapidly, where prices are falling instead of rising; notably the computer industry, and whatever emerges from the much-hyped “information superhighway,” when, at some wonderful point in the near or mid-future, Americans can drown their increasing miseries in the glories of 500 interactive, digital, cybernetic channels, each offering another subvariant of mindless pap.
This is a future that may satisfy techno-futurist gurus like Alvin Toffler and Newt Gingrich, but the rest of us, I bet, will become increasingly unhappy and ready to lash out at the political system that—through massive taxation, cheap money and credit, social insurance schemes, mandates, and government regulation—has brought us this secular deterioration, and has laid waste to the American dream.
First published in February 1995.
2
TEN GREAT ECONOMIC MYTHS
Our country is beset by a large number of economic myths that distort public thinking on important problems and lead us to accept unsound and dangerous government policies. Here are ten of the most dangerous of these myths and an analysis of what is wrong with them.
Myth 1:Deficits are the cause of inflation; deficits have nothing to do with inflation.
In recent decades we always have had federal deficits. The invariable response of the party out of power, whichever it may be, is to denounce those deficits as being the cause of perpetual inflation. And the invariable response of whatever party is in power has been to claim that deficits have nothing to do with inflation. Both opposing statements are myths.
Deficits mean that the federal government is spending more than it is taking in in taxes. Those deficits can be financed in two ways. If they are financed by selling Treasury bonds to the public, then the deficits are not inflationary. No new money is created; people and institutions simply draw down their bank deposits to pay for the bonds, and the Treasury spends that money. Money has simply been transferred from the public to the Treasury, and then the money is spent on other members of the public.
On the other hand, the deficit may be financed by selling bonds to the banking system. If that occurs, the banks create new money by creating new bank deposits and using them to buy the bonds. The new money, in the form of bank deposits, is then spent by the Treasury, and thereby enters permanently into the spending stream of the economy, raising prices and causing inflation. By a complex process, the Federal Reserve enables the banks to create the new money by generating bank reserves of one-tenth that amount. Thus, if banks are to buy $100 billion of new bonds to finance the deficit, the Fed buys approximately $10 billion of old Treasury bonds. This purchase increases bank reserves by $10 billion, allowing the banks to pyramid the creation of new bank deposits or money by ten times that amount. In short, the government and the banking system it controls in effect “print” new money to pay for the federal deficit.
Thus, deficits are inflationary to the extent that they are financed by the banking system; they are not inflationary to the extent they are underwritten by the public.
Some policymakers point to the 1982–83 period, when deficits were accelerating and inflation was abating, as a statistical “proof’ that deficits and inflation have no relation to each other. This is no proof at all. General price changes are determined by two factors: the supply of, and the demand for, money. During 1982–83 the Fed created new money at a very high rate, approximately at 15 percent per annum. Much of this went to finance the expanding deficit. But on the other hand, the severe depression of those two years increased the demand for money (i.e., lowered the desire to spend money on goods) in response to the severe business losses. This temporarily compensating increase in the demand for money does not make deficits any less inflationary. In fact, as recovery proceeds, spending picked up and the demand for money fell, and the spending of the new money accelerated inflation.
Myth 2:Deficits do not have a crowding-out effect on private investment.
In recent years there has been an understandable worry over the low rate of saving and investment in the United States. One worry is that the enormous federal deficits will divert savings to unproductive government spending and thereby crowd out productive investment, generating ever-greater long-run problems in advancing or even maintaining the living standards of the public.
Some policymakers once again attempted to rebut this charge by statistics. In 1982–83, they declare deficits were high and increasing while interest rates fell, thereby indicating that deficits have no crowding-out effect.
This argument once again shows the fallacy of trying to refute logic with statistics. Interest rates fell because of the drop of business borrowing in a recession. “Real” interest rates (interest rates minus the inflation rate) stayed unprecedentedly high, however—partly because most of us expect renewed inflation, partly because of the crowding-out effect. In any case, statistics cannot refute logic; and logic tells us that if savings go into government bonds, there will necessarily be less savings available for productive investment than there would have been, and interest rates will be higher than they would have been without the deficits. If deficits are financed by the public, then this diversion of savings into government projects is direct and palpable. If the deficits are financed by bank inflation, then the diversion is indirect, the crowding-out now taking place by the new money “printed” by the government competing for resources with old money saved by the public.
Milton Friedman tries to rebut the crowding-out effect of deficits by claiming that all government spending, not just deficits, equally crowds out private savings and investment. It is true that money siphoned off by taxes could also have gone into private savings and investment. But deficits have a far greater crowding-out effect than overall spending, since deficits financed by the public obviously tap savings and savings alone, whereas taxes reduce the public’s consumption as well as savings.
Thus, deficits, whichever way you look at them, cause grave economic problems. If they are financed by the banking system, they are inflationary. But even if they are financed by the public, they will still cause severe crowding-out effects, diverting much-needed savings from productive private investment to wasteful government projects. And, furthermore, the greater the deficits the greater the permanent income tax burden on the American people to pay for the mounting interest payments, a problem aggravated by the high interest rates brought about by inflationary deficits.
Myth 3:Tax increases are a cure for deficits.
Those people who are properly worried about the deficit unfortunately offer an unacceptable solution: increasing taxes. Curing deficits by raising taxes is equivalent to curing someone’s bronchitis by shooting him. The “cure” is far worse than the disease.
One reason, as many critics have pointed out, raising taxes simply gives the government more money, and so the politicians and bureaucrats are likely to react by raising expenditures still further. Parkinson said it all in his famous “Law”: “Expenditures rise to meet income.” If the government is willing to have, say, a 20 percent deficit, it will handle high revenues by raising spending still more to maintain the same proportion of deficit.
But even apart from this shrewd judgment in political psychology, why should anyone believe that a tax is better than a higher price? It is true that inflation is a form of taxation, in which the government and other early receivers of new money are able to expropriate the members of the public whose income rises later in the process of inflation. But, at least with inflation, people are still reaping some of the benefits of exchange. If bread rises to $10 a loaf, this is unfortunate, but at least you can still eat the bread. But if taxes go up, your money is expropriated for the benefit of politicians and bureaucrats, and you are left with no service or benefit. The only result is that the producers’ money is confiscated for the benefit of a bureaucracy that adds insult to injury by using part of that confiscated money to push the public around.
No, the only sound cure for deficits is a simple but virtually unmentioned one: cut the federal budget. How and where? Anywhere and everywhere.
Myth 4:Every time the Fed tightens the money supply, interest rates rise (or fall); every time the Fed expands the money supply, interest rates rise (or fall).
The financial press now knows enough economics to watch weekly money supply figures like hawks; but they inevitably interpret these figures in a chaotic fashion. If the money supply rises, this is interpreted as lowering interest rates and inflationary; it is also interpreted, often in the very same article, as raising interest rates. And vice versa. If the Fed tightens the growth of money, it is interpreted as both raising interest rates and lowering them. Sometimes it seems that all Fed actions, no matter how contradictory, must result in raising interest rates. Clearly something is very wrong here.
The problem is that, as in the case of price levels, there are several causal factors operating on interest rates and in different directions. If the Fed expands the money supply, it does so by generating more bank reserves and thereby expanding the supply of bank credit and bank deposits. The expansion of credit necessarily means an increased supply in the credit market and hence a lowering of the price of credit, or the rate of interest. On the other hand, if the Fed restricts the supply of credit and the growth of the money supply, this means that the supply in the credit market declines, and this should mean a rise in interest rates.
And this is precisely what happens in the first decade or two of chronic inflation. Fed expansion lowers interest rates; Fed tightening raises them. But after this period, the public and the market begin to catch on to what is happening. They begin to realize that inflation is chronic because of the systemic expansion of the money supply. When they realize this fact of life, they will also realize that inflation wipes out the creditor for the benefit of the debtor. Thus, if someone grants a loan at 5 percent for one year, and there is 7 percent inflation for that year, the creditor loses, not gains. He loses 3 percent, since he gets paid back in dollars that are now worth 7 percent less in purchasing power. Correspondingly, the debtor gains by inflation. As creditors begin to catch on, they place an inflation premium on the interest rate, and debtors will be willing to pay it. Hence, in the long-run anything which fuels the expectations of inflation will raise inflation premiums on interest rates; and anything which dampens those expectations will lower those premiums. Therefore, a Fed tightening will now tend to dampen inflationary expectations and lower interest rates; a Fed expansion will whip up those expectations again and raise them. There are two, opposite causal chains at work. And so Fed expansion or contraction can either raise or lower interest rates, depending on which causal chain is stronger.
