SECTION 3: BANKING & THE BUSINESS CYCLE 83. THE CASE FOR THE BARBAROUS RELIC November 2005

We flatter ourselves, in this technological age driven by financial innovation and mind-boggling efficiencies, that we know more than any previous generation. But there is lost knowledge, among which is the knowledge of what sound money feels and looks like, what it does, who makes it and why, and how it holds its value.

So let us revisit Robert Louis Stevenson’s classic story, Treasure Island, and the climactic scene where the pirates and their companions have finally found their treasure and prepare to haul it away. The narrator reports as follows:

It was a strange collection, like Billy Bones’s hoard for the diversity of coinage, but so much larger and so much more varied that I think I never had more pleasure than in sorting them. English, French, Spanish, Portuguese, Georges, and Louises, doubloons and double guineas and moidores and sequins, the pictures of all the kings of Europe for the last hundred years, strange Oriental pieces stamped with what looked like wisps of string or bits of spider’s web, round pieces and square pieces, and pieces bored through the middle, as if to wear them round your neck—nearly every variety of money in the world must, I think, have found a place in that collection; and for number, I am sure they were like autumn leaves, so that my back ached with stooping and my fingers with sorting them out.

There is more to learn about real money from this paragraph than in most money and banking texts. Here we discover that money is international. It matters not what nation-state or private party mints it. Money can come in all shapes and sizes. It has enduring value for hundreds of years. It can be put in a vault and found by anyone in the future and retains its value. Its merit as money is not dependent on the existence or persistence of any single government.

The regimes that minted the coins may be long forgotten but the money they made stays as a permanent part of the economic landscape until it is melted. What this suggests is independence for the people who have, hold, and use the money. They are not roped into any regime as such. They go about their economic affairs as independent people. Their money, which cannot be destroyed by the actions of a central government or a central bank, testifies to their status as free people.

And what is it made of? Gold, silver, or any precious metal, something or anything that will cause a back to ache and the fingers to hurt from sorting them out. Money is heavy, robust, durable, divisible, enduring. It is treasure. It is worth hiding when one is in trouble and worth hunting for if one stumbles upon a map to guide you there. As to when it was minted and by whom, it doesn’t matter. Money lasts. Money is true. It transcends the generations. It transcends the nation. It transcends the state.

As for any money minted or printed in the last 50 years, some of it may have value as a collectible but its value would vanish to near zero if it were melted. As for the paper, it would be truly worthless. One can imagine the scene in Treasure Island had they opened the trunk to discover wads of paper currency from defunct governments. Let’s just say the story would have ended very differently. It might have looked more like that scene in Lawrence of Arabia where the warriors trek hundreds of miles across the desert for treasure only to find crates full of paper cash, which the plunderers promptly throw to the wind. Lawrence wisely departs the scene on a horse, promising to return with real money.

Incidentally, I do think there is a point to buying children coins for presents. Just to hold an older coin of gold and silver imparts a lesson of sorts. It illustrates the reality of a history that is different from our present. I’ve never seen a child disregard a nice gold or silver coin. They keep it in a safe box, show it to their friends, and reflect on the sense of personal empowerment they experience from owning it. Children know what treasure is, even if central bankers do not.

Today we think of money as something to possess for instrumental purposes but something otherwise created and managed by the government to keep the economy going.

The new Fed chairman, Ben Bernanke, was grilled at his Senate confirmation hearings as if he were a magician who could pull rabbits or squirrels out of his hat, depending on his mood that day. All the questions related to whether he would tend to prefer the rabbit of employment to the squirrel of inflation. The goal of these politicians was to prod him into admitting that squirrels are far more preferable than rabbits, and if he would just admit it and swear to it, they would give him a free pass and let him perform, while Congress and president provide the necessary smoke and mirrors.

And by the way, Bernanke also promised to keep the Fed completely free from politics.

I assure this committee that, if I am confirmed, I will be strictly independent of all political influences and will be guided solely by the Federal Reserve’s mandate from Congress and by the public interest.

When ex-Fed chairman Arthur Burns arrived at the Bonn airport as ambassador to Germany, a reporter asked him how he could have agreed to Nixon’s desire to inflate so massively? The Fed chairman must do as the president wants, he answered, or the Fed would lose its independence.

Here is a rule of thumb. If an institution has a dot-gov in its web address, as in FederalReserve.gov, it is not independent and it is not free of politics.

One politician summed up the Fed’s mandate this way: “guiding the economy to create broadly shared prosperity.”

Herein we find the perfect summary of what is wrong with Washington’s view of economic life. It imagines the economy to be guided by the Fed, and that prosperity is created by its printing press. Bernanke, however, was not in a position to correct the record, for he has himself spoken about the wonderful and limitless power of the Fed to create as much money as it wants to.

Thus spake Bernanke to those worried about deflation:

The US government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many US dollars as it wishes at essentially no cost. By increasing the number of US dollars in circulation, or even by credibly threatening to do so, the US government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.

What awesome power! Are we really supposed to believe that a government that possesses the ability to create unlimited amounts of money will wall off the institution that does the creating from any political influence? Surely not. The independence of the Fed is just a mask that the government uses so that it can avoid taking responsibility for any downside that comes about from the Fed’s awesome power.

I suppose that if I had a counterfeiting machine, I too would want it kept out of the house and run by someone I could appoint who would nonetheless swear to be completely independent if caught in the act.

The Bernanke hearing was a despicable display in more ways than we can count. That there is a direct relationship between inflation and employment was never questioned, even though that relationship does not exist as a matter of history or economic law.

To use the printing presses to drive down unemployment is to risk not only inflation but also radical economic instability and business cycles that can end in the worst of all worlds. And the idea that low unemployment—as a symbol of a growing economy—needs constant infusions of paper money inflation from the Fed is belied by the whole of the nineteenth century, as well as by economics.

What did Bernanke and his examiners agree on? They agreed that the Fed should be all-powerful in matters of macroeconomics. They agreed that there should not be any ironclad rule for the conduct of monetary affairs, but rather that smart guys ought to wing it day by day to achieve the right mix of policy options. And they all agreed that the prevention of deflation, meaning a fall in the general level of prices, ought to be the number one priority. So when you hear that Bernanke favors “low inflation,” remember that the emphasis is on the noun and not its modifier. It means that he prefers any amount of inflation to a condition of deflation.

Why the hysteria against deflation? We are faced with a real puzzle here. In the whole of the private sector, the number one focus of retailers these days, particularly those dominant retailers such as Wal-Mart and Home Depot, is low prices. This they emphasize above all else because they know that this is what consumers want.

And yet in the public sector, we find exactly the opposite: an ironclad promise that prices will not be low but rather will be continually rising. So if Wal-Mart’s slogan is “Always Low Prices,” the slogan of the Fed and the government should be “Always Higher Prices.”

The question is why. Why is it that Congress, the Fed, and the presidency all agree that deflation is something to be avoided at all costs?

The experience of the Great Depression looms large, but as Murray Rothbard has shown, low prices were just about the only good economic trend that was happening throughout the 1930s. Imagine if you had all the same disasters occurring—all inspired by bad economic policy—but with high prices on top of it all! Here is a test. We all know people who lived through it. Ask them today if they would have been better off if all goods and services had been two or three or ten times more expensive.

No, the trouble with the Great Depression was not low prices. Nor were low prices and wages the cause of the economic downturn. As Rothbard further showed, the downturn was a correction of a previous inflation, a macroeconomic version of the dot-com bust, and one that was made ever worse by governmental attempts to fix the problem. As for the Fed, it did not pursue a policy of benign neglect but rather desperately attempted to inflate the money supply and was unable to do so.

The real blame for the Great Depression lies with precisely the policy that Bernanke favors, that is, a steady and relentless increase in the money supply to keep the economy humming while not sparking price increases that are politically objectionable. This inflation targeting is precisely the problem since it sends false signals to capital-goods investors and borrowers, skewing the production structure forward in time to a greater degree than underlying savings can support.

Not knowing what the Austrian School says, Congress and the Fed might believe that a policy of low-grade inflation is the best protection against depression. But I don’t believe that this is why they favor such a policy. Nor do I think that the desire to boost employment is the reason, since there is no evidence for anything like a long-run tradeoff between inflation and unemployment.

The reason the government—and here I speak of Congress and the presidency—favors a loose monetary policy, a discretionary rule at the Fed, and ongoing low-grade inflation is the most obvious one of all. It pays the bills.

