Six Economic Myths and Realities

The following are six of the most prevalent economic myths that appear time and again in the mainstream media.  I will give a brief description of each and a brief description of the economic reality, as seen from an Austrian perspective.

Myth #1: Increased money leads to economic prosperity.

This Keynesian myth postulates that increasing aggregate demand through increasing the money supply will lead to more spending, higher employment, increased production, and a higher overall standard of living.

The reality is that an increase in money leads to malinvestment. The time structure of production is thrown into disequilibrium by encouraging investment in projects more remotely removed in time from final consumption.  There are insufficient resources in the economy for the profitable completion of all projects, since individual time preference is unchanged, meaning that there is no increase in savings.  When prices rise, due to this unchanged time preference, these projects will be liquidated, revealing the loss of capital.  Production will be lower than otherwise.  Unemployment will increase while workers adapt to economic reality.

Myth #2: Manipulating interest rates leads to economic prosperity.

This is a corollary of Myth #1 but deserves its own discussion.  In the Keynesian view lower interest rates always are beneficial; therefore, it is the proper role of the monetary authorities to drive down the interest rate via open market operations.

The reality is that interest rates are a product of the market, reflecting the interplay of the demand for loanable funds and the availability of loanable funds.  Historically high or low interest rates can have multiple causes, none of which are prima facie good or bad.  For example, rates can be high because entrepreneurs have highly profitable opportunities due to reduced regulation or a breakthrough in technology.  If time preference is unchanged and, therefore, savings is unchanged, the interest rate rises and allocates the scarce savings to the most highly desired ends.  Or, interest rates can be low due to a change in time preference that leads to increased savings.  If entrepreneurial opportunities are unchanged, interest rates will fall.  Likewise, demand for loans can be high while savings is high or vice versa.  Manipulating the interest rate truly is an act of fantasy by the monetary authorities, who believe that they can know the impact of billions of ever changing decisions affecting the supply of money and demand for money.

Myth #3: Lowering the foreign exchange rate of the currency, to give more local currency in exchange for foreign currency, will lead to an export driven economic recovery.

The reality is that no country can force another to subsidize its economy by manipulating its exchange rate.  Giving more local currency subsidizes foreign buyers in the near term, but it creates higher prices in the domestic economy later.  Early receivers of the new money–exporters, their employees, their suppliers, etc.–benefit by a transfer of wealth from later receivers of the new money.  But as the price level rises from the increase in the domestic money supply, the benefit to foreign buyers evaporates.  Then the exporters demand that the monetary authorities conduct another round of exchange rate interventions.  The big winners are foreign buyers.  Intermediate winners are exporters, but their advantage ends eventually.  The losers are non-exporters, especially retired people.

Myth #4: Money expansion will not cause higher prices.

Currently the U.S. government is engaged in a propaganda campaign to convince us that it can both monetize the government’s debt and engage in quantitative easing without causing a rising price level.

The reality is that there is no escaping the fundamentals of economic law in the monetary sphere.  Ludwig von Mises and many excellent Austrian economists since, such as Murray N. Rothbard, have explained that the relationship between an increase in money and an increase in the price level is not a mechanical one.  Nevertheless, even Mises explained that the basis of all monetary theory is the “Quantity Theory of Money”, that states that there is a positive relationship between the money supply and the price level.  In other words, more money eventually leads to higher prices and vice versa.  What causes all the confusion is that the price level actually can fall even when the money supply expands, if all of the new money plus some of the existing money stock are hoarded.  Mises call this the first stage of the three stages of inflation.  The public expects prices to remain the same or even fall, so they do not increase their spending even when the money supply expands. Eventually, though, the public comes to understand that the money supply will keep increasing and that prices will not return to some previous golden age.  At this point the public will begin to increase spending to buy at lower prices today rather than higher prices tomorrow.  The price level will rise even if the money supply shrinks, because the public spends previously hoarded money faster.  This is Mises’ phase two of inflation.  In the final stage money loses its value, as the public spends it as fast as possible.  This is Mises’ stage three, the “crackup boom”.

Myth #5: More, better, and more vigorously enforced regulations can prevent loan and investment losses.