Which will be stronger? There is no way to know for sure. In the early decades of inflation, there is no inflation premium; in the later decades, such as we are now in, there is. The relative strength and reaction times depend on the subjective expectations of the public, and these cannot be forecast with certainty. And this is one reason why economic forecasts can never be made with certainty.
Myth 5:Economists, using charts or high speed computer models, can accurately forecast the future.
The problem of forecasting interest rates illustrates the pitfalls of forecasting in general. People are contrary cusses whose behavior, thank goodness, cannot be forecast precisely in advance. Their values, ideas, expectations, and knowledge change all the time, and change in an unpredictable manner. What economist, for example, could have forecast (or did forecast) the Cabbage Patch Kid craze of the Christmas season of 1983? Every economic quantity, every price, purchase, or income figure is the embodiment of thousands, even millions, of unpredictable choices by individuals.
Many studies, formal and informal, have been made of the record of forecasting by economists, and it has been consistently abysmal. Forecasters often complain that they can do well enough as long as current trends continue; what they have difficulty in doing is catching changes in trend. But of course there is no trick in extrapolating current trends into the near future. You don’t need sophisticated computer models for that; you can do it better and far more cheaply by using a ruler. The real trick is precisely to forecast when and how trends will change, and forecasters have been notoriously bad at that. No economist forecast the depth of the 1981–82 depression, and none predicted the strength of the 1983 boom.
The next time you are swayed by the jargon or seeming expertise of the economic forecaster, ask yourself this question: If he can really predict the future so well, why is he wasting his time putting out newsletters or doing consulting when he himself could be making trillions of dollars in the stock and commodity markets?
Myth 6:There is a tradeoff between unemployment and inflation.
Every time someone calls for the government to abandon its inflationary policies, establishment economists and politicians warn that the result can only be severe unemployment. We are trapped, therefore, into playing off inflation against high unemployment, and become persuaded that we must therefore accept some of both.
This doctrine is the fallback position for Keynesians. Originally, the Keynesians promised us that by manipulating and fine-tuning deficits and government spending, they could and would bring us permanent prosperity and full employment without inflation. Then, when inflation became chronic and ever-greater, they changed their tune to warn of the alleged tradeoff, so as to weaken any possible pressure upon the government to stop its inflationary creation of new money.
The tradeoff doctrine is based on the alleged “Phillips curve,” a curve invented many years ago by the British economist A.W. Phillips. Phillips correlated wage rate increases with unemployment, and claimed that the two move inversely: the higher the increases in wage rates, the lower the unemployment. On its face, this is a peculiar doctrine, since it flies in the face of logical, commonsense theory. Theory tells us that the higher the wage rates, the greater the unemployment, and vice versa. If everyone went to their employer tomorrow and insisted on double or triple the wage rate, many of us would be promptly out of a job. Yet this bizarre finding was accepted as gospel by the Keynesian economic Establishment.
By now, it should be clear that this statistical finding violates the facts as well as logical theory. For during the 1950s, inflation was only about one to two percent per year, and unemployment hovered around three or four percent, whereas later unemployment ranged between eight and 11 percent, and inflation between five and 13 percent. In the last two or three decades, in short, both inflation and unemployment have increased sharply and severely. If anything, we have had a reverse Phillips curve. There has been anything but an inflation-unemployment tradeoff.
But ideologues seldom give way to the facts, even as they continually claim to “test” their theories by facts. To save the concept, they have simply concluded that the Phillips curve still remains as an inflation-unemployment tradeoff, except that the curve has unaccountably “shifted” to a new set of alleged tradeoffs. On this sort of mind-set, of course, no one could ever refute any theory.
In fact, current inflation, even if it reduces unemployment in the shortrun by inducing prices to spurt ahead of wage rates (thereby reducing real wage rates), will only create more unemployment in the long run. Eventually, wage rates catch up with inflation, and inflation brings recession and unemployment inevitably in its wake. After more than two decades of inflation, we are now living in that “long run.”
Myth 7:Deflation—falling prices—is unthinkable, and would cause a catastrophic depression.
The public memory is short. We forget that, from the beginning of the Industrial Revolution in the mid-eighteenth century until the beginning of World War II, prices generally went down, year after year. That’s because continually increasing productivity and output of goods generated by free markets caused prices to fall. There was no depression, however, because costs fell along with selling prices. Usually, wage rates remained constant while the cost of living fell, so that “real” wages, or everyone’s standard of living, rose steadily.
Virtually the only time when prices rose over those two centuries were periods of war (War of 1812, Civil War, World War I), when the warring governments inflated the money supply so heavily to pay for the war as to more than offset continuing gains in productivity.
We can see how free-market capitalism, unburdened by governmental or central bank inflation, works if we look at what has happened in the last few years to the prices of computers. Even a simple computer used to be enormous, costing millions of dollars. Now, in a remarkable surge of productivity brought about by the microchip revolution, computers are falling in price even as I write. Computer firms are successful despite the falling prices because their costs have been falling, and productivity rising. In fact, these falling costs and prices have enabled them to tap a mass market characteristic of the dynamic growth of free-market capitalism. “Deflation” has brought no disaster to this industry.
The same is true of other high-growth industries, such a electronic calculators, plastics, TV sets, and VCRs. Deflation, far from bringing catastrophe, is the hallmark of sound and dynamic economic growth.
Myth 8:The best tax is a “flat” income tax, proportionate to income across the board, with no exemptions or deductions.
It is usually added by flat-tax proponents, that eliminating such exemptions would enable the federal government to cut the current tax rate substantially.
But this view assumes, for one thing, that present deductions from the income tax are immoral subsidies or “loopholes” that should be closed for the benefit of all. A deduction or exemption is only a “loophole” if you assume that the government owns 100 percent of everyone’s income and that allowing some of that income to remain untaxed constitutes an irritating “loophole.” Allowing someone to keep some of his own income is neither a loophole nor a subsidy. Lowering the overall tax by abolishing deductions for medical care, for interest payments, or for uninsured losses, is simply lowering the taxes of one set of people (those that have little interest to pay, or medical expenses, or uninsured losses) at the expense of raising them for those who have incurred such expenses.
There is furthermore neither any guarantee nor even likelihood that, once the exemptions and deductions are safely out of the way, the government would keep its tax rate at the lower level. Looking at the record of governments, past and present, there is every reason to assume that more of our money would be taken by the government as it raised the tax rate backup (at least) to the old level, with a consequently greater overall drain from the producers to the bureaucracy.
It is supposed that the tax system should be analogous to roughly that of pricing or incomes on the market. But market pricing is not proportional to incomes. It would be a peculiar world, for example, if Rockefeller were forced to pay $1,000 for a loaf of bread—that is, a payment proportionate to his income relative to the average man. That would mean a world in which equality of incomes was enforced in a particularly bizarre and inefficient manner. If a tax were levied like a market price, it would be equal to every “customer,” not proportionate to each customer’s income.
Myth 9:An income tax cut helps everyone; not only the taxpayer but also the government will benefit, since tax revenues will rise when the rate is cut.
This is the so-called “Laffer curve,” set forth by California economist Arthur Laffer. It was advanced as a means of allowing politicians to square the circle; to come out for tax cuts, keeping spending at the current level, and balance the budget all at the same time. In that way, the public would enjoy its tax cut, be happy at the balanced budget, and still receive the same level of subsidies from the government.