In other words, the reason is no different from that of private counterfeiting. They like to have money without having to work to get it. That is essentially what the Federal Reserve provides the government. It doesn’t have to worry about its bond rating collapsing or its credit standing falling. It doesn’t have to bother with taxing people. It can hide the costs of government in the complications associated with monetary affairs.

Looking back at the history of inflations in the United States, we can detect a single event that, more than any other, prompts the government to engage in inflationary finance. I wish I could report to you that inflationary finance was a modern invention of the modern regime with its endless wars and welfare expansions.

Sadly, America was born in monetary sin, so to speak. The Continental Congress financed the Revolutionary War with paper money, beginning in 1775.

The currency was supposed to be retired in seven years with a pro rata tax levied by the states. But once the government got the hang of the magic of war finance, it forgot about the pledge and endlessly expanded the currency. Between 1775 and 1781, the Continental went from trading on par with one dollar in specie to being nearly worthless.

It was a tragic incident because it benefited all the worst people in this young country, the very group that later pushed for the Constitution to replace the Articles, and backed the creation of the first central bank, to enrich themselves. In some way, this war, which was undoubtedly just and involved a meritorious secession from a distant government, was the beginning of the end, precisely because it unleashed a horrendous inflation and schooled a new governing elite in the benefits of inflationary finance.

It has been war that has been the driving force in monetary depreciation throughout history. If Bush had been forced to raise the hundreds of billions that he has spent on his Iraq caper through taxation, his supporters would be far less supportive, and his policy more honest. Instead, he has been able to count on the inflationary finance of his friends at the Fed to make it all possible. Monetary policy has been the handmaiden of empire in other ways too, as the dollar is used as political leverage against nearly every country in the world from Argentina to China to Russia.

Fiat currency engenders conflict of all sorts, unbalances the economic structure, and puts everyone’s savings at risk. It is for this reason that Alan Greenspan once wrote that the cause of freedom is bound up with the cause of the gold standard.

Should our monetary system be reformed so that it is based on a pure gold coin standard? Yes it should. This would be the single best reform we could make for the cause of freedom. Its commercial benefits include stability, predictability, and honesty in finance. Its moral benefits include a financial system that does not reward living beyond one’s means. From the point of view of government, a gold standard would tie the hands of the state. They could wish and long for wars, welfare, foreign aid, bailouts, subsidies, and graft, but unless they could raise the money by taxing, all their talk would be pointless. That is a country I want to live in.

For years I’ve heard people suggest that the Mises Institute come up with a detailed plan for how the conversion would work. In fact, there are many models to choose from, from Joseph Salerno’s to Murray Rothbard’s to George Reisman’s to Ron Paul’s own legislation, which has been before the House for some two decades. What is lacking is not a plan. It is the political will. It would require that the government recognize the error of its own ways, agree to limit its power and influence, abolish the Fed, and return the control over economic structures back to the people. And you wonder why the movement for a gold standard struggles!

But let me just clear up a few myths about gold. It is not the case that under a gold standard, we would all find ourselves in the position of that young man in Treasure Island, with aching backs and throbbing fingers. Banks would continue to exist and compete on a sound basis. All financial services would continue to exist just as they do now, from credit cards and bankcards to PayPal and stock portfolio checking and all the rest. Indeed, we would see an explosion of financial innovation under the gold standard because so many of the uncertainties associated with inflationary finance would be a thing of the past.

Money would become truly international, or would tend in that direction as more countries decided to make their currencies as good as gold. And if we managed the transition properly, government would have no monopoly on the production of money. This would be something handled by the private sector, as suppliers competed based on beauty and design and reliability. In an ideal world, all currencies in the world would be different names for precious metals, all interchangeable with each other based on weight and fineness.

If that sounds complicated or unreasonable, or even completely unviable, let us remember that all forms of freedom seem impossible in the midst of despotic control.

Many intellectuals and officials in Russia and China couldn’t really imagine how society would work if people were permitted to live and work and move where they wanted. To them it sounded like chaos. Germans can’t imagine how society would survive without strict laws on when retail shops can open and close. And people in Britain went into a panic recently on the suggestion that pubs be permitted to stay open longer than usual.

In our own country, we can’t imagine the legalization of drugs, the elimination of the minimum wage, the abolition of Society Security, or not bombing someone every two years. These things seem crazy to us because we have adapted to statism. So it is with money. We are used to the idea that government should run the monetary system. And that’s why when we say we favor the gold standard, people think we are nuts. But today in China or Russia, anyone who favors a return of travel and moving restrictions is considered dangerous and deranged—which is precisely how I feel about anyone who says that government ought to be given full control of a nation’s monetary institutions!

So I ask you to imagine how the world worked before the advent of central banking and before our permanent state of inflationary paper currency. Imagine if the money you made and saved were as good as gold—a truly independent medium of exchange that was not subject to political manipulation, confiscation, or depreciation. The wizards at the Fed would not control our destinies, Congress’s appetite for spending would be curbed, and the president would be a bit more cautious about embarking on wars that would cost political capital. It would be the world of Treasure Island, where the only criminals we would need to worry about owned ships, not fleets, and where the pirates sang ditties about rum, not national anthems to the glory of the state.

84.
THOSE BAD OLD BUTTONED-UP DAYS
September 1991

Anything dismissed as “Victorian” these days is bound to be virtuous and rare, yet so compelling to decent people that a mere mention scares the pants off libertines. I’m talking, of course, about sound banking, which the Wall Street Journal dismisses in an editorial as “Victorian Finance.”

“The Victorians were people, you recall, who upon discovering the little secret of sex, thought the human race was about to vanish,” says the Journal. “Likewise, our modern Financial Victorians have discovered the little secret of credit.”

The Victorians were merely realistic about sex, as we are not about credit, but the wages of sin are about to be paid.

After the S&L-bank orgy, Americans no longer believe in financial promiscuity. That’s why, says the Journal, a belief in 100 percent reserves and “worries about ‘too much leverage’ or ‘too little capital’ creep out of heavily curtained conference rooms and into daily conversations.” A “modern economy runs on credit. And credit runs on fractional reserves.” Without them, banks would have “nothing to lend.”

Except on the point that people are worried, the Journal is wrong about everything, including the most important: the Mises Institute’s conference room doesn’t have any curtains. But I can’t blame the editorialist. The entire establishment is white knuckling it these days.

If enough people realize the banks are a house of cards, it will be 52 pick-up. When a very small percentage of depositors demanded their money, it closed the giant Bank of New England. Every other big bank is in similar condition, protected from the same fate by an increasingly ephemeral “confidence,” with the Federal Reserve as tender of last resort. But here’s the real “little secret” of our age: the Fed can’t bail out more than a few big banks without hyperinflation. Thus the Journal’s distress. The government is coming to the end of its rope, and it’s around the neck of the banks.

All these troubles can be traced to the legal doctrine of fractional reserves, which says that your liquid bank deposits are owned not by you, but by your bank, to do with as it pleases. When people realize this, it scares them. They want their money to be there when they need it, not in some deadbeat real estate project or Third-World politician’s pocket.

As Murray N. Rothbard and every other free-market economist before the Progressive Era argued, there are two functions in honest banking: warehousing money as versus loaning it out. When a customer deposits his cash for a fixed term—by purchasing a CD, for example—the bank can properly loan it out for one day less, with prudential reserves against loan losses. But a demand deposit is different.

Under the terms of the contract, demand deposits are to be available any time the customer wants them. In a sound system, the banks keep 100 percent reserves for their demand deposits. Anything else is fraud, as the best of the Founding Fathers argued—if I may be forgiven for harking back to pre-Victorian times.

As the libertarian Tom Paine said, money in a bank is “the property” of the man who “deposits cash there.” He “can draw the money from it when he pleases. Its being in the bank, does not in the least make it the property of the stockholders.”

Accompanying unsound banking is fiat paper money. The only “proper use for paper,” wrote Paine, is “to write promissory notes and obligations of payment in specie upon.” But when a government “undertakes to issue paper as money, the whole system of safety and certainty is overturned, and property set afloat.” It is “like putting an apparition in the place of a man; it vanishes with looking at it, and nothing remains but the air.”

Paper money, wrote Paine, “turns the whole country” into speculators.

The precariousness of its value and the uncertainty of its fate continually operate, night and day, to produce this destructive effect. Having no real value in itself it depends for support upon accident, caprice and party, and as it is the interest of some to depreciate,

the “morals of the country” are destroyed with “new schemes of deceit. Every principle of justice is put to the rack, and the bond of society dissolved.”

