The Free Market’s Unlikely Champion

In the dark hours of a collapse is when the free market tends to undergo its most radical depredations. Politicians never seem to grasp the complexities of what’s going on, but understand that SOMETHING needs to be done. Like FDR, they just start changing things and hope for the best. Later, a whole generation of economists would praise FDR for his decisive actions. “It’s not that his actions were particularly good,” they might say, “but something needed to be done.” A crisis can not go unanswered. To believe otherwise is sacrilege in macroeconomics. If one believes that an economy can be managed by comparing aggregate supply to aggregate demand, then one has not only the right, but the responsibility to correct the situation.

“With great power, comes great responsibility” were the fictionalized words of Spiderman’s Uncle Ben to Peter Parker, the main character. Peter resisted being called to the role of hero, but in the end, who else had the power to save the world. And this must be how politicians and macroeconomists must feel. They have been given the almost superhuman power to restore confidence in Capitalism by correcting some of the messier elements of the free market system.

And then there’s France. France has always been the butt of America’s jokes; the nation labeled by Homer Simpson as the land of “cheese eating surrender monkeys.” Americans fancy themselves as rugged individualists living by their wits in the dog eat dog world of free market capitalism.  We seem to feel that France is the sissy brother of our western allies: people speaking a strange language in a system so collectivist in their Socialism that it borders on Communist. Like most of America’s fantasies, we seem a bit off base; our system is far more collectivist (and socialist) than we would like to admit and our attitudes regarding France seem unduly harsh. Truthfully, I feel that those two nations have much more in common that either would like to admit. 

Lest we forget, it was France that enabled us to win our independence to begin with. While Americans seem to approach having an empire as a novel idea with grand appeal, France has already gone through their empire phase, complete with an attempt to take over the world through force. And when it comes to fiscal discipline, France seems to have a better understanding of when the game is up than we do. Experience is the best teacher and France has been burned before in the game of holding foreign currencies in the name of global stability. As Murray Rothbard recounted in A History of Money and Banking in the United States: The Colonial Era to World War II France was made a dutiful martyr early in the game of modern finance.

After the aftermath of the first world war, Britain made an attempt to return to the gold standard at their pre-war par. Normally this would have been a very contractionary move, as Britain had vastly inflated their money supply to fight the first world war and therefore there was a far greater ration of paper pounds to central bank gold to back it. One would expect that they would merely have taken the more conventional move of returning to the gold standard at a new par that reflected the vastly inflated quantity of paper notes in circulation. If Britain desired, for whatever reason, to return to valuing the pound at the old par, then one would then have expected for Britain to start contracting their money supply over the years as the United States did in retiring the greenback after the Civil War. But the master planners in Britain, now doubt influenced by the most prominent British economist of the time, John Maynard Keynes. Instead they desired to actually inflate their money supply while simultaneously revert to redeeming their pound in gold. While this scheme might seem absurd to the likes of ordinary mortals like you and I, the British economists felt they could do it.

Part of the plan was that they would not redeem the pound for gold with ordinary citizens, so it was not a true gold standard but rather what became to be called a gold exchange standard. Since the other nations of the world were also in shambles from the first world war (with the notable exception of the United States) Britain felt that no one else would be in a position to present large quantities of paper pounds for redemption as long as the Britain could get the United States to play along. The Federal Reserve, under the leadership of Benjamin Strong, supported this move by the British, for it required the Federal Reserve to expand its money supply even more than the British were doing. Both countries economies underwent a huge inflationary boom in “the roaring twenties”. We all know how that story ended.

What is often lost on those of us not familiar with Rothbard’s excellent history, is that the central bank of France began acquiring large quantities of British pounds as its industries revived and it ran a trade surplus with its British neighbor. The French became nervous as they watched the British and the United States continue their inflationary campaign. They understood that Britain might have a problem redeeming all of the pounds the French possessed should they be ever be presented. But the British central banker, Lord Montagu Norman, convinced the French that Great Britain would stand by their pledge to redeem their pound in gold, even if they had to start raising interest rates and end their inflationary campaign to do it.

