Unfettered Powerful Extremes; D. Boudreaux

Such arguments, even though deeply flawed, never infuriate me. Not so with a far-more common mode of criticizing the market, namely, tossing out slogans. Three of these anti-free-market slogans are particularly galling. Is Capitalism "Unfettered"? The first is "unfettered capitalism" (or "unfettered free markets"). Opponents of lais sez faire love this one because it so obviously describes an economic system that no reason able person endorses. So, before I go on, let me declare without qualification: I, too, oppose unfettered capitalism. The trouble with this slogan is that capital ism, by its very nature-by the fact that it is the product of a system of private property rights-is necessarily constrained. Capitalism is internally and inexorably fettered. To the extent that a society is capitalistic, no one in that society can coercively or fraudulently harm others. Everyone is restrained from vio lating the equal rights of others.

Consider, for example, Michael Dell, founder of Dell Computers. He earned an Donald J. Boudreaux is president ofFEE. 4 impressive fortune by producing affordable computers that consumers voluntarily pur chase. Like everyone in a capitalist system, Dell was and remains quite constrained by the rules of private property. Had he produced lousy machines, or had he stubbornly priced his machines so high that too few consumers bought them, he would today be in some less lucrative line of work. Dell is emphatically fettered by the ability of consumers to spend their money as they see fit, along with the ability of other entrepreneurs to compete with him. Indeed, central to the economic and ethical case for laissez faire is the recognition that it is the only system that provides adequate and appropriate fetters. One of the great benefits of private property and voluntary exchange is that, because no one is compelled to engage in any exchange, all exchanges that do take place are believed by all parties to them to be beneficial.

The ability not to exchange-what Boston University law professor Randy Barnett calls "freedom from contract"-is an enormously effective fetter protecting the weak from the strong.! And only under laissez faire is every one's freedom from contract (along with the freedom to contract) consistently respected. Does Capitalism Favor "The Powerful"? Reflecting on freedom from contract allows us to dismantleanotherpopular slogan,namely, that "markets favor the powerful over the weak." Indeed private property rights eliminate the distinction between "powerful" and "weak." In a market economy, some people are wealthi er than others, but no one exercises power over others. Although Bill Gates's wealth is about 600,000 times greater than my own, he has no more power over me than I have over him. If he wants my car, he cannot have it unless I agree to sell it to him. He cannot imprison me, shoot me, or enslave me. He cannot tell me what to eat or drink or with whom I may be intimate. He can not tell me how to educate my son, or how I may earn a living. It's true that if I want to use Microsoft software I must first buy it from him, but so, too, must he buy from me anything that he wants which I own. We are both free not to contract with the other. It would be perverse to assert that Bill Gates has "power" because he is unusually talented at producing products that please consumers.2 A person (or an institution) is powerful only insofar as he can use authorized force to com pel others to act against their wills. Only the state has such power. This fact is why the fur ther we move toward laissez faire, the smaller is the scope for the truly powerful-those with political authority-to dominate others. At the laissez-faire limit, all power is eliminated.

Is Laissez Faire "Extreme"? The third galling slogan is that those of us who consistently champion laissez faire are "extremists." "We must strike a balance between the state and the market," the refrain goes. "Laissez-faire proponents such as Mil ton Friedman, F. A. Hayek, and Ludwig von Mises are extremists." Wrong. The fact is, laissez faire eliminates extremes and extremists. That's one of its principal virtues. The greater the scope of the market, the less likely there will be extremes and extremists. Compare the relationship of one market participant to another with that of the state to its subjects. On the market, farmer Jones can get Ms. Smith's money only by offering her something that she values. Each party to the 5 exchange gains; no one is harmed and no one carries away all of the benefit. If farmer Jones seeks to be an extremist-say, if he asks Ms. Smith to pay $1,000 per bushel of his com Ms. Smith walks away. Ms. Smith's freedom not to contract with farmer Jones, along with her freedom to contract with other suppliers, ensures that farmer Jones will abandon his extremist position. Likewise, Ms. Smith can not be an extremist. She might initially offer farmer Jones a mere one cent for each bushel of his com, but farmer Jones need not accept.