No matter how often—or maybe because of how often—we are told that the bank apparitions are solid, we still want 100 percent reserves, witness the extreme reluctance to leave more than $100,000 in any one account. What is deposit insurance but an attempt to provide 100 percent reserves by another name? Unlike real 100 percent reserves, however, it allows the banks to profit from what Paine called “vice and immorality.”

It’s true that eliminating deposit insurance under a papermoney, fractional-reserve system like ours would bring chaos, but that is what’s coming anyway. Substitute hard money for paper, make the dollar an unchanging weight of gold, and we would have a real market system.

Note: so-called deposit insurance cannot be privatized. Banks, as entrepreneurial ventures, are not insurable, except against poolable risks like fire and theft. No businessman can purchase insurance against failure, and in a free market, neither would any bank. Deposit insurance is merely a government subsidy to the banks, and as such, illegitimate. Without it, banks would be subject to market forces like every other business. They would have no privileges or immunities beyond the rule of law.

“Paper money appears,” said Paine, to cost “nothing; but it is the dearest money there is.” More bank credit inflation, which the Journal advocates to turn “bad credits into good credits,” is no different; it causes economic distortions, future recession, and illegitimate transfers of wealth, all to bail out a group that deserves opprobrium, not welfare for the well connected.

Human nature is the same today as in the Victorian era, and so are the laws of economics. The only solution to the bank crisis is the old solution, which every good economist advocated before our wanton century: honest money and honest banking. Now all we need is a Tom Paine to lead that revolution.

85.
THE POLITICAL BUSINESS CYCLE
October 1991

It’s September 1992 and Federal Reserve chairman Alan Greenspan announces a big increase in the discount rate and bank reserve requirements. Interest rates and unemployment increase, the economy goes into a deeper recession, and Bush is defeated. But Greenspan has no apologies: as a nonpartisan servant of the public, his policies must “focus only on what’s good for the economic health of America. The boom was hurting our country; we had to purge the malinvestments to make way for long-lasting growth.”

That scenario is about as likely, of course, as Madonna joining Mother Theresa. Greenspan will do what Fed chairmen always do: the White House’s bidding. Thus he has artificially lowered interest rates for most of 1991, leading to more economic troubles after the election.

The first economists to examine thoroughly the political business cycle, Stephen Haynes and Joe Stone, found “strong four-year cycles in unemployment and inflation, with peaks and troughs consistent with the four-year electoral cycle” from 1951 through 1980, the last year they looked at.

Why isn’t this as big a scandal as the October Surprise? It almost was, in the early 1970s, when Richard Nixon appointed Arthur F. Burns, beloved economist and party hack—the Greenspan of his time—as chairman of the Fed’s board of governors. In making the announcement, Nixon said, “I respect his independence. However, I hope that independently he will conclude that my views are the ones that should be followed.” The audience applauded, and Nixon turned to his old friend. “You see, Dr. Burns, that is a standing vote for lower interest rates and more money.” It was the only vote needed.

In August 1971, with price inflation running at 4 percent, Nixon severed the dollar’s final tie to gold and imposed price and wage controls. Under that stunningly opportunistic cover, Burns hiked money growth from 3.2 percent in the last quarter of 1971 to 11 percent in the first quarter of 1972, the election year. The economy boomed, prices were artificially restrained, and Nixon was reelected in a landslide. After the election, he removed some of the controls, price inflation soared to 12 percent, and Burns stepped on the monetary brakes, bringing on a recession.

Such economic offenses are more difficult to prove these days, since Burns abolished the practice of taking detailed minutes of the meetings of the Federal Open Market Committee.

Recorded or not, however, Greenspan also does the president’s bidding. After all, as Arthur Burns once explained to a German reporter, “If the chairman didn’t do what the president wanted, the Federal Reserve would lose its independence.” Steve Axelrod, former staff head of the Open Market Committee now making his fortune on Wall Street, told me that was “the most damaging statement ever made by anyone connected with the central bank.” Damaging, of course, because true.

The Fed serves two masters, the government and the big banks. In matters of the government’s core interests, i.e., elections, it calls the tunes—not that it gets any opposition from the big banks on inflating.

At its inception, the Federal Reserve’s proponents said it would be above politics. Thus its “independence.” But this has always been disinformation. The Fed is the quintessentially political agency in DC.

Not that Fed policy is the only way Washington, DC, gets its way. For example, politicians also have fiscal policy at their disposal, which is to say they can spend more of our money on public works, welfare, etc. And trade regulators can wipe out whole classes of imports to create boomlets for select domestic manufacturers.

All these strategies seem to improve the economy, only later turning out to be deadly. By then, the politicians are safely reelected.

The cost in human suffering of the political business cycle and related political manipulations is incalculable—but we can know that most Americans are poorer, and most businesses shakier, than they would be without government central banking, high spending, and regulations.

86.
Y2K AND THE BANKS
April 1999

The Y2K computer bug isn’t like a natural disaster or mass disease. It is a technical problem with a technical fix that can be overcome with work and time. However, and without speculating about the ultimate fallout from the problem, the bug has exposed a very real and deep infraction that has long plagued the US banking system.

Thanks to long-ago government interventions that redefined a bank deposit as a loan, modern banks only hold a fraction of the demand deposits in people’s cash accounts. The rest is used as the basis for extending and pyramiding loans. If too many depositors demand their cash at once, which is their right, it would trigger a bank run, which in turn would lead to the so-called contagion effect, and runs on other banks.

Under this scenario, since most banks these days are considered “too big to fail,” the Fed would have to run the printing press full time or they would go belly-up immediately. The result would be a dramatic deflation followed by hyperinflation.

Banks genuinely fear that this will be the result of public nervousness over Y2K. In February, a Southern California office of GTE suggested that its customers hold a month’s salary in cash during the transition to the new millennium. The banking industry went bonkers, denouncing GTE for breaking silence on the question and attempting to reassure the public that extra cash holdings were unnecessary.

The point is this: whether or not it is prudent to withdraw money from the bank, why should the suggestion alone be enough to drive the industry into paroxysms of fright? It is one thing to desire someone’s business. It is quite another to regard the perfectly reasonable actions of your customers as a mortal and systemic threat to the well-being of society as a whole. To understand why takes us to the heart of the great secret of modern banking.

Under genuinely sound banking, in which the money you deposit at the bank is held for safekeeping while you draw down your funds as you see fit, it wouldn’t matter at all how many people withdrew funds or when. The analogy here is the grain elevator, which is used solely for storage. Every customer of the elevator is free to withdraw the full quantity of his grain at any time because the proprietor must keep 100 percent reserves on penalty of fraud.

So it is under the gold standard, in which sound banking could be divided into two kinds. With deposit banking, you retain full title to your gold and only use the bank as a storage warehouse. Paper money was a ticket that acknowledged your ownership of the gold. The tickets were accepted because the bank was trusted. Free-market competition ensured that reputable banks would not fudge their holdings and loan out what did not belong to them; indeed, banks would hold 100 percent reserves. With loan banking, on the other hand, the depositor surrenders his right to withdraw his money at any time and instead transfers title to the bank itself, which is then free to extend loans and earn (and pay) interest on the money.

Under today’s fiat money, fractional reserve system, all banking is treated as loan banking, and, with some accounts, banks hold no reserves whatsoever. As Murray N. Rothbard frequently reminded us, under the old rules of accounting, all modern banks are technically bankrupt all the time.

The only factor that suppresses that fundamental reality is consumer confidence. Deposit insurance, an institution designed to shore up a bankrupt system, contributes to the sense of confidence. Even small depositors’ actions, like withdrawing a bit more cash, undermine that confidence.

Despite the appearance of stability and soundness, then, the foundations of modern banking are actually extremely precarious. It would only take the right kind of crisis, or perceived crisis, to throw the entire system into chaos.

Bank runs and the threat of bank runs serve a heroic function in a free society. They spur banks on to be more careful in the conduct of their business. We need more, not fewer, of them. The right to withdraw one’s funds from the bank is not only an essential part of freedom; it is a way of reminding banks that they are part of the matrix of voluntary exchange in a market economy, even if they do benefit from huge subsidies from the Federal Reserve.

87.
BANK PRIVACY HYPOCRISY
July 2001

One of many pastimes of government bureaucrats is forcing foreign banks to cough up tax information on US citizens. This is a disaster for the cause of privacy, the right of contract, and freedom itself. If the campaign, which has been going on for years, finally succeeds, it will mean the end of bank privacy for Americans. It also devastates foreign economies that see a comparative advantage in offering secure banking to people from around the world.