So the French played along and held onto their British pounds. As the situation became increasingly untenable, the French began demanding that the British halt their inflationary ways and instead start contracting their money supply. The British were forced to either abandon their pledge to the world to redeem their pounds or they had to stop inflating. Instead of face the pain that might come with higher interest rates, they chose the abandon their gold standard.  France’s central bank had to take a huge loss on the paper pounds it held in it’s vaults.

Fast forward a few decades, and now the players are slightly different, but the story remains the same. Now it is the United States that is maintaining a gold exchange standard, and France is, once again, acquiring a large number of paper dollars. It received similar pledges from the United States that it would stand by its pledge to redeem the dollars in gold, but France once against watched as first LBJ and later Nixon expanded the money supply to increase government entitlements and fight a war in Southeast Asia. As they saying goes, “Fool me once, shame on you, fool me twice, shame on me.” Or, as President Bush shortened it, “You can’t get fooled again.” And so the French didn’t.

Having been burned by their previous experience with England no doubt colored the French decision to continue presenting their dollars to the United States for redemption. And again the leaders of the currency promising to redeem the dollar in gold, were so resistant to the idea of reigning in their spending, that they chose instead to simply make them irredeemable. Yet again, France and the other nations of the world took a loss on their dollar holdings, and today the loss has now spread over to the include debt instruments backed by the dollar as well. 

So now the French are lecturing the world on the benefits of fiscal discipline: Both French President Nicolar Sarkozy as well as Europe’s central banker Jean-Clause Trichet have recently announced a conference in mid-November that will be attended by all of the major western powers including the United States. The topic of this conference is to be a return to the Bretton Woods accord- the accord which Nixon abandoned by ceasing redemption of dollars for gold. 

It’s not hard to figure out the true motive here. Sarkozy and Trichet want to displace the US Dollar from the reserve currency of the world and instead put the Euro in its place. And why not? God has not ordained the US Dollar legal tender for all debts, the US government has; the history of the dollars reign as reserve currency of the world is one ripe with abuse as America has inflated its money supply and forced the other nations of the world to eat the cost. The nations of the world might be ready for a new currency, and Sarkozy and Trichet are certainly ready to make it the Euro. Odds are, this conference may produce little more than lip service, but there is also a chance that Europe may announce a coup by declaring a standard of redeem ability for the Euro in gold. If so, then I would image a stampede of the nations of the world out of the US Dollar and into this newly found hard money. I can only imagine what would happen to the value of the dollar.

Paul Krugman Gets a Funny Kind of Prize

For those of you who don’t know, Paul Krugman, Economics Professor and NY Times columnist, has recently been named recipient of the 2008 The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel. This blog may be one of the only places you see it expressed in this fashion because most media outlets just say he got the “Nobel Memorial Prize in Economic Science” or, even more simply, the “Nobel Prize in Economics.” There’s only one problem with this, and that is that there simply is no Nobel Prize in Economics. 

Alfred Nobel was the chemist who invented dynamite and made a fortune manufacturing explosives. One day he was reading the paper and came across his own obituary. It was sobering for him to read that the major work of his life was viewed as a “merchant of death” and this motivated him to want to improve his name and legacy. So his will set up for annual prizes to be awarded for significant achievements in five fields: Medicine, Chemistry, Physics, Literature, and Peace. The first group of prizes were given in 1901. Economics was not among them. 