If Ms. Smith wants to buy com from farmer Jones, she'll raise her offer; she'll abandon her extremist position. Market prices balance the costs and bene fits to all parties of producing and consuming. Extremes are avoided. Suppose, though, that farmer Jones is so greedy that he isn't content to play by the rules of private property. So he successfully lobbies Uncle Sam for a higher, guaranteed minimum price for corn. The state might achieve this price hike by paying farmer Jones and other corn farmers to reduce their pro duction, and by prohibiting upstart com farm ers from entering the market. Now we've got true extremism. Not only does the state stand ready, ultimately, to kill anyone who insists on doing nothing more heinous than selling corn at prices lower than the dictated minimum, but farmer Jones need no longer bargain with Ms. Smith. If Ms. Smith isn't content to pay the state-enforced minimum price, too bad for her. She remains free not to buy the com (except insofar as her taxes are used to subsi dize corn farmers 0, but she may not now bar gain with other farmers for a lower price.

Government intervention favors com farmers with a disproportionate-we might say "extreme" -advantage. Beware of slogans. They are verbal camouflage for weak arguments. 0 1. For a more elaborate explanation, see Barnett's impressive and important book The Structure of Liberty (New York: Oxford Uni versity Press, 1998). 2. The popular belief that Microsoft's current large market share is due to monopolistic practices, network effects, or inefficient "lock in" has been convincingly exploded in the fact-laden book by Stan J. Liebowitz and Stephen E. Margolis, Winners, Losers, and Microsoft (Oakland, Calif.: The Independent Institute, 1999).

The Fed Sets Interest Rates? It Just Ain'tSol N ewspaper headlines across the country on July I provided some bad news for consumers: "Fed moves to raise interest rates." Associated Press writer Martin Crutsinger explained: "The Federal Reserve raised interest rates for the first time in two years ... nudging bor rowing costs higher for millions of American consumers and businesses .... At the conclu sion of two days of closed-door discussions, Fed policymakers said they were increasing the target for the federal funds rate, the inter est [rate] that banks charge each other on overnight loans, from 4.75 to 5 percent. The Fed said in a statement that it felt the need to be 'especially alert to the emergence, or potential emergence, of inflationary forces that could undermine economic growth.'" "When the economy is growing at a rate the Fed·believes is too fast," Crutsinger advised his readers, "it raises interest rates· to slow spending on big-ticket items such as homes, autos and appliances."

How It Works Every householder and businessman can relate to an interest rate. They see it as con tributing to the cost of the monthly mortgage payment and the payment owed the bank for a business loan. So everyone has some idea that the Fed occasionally cranks up its interest-rate machine, which it keeps in a crypt in the base ment of the Federal Reserve Bank of New York, to raise or lower rates. But how does that infernal machine work? Who follows the blueprint, manipulates the levers, and chants the rites to implement an interest-rate change? 6 Let's peek into the basement of the bank and see what goes on there. I do not have Superman's X-ray vision, but I am certain beyond any doubt that neither the Fed Bank ofNew Yorknor any other Fed insti tution has an interest-rate machine. Neverthe less, the popular belief, as emphasized by the newspaper headline "Fed moves to raise inter est rates," must have some foundation in fact.