It is true that if tax rates are 99 percent, and they are cut to 95 percent, tax revenue will go up. But there is no reason to assume such simple connections at any other time. In fact, this relationship works much better for a local excise tax than for a national income tax. A few years ago, the government of the District of Columbia decided to procure some revenue by sharply raising the District’s gasoline tax. But, then, drivers could simply nip over the border to Virginia or Maryland and fill up at a much cheaper price. D.C. gasoline tax revenues fell, and much to the chagrin and confusion of D.C. bureaucrats, they had to repeal the tax.
But this is not likely to happen with the income tax. People are not going to stop working or leave the country because of a relatively small tax hike, or do the reverse because of a tax cut.
There are some other problems with the Laffer curve. The amount of time it is supposed to take for the Laffer effect to work is never specified. But still more important: Laffer assumes that what all of us want is to maximize tax revenue to the government. If—a big if—we are really at the upper half of the Laffer curve, we should then all want to set tax rates at that “optimum” point. But why? Why should it be the objective of every one of us to maximize government revenue? To push to the maximum, in short, the share of private product that gets siphoned off to the activities of government? I should think we would be more interested in minimizing government revenue by pushing tax rates far, far below whatever the Laffer Optimum might happen to be.
Myth 10:Imports from countries where labor is cheap cause unemployment in the United States.
One of the many problems with this doctrine is that it ignores the question: why are wages low in a foreign country and high in the United States? It starts with these wage rates as ultimate givens, and doesn’t pursue the question why they are what they are. Basically, they are high in the United States because labor productivity is high—because workers here are aided by large amounts of technologically advanced capital equipment. Wage rates are low in many foreign countries because capital equipment is small and technologically primitive. Unaided by much capital, worker productivity is far lower than in the United States. Wage rates in every country are determined by the productivity of the workers in that country. Hence, high wages in the United States are not a standing threat to American prosperity; they are the result of that prosperity.
But what of certain industries in the U.S. that complain loudly and chronically about the “unfair” competition of products from low-wage countries? Here, we must realize that wages in each country are interconnected from one industry and occupation and region to another. All workers compete with each other, and if wages in industry A are far lower than in other industries, workers—spearheaded by young workers starting their careers—would leave or refuse to enter industry A and move to other firms or industries where the wage rate is higher.
Wages in the complaining industries, then, are high because they have been bid high by all industries in the United States. If the steel or textile industries in the United States find it difficult to compete with their counterparts abroad, it is not because foreign firms are paying low wages, but because other American industries have bid up American wage rates to such a high level that steel and textile cannot afford to pay. In short, what’s really happening is that steel, textile, and other such firms are using labor inefficiently as compared to other American industries. Tariffs or import quotas to keep inefficient firms or industries in operation hurt everyone, in every country, who is not in that industry. They injure all American consumers by keeping up prices, keeping down quality and competition, and distorting production. A tariff or an import quota is equivalent to chopping up a railroad or destroying an airline—for its point is to make international transportation artificially expensive.
Tariffs and import quotas also injure other, efficient American industries by tying up resources that would otherwise move to more efficient uses. And, in the long run, the tariffs and quotas, like any sort of monopoly privilege conferred by government, are no bonanza even for the firms being protected and subsidized. For, as we have seen in the cases of railroads and airlines, industries enjoying government monopoly (whether through tariffs or regulation) eventually become so inefficient that they lose money anyway, and can only call for more and more bailouts, for a perpetual expanding privileged shelter from free competition.
First published in April 1984.
3
DISCUSSING THE “ISSUES”
Depending on your temperament, a presidential election year is a time for either depression or amusement. One befuddling aspect of campaign time is the way the Respectable Media redefine our language. Orwell wrote a half-century ago that he who controls the language wields the power, and the media have certainly shown that they have learned this lesson. For example, the Respectable Media have presumed to declare what “the issues” are in any campaign. If Candidate X finds his Opponent Y’s hand in the till, the media rush up to exclaim: “That’s irrelevant. Why don’t you talk about The Issues?”
In the Bush-Dukakis race, the media anointed The Economy as the only worthwhile topic; anything else was only a smokescreen designed to “detract” from the “real issues.” One would think that such a focus would gladden the heart of any economist, but if you thought so, you’re not reckoning with the semantics experts in the Establishment media. For the Economy can only be approached in certain, narrow, allowable grooves. Any other approach is brusquely read out of court.
The media focus, quite legitimately, on The Recession, but again, only in certain narrowly permissible ways. Because of the recession, Unemployment has soared (a “lack of jobs”); Affordable Housing has dwindled (the Homeless); Affordable Health Care is diminishing because of increased health costs, and, in addition to these particular sectors, deficits have soared to $400 billion a year.
In short: there is a lack of jobs, health care, housing and other goodies, and it follows, either implicitly or explicitly, that the federal government must expand its spending by an enormous amount, as part of its alleged Responsibility to supply such goods and services, or to see to it that they are supplied. Anyone who may presume to rise up and say, “Whoa, it is not the responsibility of the federal government to supply these goodies,” is, of course, accused by the ever-vigilant Respectable Media of Evading and not discussing The Issues.
In media lingo, in short, “discussing” the issues means accepting the media’s statist premises, and solemnly haggling over minute technicalities within those premises. If, for example, you say that national health insurance is tantamount to socialized medicine you are accused of using “scare words” and of not discussing The Issues. Anyone who thinks that socialism or collectivism is an important issue is quickly swept aside.
But how then is the federal government to spend hundreds of billions more and yet Do Something about the deficit? Ahh, the cure-all, of course: huge increases in taxation. It is only a myth that anyone who proposes tax cuts is lionized while those who urge tax increases are ostracized. While the general public may still feel a vestigial admiration for tax cuts, they are usually overwhelmed by the intellectual and media elites who trumpet the precise opposite message: that proposing big tax increases “faces The Issues,” is courageous and responsible, and on and on.
Narrow-gauge discussions also have the advantage of bringing in the ubiquitous Washington “policy wonks,” the supposedly value-free “experts” who are ready to trot out computerized analyses of the alleged quantitative results of every proposed tax increase or of any other program. And so we have this unedifying spectacle: Candidate A proposes a tax increase; his opponent B charges that A’s plan will cost middle-income taxpayers X-hundred billion dollars; A accuses B of “lying,” while B does the same to A’s different proposal for tax increases.
Most irritating of all is the media’s current penchant for making their alleged “correction,” in which a paper or network’s own policy wonk claims that the “facts are” that B’s increase will cost taxpayers Y-hundred billion instead. The media’s “correction” is most annoying because everyone realizes that each candidate and his supporters will put the best possible spin on his own programs and the worst on his opponents’; but the media’s own bias masquerades as objective truth and expertise.
For the point is that no one actually knows how much is going to be paid by which group under any of these programs. The numbers that are tossed around as gospel truth, as “facts,” in an America that has always worshiped numbers, all depend on various fallacious assumptions. They all assume, for example, that quantitative relations between different variables in the economy will continue to be what they have been in the last several years. But the whole point is that these relations change and in unpredictable ways.
How is it that not a single computerized economist or policy wonk predicted the current recession? That not a single one predicted its great length and depth? Precisely because this recession, like all recessions, is quantitatively unique; if there hadn’t been some sudden change in the various numbers, there wouldn’t have been a recession, and we’d still be enjoying a seemingly untroubled boom. As former German banker Kurt Richebacher pointed out in his Currency and Credit Markets newsletter, in contrast to the 1920s and 1930s, economists don’t think anymore; they just plug in obsolescent numbers, and then wonder why their forecasts all go blooey.
Here is a suggested Discussion of The Issues that will never make the media hit parade: Yes, the deficit is a grave problem, but the way to cut it is never to increase taxes (certainly not during a recession!) but instead to slash government expenditures. In contrast to the conventional media wisdom, increasing taxes is not, except strictly arithmetically, equivalent to cutting expenditures. Increasing taxes or expenditures aggravates the dangerous parasitic burden of the unproductive public sector and its clients, upon the increasingly impoverished but productive private sector; while cutting taxes or expenditures serves to lighten the chains of the productive private sector.