Then the central Bank of Sweden in 1968 decided to donate money and give away it’s own prize “in memory of Alfred Nobel.” It is not a nobel prize, and that’s according to the Nobel Foundation itself. But people call it that, and that’s because the Bank of Sweden wanted to cash in on the prestige of the Nobel name. It’s a bit like me giving out a prize for best blogger “in memory of Alfred Nobel”. It’d be interesting to see if we could get the press to pick up on it and start saying “this years Nobel prize for blogging was awarded to…”. You have to give it to Economists, they understand the importance of controlling people’s perceptions more than anyone else. It is rather fitting then that their prize is only prestigious because they did such an excellent job confusing people into thinking of it as a Nobel Prize, given that one of the main contributions of the “science” has been confusing people into thinking that fiat money has intrinsic value or that inflation adjusted “real earnings” per hour worked are only down 2.5% from a year ago. As I discuss in my book, the whole “science” boils down to little more than conjecture expressed in mathematics too sophisticated for the majority of people to understand.

So what is it that Dr. Krugman won the prize for? He came up with a theory that industrialized nations tend to trade a lot of the same goods back and forth. No, I’m not joking. You can read the NY Times story for yourself if you don’t believe me. Krugman came up with a theory that corporations develop in different countries that specialize in slightly different versions of the same goods and that different consumers in different countries will develop a preference for some of those particular variations. Therefore, international trade will show a lot of nations shipping similar stuff back and forth; the article gives the examples of Fords and Volkswagens being shipped across the Atlantic.

Wow. Well I suppose congratulations to Dr. Krugman are in order. The Nobel may be phony, but the prize money is real. And his theory has clear application… but I’m not quite sure how or to what. The theory that he was correcting was David Ricardo’s defense of free trade which supposed that nation’s would specialize in goods where they had a competitive advantage. That we did not necessarily see this represented in the flow of goods (e.g. Japan doesn’t make all the world’s cars) was to me not as important as whether rich nations, where capital has been invested in plants and technologies, should trade with poor nations which have only cheap labor to offer. Ricardo demonstrated through math than any 8th grader could do that allowing free trade between these nations would be beneficial to both countries because the high labor cost goods would start to be made where the labor was cheaper and vice versa (which we do still observe today). That Mr. Krugman has instead theorized that industrialized nations trade a lot of the same goods back and forth does not even seem relevant to me. So I suppose it’s good for him I wasn’t on the selection committee. 

So we have a committee set up for a central bank that set up this “prize” more or less as a public relations exercise. Presumably they figured that if “Nobel Prizes” were awarded then people would think it was a real science, and they probably aren’t wrong. I remember when A Beautiful Mind came out, I don’t remember encountering anyone who did not feel that John Nash had not been awarded a genuine Nobel Prize. You would expect that the winners of this “prize” tend towards being people who favor theories which feature strong central banks, for instance, and that is exactly what we have with Krugman. To quote Dan Klein’s review of all the columns that Krugman has written, “Krugman has almost never come out against extant government interventions, even ones that expert economists seem to agree are bad, and especially so for the poor.” 

Let’s call this ridiculous prize what it is, a sham. Alfred Nobel did not establish this prize, the central Bank of Sweden did. And it has given awards to Economists such as Merton and Scholes for their theory on options pricing that is widely viewed as producing option prices that don’t work. As if to prove their critics point for them, Mr. Scholes has gone on to lose a spectacular amount of money with it with the meltdown of Long Term Capital Management, which you can read all about in Roger Lowenstein’s book When Genius Failed

Economics is a graveyard of failed theories that are still paraded about as validated truths. Keynesian Economics has been dogmatically followed by both the United States and Japan in efforts to get out of depressions, and it has failed spectacularly. Yet we still see Keynesian theory and the government intervention it (and Dr. Krugman) recommend as the savior that we now need to embrace in the face of our new credit crisis. When we will ever wise up?

Everything I Need to Know I Learned from a Shock Jock

For those of you who don’t know, I listen to some pretty salty radio. Specifically, I listen to both Howard Stern and Bubba the Love Sponge on Sirius Satellite radio and, while I can’t specifically recommend shock radio for everyone, I can say that both shows have, in addition to a lot of material many would find objectionable, a healthy amount of intelligent dialogue. Both shock jocks have gotten increasingly more political over the last handful of years as both were targeted by George Bush’s FCC chairman Michael Powell with the largest fines in radio history. Having both found their home on sensor free satellite radio, they now both routinely comment on the absurdity of the “War on Terror” as well as favoring Barrack Obama in the Presidential race.