A priority for totalitarian states is to smash the ability of citizens to escape the reach of government, particularly in their personal finances. The government wants money more than anything else, and the bigger the government, the more willing it is to use unseemly and evil tactics to get it. The US government claims to be the model for free societies but in its attacks on citizens banking outside its borders, it is acting in the tradition of the worst despots.

Adding to the outrage is the typical hypocrisy, insisting on a standard for other countries that the US government will not apply to itself. And this is where the subject of bank privacy gets really interesting. It turns out that many citizens of governments around the world like to use US banks because they can be trusted not to steal the money and also because the US doesn’t share tax information on foreigners with their governments. In other words, the United States, and particularly Florida, is a tax haven for many foreign peoples.

Now, this is a good thing, something of which we can be proud. It is the best tradition of freedom to provide a safe harbor from grasping governments wherever they may be. But where does the US government get off denouncing every tax haven in the world and strangling any other government that permits private banking? The hypocrisy is obvious, and the way to end it is to allow other countries to be havens from US laws in the same way the United States is a haven from other governments’ laws.

The Clinton administration, in its final scary days, had the idea that it would deal with the evident hypocrisy by forcing US banks to cough up information on foreigners who do their business here.

This is consistent with the Clinton philosophy: the first and only purpose of any citizen anywhere is to serve the state. To the extent that the US government can facilitate this, the Clinton regime believed, it should do so in every possible way.

But here’s the trouble. With the regulation poised to go into effect, many domestic banks started to complain. If we start to report interest income earned by foreign depositors to their governments, bankers worried, these people might just take their money elsewhere.

Florida Governor Jeb Bush was particularly incensed about the idea and made his position clear to Treasury Secretary Paul O’Neill. Bush wrote him that the proposed regulation

would place US banks at a competitive disadvantage relative to banks in the Caribbean and Europe... and would seriously hamper the ability of US banks to continue to attract foreign deposits.

How much money is at stake? One Miami banker said that if new disclosure regulations are imposed, the city of Miami alone would see the withdrawal of $15 to $20 billion from the banking system. These are depositors who fear that their governments will persecute them for the crime of making money and not giving their governments a cut. These are governments that hate free enterprise and wealth, or regard any pot of money as the state’s for the taking. Of course, all governments are kleptocracies, but these regulations imposed on US banks would make life for foreign despots even easier.

It is very likely that the Bush administration will reverse the Clinton administration’s regulation and permit US banks to continue to withhold information about interest-bearing accounts from foreign governments. The administration might just seek to strike a deal with Britain just as it currently has a deal with Canada. This would be a terrible thing, but it is not as bad as the goal of the Clinton administration to turn the entire world-banking sector into a huge tax-collection cartel.

In the cause of freedom and privacy, the United States should go further to permit other countries around the world to become tax havens from those oppressed by US taxes, in the same way that the United States is a haven from other governments. The more countries compete for depositors’ money, the better off we are. And economist Richard Rahn is exactly right that providing privacy in the age of Leviathan is a wonderful service that consumers seek and that all banks would provide if the government would leave them alone to do so.

We all go to great lengths to keep our finances private. We have passwords on our online accounts. We worry about the security of online orders. Websites purchase very expensive software to make this possible. There’s a national movement on to prevent business from using any knowledge they have of health or purchasing habits. Americans love their privacy.

But you know what? None of the corporations or colleagues we worry about can legally steal our money. That is a power reserved to governments alone. Hence, if privacy from others is important, it is hugely important for the cause of liberty that we have it from government. The existence of the income tax itself dealt a deadly blow to privacy, which is just one more reason the income tax should be scrapped.

Another problem is that the banking system has become something of an adjunct of the state, thanks to the Federal Reserve System. Once the large banks sought a government-backed lender of last resort, the game was over: as the decades have passed, they are more and more used by their benefactor, the state, to achieve the aims of the political class at the expense of their customers.

There was a time in American history when any banker who turned over information to the government would be seen as traitorous and evil. It’s hard to blame the banks today for the problem because they are coerced as much as the rest of us. But let us not ever forget the ideal: a complete separation between banking and the state. May all the world be a tax haven.

88.
UNPLUG THE MONEY MACHINE
February 1995

When antisocialist, post-Soviet reformers of the Baltic states sought to reign in government power, they looked to solve the money problem first. Moscow held unlimited power to flood their economies with cheap money, and to fund itself as an imperial power lording it over other peoples. That had to end before the market economy could be restored.

Republicans should follow this lead if they want to solve our problem with big government. Richard Nixon thought that going off the gold standard would be good for himself politically. But his reckless action made possible, even inevitable, the explosive expansion of government spending, debt, and intervention that followed.

Alan Greenspan, then an independent economist, warned that the remnants of the gold standard were all that stood between the American people and Leviathan. He was right, of course, but now, as chairman of the Federal Reserve, he exercises the power over the economy he once told all freedom lovers to loathe.

From time to time, James Grant, the Austrian School journalist of Grant’s Interest Rate Observer, prepares a prospectus on the US government. He’s not trying to market US debt to his subscribers, but to make a more profound point: no sane person would buy US debt if the issuing agent were judged by market standards of creditworthiness. It is only the central bank’s power to buy debt, to be the “lender of last resort,” that leads people to buy and hold in perpetuity.

When Orange County went bankrupt, the market worked as it is supposed to. It evaluated the bonds, saw that something was fishy, and dumped them all at once. The Orange County government, like the fabled tulip bulb industry in Denmark, was bust. Now, if Orange County had a Federal Reserve, its powerful treasurer could have fueled the growth of county government until the next millennium.

That’s nothing to brag about. It’s not alchemy at work, but a highbrow version of old-fashioned counterfeiting. A central bank agrees to create as much money as is necessary to cover every potential monetary claim. This allows for miles-high pile-up of debt and the unlimited creation of new money. The Fed, in particular, has a variety of tricks in its bag: requiring banks to keep fewer savings for outstanding loans, lowering the rate charged to member banks for overnight purchases, and outright purchase of Treasury securities.

Much of our country’s economic and cultural decline dates from 1972, and the Fed is a primary cause. A 1972 dollar is now worth about 29 cents, thanks to the central bank’s power to create money out of thin air and “insure” deposits with a promise never to run out of printer’s ink. People who saved for their retirement then know now that they are not even close to being prepared now.

The increase in nominal prices and wages has not harmed everyone proportionately. The government is much richer than it was, and look who’s poorer: savers, families, small businessmen, workers, and the rest of the middle class. We’ve been clobbered by the Fed’s printing presses. The essentials of life—education, health care, housing—have all become much less affordable.

The destruction of the gold standard—which really began with the founding of the Fed in 1913—has allowed the government to fund an entire class of reliably left-liberal voters, and agitators to push for more programs.

The growth of government made possible by fiat, Fed-controlled money has created a policy culture in which everything is permissible. Every good and service comes under a myriad of regulations. Every business and local government obeys countless mandates. No one in public life talks of substantial budget cuts on the order of $500 billion, which ought to be only the beginning.

The Fed is indeed mischievous, and in more ways than even gold bugs know. The central bank has recently thrown itself into the social engineering business. Its regulatory arm won’t approve bank mergers unless the banks have paid tribute to the underclass by overlooking poor credit histories.

The gold standard was once a dam holding back the floods of statism, but it was blown up by a multigenerational conspiracy of self-interested politicians and special interests. It wasn’t just the central government that benefited. Large bankers themselves appreciate the profits and power that come with the ability to expand money and credit beyond what real savings could ever support.

A form of the gold standard was called for in the 1980 Republican platform, although Ronald Reagan did nothing to give us one (though he deserves credit for creating the US Gold Commission that enabled Ron Paul and Jesse Helms to bring back American gold coinage). The point is this: Republicans in those days at least understood the importance of reining in the power of the Fed-bank-government cartel to create unlimited amounts of fiat money.

The then-prominence of supply-siders brought some attention to the issue of monetary reform. But their preferred solution—a watered-down version of the already diluted Bretton Woods system—would not have defined the dollar in terms of gold, or allowed domestic convertibility. Instead it would have resurrected something weaker than the system that fell apart in the early 1970s, suggesting that even supply-siders are unwilling to learn from history.

Since the 1994 election, the Republican elite hasn’t breathed a word challenging the enormous power the Federal Reserve exercises over the economy. For the backbenchers, anyway, let’s hope it’s because of ignorance, and not because they’re owned by the large banks or want the Fed to fund their pet legislative projects, just as it funded Democratic ones in the past.