In the long run, as we have seen under communism, the parasitic sector destroys the private productive sector and harms even the parasites in the process. But it is ironic that left-liberals who affect to be so concerned about the state of “the environment” or of Mother Earth 5,000 years from now, should adopt such a short-sighted perspective on the economy that only immediate problems count, and who cares about savers, investors, and entrepreneurs?
Where to cut the government budget? The simplest way is the best: just pass a law, overriding all existing ones, that no agency of the federal government is allowed to spend more, next year, that it did in some previous year—the earlier the year the better, but for openers how about the penultimate Carter year of 1979, when the federal government spent $504 billion? Just decree that no agency can spend more than whatever it spent in 1979; agencies that didn’t exist in 1979 could just subsist from then on, if they so desire, on zero funding.
But of course, this proposal would be both too simple and too radical for the Establishment policy wonks. By definition, it cannot come under the official rubric of “discussing The Issues.”
First published in February 1992.
4
CREATIVE ECONOMIC SEMANTICS
If the federal government’s economists have been good for nothing else in recent years, they have made great strides in what might be called “creative economic semantics.” First they’re defined the seemingly simple term “budget cut.” In the old days, a “budget cut” was a reduction of next year’s budget below this year’s. In that old-fashioned sense, Dwight Eisenhower’s first two years in office actually cut the budget substantially, though not dramatically, below the previous year. Now we have “budget cuts” which are not cuts, but rather substantial increases over the previous year’s expenditures.
“Cut” became subtly but crucially redefined as reducing something else. What the something else might be didn’t seem to matter, so long as the focus was taken off actual dollar expenditures. Sometimes it was a cut “in the rate of increase,” other times it was a cut in “real” spending, at still others it was a percentage of GNP, and at yet other times it was a cut in the sense of being below past projections for that year.
The result of a series of such “cuts” has been to raise spending sharply and dramatically not only in old-fashioned terms, but even in all other categories. Government spending has gone up considerably any way you slice it. As a result, even the idea of a creatively semantic budget cut has not gone the way of the nickel fare and the Constitution of the United States.
Another example of creative semantics was the “tax cut” of 1981–1982, a tax cut so allegedly fearsome that it had to be offset by outright tax increases late in 1982, in 1983, in 1984,and on and on into the future. Again in the old days, a cut in income taxes meant that the average person would find less of a slice taken out of his paycheck. But while the 1981–82 tax changes did that for some people, the average person found that the piddling cuts were more than offset by the continuing rise in the Social Security tax, and by “bracket creep”—a colorful term for the process by which inflation (generated by the federal government’s expansion of the money supply) wafts everyone into higher money income (even though a price rise might leave them no better off) and therefore into a higher tax bracket. So that even though the official schedule of tax rates might remain the same, the average man is paying a higher chunk of his income.
The much-vaunted and much-denounced “tax cut” turns out, in old-fashioned semantics, to be no cut at all but rather a substantial increase. In return for the dubious pleasure of this non-cut, the American public will have to suffer by paying through the nose for years to come in the form of “offsetting,” though unfortunately all-too-genuine, tax increases.
Of course, government economists have been doing their part as well to try to sugar-coat the pill of tax increases. They never refer to these changes as “increases.” They have not been increases at all; they were “revenue enhancement” and “closing loopholes.” The best comment on the concept of “loopholes” was that of Ludwig von Mises. Mises remarked that the very concept of “loopholes” implies that the government rightly owns all of the money you earn, and that it becomes necessary to correct the slipup of the government’s not having gotten its hands on that money long since.
Despite promises of a balanced budget by 1984, we found that several years of semantically massaged “budget cuts” and “tax cuts” as well as “enhancements” resulted in an enormous, seemingly permanent, and unprecedented deficit. Once again, creative semantics have come to the rescue. One route is to use time-honored methods to redefine the deficit out of existence. The Keynesians used to redefine it by claiming that in something called a “full employment budget” there was no deficit, that is, that if one subtracts the spending necessary to achieve full employment, there would be no deficit, perhaps even a surplus. But while such a sleight-of-hand might work with a deficit of $20 billion, it is a puny way to wish away a gap of $200 billion. Still, the government’s economists are trying.
They have already redefined the “deficits” as a “real increase” in debt, that is, a deficit discounted by inflation. The more inflation generated by the government, then, the more it looks as if the deficit is washed away. On the very same semantic magic, the apologists for the disastrous runaway German inflation of 1923 claimed that there was no inflation at all, since in terms of gold, German prices were actually falling! And similarly, they claimed, that since in real terms the supply of German marks was falling, that the real trouble in Germany was that there was too little money being printed rather than too much.
There is no general acceptance for the idea that, based on some legerdemain, the deficit doesn’t really exist. But there is acceptance of the view that a tax increase constitutes a “down payment” on the deficit. Again, in the old days, a “down payment” on a debt meant that part of the debt was being paid off. Washington’s creative economists have managed to redefine the term to mean a hoped-for reduction of next years’s increase in the debt—a very different story indeed.
First published in September 1984.
5
CHAOS THEORY: DESTROYING MATHEMATICAL ECONOMICS FROM WITHIN?
The hottest new topic in mathematics, physics, and allied sciences is “chaos theory.” It is radical in its implications, but no one can accuse its practitioners of being anti-mathematical, since its highly complex math, including advanced computer graphics, is on the cutting edge of mathematical theory. In a deep sense, chaos theory is a reaction against the effort, hype, and funding that have, for many decades, been poured into such fashionable topics as going ever deeper inside the nucleus of the atom, or ever further out in astronomical speculation. Chaos theory returns scientific focus, at long last, to the real “microscopic” world with which we are all familiar.
It is fitting that chaos theory got its start in the humble but frustrating field of meteorology. Why does it seem impossible for all our hot-shot meteorologists, armed as they are with ever more efficient computers and ever greater masses of data, to predict the weather? Two decades ago, Edward Lorenz, a meteorologist at MIT stumbled onto chaos theory by making the discovery that ever so tiny changes in climate could bring about enormous and volatile changes in weather. Calling it the Butterfly Effect, he pointed out that if a butterfly flapped its wings in Brazil, it could well produce a tornado in Texas. Since then, the discovery that small, unpredictable causes could have dramatic and turbulent effects has been expanded into other, seemingly unconnected, realms of science.
The conclusion, for the weather and for many other aspects of the world, is that the weather, in principle, cannot be predicted successfully, no matter how much data is accumulated for our computers. This is not really “chaos” since the Butterfly Effect does have its own causal patterns, albeit very complex. (Many of these causal patterns follow what is known as “Feigenbaum’s Number.”) But even if these patterns become known, who in the world can predict the arrival of a flapping butterfly?
The upshot of chaos theory is not that the real world is chaotic or in principle unpredictable or undetermined, but that in practice much of it is unpredictable. And in particular that mathematical tools such as the calculus, which assumes smooth surfaces and infinitesimally small steps, is deeply flawed in dealing with much of the real world. (Thus, Benoit Mandelbroit’s “fractals” indicate that smooth curves are inappropriate and misleading for modeling coastlines or geographic surfaces.)
Chaos theory is even more challenging when applied to human events such as the workings of the stock market. Here the chaos theorists have directly challenged orthodox neoclassical theory of the stock market, which assumes that the expectations of the market are “rational,” that is, are omniscient about the future. If all stock or commodity market prices perfectly discount and incorporate perfect knowledge of the future, then the patterns of stock-market prices must be purely accidental, meaningless, and random (“random walk”), since all the underlying basic knowledge is already known and incorporated into the price.
The absurdity of believing that the market is omniscient about the future, or that it has perfect knowledge of all “probability distributions” of the future, is matched by the equal folly of assuming that all happenings on the real stock market are “random,” that is, that no one stock price is related to any other price, past or future. And yet a crucial fact of human history is that all historical events are interconnected, that cause and effect patterns permeate human events, that very little is homogeneous, and that nothing is random.