The politicians and their regulatory agencies believe that prior monetary crises were caused by a combination of stupidity, greed, and criminality by bankers and sellers of investments.

The reality is that no army of regulators armed with the most modern analytical tools and the most powerful means of regulatory enforcement can prevent malinvestment from money supply expansion.  The monetary expansion encourages longer term projects for which the cost of money is a major factor in forecasting success.  But without an increase in real savings, insufficient resources will ensure that many of these projects will never earn a profit and must be liquidated.  Bank and investor losses are inescapable.

Myth #6: Government can prevent hyperinflation.

This is a corollary of Myth #4.  If our monetary masters believe that money expansion will not cause higher prices, then they believe that they can prevent hyperinflation; i.e., the total destruction of the monetary unit as a universal medium of exchange.

The reality is that hyperinflation is cause by a loss of confidence in the money unit, which the monetary authorities may be incapable of preventing.  Once the panic starts, the demand by the public to hold money falls to zero.  Prices skyrocket.  Even if the monetary authorities got religion at this point and froze the money supply, the panic will run its course.  No one will want to be the last holding worthless paper.  More likely, though, the monetary authorities will aid and abet the panic, even if unwittingly, due to political pressure to increase payments to powerful domestic constituencies, such as retirees, the military, the public safety sector, government contractors, etc.  This was the case in Revolutionary France, Weimar Germany, and modern day Zimbabwe.  The mindset of today’s money masters seems little more advanced.

Conclusion

I encourage Austrian economists to point out these common myths whenever encountered.  I have had success writing letters-to-the-editor of major newspapers.  Their editors often seem genuinely pleased to receive a polite letter pointing out the Austrian view.  Perhaps it is simply  a case of controversy selling newspapers.  Furthermore, much business writing often has imbedded Keynesian assumptions that drive the narrative toward government intervention.  Most business reporters have no economic training, so Austrians should politely point out these errors, too.

Patrick Barron

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I’m Shocked! Shocked!

From today’s Open Europe news summary:

In its quarterly report, the Greek Parliament’s State Budget Office has warned that Greece will require a third bailout package to avoid a default, and that despite capital injections, the problems of the country’s banks has not been resolved yet, reports Kathimerini.
Greece will “need” a third bailout, and a fourth bailout, and a fifth bailout, ad infinitum until the EU has had enough.  As long as Greece can get more money from the EU, it will never adopt the reforms needed to stand on its own. Such are the wages of socialism everywhere, whether pertaining to the individual or entire nations.
Patrick Barron
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Governments Collude to Fleece the World

Re: Luxembourg tax regime under siege

This recent article by Vanessa Houlder of the Financial Times, London, details the economic success that Luxembourg has enjoyed by keeping its business tax rates at a moderate level and the threat to that success from high tax governments colluding to force it to raise its rates.  Ms. Houlder seems to be carrying the water for the EU and the OECD in calling for “European governments to pull together and stamp out harmful tax competition.”  Elsewhere Ms. Houlder reports that “the OECD is intent on closing loopholes” and wants to “stamp  out treaty shopping” by big, international companies who seek to avoid taxes.  Likewise, consumption taxes for Luxembourg citizens “are already set to rise.”  The general tenor of the article is that governments have a right to collude to ensure that no company or individual can escape paying high taxes.

Governments try to make a virtue out of doing something for which they would prosecute private companies, namely price fixing via a closed cartel. They wish to trap capital and profits behind a façade of legality and will bully any country, especially a small country, into adopting their confiscatory tax regime that is the foundation of their bloated and inefficient welfare states.  They want to prevent Microsoft and Amazon, for example, from escaping their clutches just as the former communist countries of the Warsaw Pact tried every means possible to prevent their citizens from fleeing to the West.  The US is part of this government led conspiracy.  Recently it pressured Switzerland to reveal the names of American holders of Swiss bank accounts in their search for assets to plunder on behalf of the American welfare/warfare state.  Naturally, these governments use propaganda to incite the masses to start a new class war.