At least one trend points in the wrong direction: the Republican leadership doesn’t want to force the Fed chairman to testify before the Banking Committee anymore. That’s too bad since it removes one source of accountability, if a small one, from an otherwise unaccountable entity.

Some Republicans operate on the theory that the more “independent” a central bank is, the less it is tempted into inflationary policies. The view is a conventional one and derives largely from the empirical example of Switzerland and Germany.

The problem with purely empirical analysis is that it ignores cause and effect. The Germans and Swiss have relatively sound money not because the central bankers are independent, but because the economic and political culture won’t allow inflationary schemes of the sort we’re saddled with. The central banks would lose all credibility if they tried.

There can be no such thing as a thoroughly independent central bank in the way the corner grocery store is independent. Politics determines a central bank’s decisions, as does the desire to increase bank profits. We’re just not supposed to notice or talk about it in polite company.

If the Republicans really wanted to challenge Leviathan, they would strangle the Fed, its very lifeblood. If we dismantled the Fed and made our money good as gold again, it would matter a lot less who sat in the White House or in Congress, for they would have much less power to harm us even if they wanted to.

Forget the balanced-budget amendment: the gold standard is what big government types really fear. That so few want to unplug the government’s money machine tells us more about the governing elites, including the Republicans, then we are perhaps willing to face.

89.
THE DOT-COM FUTURE
July 2001

Owners of dot-com stock funds regret ever having heard of the Internet. Webmasters who dropped out of school to get rich quick are crawling back to their guidance counselors to be readmitted. Companies that laid many miles of fiber-optic cable wonder whether they made a huge error.

Lost in all the talk of the tech meltdown, however, is any distinction between where the Internet has succeeded and where it has failed. Neither has there been much sensible analysis of why the run-up and fall-off of Internet stocks were as dramatic as they were. Let’s take the second question first.

The Internet boom is often chalked up to capitalist man’s tendency toward maniacal waves of overreaction. A new technology appears on the horizon, the theory goes, and people run like lemmings until they find themselves falling off a cliff into the sea (although I’m told that, in real life, lemmings don’t actually do that). Such is life under a system that rewards greed before need, they say. Perhaps we need government to make us more responsible?

The trouble with the lemming metaphor is that it has nothing to do with economics. New technologies are always available for the taking for commercial applications, and have been since ancient days. Technology by itself is not inherently valuable. The key question is whether the technology is profitable relative to other projects. It is the job of entrepreneurs to exercise judgment about whether their use will really pay off in the long run.

Hence, it is not new technology alone that spawns hysteria in a market economy. In a typical market setting, some people are enthusiasts and others are skeptics. Where some see profits, others see losses, and whoever ends up right wins (until something else comes along). It’s not a perfect system, but it prevents lemming-like behavior from becoming the norm.

The necessary ingredient that turns new technologies into market manias is excess supplies of credit that can be burned up by speculators. There’s only one institution in our society that makes such credit appear to be free for the taking: the Federal Reserve. It alone has the power to make money appear out of thin air. Working through the banking system, it can pump money into and out of the economy and bring about all kinds of zany behavior.

Sure enough, when you look at the Federal Reserve policy of the late 1990s, you find dramatic inflation of the core measures of the money stock (M2, M3, and MZM [M1 no longer has much meaning because of financial deregulation]). These core measures hit bottom in 1995 and then began a straight upward climb until peaking in early 1999. By 2000, a long fall in the rate of increase was evident in all three, until earlier this year, when the Fed turned on the spigots once again. Why can’t the Fed keep going indefinitely? That way lies hyperinflation.

This pattern closely tracks the run-up and subsequent collapse of Internet stocks. Because of the loose money policies of the Fed, venture capitalists enjoyed a huge increase in funds available for investment. What they may or may not have known is that the funding was an illusion created by the central bank. It wasn’t based on savings (which actually fell during the same period), and the investments they made were not based on a realistic assessment of firms’ earning potential.

Investors weren’t so much blinded by technology as drowned in seas of cash, freshly created by the Federal Reserve system. Many projects that might have been worth trying out expanded too fast too quickly and ended up squandering the phenomenal infusions of cash.

It was inevitable that the illusion would dissipate; it was only a matter of timing. Some of the skeptics figured it would happen in 1997 and 1998, and when the crash didn’t occur, they were called troglodytes who didn’t understand that risk had been repealed in a new era of cyberspace. But once the Fed stopped feeding it, the tech boom did indeed come to an end.

There is a psychological element to the story. In the late 1990s, speculation abounded about the advent of a new economy and a new world, even new modes of being, brought on by the new age of cyber-living. Today, all such talk is regarded as a sign of insanity. Just as ’Net promoters were once hep and happening, ’Net debunking is now all the rage.

Just as inflationary finance creates manias, the slump can create exaggerated reactions in the other direction. Regardless of Webvan and Salon.com and other famous failures, the Internet has permanently changed the way free enterprise works. Because of the speed at which information travels, the economy is more efficient than it was. Web traffic, despite the dot-com collapse, is higher than ever. Particularly in areas of news and research, the Web continues to be an unparalleled success.

And while it is fashionable to cite the unreliability of the Web for information, this, too, is sorting itself out. There are reputable and disreputable sources of information on the Web, just as there are in the print media. What a surprise: consumers themselves are figuring out ways to tell the difference. What the establishment doesn’t like is that The New York Times can no longer pose as a national organ of truth because the full story is only a click away.

It’s not only dot-coms that are failing. Print publications, particularly those dealing with public affairs and other boring topics, are failing left and right. It turns out that for those who keep up with politics, the Web continues to be a dreamland of information and commentary. It’s also wonderful to see the way the Web is shaping up to work much like the old economy, with mergers and big players playing a decisive role in driving innovation and profits.

Far from having discredited capitalism, our experience with the Web so far is that it underscores the structures of the free-enterprise economy and vastly outcompetes any services offered by government. To the extent anything should be discredited today, it is the Federal Reserve with its policy of distorting reality and delivering false signals to market players.

And let it never be forgotten that without government backing, the Federal Reserve would be just another marble building in an imperial capital. It certainly wouldn’t have the frightening power to spur global manias.

The lesson: Don’t blame the market; place the blame exactly where it belongs, with our masters in DC who prevent free enterprise from bringing discipline to the monetary system.

90.
BLAMING BUSINESS
July 2002

Forget gridlock and partisanship, the US Senate has found something besides attacking other countries to agree on: attacking business right here at home.

No one can accuse these guys of being soft on crime, so long as the alleged crime occurs within the private sector, and involves the always-vulnerable businessman.

Should supposedly defrauding shareholders be a distinct crime punishable by up to 10 years in prison, thereby replacing the existing system in which defrauding shareholders falls under the category of mail and wire fraud? Yes, said the Senate in a 100-to-0 vote.

Should the government prohibit companies from docking the pay of employees who scheme with government investigators? Yes, 100 to 0.

Should the period of time in which investors can file lawsuits against companies to recoup losses due to alleged securities fraud be extended? Yes, 100 to 0.

Should it be easier to prosecute people for altering or destroying their records when a government agency is investigating a corporation, even if the investigation isn’t yet official? Yes, 100 to 0.

Should all penalties of all sorts be expanded? Yes, 100 to 0.

John “The Bomber” McCain caught the reigning fascistic spirit of the moment: “Until somebody responsible goes to jail for a significant amount of time, I’m not sure these people are going to get the message.”

The message is: all the crooks are in business, and only great government can save us.

The proposals to crush, thrash, smash, and otherwise slam business are raining down hard, with Republicans joining with Democrats in sheer demagogic hatred of the capitalist system itself.

None of this has to do with a conviction that WorldCom and Enron and the rest really committed fraud in the usual sense. The problem with these companies (and they are not typical) is that they took part in a more general fraud called the New Economy: the idea that the Federal Reserve can create limitless prosperity through money creation and lower interest rates.

Had these companies’ forecasts of infinite product demand, and thus infinitely increasing stock prices panned out, nobody would be complaining. But the Fed’s boom turned to bust, as it must, and the political parasites had to find some way to deflect the blame.

Remember the scale of what we are dealing with. By the late 1990s, tens of millions of people had grown accustomed to checking their online holdings daily, and watching them grow. Regular citizens became day-traders. Folks were exuberant as their portfolios rose to double and triple expected figures. Visions of early retirement and the lush life danced in their heads.

Everyone was a financial genius.

But by this year, these same people have seen their once-fat portfolios grow shockingly skinny. While people can deal with stock-market losses, they cannot understand how in a mere 12 to 19 months, trillions could have vanished, and their exuberant visions too.