With their enormous prestige, the chaos theorists have done important work in denouncing these assumptions, and in rebuking any attempt to abstract statistically from the actual concrete events of the real world. Thus, the chaos theorists are opposed to the common statistical technique of “smoothing out” the data by taking twelve-month moving averages of monthly data—whether of prices, production, or employment. In attempting to eliminate jagged “random elements” and separate them out from alleged underlying patterns, orthodox statisticians have been unwittingly getting rid of the very real-world data that need to be examined.
These are but a few of the subversive implications that chaos science offers for orthodox mathematical economics. For if rational expectations theory violates the real world, then so too does general equilibrium, the use of the calculus in assuming infinitesimally small steps, perfect knowledge, and all the rest of the elaborate neoclassical apparatus. The neoclassicals have for a long while employed their knowledge of math and their use of advanced mathematical techniques as a bludgeon to discredit Austrians; now comes the most advanced mathematical theorists to replicate, unwittingly, some of the searching Austrian critiques of the unreality and distortions of orthodox neoclassical economics. In the current mathematical pecking order, fractals, nonlinear thermodynamics, the Feigenbaum number, and all the rest rank far higher than the old-fashioned techniques of the neo-classicals.
This does not mean that all the philosophical claims for chaos theory must be swallowed whole—in particular, the assertions of some of the theorists that nature is undetermined, or even that atoms or molecules possess “free will.” But Austrians can hail the chaos theorists in their invigorating assault on orthodox mathematical economics from within.
First published in March 1988.
6
STATISTICS: DESTROYED FROM WITHIN?
As improbable as this may seem now, I was at one time in college a statistics major. After taking all the undergraduate courses in statistics, I enrolled in a graduate course in mathematical statistics at Columbia with the eminent Harold Hotelling, one of the founders of modern mathematical economics. After listening to several lectures of Hotelling, I experienced an epiphany: the sudden realization that the entire “science” of statistical inference rests on one crucial assumption, and that that assumption is utterly groundless. I walked out of the Hotelling course, and out of the world of statistics, never to return.
Statistics, of course, is far more than the mere collection of data. Statistical inference is the conclusions one can draw from that data. In particular, since—apart from the decennial U.S. census of population—we never know all the data, our conclusions must rest on very small samples drawn from the population. After taking our sample or samples, we have to find a way to make statements about the population as a whole. For example, suppose we wish to conclude something about the average height of the American male population. Since there is no way that we can mobilize every male American and measure everyone’s height, we take samples of a small number, say 500 people, selected in various ways, from which we presume to say what the average American’s height may be.
In the science of statistics, the way we move from our known samples to the unknown population is to make one crucial assumption: that the samples will, in any and all cases, whether we are dealing with height or unemployment or who is going to vote for this or that candidate, be distributed around the population figure according to the so-called “normal curve.”
The normal curve is a symmetrical, bell-shaped curve familiar to all statistics textbooks. Because all samples are assumed to fall around the population figure according to this curve, the statistician feels justified in asserting, from his one or more limited samples, that the height of the American population, or the unemployment rate, or whatever, is definitely XYZ within a “confidence level” of 90 or 95 percent. In short, if, for example, a sample height for the average male is 5 feet 9 inches, 90 or 95 out of every 100 such samples will be within a certain definite range of 5 feet 9 inches. These precise figures are arrived at simply by assuming that all samples are distributed around the population according to this normal curve.
It is because of the properties of the normal curve, for example, that the election pollsters could assert, with overwhelming confidence, that Bush was favored by a certain percentage of voters, and Dukakis by another percentage, all within “three percentage points” or “five percentage points” of “error.” It is the normal curve that permits statisticians not to claim absolute knowledge of all population figures precisely but instead to claim such knowledge within a few percentage points.
Well, what is the evidence for this vital assumption of distribution around a normal curve? None whatever. It is a purely mystical act of faith. In my old statistics text, the only “evidence” for the universal truth of the normal curve was the statement that if good riflemen shoot to hit a bullseye, the shots will tend to be distributed around the target in something like a normal curve. On this incredibly flimsy basis rests an assumption vital to the validity of all statistical inference.
Unfortunately, the social sciences tend to follow the same law that the late Dr. Robert Mendelsohn has shown is adopted in medicine: never drop any procedure, no matter how faulty, until a better one is offered in its place. And now it seems that the entire fallacious structure of inference built on the normal curve has been rendered obsolete by high-tech.
Ten years ago, Stanford statistician Bradley Efron used highspeed computers to generate “artificial data sets” based on an original sample, and to make the millions of numerical calculations necessary to arrive at a population estimate without using the normal curve, or any other arbitrary, mathematical assumption of how samples are distributed about the unknown population figure. After a decade of discussion and tinkering, statisticians have agreed on methods of practical use of this “bootstrap.” method, and it is now beginning to take over the profession. Stanford statistician Jerome H. Friedman, one of the pioneers of the new method, calls it “the most important new idea in statistics in the last 20 years, and probably the last 50.”
At this point, statisticians are finally willing to let the cat out of the bag. Friedman now concedes that “data don’t always follow bell-shaped curves, and when they don’t, you make a mistake” with the standard methods. In fact, he added that “the data frequently are distributed quite differently than in bellshaped curves.” So that’s it; now we find that the normal curve Emperor has no clothes after all. The old mystical faith can now be abandoned; the Normal Curve god is dead at long last.
First published in February 1989.
7
THE CONSEQUENCES OF HUMAN ACTION: INTENDED OR UNINTENDED?
Some economists are given to insisting that Austrian economics studies only the unintended consequences of human action, or, in the favorite phrase (from the 18th-century Scottish sociologist Adam Ferguson as filtered down to F.A. Hayek), “the consequences of human action, not human design.”
At first glance, there is some plausibility to this oft-repeated slogan. As Adam Smith pointed out, it is a good thing that we don’t rely on the benevolence of the butcher or baker for our daily bread, but rather on their self-interested drive for income and profit. They may intend to achieve a profit, but the efficient production for consumer wants and the advancement of the prosperity of all is the unintended consequence of their actions.
But this slogan can be shown to be faulty on further analysis. For example, how do we know what the intentions of the butcher, the baker, or indeed any businessman, are? We cannot look inside their heads and tell for sure. Suppose, for example, that the butcher and baker, out to maximize their profits, read free-market economics and see that maximizing profit also benefits their fellow-man and society as a whole.
As they go about their business, they now intend the consequence of efficient satisfaction of consumer wants as well as their own monetary profit. So if, as some indicate, economic theory only studies unintended consequences of human action, does the learning of some economic theory by businessmen invalidate that theory because now these consequences are consciously intended by the participants on the market?
Furthermore, the learning of sound economic theory can actually change the actions of businessmen on the market. Many businessmen, influenced by anti-capitalist propaganda, have been consumed by guilt, and may consciously restrict their pursuit of profit in the mistaken idea that they are helping their fellow man. Reading and absorbing sound economic analysis may relieve them of guilt and lead them to seek the maximization of their own profit. In short, now that they are fully cognizant of economics, the intended consequences of their actions will lead to higher profits for themselves as well as greater prosperity for society.
So what is so great about unintended consequences, and why may no intended consequences be studied as well? And doesn’t the accumulation of knowledge in society change consequences from unintended to intended?
Not only that: the Misesian discipline of praxeology explicitly states that individual men consciously pursue goals, and choose means to try to attain them. And if men pursue goals, surely it is only common sense to conclude that a good deal of the time they will attain them, in others words they will intend, and attain, the consequences of their actions. Mises’s emphasis on conscious choice treats men and women as rational, conscious actors in the market and the world; the other tradition often falls into the trap of treating people as if they were robots or amoebae blindly responding to stimuli.
Arcane matters of methodology often have surprising political consequences. Perhaps, then, it is not an accident that those who believe in unintended and not intended consequences, will also tend to whitewash the growth of government in the twentieth century. For if actions are largely always unintended, this means that government just grew like Topsy, and that no person or group ever willed the pernicious consequences of that growth. Stressing the Ferguson-Hayek formula cloaks the self-interested actions of the power elite in seeking and obtaining special privileges from government, and thereby impelling its continuing growth.