Having been so financially touched by the latest administration, politics has become personal issue for them. I find the politics of the Bubba show particularly interesting as he is not a traditional Democrat but rather someone like myself who has developed a Democratic sympathy out of utter dislike for the policies of the Republican party. Yesterday on the Bubba show, the topic of the housing crisis came up. Specifically they were discussing John McCain’s recent proposal that the government simply buy up all of the troubled mortgage’s and have the government renegotiate better terms with the home owners so as to keep everyone in their homes. Brent, the producer, pointed out that he had reread Ron Paul’s A Foreign Policy of Freedom and that the book had predicted both the housing crisis as well as the government’s bailout of it. Bubba then went on to say words to the effect that:

If they want to stabilize housing prices here’s what they need to do. Stop all this bailout <stuff> and just lower the price. Eventually, the price will get lower to those of us that have some spare change will go out and buy the house as an investment property and fix it up. Crisis solved.

This reinforced in my mind the utter simplicity of classical economic theory because Bubba, who did not even go to college, was doing a wonderful job as describing the effects of Say’s Law. Jean-Baptist Say (1767-1832) was a French economist who attacked the Mercantilist notion that recessions were caused by a shortage of money. Instead, Say argues that money is merely a medium of exchange and one can not actually buy anything without first supplying something else (i.e. a worker must first supply his labor in order to get its money’s worth to then buy goods) that it is not money that is in short supply but other goods. According to Say, a generalized over-production was simply not possible, while a specific overproduction of one given good certainly was. Thus Say’s solution was to allow the markets of goods and services to find their own clearing price and that that would quickly bring an economy back to stability and further help orient the markets production of goods and services towards what the society actually valued. 

Say’s law was attacked by Keynes who theorized that a generalized over-production was not only possible, but that it would tend to be persistent unless the government took action. It is Keynesian theory that lies behind John McCain’s plan, but Keynesians will quickly admit that if Say’s law is correct, that all of Keynes’s theories will fall apart. William Hutt’s A Rehabilitation of Say’s Law points out the how Keynes seemingly intentionally misstated Say’s Law in order that he might then attack it and how Keynes’s misstatement still seems to be accepted by most modern economists as the law itself when it, in fact, is not. 

Say’s law is obvious. So much so that it was unintentionally state by Bubba when describing the John McCain’s housing plan. To allow the economy to quickly realign itself with the actual wants and needs of society, we need to allow the value of housing, bank stocks, and collateralized debt obligations (CDOs) to find their own price rather than have the government move in to buy these products. Do not believe the argument that the “credit markets are frozen” and that no one will buy CDOs at any price. That is simple nonsense. I guarantee that if CDOs are allowed to fall enough in price, eventually they will find a market clearly price and the market will unfreeze itself. The problem is that this market clearing price is probably far below where the banks have it marked on their balance sheets. So you see, the problem is a political one, not a defect of the market itself. 

All in all, I think we would do well to follow the simple logic of Bubba and his crew. Allow the market to find it’s own market clearing price, and let the chips fall where they may.

On Patriotism

My good friend Taylor recently posted this comment:

Not sure I would use predictions from Mahmoud Ahmadinejad to bolster my opinions. Actually that last graph was pretty unpatriotic. Why not put your efforts more into the “here is what I think we can do to see that this country remains/becomes great” instead of “I will enjoy watching you burn.” There are enough nay-sayers on the net already, I think people would rather read and contemplate ideas of salvation (for the economy and country) rather then have reiterated the doom and gloom they already are getting from the media (not to mention from their investment statements).

I see a trend on your blogs to gloat at the circumstances we are in. You do offer alternatives but few seem viable (i.e. returning to the gold standard). I guess what I am trying to convey here is that I want to read your opinion on what can actually be done to better the situations you comment on.