So in what sense did the Fed "raise rates"? What the Federal Reserve does have is a powerful moneymaking machine that oper ates through the offices of its New York bank. In activating this machine to raise rates, the Fed's decisionmaking board, the Federal Reserve Open-Market Committee (FOMC), issues a directive to the bank's account man ager to sell more or buy fewer government securities in New York's financial market. This time the directive was to buy fewer. Since the Fed is a major player in the government secu rities market, when it buys fewer securities it causes the price to fall and their interest rate to increase. Unlike anyone else who buys something in markets, a Federal Reserve purchase is not made with old money but with brand-new money. The Fed creates the means of pay ment. If the seller of the securities wants cash, the Fed uses its authority to print new Federal Reserve notes. If the seller wants a check, the Fed account manager has the authority to issue one that becomes new bank reserves when deposited. Since the Fed creates new currency and bank reserves to purchase gov ernment securities, the securities are perforce monetized. They are no longer outstanding debt, but by the alchemy of central banking have been converted into money. Likewise, when the FOMe sells securities or buys fewer than it had been buying, as in this case, the quantity of money in the economy is reduced or its rate of increase is slowed.

The action on July 1 called for the account manager to buy fewer securities until the Fed funds rate rose from 4.75 to 5 percent. "Fed funds" are the loans banks make to each other for a 24-hour period. Some banks need extra reserves, others have excess reserves. The Fed funds market resolves these asymmetries. Since Fed funds are an important segment of the reserves commercial banks need to carry on their lending and investing business, any central bank action that constrains reserves raises that particular interest rate. Monopoly Power Over Money The answer to the question posed above, therefore, is: the FaMe can raise this one short-term interest rate-the Fed funds rate for a few days. Its means for doing so, how ever, is its monopoly power to increase or decrease the economy's stock of money, not any device that directly alters market interest rates. Let's see what happened to other interest rates.

The Federal Reserve Bank of St. Louis publishes weekly a newsletter, u.s. Financial Data, which furnishes week-by-week accounts of the U.S. economy's monetary and financial data over the most recent 15 months. According to the July 22 issue, the Fed funds rate duly recorded an uptick on July 1 follow ing the FOMC's action. Most other rates, however, did not follow suit. Corporate AAA bond rates hit a low point in January 1999, rose 100 basis points (1 percent) to June 25, and fell 20 basis points in the weeks after the Fed "raised rates." Tax-free municipal bonds, which show little interest-rate movement, had risen slightly since October 1998. After the July rate "hike," their rates too showeda slight decline. Rates for 30-day commercial paper, loans made by nonfinancial companies, were flat for the first six months of this year, rose slightly in June until the rate "hike," then showed a downtick. Thirty-year Treasury rates hit a low spot in October 1998 and rose 7 constantly (about 100 basis points) until the rate "hike." After that, they too declined.

The AP report included charts of interest rates on mortgages and Treasury bonds that showed significant increases in rates since the autumn of 1998. So how could the AP claim that the "Fed raised interest rates" on July 1, when most rates had been rising since the pre vious October and several rates fell after the rate "hike"? Their report was not an example of valid news but of "economically correct" journalism. Traditional economics properly teaches that many complex market forces-countless investment and savings decisions not depen dent on monetary factors-are essential in determining interest rates. The Fed funds rate that Fed policy can influence through its monopoly over the quantity of money is inconsequential in shaping most short-term and long-term rates in capital markets, unless that moneymaking power subsequently pro motes a pervasive price inflation. Federal Reserve policy is responsible for the quantity of money-cash and bank deposits-that all households and business firms have in their possession at any moment.

Furthermore, all severe price inflations and contractions (such as the one from 1929 to 1933) result from excesses or deficiencies of central hank money. All of which means that the Fed's current role in "fighting inflation" amounts to nothing more than undoing things it should not have done in the first place. By controlling the basic stock of money in the U.S. economy, Fed policy determines the general level of prices. And for a fleeting moment through its control over the money stock, the Fed may influence a few short-term interest rates. But the media claim that the "Fed moves to raise [or lower] interest rates"? It just ain't so. D -RICHARD H. TIMBERLAKE ContributingEditor WhyY2K? by Bill O. Reitz W e are fast approaching that fateful day, January 1, 2000. Whether the much debated Y2K problem will come in with a bang or merely a whimper, only time will tell. But it is interesting to ask why we are in this situation today.