There are two ways to advance the message of Austrian economics. One is to fearlessly hold high the banner of Misesian theory to which the wise and honest can repair—a banner which requires calling a spade a spade and pointing out the special interests all too consciously at work behind the government’s glittering facade of the “public interest” and the “general welfare.”
The other path is to seek acceptance and respectability by watering down the Misesian message beyond repair, and carefully avoiding anything remotely “controversial” in your offering. Even to the point of taking the “free” out of “free market.” Such a path only entrenches big government.
First published in May 1987.
8
THE INTEREST RATE QUESTION
The Marxists call it “impressionism”: taking social or economic trends of the last few weeks or months and assuming that they will last forever. The problem is not realizing that there are underlying economic laws at work. Impressionism has always been rampant; and never more so than in public discussion of interest rates. For most of 1987, interest rates were inexorably high; for a short while after Black Monday, interest rates fell, and financial opinion turned around 180 degrees, and started talking as if interest rates were on a permanent downward trend.
No group is more prone to this day-to-day blowin’ with the wind than the financial press. This syndrome comes from lack of understanding of economics and hence being reduced to reacting blindly to rapidly changing events. Sometimes this basic confusion is reflected within the same article. Thus, in the not-so-long ago days of double-digit inflation, the same article would predict that interest rates would fall because the Fed was buying securities in the open market, and also say that rates would be going up because the market would be expecting increased inflation.
Nowadays, too, we read that fixed exchange rates are bad because interest rates will have to rise to keep foreign capital in the U.S., but also that falling exchange rates are bad because interest rates will have to rise for the same reason. If financial writers are mired in hopeless confusion, how can we expect the public to make any sense of what is going on?
In truth, interest rates, like any important price, are complex phenomena that are determined by several factors, each of which can change in varying, or even contradictory, ways. As in the case of other prices, interest rates move inversely with the supply, but directly with the demand, for credit. If the Fed enters the open market to buy securities, it thereby increases the supply of credit, which will tend to lower interest rates; and since this same act will increase bank reserves by the same extent, the banks will now inflate money and credit out of thin air by a multiple of the initial jolt, nowadays about ten to one. So if the Fed buys $1 billion of securities, bank reserves will rise by the same amount, and bank loans and the money supply will then increase by $10 billion. The supply of credit has thereby increased further, and interest rates will fall some more.
But it would be folly to conclude, impressionistically, that interest rates are destined to fall indefinitely. In the first place, the supply and demand for credit are themselves determined by deeper economic forces, in particular the amount of their income that people in the economy wish to save and invest, as opposed to the amount they decide to consume. The more they save, the lower the interest rate; the more they consume, the higher. Increased bank loans may mimic an increase in genuine savings, yet they are very far from the same thing.
Inflationary bank credit is artificial, created out of thin air; it does not reflect the underlying saving or consumption preferences of the public. Some earlier economists referred to this phenomenon as “forced” savings; more importantly, they are only temporary. As the increased money supply works its way through the system, prices and all values in money terms rise, and interest rates will then bounce back to something like their original level. Only a repeated injection of inflationary bank credit by the Fed will keep interest rates artificially low, and thereby keep the artificial and unsound economic boom going; and this is precisely the hallmark of the boom phase of the boom-bust business cycle.
But something else happens, too. As prices rise, and as people begin to anticipate further price increases, an inflation premium is placed on interest rates. Creditors tack an inflation premium onto rates because they don’t propose to continue being wiped out by a fall in the value of the dollar; and debtors will be willing to pay the premium because they too realize that they have been enjoying a windfall.
And this is why, when the public comes to expect further inflation, Fed increases in reserves will raise, rather than lower, the rate of interest. And when the acceleration of inflationary credit finally stops, the higher interest rate puts a sharp end to the boom in the capital markets (stocks and bonds), and an inevitable recession liquidates the unsound investments of the inflationary boom.
An extra twist to the interest rate problem is the international aspect. As a long-run tendency, capital moves from low-return investments (whether profit rates or interest rates) toward high-return investments until rates of return are equal. This is true within every country and also throughout the world. Internationally, capital will tend to flow from low-interest- to high-interest-rate countries, raising interest rates in the former and lowering them in the latter.
In the days of the international gold standard, the process was simple. Nowadays, under fiat money, the process continues, but results in a series of alleged crises. When governments try to fix exchange rates (as they did from the Louvre agreement of February 1987 until Black Monday), then interest rates cannot fall in the United States without losing capital or savings to foreign countries.
In the current era of a huge balance of trade deficit in the U.S., the U.S. cannot maintain a fixed dollar if foreign capital flows outward; the pressure for the dollar to fall would then be enormous. Hence, after Black Monday, the Fed decided to allow the dollar to resume its market tendency to fall, so that the Fed could then inflate credit and lower interest rates.
But it should be clear that that interest rate fall could only be ephemeral and strictly temporary, and indeed interest rates resumed their inexorable upward march. Price inflation is the consequence of the monetary inflation pumped in by the Federal Reserve for several years before the spring of 1987, and interest rates were therefore bound to rise as well.
Moreover, the Fed, as in many other matters, is caught in a trap of its own making; for the long-run trend to equalize interest rates throughout the world is a drive to equalize not simply money, or nominal, returns, but real returns corrected for inflation. But if foreign creditors and investors begin to receive dollars worth less and less in value, they will require higher money interest rates to compensate—and we will be back again, very shortly, with a redoubled reason for interest rates to rise.
In trying to explain the complexities of interest rates, inflation, money and banking, exchange rates and business cycles to my students, I leave them with this comforting thought: Don’t blame me for all this, blame the government. Without the interference of government, the entire topic would be duck soup.
First published in February 1988.
9
ARE SAVINGS TOO LOW?
One strong recent trend among economists, businessmen, and politicians, has been to lament the amount of savings and investment in the United States as being far too low. It is pointed out that the American percentage of savings to national income is far lower than among the West Germans, or among our feared competitors, the Japanese. Recently, Secretary of the Treasury Nicholas Brady sternly warned of the low savings and investment levels in the United States.
This sort of argument should be considered on many levels. First, and least important, the statistics are usually manipulated to exaggerate the extent of the problem. Thus, the scariest figures (e.g., U.S. savings as only 1.5 percent of national income) only mention personal savings, and omit business savings; also, capital gains are almost always omitted as a source of savings and investment.
But these are minor matters. The most vital question is: even conceding that U.S. savings are 1.5 percent of national income and Japanese savings are 15 percent, what, if anything, is the proper amount or percentage of savings?
Consumers voluntarily decide to divide their income into spending on consumer goods, as against saving and investment for future income. If Mr. Jones invests X percent of his income for future use, by what standard, either moral or economic, does some outside person come along and denounce him for being wrong or immoral for not investing X+l percent? Everyone knows that if they consume less now, and save and invest more, they will be able to earn a higher income at some point in the future. But which they choose depends on the rate of their time preferences: how much they prefer consuming now to consuming later. Since everyone makes this decision on the basis of his own life, his particular situation, and his own value-scales, to denounce his decision requires some extraindividual criterion, some criterion outside the person with which to override his preferences.
That criterion cannot be economic, since what is efficient and economic can only be decided within a framework of voluntary decisions made by individuals. For the criterion to be moral would be extraordinarily shaky, since moral truths, like economic laws, are not quantitative but qualitative. Moral laws, such as “thou shalt not kill” or “thou shalt not steal,” are qualitative; there is no moral law which says that “thou shalt not steal more than 62 percent of the time.” So, if people are being exhorted to save more and consume less as a moral doctrine, the moralist is required to come up with some quantitative optimum, such as: when specifically, is saving too low, and when is it too high? Vague exhortations to save more make little moral or economic sense.
But the lamenters do have an important point. For there are an enormous number of government measures which cripple and greatly lower savings, and add to consumption in society. In many ways, government steps in, employs many instruments of coercion, and skews the voluntary choices of society away from saving and investment and toward consumption.