– How can we practically reduce entitlement program spending?
– How can we practically buy out our debt?
– How can we practically curb inflation, raise home value, bolster jobs and growth?

Anybody can tell me the situation is bad…put your efforts into educating us instead? If there is something to be learned from you I want to know it.

It’s not that I respect the words of Mahmoud Ahmadinejad that caused me to quote him. After all, how accurate can someone be when the claim that there are no homosexuals in their entire country? But when he is one of a chorus of voices saying that this is the end of the American Empire, it’s worth noting. 

In regards to your charges of my lack of patriotism, that would depend entirely on how you define it. If you define patriotism as the willingness to make sacrifices for your country, then I am clearly not a patriot. As far as I’m concerned, I think I’m getting a raw deal on the taxes I pay and I’ll be damned if I sacrifice anything more. But if you define patriotism more broadly to be acting in support of the ideals of liberty on which this nation was founded, then I feel I am being very patriotic. 

Our founding fathers, whom we consider paragons of patriotism, were clearly not patriotic to the causes of the British, the ruling government of the time. As Jefferson wrote

“The spirit of resistance to government is so valuable on certain occasions, that I wish it to be always kept alive. It will often be exercised when wrong, but better so than not to be exercised at all. I like a little rebellion now and then. It is like a storm in the atmosphere.” 

I feel Jefferson would be proud of the people speaking out against our government today. I feel he would call us patriots. This, of course, just reinforces the saying that “One man’s patriot is another man’s terrorist.” 

In regards to what can practically be done to improve our current situation, my answer is this: nothing. The American political system has rotted to its core. The realities of fiat money have combined with powerful corporations to ensure that what is in the best interests of the people will be hardly given any consideration at all. If that we’re enough, mass media and polling have enabled politicians to shift the political dialogue away from anything meaningful and towards such chestnuts as abortion, gay marriage, and the “War on Terror.” I watch in abject horror as every year our politicians seem to get dumber and more empty. Just when I though George Bush was as low as we could go, McCain dug up Sarah Palin. 

That’s not to say that there weren’t meaningful candidates running this year. One person was running for President who say this crisis coming a long time ago, and he was running as a Republican. But the Republican establishment was not ready for someone like Ron Paul. They distanced themselves from him and even went so far as to form a collation to deny him the delegates from the State of Louisiana

Since you work in the corporate world, here’s a corporate analogy for you. Pretend you were brought in as a consultant to clean up a failing company. The problems with the company were obvious, but when you proposed the obvious solutions, you were told none of them could be undertaken because management wouldn’t allow it. Would you not then call for the ousting of management?

You are asking for new insight into this problem. It seems to me almost as if you were asking for a magic bullet. “Please don’t talk to me about the gold standard and the dangers of fiat money.” you seem to say, “I just want to know what policies we can adopt that will fix this situation (and allow us to go on just as we have been).” Were there is no magic bullet. Nothing will fix what is so clearly broken. You can add all the fertilizer you want. the tree of our nation’s governance died long ago. 

The solutions to this problem are as simply as they are unpalatable. Take all powers to control money away from the government entirely and outlaw fractional reserve banking. The resulting monetary system will be run by private institutions who are closely audited by their depositors, and precious metals (or whatever the free market decides) will be the unit of accounting of commerce. Suddenly the government will have to raise in tax revenue all that it spends. When such a day comes, you will notice a sudden and drastic curtailing of government spending, including entitlement programs. Meaningless wars will suddenly shift from convenient exercises to gain public support to the truly horrible actions that should only be taken as a dire last resort that they really are. 

None of these ideas are new. Jefferson wrote about them in the late 1700s, as did Murray Rothbard in Man, Economy, and State in the late 1900s. If you’re looking for a sample of Dr. Rothbard’s work, check out his essay on “Taking Money Back.” Times may change, but our situation is not new. But then again I think you knew this. I suspect you’re now saying to yourself how impractical all of these hard money ideas are in our current environment. “There must be some other way to fix the system,” you might ask. 