There is something intuitively correct about the average person’s suspicions. It doesn’t make sense that so much could be wiped out so quickly, and people are right to assume that powerful people are rigging the game. The business cycle isn’t an act of nature. It is brought about by shady characters working behind the scenes.

So Washington is attempting to turn public anger away from the guilty—the Federal Reserve and the politicians who cheered on its credit run-up—to business. All this hot air about corporate fraud is designed to permit people to believe that their portfolios were looted by CEOs with shredding machines.

You say: nobody is stupid enough to believe that!

Think again. In the early 1930s, this was precisely the view promoted by FDR and widely believed among the general public. This was also the import of Bush’s antibusiness rave on Wall Street, which Republicans celebrated and Democrats denounced for not going far enough. This is why the Senate is passing stupid resolutions and voting on bad legislation, which will muck matters up further in predictable and unpredictable ways.

Not even Wall Street experts have a clear fix on why markets fall, other than some general lack of confidence that plays on itself. Not one in a thousand would identify the loose credit of the 1990s as the cause of the boom, and fewer still could explain how that boom unraveled and why.

Every economic downturn in modern history has been accompanied by a boom-time accounting scandal, leading to more regulation. This is why ignorance of economics—in particular Austrian economics—is so dangerous. Something about the business cycle seems fishy, even crooked, but precisely what does not flow from intuition alone.

It’s time to buy copies of Gene Callahan’s smart and funny Economics for Real People for your friends and family, and your stockbroker and congressman too. Knowledge may be the only way to stop the government from blaming everyone but itself for the meltdown nobody but it brought about.

91.
DEFINE IT AWAY
February 1996

People made fun of Gerald Ford’s buttons that said “WIN”—meaning “Whip Inflation Now.” The buttons and the accompanying propaganda campaign implied that consumers’ bad vibes were the cause of inflation. Ha, Ha.

Now, the White House, members of both parties, and their court economists have done Gerry one better. Lacking any strategy for getting rid of inflation, they intend to redefine it. Their new formula will show prices going up more slowly. This will help the government, but for anyone trying to keep tabs on unceasing monetary destructionism, it’s a terrible, even dangerous, idea.

Redefining the Consumer Price Index will have large and immediate repercussions. Thanks to a Nixon-era change, Social Security benefits are increased automatically by inflation. The higher prices go, the larger the checks. A deliberate dumbing down of the CPI is a way of saving money. That—supposedly— is why Republicans support it.

Cutting spending in times of $1.7 trillion budgets is, of course, a moral obligation. But there are better ways. Why not cut or eliminate cost-of-living adjustments themselves? It turns out that the American Association of Retired Persons opposes this direct route, but won’t oppose changing the inflation rate.

A seedier side to this scheme has to do with taxes, and Republicans are hush-mouthed about it. If government statistics reveal less inflation, the tax brackets won’t adjust to price movements. The difference between actual and official inflation will net billions for the government. And here we see a secret purpose: to extract more wealth from the American people in ways they won’t detect.

From the taxpayer’s point of view, then, the proposed change means higher taxes, better disguised, although the Republican supporters of the plan won’t tell you that.

To drum up support, backers are quick to reassure us that all good economists say the current CPI understates the real inflation rate. But if economists could know the real inflation rate, there would be no need for a CPI. We’d only need to consult the financial fortunetellers.

In the old days, only Austrian School economists criticized government economic data. They refuted the idea that economic activity can be accurately quantified and they debunked the gizmos economists use to pretend it can.

But nowadays, there’s a raging debate on the CPI. Every theory is shot down by someone else, and on seemingly solid grounds. There are hundreds of formulas and strategies for determining the direction and range of price movements. There’s the “geometrical” formula, the “harmonic average” formula, and the “arithmetic” formula currently in use. Moreover, everyone has an idea of what should and shouldn’t be in there and how much it should count.

Why so much debate? Because every attempt to discover an inflation rate is necessarily flawed. We can’t just measure inflation the way we measure the height of a tree. Prices reflect too many variables. We can’t be sure what accounts for changes. It makes no sense to lump together price changes for incomparable goods.

Nor is there a “price level” in the sense that there’s a sea level, and the desire to make it stable (monetarism was the most elaborate) is a futile exercise. Let’s say: liver transplants are going up in price, computers are going down in price, and milk remains the same. What can we conclude about movements in the overall price level? Honestly speaking, nothing.

There is no “average” price for goods and services because there are no “average” buyers of goods and services. There are only specific consumers who purchase specific products and services. People who buy college tuition for five children experience a different “inflation rate” than twenty-something techno-hermits.

Neither is there a definite “inflation rate” waiting to be unveiled. Even when the government is goosing the money supply, inflation affects different goods and sectors at different times and to varying degrees.

All that said, we do need some way to gauge the effects of monetary policy on prices. The index number, for all its faults, is about the best we can do. The CPI, like all index numbers, is generated by comparing the data from one “basket” of goods in period A with the data from the same basket in period B, and formulating the change.

The results will be fraught with errors. To retain some modicum of honesty, we must adhere to two rules. The formula must be inclusive of many goods, sectors, regions, etc., and it must be consistent. The best and practically only way to render an index number utterly useless is to change its definition in mid-course.

That, of course, is precisely what the politicians are planning to do, and not because the current CPI is wildly inaccurate. The problem, if anything, is that it is revealing the wrong thing: that prices keep going up. What the government wants is a measure—any measure—that shows less inflation.

The Federal Reserve always promises that it’s working to bring down inflation, but, as Murray N. Rothbard shows in The Case Against the Fed, it never does. Since the Fed came into being, the dollar’s value has plummeted to less than a nickel, and even at a 3 percent inflation rate, prices will tend to double every 25 years.

Now we can tell why the Fed supports the CPI change. It wants to cover its crimes by appearing more successful at “battling inflation.” What the Fed doesn’t want to talk about is the real cause of inflation: not greedy consumers, avaricious workers, or price-gouging corporations, but the central bank itself, with its power and practice of creating money out of thin air.

If the government and the Fed really want to lower inflation, there’s an easy way to do it. Stop the printing presses with a gold standard. With no artificial increases in the money supply and a growing economy, prices would tend to fall over the long run. The norm in the computer industry would become economy wide under sound money.

A truly inflation-free economy would spur savings and growth, be free of business cycles, restrict government power, and restore living standards. To reduce inflation by defining it away, on the other hand, is like eliminating debased coinage by readjusting the scales. It’s something only government would do.

92.
WHAT MADE THE NEXT DEPRESSION WORSE
April 2005

How inevitable is the continuing expansion of the domestic and international economy? Barring a major war and a major depression, and a policy response that repeats the errors of traditional countercyclical policies, I would say that continued world economic expansion is likely.

For an Austrian all too aware of how governments can foil prosperity, that may sound like an optimistic prediction. But consider. With the fall of socialism, the world economy has opened up as never before. New technologies have wrought new efficiencies. Private enterprise has become ever better at mass marketing to the benefit of everyone. The division of labor is expanding internationally. No matter how hard the government continues to try, it just can’t seem to throttle the extraordinary power of the market economy.

And yet we cannot bar every contingency, particularly for the United States. The economy is not depression proof. If the government and the Federal Reserve are willing to work hard enough, they can kill off even the most robust economic expansion. From an Austrian perspective, the likely scenario is that the Fed will attempt to forestall recession via credit expansion, which distorts production structures and makes the recession even deeper.

I seriously doubt that our economic managers have learned enough about economics to avoid this fate. We still must grapple with the problem of the business cycle, which is a feature of the market economy insofar as it is fueled by fiat money managed by a central bank.

Let me begin, then, with some background on the Austrian business cycle theory. At the start of the Great Depression in Europe, the Austrian School, then still centered in Vienna, was well positioned to explain the cause and offer a way out. Mises’s first statement of the core of the theory had been widely circulated in his 1912 book, The Theory of Money and Credit. It was still considered the definitive work. In this book, he explains how interest rates are not arbitrary constructs or prices of money dictated by central banks, but rather an integral part of the market economy, coordinating productivity, investment, and savings.

When these signals are manipulated by the central bank, they convey bad information to producers about the availability of resources. Producers invest for a longer time horizon than exists in the real economy and their clusters of errors create what appears to be a sharp rise in productivity and growth. But the boom turns to bust in the passage of time, as consumers run out of resources and projects are left unfinished. The low-interest rate policy had a good run of it, but eventually reality returns and the bad investments are washed out of the system.