Our complainers about saving don’t always say what, beyond exhortation, they think should be done about the situation. Left-liberals call for more governmental “investment” or higher taxes so as to reduce the government deficit, which they assert is “dissaving.” But one thing which the government can legitimately do is simply get rid of its own coercive influence in favor of consumption and against saving and investment. In this way, the voluntary time preferences and choices of individuals would be liberated, instead of overridden, by government.
The Bush administration began eliminating some of the coercive anti-saving measures that had been imposed by the so-called Tax Reform Act of 1986. One was the abolition of tax-deduction for IRAs, which wiped out an important category of middle-class saving and investment; another was the steep increase in the capital gains tax, which is a confiscation of savings, and—to the extent that capital gains are not indexed for inflation—a direct confiscation of accumulated wealth.
But this is only the tip of the iceberg. To say that only government deficits are “dis-saving” is to imply that higher taxes increase social savings and investment. Actually, while the national income statistics assume that all government spending except welfare payments are “investment,” the truth is precisely the opposite.
All business spending is investment because it goes toward increasing the production of goods that will eventually be sold to consumers. But government spending is simply consumer spending for the benefit of the income, and for the whims and values, of government’s politicians and bureaucrats. Taxation and government spending siphon social resources away from productive consumers who earn the money they receive, and away from their private consumption and saving, and toward consumption expenditure by unproductive politicians, bureaucrats, and their followers and subsidies.
Yes, there is certainly too little saving and investment in the United States, as a result of which the U.S. standard of living per person is scarcely higher than it was in the early 1970s. But the problem is not that individuals and families are somehow failing their responsibilities by consuming too much and saving too little, as most of the complainers contend. The problem is not in ourselves the American public, but in our overlords.
All government taxation and spending diminishes saving and consumption by genuine producers, for the benefit of a parasitic burden of consumption spending by non-producers. Restoring tax deductions and repealing—not just lowering—the capital gains tax, would be most welcome, but they would only scratch the surface.
What is really needed is a drastic reduction of all government taxation and spending, state, local, and federal, across the board. The lifting of that enormous parasitic burden would bring about great increases in the standard of living of all productive Americans, in the short-run as well as in the future.
First published in November 1989.
10
A WALK ON THE SUPPLY SIDE
Establishment historians of economic thought—they of the Smith-Marx-Marshall variety—have a compelling need to end their saga with a chapter on the latest Great Man, the latest savior and final culmination of economic science. The last consensus choice was, of course, John Maynard Keynes, but his General Theory is now a half-century old, and economists have for some time been looking around for a new candidate for that final chapter.
For a while, Joseph Schumpeter had a brief run, but his problem was that his work was largely written before the General Theory. Milton Friedman and monetarism lasted a bit longer, but suffered from two grave defects: (1) the lack of anything resembling a great, integrative work; and (2) the fact that monetarism and Chicago School Economics is really only a gloss on theories that had been hammered out before the Keynesian Era by Irving Fisher and by Frank Knight and his colleagues at the University of Chicago.
Was there nothing new to write about since Keynes?
Since the mid-1970s, a school of thought has made its mark that at least gives the impression of something brand new. And since economists, like the Supreme Court, follow the election returns, “supply-side economics” has become noteworthy.
Supply-side economics has been hampered among students of contemporary economics in lacking anything like a grand treatise, or even a single major leader, and there is scarcely unanimity among its practitioners. But it has been able to take shrewd advantage of highly placed converts in the media and easy access to politicians and think tanks. Already it has begun to make its way into last chapters of works on economic thought.
A central theme of the supply-side school is that a sharp cut in marginal income-tax rates will increase incentives to work and save, and therefore investment and production. That way, few people could take exception. But there are other problems involved. For, at least in the land of the famous Laffer Curve, income tax cuts were treated as the panacea for deficits; drastic cuts would so increase stated revenue as allegedly to yield a balanced budget.
Yet there was no evidence whatever for this claim, and indeed, the likelihood is quite the other way. It is true that if income-tax rates were 98 percent and were cut to 90 percent, there would probably be an increase in revenue; but at the far lower tax levels we have been at, there is no warrant for this assumption. In fact, historically, increases in tax rates have been followed by increases in revenue and vice versa.
But there is a deeper problem with supply-side than the inflated claims of the Laffer Curve. Common to all supply-siders is nonchalance about total government spending and therefore deficits. The supply-siders do not care that tight government spending takes resources that would have gone into the private sector and diverts them to the public sector.
They care only about taxes. Indeed, their attitude toward deficits approaches the old Keynesian “we only owe it to ourselves.” Worse than that: the supply-siders want to maintain the current swollen levels of federal spending. As professed “populists,” their basic argument is that the people want the current level of spending and the people should not be denied.
Even more curious than the supply-sider attitude toward spending is their viewpoint on money. On the one hand, they say they are for hard money and an end to inflation by going back to the “gold standard.” On the other hand, they have consistently attacked the Paul Volcker Federal Reserve, not for being too inflationist, but for imposing “too tight” money and thereby “crippling economic growth.”
In short, these self-styled “conservative populists” begin to sound like old-fashioned populists in their devotion to inflation and cheap money. But how square that with their championing of the gold standard?
In the answer to this question lies the key to the heart of the seeming contradictions of the new supply-side economics. For the “gold standard” they want provides only the illusion of a gold standard without the substance. The banks would not have to redeem in gold coin, and the Fed would have the right to change the definition of the gold dollar at will, as a device to fine-tune the economy. In short, what the supply-siders want is not the old hard-money gold standard, but the phony “gold standard” of the Bretton Woods era, which collapsed under the bows of inflation and money management by the Fed.
The heart of supply-side doctrine is revealed in its best-selling philosophic manifesto, The Way the World Works, by Jude Wanniski. Wanniski’s view is that the people, the masses, are always right, and have always been right through history.
In economics, he claims, the masses want a massive welfare state, drastic income-tax cuts, and a balanced budget. How can these contradictory aims be achieved? By the legerdemain of the Laffer Curve. And in the monetary sphere, we might add, what the masses seem to want is inflation and cheap money along with a return to the gold standard. Hence, fueled by the axiom that the public is always right, the supply-siders propose to give the public what they want by giving them an inflationary, cheap-money Fed plus the illusion of stability through a phony gold standard.
The supply-side aim is therefore “democratically” to give the public what they want, and in this case the best definition of “democracy” is that of H.L. Mencken: “Democracy is the view that the people know what they want, and deserve to get it good and hard.”
First published in October 1984.
11
KEYNESIAN MYTHS
The Keynesians have been caught short again. In the early and the late 1970s, the wind was taken out of their sails by the arrival of inflationary recession, a phenomenon which they not only failed to predict, but whose very existence violates the fundamental tenets of the Keynesian system. Since then, the Keynesians have lost their old invincible arrogance, though they still constitute a large part of the economics profession.
In the last few years, the Keynesians have been assuring us with more than a touch of their old hauteur, that inflation would not and could not arrive soon, despite the fact that “tight-money” hero Paul Volcker had been consistently pouring in money at double-digit rates. Chiding hard-money advocates, the Keynesians declared that, despite the monetary inflation, American industry still suffered from “excess” or “idle” capacity, functioning at an overall rate of something like 80 percent. Thus, they pointed out, expanded monetary demand could not result in inflation.
As we all know, despite Keynesian assurances that inflation could not reignite, it did despite the idle capacity, leaving them with something else to puzzle over. Inflation rose from approximately 1 percent in 1986 to 6 percent, interest rates the next year rose again, the falling dollar raised import prices, and gold prices went up. Once again, the hard-money economists and investment advisors have proved far sounder than the Establishment-blessed Keynesians.
Along with that the best way to explain where the Keynesians went wrong is to turn against them their own common reply to their critics: that anti-Keynesians, who worry about the waste of inflation or government programs, are “assuming full employment” of resources. Eliminate this assumption, they say, and Keynesianism becomes correct in the through-the-looking glass world of unemployment and idle resources. But the charge should be turned around, and the Keynesians should be asked: why should there be unemployment (of labor or of machinery) at all? Unemployment is not a given that descends from heaven. Of course, it often exists, but what can account for it?