Let me assure you, there is not. Attempts at fixing our current system is as meaningless as rearranging deck chairs on the Titanic. The system is broken, but few seem to realize it. Until the system is allowed to collapse, we are powerless to improve the situation. You yourself once ridiculed me for being a Libertarian as “wasting my vote.” So you now claim to think that there is some meaningful action that I can take? 

The system must be shown to be what it is: a failure; a sham; a tragic disaster. It is only from its ashes that we can meaningfully move forward. Only once people clearly understand the folly of the life that they have been leading can we make the hard decisions to take back our liberties from the all powerful nanny state we have built to take care of us all. That is why I am contently and excitedly watching the decay and collapse of the system. I believe I am going to outlive our current system, and it is what lies on the other side of it that excites me. 





Bush’s Plea for $700 Billion

I’ve often considered George W. Bush to be one of the most arrogant Presidents of my lifetime. A Republican friend of mine argues that it was William Clinton, and I do have to concede that Clinton certainly had his arrogant moments, but he came off humble when he had to be. By comparison, Bush has always seemed to me to be someone who was reveling in the fact that people intensely disliked him. Maybe it was the way he would tend to give a half-smile to his own jokes when he thought he had told a zinger, or maybe it was the way he won by both of his elections by very thin electoral margins yet seemed convinced that he had a mandate from the people in favor of what he was doing. Whenever I hear him speak, I feel I can hear him telling me that he doesn’t care whether he’s popular with the people or not, he’s going to do with this country whatever he and his cronies decide and the rest of us will just have to live with it. 

Consequentially, on occasions like last night where he comes on national TV to convince us all that *gasp* the economy’s not going so well and desperately needs a bailout, I really wish there was a service that could show me the speech complete with those robots from Mystery Science Theater at the bottom to make snaky comments. President Bush’s speech included a description of exactly how our economy got in such dire circumstances to begin with- that cheap credit caused a housing boom and that now both the loans made to the homeowners as well as the value of the underlying real estate are all in question. As I read his description, the feeling I get must be the same as a parent who is listening to his teenager tell him that somehow the idea to sneak out, go to a friends house, and get hammered somehow didn’t turn out so well. I mean, if it really is as simple as credit inducing a inflationary boom which later came crashing down, why didn’t President Bush call a halt to the easy credit terms that lead to the inflationary boom to begin with?

It’s not like he didn’t know it was going on. In fact, it was a point of pride for the President who in 2003 crowed that low interest rates had given rise to a record level of home ownership in the United States. In fact, President Bush went on to say that he goal was to increase home ownership further by reducing the purchasing price of the home via tax credit, the interest rates one would have to pay, and the amount of paperwork one would need to go through to get approved for a mortgage. Looks like all those chickens are coming home to roost, eh George?

That’s the real kicker about macroeconomists and politicians; when the economy is booming because it’s being force feed credit like a goose being fattened for a French delicacy, they want to talk about how amazingly healthy the economy is. When it finally all comes crashing down, they act as though they had nothing to do with it. It’s strange, but of all the individuals involved in the current Presidential race, I think I agree with Sarah Palin the most when she said that America was facing “another Great Depression.”  Although it’s hard for me to admit that, because she’s probably my least favorite person of the four, but I think she may have accidentally nailed it. We’re not just talking about a recession anymore, we’re talking about a depression. And it’s probably not going to be the complete slow down of commerce that the 1930s was, but instead the Japanese type of downturn that never seems to end. America is about to have it’s own “lost decade” or two, and that’s unfortunately turn regardless of which party you vote in for President. 

As I council my friends, there’s nothing that can be done to stop the fall of the Pax Americana, nor is there anything that can be done to stop the oncoming depression. Perhaps certain politicians can help to make it a harder or softer depression, but it’s going to come. Make yourself ready.