But here is a complicating factor. Since the Great Depression, governments have hardly ever permitted recessions to take their market-driven course. Instead, they tend to pile artificial booms on top of economic busts, which can lead to very odd results. The examples are all around us.

The last economic crisis we faced was five years ago. The central banks of the world began to inflate by driving interest rates down to historically low levels. Adjusted for inflation, interest rates have been negative in Japan, Europe, and the United States since early 2004. This proves very attractive for borrowers, and leads to reckless lending, waves of entrepreneurial errors, and sector-specific inflation.

Contrary to conventional wisdom, we have more to fear from the political response to recession than we do from recession itself. That’s because the response usually consists in pumping ever more money and credit into the economy.

Part of the problem is intellectual. In the Great Depression, for example, people observed that banks were failing and immediately concluded that the problem was not enough liquidity. They observed that consumers were not spending and assumed they needed more money. They observed that businesses were having their credit lines cut and thought that more credit was needed.

As Murray Rothbard has shown, this was the path chosen by both Hoover and FDR in the early years of the Great Depression. And though it did not work, the inflationist remedy remained the policy response of first resort. In every case, the solution is the same: plug in the printing presses and let them perform their magic. Alan Greenspan, for example, has the reputation of an inflation hawk but consider that he has turned to the printing presses in every crisis that has come about during his tenure.

What is unseen is the hidden cause of the crisis, which is in the past. It is the expansion of money and credit that leads to imbalances that eventually turn booms to busts. What people have done in concluding otherwise is to confuse cause and effect, something akin to concluding that puddles of water on the ground are causing it to rain. To carry the analogy further, these same people might attempt to drain all puddles as a way of stopping the rain. We can laugh at such absurdities, but these fallacies are a common strain among social scientists trying to understand the business cycle.

In Mises’s day, the rise of positivism meant a new fashion for collecting data and eschewing all forms of deductive theory. So despite many years of work, and growing acceptance of Mises’s own theory, it was not only difficult to explain cause and effect, it was difficult to get even economists to look beyond the here and now to see the underlying causes. This was the first serious indication among the Austrians that the battle for the future of economics would in part be a battle over economic methodology.

Does good economics consist in collecting and manipulating data, organizing them in a manner to measure the extent to which any two random economic phenomena collide in time and thereby concluding that this statistical correlation can serve as a proxy for causation? This is the theory that led people to believe that it was a burst of technology that caused the dotcom boom, or that the dot-com bust was God’s way of smiting greedy CEOs.

Really, this approach to business cycles is no more scientific than the approach a primitive witch doctor takes to healing, but at least the witchdoctor has to take some responsibility for whether the patient lives or dies. The economists just wash their hands and walk away.

In the United States, the Great Depression presented similar difficulties. There were very few economists here who understood the theory, and so a void was left for Keynes, who told the government everything it wanted to hear. He said the core problem lies with too little money, too little government spending, too little central management of investment. After many decades of hearing economists tell how government should curb its appetite for power, this new message was much welcome. Corrupt politicians the world over celebrated!

Benjamin Anderson and Henry Hazlitt battled it out in the early 1930s, but they too confronted an establishment anxious for fast solutions to endemic problems, and the rise of an economic profession that was increasingly impatient with deep theoretical understanding. What sold in the intellectual world then was superficiality. So Keynesian solutions were tried, and failed, in a repeated pattern from the 1930s until our own times.

Only the Austrians seem to be willing to take a careful look at not only what is seen but also what is unseen. Mark Thornton has shown that it was only the Austrians who seemed to understand that something had gone very wrong in the mid- and late-1990s, and foresaw that the dot-com boom was essentially unsustainable.

As a result, more people are paying attention to the Austrian theory now than ever before. In fact, a leading post-Keynesian was recently accused by a colleague of being an Austrian, and he quickly denied it. But then he added: “The Austrian theoretical framework seems to be the only tool at hand. And when all you have is a hammer....”

I always imagine what Mises would say if he heard these words, nearly 100 years after he first came up with his explanation for the business cycle. How such knowledge would have brought him solace in those difficult years of total Keynesian dominance. It goes to show that if you are willing to wait and be patient, the truth will win out in the end. Mises believed in this principle. We should too.

I’ve already mentioned what the world economy has going for it: the expansion of the division of labor, technological advance, and economies that are opening up to trade and investment. The dollar is still the dominant currency the world over, which gives the US economy in particular a competitive advantage. We have been able to enjoy the comparative nirvana of low-priced consumer goods while depending on foreign markets to absorb the dollars created domestically.

But related to this last point, let’s talk about the downside. The falling dollar on international exchange portends an ominous change for the US economy. The factors that permitted the United States to export inflation have come under challenge. The Euro can be a viable competitor to the dollar in the future. With shrinking demand for dollars, the United States could find itself with genuine inflation on its hands. There are already signs of this on the way, with rising commodity prices and oil prices.

As Antony Mueller has pointed out, the three most essential price systems of the modern economy are unusually sensitive to political manipulation: the oil price, the interest rate, and the exchange rate. This doesn’t mean that the Fed and the government can dictate them but it does mean that these prices respond especially rapidly and dramatically to political error.

It would be very easy to drum up a scenario in which the US economy falls into a tailspin, with the dollar losing its position as the world standard, interest rates soaring, housing prices collapsing, inflation taking off, and the economy left with few means of recovery given the high debt load and low savings rate of the American family. Whether and to what extent this is a likely scenario I do not know, but it does seem clear that until something is done to stop the spending and debt generated by Washington, DC, there will be a high price to pay.

Now, in my ideal world, the United States would take the path long recommended by the old liberal tradition. We would have free trade with the world, establish a gold standard that defined the dollar as gold, end central banking, and bring about completely free domestic markets. This is the Austrian version of utopia, and it has two key advantages: it would bring about the most productive economy in the history of the world, and it would also serve as the best guard to freedom.

Tragically, however, the Bush administration has brought us no closer to that ideal. Instead it has pursued a huge range of interventions in the market process that may seem uneventful now but could matter far more should the economy once again fall on bad times.

Economic downturns are precipitated by credit expansions and contractions but monetary policy cannot alone account for the length, breadth, and shape. This is inspired by other factors. The Hoover and FDR interventions in the early stages of the Great Depression made matters worse by preventing a downward wage correction, by interfering with the right of Americans to engage in foreign trade, by bailing out bankrupt banks, and otherwise inhibiting the operations of the market.

In those days, politicians waited for economic downturns before wrecking the market. Nowadays, they are glad to intervene for any reason anytime. Republicans are no better than Democrats in this regard, despite the former’s professed love of free enterprise.

I here offer what I regard as Bush’s top ten economic errors, which might be the very errors that will make the next depression far worse than it needs to be.

Number Ten: Martha Stewart Jailing. This was just a disgrace. This great entrepreneur was guilty of nothing but being beloved, famous, and rich. When the Justice Department couldn’t get her for insider trading, of which she was not guilty under any conceivable definition, the government changed the charges to obstruction of justice, which really comes down to being willing to defend yourself. If you claim you are not guilty, you open yourself up to prosecution for being wrong. The real point of this case, I believe, was to put a great American entrepreneur in her place, and inspire fear and loathing across corporate America. This isn’t just my opinion. This was a point made by the New York Times, in the hope that her jailing would intimidate the whole of the American business class.

Two additional points behind this fiasco. The original case concerned an anticancer drug that was made by the company in which she held stock, ImClone. The corporate stock took a dive after the FDA barred the drug, but later tests revealed that the drug was everything the company said it was.

Also, in sweet revenge, Martha Stewart handled herself in jail with great dignity and now goes on to greater heights in her commercial endeavors. All power to her, but the costs are still there: investors are more cautious, corporate America is more cautious, and ever more live in fear of their DC masters. A fearful and oppressed business class is a very bad omen for continued economic expansion.

Number Nine: Unrelenting Protectionism. The Bush administration began its campaign for old-fashioned protectionism with a disgraceful tariff on steel that did nothing to help the industry but much to harm American business by vastly raising the costs of steel. After incredible protest, the Bush administration finally declared victory and repealed its tariff, but only while adding more tariffs and protections for timber, shrimp, clothing, and a hundred other items in the US Trade Representative’s daily operations, all of which have the same theme: the rest of the world had better buy our stuff, but the US government has no obligation to stop taxing American consumers to benefit well-connected US companies.

I’m especially concerned about the Bush administration’s obsession with what it calls intellectual property rights. I’m as sorry as the next guy that merchants on the streets of Beijing are selling illicit copies of The Incredibles and the complete ninth season of Friends. But I do not believe it is the job of the US government to go abroad with the goal of slaying these particular monsters.