The Keynesians themselves create the problem by leaving out the price system. The hallmark of crackpot economics is an analysis that somehow leaves out prices, and talks only about such aggregates as income, spending, and employment.
We know from “microeconomic” analysis that if there is a “surplus” of something on the market, if something cannot be sold, the only reason is that its price is somehow being kept too high. The way to cure a surplus or unemployment of anything, is to lower the asking price, whether it be wage rates for labor, prices of machinery or plant, or of the inventory of a retailer.
In short, as Professor William H. Hutt pointed out brilliantly in the 1930s, when his message was lost amid the fervor of the Keynesian Revolution: idleness or unemployment of a resource can only occur because the owner of that resource is deliberately withholding it from the market and refusing to sell it at the offered price. In a profound sense, therefore, all unemployment and idleness is voluntary.
Why should a resource owner deliberately withhold it from the market? Usually, because he is holding out for a higher price, or wage rate. In a free and unhampered market economy, the owners will find out their error soon enough, and when they get tired of making no returns from their labor or machinery or products, they will lower their asking price sufficiently to sell them.
In the case of machinery and other capital goods, of course, the owners might have made a severe malinvestment, often due to artificial booms created by bank credit and central banks. In that case, the lower market clearing price for the machinery or plant might be so low as to not be worth the laborer’s giving up his leisure—but then the unemployment is purely voluntary and the worker holds out permanently for a higher wage.
A worse problem is that, since the 1930s, government and its privileged unions have intervened massively in the labor market to keep wage rates above the market-clearing wage, thereby insuring ever higher unemployment among workers with the lowest skills and productivity. Government interference, in the form of minimum wage laws and compulsory unionism, creates compulsory unemployment, while welfare payments and unemployment “insurance” subsidize unemployment and make sure that it will be permanently high. We can have as much unemployment as we pay for.
It follows from this analysis that monetary inflation and greater spending will not necessarily reduce unemployment or idle capacity. It will only do so if workers or machine owners are induced to think that they are getting a higher return and at least some of their holdout demands are being met. And this can only be accomplished if the price paid for the resource (the wage rate or the price of machinery) goes up. In other words, greater supply or use of capacity will only be called forth by wage and price increases, i.e., by price inflation.
As usual, the Keynesians have the entire causal process bollixed up. And so, as the facts now poignantly demonstrate, we can and do have inflation along with idle resources.
First published in September 1987.
12
KEYNESIANISM REDUX
One of the ironic but unfortunately enduring legacies of eight years of Reaganism has been the resurrection of Keynesianism. From the late 1930s until the early 1970s, Keynesianism rode high in the economics profession and in the corridors of power in Washington, promising that, so long as Keynesian economists continued at the helm, the blessings of modern macroeconomics would surely bring us permanent prosperity without inflation. Then something happened on the way to Eden: the mighty inflationary recession of 1973–74.
Keynesian doctrine is, despite its algebraic and geometric jargon, breathtakingly simple at its core: recessions are caused by underspending in the economy, inflation is caused by overspending. Of the two major categories of spending, consumption is passive and determined, almost robotically, by income; hopes for the proper amount of spending, therefore, rest on investment, but private investors, while active and decidedly non-robotic, are erratic and volatile, unreliably dependent on fluctuations in what Keynes called their “animal spirits.”
Fortunately for all of us, there is another group in the economy that is just as active and decisive as investors, but who are also—if guided by Keynesian economists—scientific and rational, able to act in the interests of all: Big Daddy government. When investors and consumers underspend, government can and should step in and increase social spending via deficits, thereby lifting the economy out of recession. When private animal spirits get too wild, government is supposed to step in and reduce private spending by what the Keynesians revealingly call “sopping up excess purchasing power” (that’s ours).
In strict theory, by the way, the Keynesians could just as well have called for lowering government spending during inflationary booms rather than sopping up our spending. But the very idea of cutting government budgets (and I mean actual cut-cuts, not cuts in the rate of increase) is nowadays just as unthinkable, as, for example, adhering to a Jeffersonian strict construction of the Constitution of the United States, and for similar reasons.
Originally, Keynesians vowed that they, too, were in favor of a “balanced budget,” just as much as the fuddy-duddy reactionaries who opposed them. It’s just that they were not, like the fuddy-duddies, tied to the year as an accounting period; they would balance the budget, too, but over the business cycle. Thus, if there are four years of recession followed by four years of boom, the federal deficits during the recession would be compensated for by the surpluses piled up during the boom; over the eight years of cycle, it would all balance out.
Evidently, the “cyclically balanced budget” was the first Keynesian concept to be poured down the Orwellian memory hole, as it became clear that there weren’t going to be any surpluses, just smaller or larger deficits. A subtle but important corrective came into Keynesianism: larger deficits during recessions, smaller ones during booms.
But the real slayer of Keynesianism came with the double-digit inflationary recession of 1973–74, followed soon by the even more intense inflationary recessions of 1979–80 and 1981–82. For if the government was supposed to step on the spending accelerator during recessions, and step on the brakes during booms, what in blazes is it going to do if there is a steep recession (with unemployment and bankruptcies) and a sharp inflation at the same time? What can Keynesianism say? Step on both accelerator and brake at the same time? The stark fact of inflationary recession violates the fundamental assumptions of Keynesian theory and the crucial program of Keynesian policy. Since 1973–74, Keynesianism has been intellectually finished, dead from the neck up.
But very often the corpse refuses to lie down, particularly one made up of an elite which would have to give up their power positions in the academy and in government. One crucial law of politics or sociology is: no one ever resigns. And so, the Keynesians have clung to their power positions as tightly as possible, never resigning, although a bit less addicted to grandiose promises.
A bit chastened, they now only promise to do the best they can, and to keep the system going. Essentially, then, shorn of its intellectual groundwork, Keynesianism has become the pure economics of power, committed only to keeping the Establishment-system going, making marginal adjustments, babying things along through yet one more election, and hoping that by tinkering with the controls, shifting rapidly back and forth between accelerator and brake, something will work, at least to preserve their cushy positions for a few more years.
Amidst the intellectual confusion, however, a few dominant tendencies, legacies from their glory days, remain among Keynesians: (1) a penchant for continuing deficits, (2) a devotion to fiat paper money and at least moderate inflation, (3) adherence to increased government spending, and (4) an eternal fondness for higher taxes, to lower deficits a wee bit, but more importantly, to inflict some bracing pain on the greedy, selfish, and short-sighted American public.
The Reagan administration managed to institutionalize these goodies, seemingly permanently on the American scene. Deficits are far greater and apparently forever; the difference now is that formerly free-market Reaganomists are out-Keynesianing their liberal forebears in coming up with ever more ingenious apologetics for huge deficits. The only dispute now is within the Keynesian camp, with the allegedly “conservative” supply-siders enthusiastically joining Keynesians in devotion to inflation and cheap money, and differing only on their call for moderate tax cuts as against tax increases.
The triumph of Keynesianism within the Reagan administration stems from the rapid demise of the monetarists, the main competitors to the Keynesians within respectable academia. Having made a series of disastrously bad predictions, they who kept trumpeting that “science is prediction,” the monetarists have retreated in confusion, trying desperately to figure out what went wrong and which of the many “M”s they should fasten on as being the money supply. The collapse of monetarism was symbolized by Keynesian James Baker’s takeover as Secretary of the Treasury from monetarist-sympathizer Donald Regan. With Keynesians dominant during the second Reagan term, the transition to a Keynesian Bush team—Bush having always had strong Keynesian leanings—was so smooth as to be almost invisible.
Perhaps it is understandable that an administration and a campaign that reduced important issues to sound bites and TV images should also be responsible for the restoration to dominance of an intellectually bankrupt economic creed, the very same creed that brought us the political economics of every administration since the second term of Franklin D. Roosevelt.
It is no accident that the same administration that managed to combine the rhetoric of “getting government off our back” with the reality of enormously escalating Big Government, should also have brought back a failed and statist Keynesianism in the name of prosperity and free enterprise.
First published in January 1989.
Making Economic Sense
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