The problem is even more significant with technology and pharmaceuticals. Patents are government grants of monopoly privilege. They are a bad enough policy at home but it amounts to an egregious form of imperialist mercantilism to use the foreign policy powers of the US government to enforce them.

Number Eight: The Social Security Reform Hoax. Genuine privatization would be a grand idea. But that is not what the Bush administration proposes. Not anywhere close. They are proposing to partially convert the existing tax-and-spend system into a forced savings program. This is not choice but rather a species of socialism. The forced investments would be fed to approved funds with approved companies and be guaranteed a rate of return.

So in the end, Bush-style privatization would partially socialize the most important sector of the American capital markets, and we aren’t talking about small change. And how would this transition be funded? Bush has suggested that he would be willing to lift the FICA cap, which would mean the worst tax increase in US history. Debt, taxes, inflation—take your pick. The costs are in the trillions.

Number Seven: Government Spending. You will notice that Bush has lately been talking like a budget cutter. He is going to rein in government spending, he says. Well, I suppose everyone has known about the great uncle who swears he is going to cut back on his drinking but somehow keeps ending up at the dry-out farm. He is the first president since John Quincy Adams not to veto a single bill during his first term in office. Total federal government spending is up by 30 percent in his first term, which is three times the rate of growth wrought by that bad old big spender Bill Clinton. Since 2001, the government has hired an additional 140,000 civilians for its ranks.

In an anomalous manner, government revenue has been falling for some six years. Now, the response in a household to this type of trend would be to cut back. But the government has the exact opposite response. It has become more profligate even as its revenue stream is not producing what it might have expected. But beware: the bills will be paid somehow someday. All we know for sure is who will be doing the paying.

Number Six: Failure To Repeal the AMT. There have been no shortages of warnings about the Alternative Minimum Tax. This sneaky little prosperity killer will snag another three million taxpayers this year, and another 30 million by the end of the decade. Now, this all results from some tiny change in the tax law that dates back to the Nixon years, which means that no one alive is willing to take any responsibility for it. But no one in Washington is complaining about it either, the Republicans least of all. Bush was in a good position to stop the nonsense, but did nothing about it. Not only that: Bush’s latest budget actually rescinds some exemptions that Congress had granted in recent years.

Number Five: Prescription Drug Benefit. This is the largest expansion of federal welfare since the Great Society. New estimates put the cost at $700 billion over 10 years but we might as well round up and say an even trillion. To think: when Congress voted on it, they believed it would cost only $400 billion. Now I’m always a bit amused by these claims that Congress is shocked! shocked! that a government program costs more than it was supposed to.

I find it even more befuddling why Congress would be all for a program that only costs $400 billion but draws the line at $700 billion. This is like a burglar leaving the last bit of jewelry in a safe on grounds that to take it too would be akin to theft. In any case, this program is a calamity. And so we have, in the name of allaying high drug prices, a vast artificial increase in demand. There were other ways to lower the costs of drugs but because it might mean denying pharmaceutical companies some revenue, the Bush regime decided instead to socialize their profits.

Number Four: Failure to Rein in Fannie/Freddie. We may very well have a housing boom on our hands. Housing prices have doubled in some markets from 2001 through 2004. The median price of a single-family home has risen from $145,000 to $183,600. The boom is caused by artificially low interest rates but facilitated by two federally chartered private institutions that are effectively too big to fail. They have doled out mortgage welfare for so long and to so many, that most Americans no longer know what it means to have to scrimp and save for a house.

But price hikes cut both ways: they are great for the seller but terrible for the buyer. Most of us fall into both categories, so we develop a dependency relationship with price hikes. We need to learn to think of rising prices as something unnatural and unwelcome. Entrepreneurial profit is a great thing, but constantly rising prices on this scale suggest a market distortion. If a depression comes, and the industry has to be bailed out, or if mortgage rates rise dramatically in the near future, we will have a calamity on our hands.

Number Three: Signing and Enforcing SOX. At the end of the dot-com bust, some people in Washington developed the idea that corporate America is run by crooks who spend all their time cooking the books. Now: imagine politicians in Washington complaining about anything run by crooks who cook the books! In any case, their answer was a series of show trials for CEOs and CFOs that completely overlooked how the business cycle had changed accounting standards.

That was followed by the passage of the Sarbanes-Oxley Act, which gave the federal government complete supervisory authority over the accounting of every publicly listed company and enforced criminal penalties against CEOs and CFOs who sign off on any audits the government disputes.

The costs have been unthinkably large: in the hundreds of billions. Accountants report spending nearly all their time complying with it, and some critiques have compared this bill with FDR’s National Industrial Recovery Act, given how much it empowers government to manage affairs that were once left to the discretion of the private sector.

And don’t you just love the theory behind these regulations, which supposes that large publicly listed companies have no strong incentive to keep good books?

It only takes a moment’s thought to realize that the investor class is the most sophisticated watcher of business, and business has every incentive to provide whatever information is needed or wanted by investors. It was the markets, not government, that discovered the anomalies at Enron and the high-profile cases. All government regulations end up doing is forcing companies to waste resources complying with edicts rather than serving stockholders and consumers.

Number Two: Markets By Force. As a lover of free markets, I’m embarrassed that the Bush administration has said that part of its goal in invading Iraq and bringing total chaos and massive death to that country was to give them a capitalistic economy. In fact, the Bush administration still enforces price controls on gasoline in Iraq, still forbids free trade, still excludes free enterprise communication and airline companies from setting up shop, and still refuses to allow Iraqis control over their own oil. However, even had US forces really brought about free enterprise in Iraq, militarism and war are not the right way to do it. The way to bring markets to the world is not by war and force, but by trade and example.

I suggest we take with a grain of salt all claims by the Bush administration that it is seeking to expand markets around the world. If it really sought to expand markets, the place to begin is right at home. Instead, we’ve seen the opposite. It is closing markets, harassing successful entrepreneurs, and hobbling enterprise through high regulations.

Number One: the Appointment of Ben S. Bernanke, formerly of the Fed, to be the chairman of the Council of Economic Advisers. Please listen to his words from a speech given in 2002—given in the context of trying to settle down people’s fears of the economic future:

The US government has a technology, called a printing press (or, today, its electronic equivalent) that allows it to produce as many US dollars as it wishes at essentially no cost. By increasing the number of US dollars in circulation, or even by credibly threatening to do so, the US government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.

Well, these comments certainly do calm fears that deflation is in our future. But what he seems incredibly sanguine about is the effects of inflation. Already, inflation amounts to a daily robbery of the American consumer. Even in these supposedly low inflation times, price indexes have doubled since 1980. What this means is that one dollar in 1980 purchases only 50 cents worth of goods and services today. There are no long lines at gas stations and we aren’t panicked for our future, but we are still being robbed, only more slowly and more subtly than in the past.

The Bernanke appointment is certainly a wake-up call for anyone who has a benign view of the Bush administration’s economic priorities. Indeed, we might as well say that, longterm, this could be the most egregious decision that the Bush administration has made.

An inflationist Keynesian and an aggressive advocate of printing-press economics, Bernanke is the sort of crank who becomes famous in history for having destroyed whole countries. He is utterly and completely dedicated to the idea that paper money will save the world, with no downside. I shudder for our future if he becomes head of the Fed. Yet this appointment is probably a pathway to Greenspan’s job, as it was for Greenspan himself.

Now, I’m not predicting another depression any time soon. But I will say that if one comes, all these Bush policies are going to make a depression less easy to recover from. They all work to make the economy less responsive to human ingenuity, harm the manner in which prices convey accurate information to entrepreneurs, and make it more difficult for individuals to put their financial houses back in order.

But just because the depression isn’t here yet, let us not wait to decry all these policies for what they are: violations of free-market ethics and the true spirit of American enterprise.

The beauty and glory of economic science are that it consists in a series of laws and principles that do not change according to time and place. The prescription for prosperity and stability and human economic flourishing is always and everywhere the same: freedom of association, freedom of contract, freedom of enterprise, freedom to trade across borders without penalty, sound money redeemable in something besides paper, private property rights, wages and prices that adjust by market conditions, and a legal structure that shores up these institutions rather than undermining them.

If the United States were to establish such conditions, my cautious optimism about the future of world economic health would turn to wild enthusiasm, because the country would once again become a beacon of liberty to the world, in precisely the manner that the best thinkers among the founding generation imagined it would be.