But if competition is right and proper for companies and forming a cartel for the purpose of holding prices high is not only illegal but also immoral, why is government itself exempt?  No one since FDR’s socialist brain trust would accept the argument from the private sector that a cartel enforced price uniformity was needed in order to establish a level playing field, yet tax uniformity is lauded by governments and their main stream media lackeys. Surely, cartels, especially those enforced by law, create huge inefficiencies in the delivery of services.  This must be one of the causes to which former member of the European Parliament Godfrey Bloom was alluding when he constantly questioned the unconscionable perks and benefits of European Union civil servants and their constant demand for even more.  Without tax competition what is there to enforce spending discipline by government?  Nothing.  Patrick Barron

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From the “You can’t make this stuff up” department

Re: EU threatens Germany with fine for running too large a surplus

Ambrose Evans-Pritchard of the Daily Telegraph reports that the International Monetary Fund is criticizing Germany for running too large a trade surplus with the other European Monetary Union states (those EU members who also use the euro).  Apparently the surplus violates EU law and requires that Germany pay a 2.4 billion euro fine.  The economic geniuses at the IMF claim that Germany’s trade surplus is “economically destructive” in that it harms weaker EMU states who suffer a “liquidity trap”, meaning that they cannot debase their  currencies to spur exports (they use the common currency, the euro, you see). The IMF admits that Germany has achieved its trade surplus in large part by holding down wages, something that the weaker EMU states refuse to attempt for fear of the dreaded “deflationary trap”. How keeping wages in line with real demand is a trap goes unexplained by the IMF.
The reality is that only Germany has displayed cost discipline, whereas other EMU states want to borrow, print, and inflate their way out of difficulty rather than confront radical unions about getting wages in line with demand.  As long as we are discussing reality rather than economic phantoms, the reality is that the European Central Bank itself aids and abets Germany’s surplus by allowing the deficit nations to borrow newly printed euros to support their failing welfare states. The fact that this action violates the Maastricht Treaty, which established the EMU, is ignored by ECB bureaucrats because it does not allow room for Keynesian monetary stimulus.
Germany has fought the ECB for years over its faithlessness in honoring solemnly negotiated treaties that enticed Germany to scrap its greatest post war achievement–the beloved deutsche mark. It is past time to bring it back.  Patrick Barron
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My letter to the Financial Times, London re: Eurozone needs quantitative easing


Re: Eurozone needs quantitative easing

Dear Sirs:
All the so-called benefits that you expect the eurozone countries to derive from a European Central Bank program of quantitative easing are myths.  Myth number one: QE will spur an economy to greater production.  Reality: QE will cause dislocations in the time structure of production, causing malinvestment mostly in longer term projects for which insufficient resources exist for successful and profitable completion, leading to capital decumulation and lower production.  Myth number two: QE will weaken the euro against other currencies and lead to an export driven recovery.  Reality: There is no way that an economic zone can force other economic zones to fund one’s own recovery. Debasing one’s own currency merely gives a bargain to foreign buyers, for which they should be very grateful, and transfers wealth within one’s own currency zone from the non-export industries to export industries.   Myth number three: Higher prices (what you erroneously call “inflation”) will lead to economic prosperity.  Reality: Higher prices will impoverish the masses of the people by forcing them to pay more for the necessities of life.  Patrick Barron

 

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New digital currency backed by gold

Gold backed digital currency

People often ask me how gold can be used as a currency, since it would be almost impossible to create a coin that would be small enough to conduct everyday transactions, such as buying a cup of coffee. This article explains how. The gold does not have to be exchanged itself from hand to hand, just the ownership of the gold that is held in safekeeping. Gold ownership would be exchanged just as we exchange ownership of our dollars today by writing a check or using a debit card.
Also notice that government involvement is not required.  Money can be produced naturally and spontaneously by the market, just as the market produces any other desired good.  A free market probably would produce many kinds of commodity backed monies–gold money, silver money, etc.  The only thing preventing this from happening today is the prevalence of legal tender laws, which force people to use only government money…which is backed by nothing!  Patrick Barron
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A treaty with the EU or the ECB means nothing

From today’s Open Europe news summary:

French Economy Minister Arnaud Montebourg said yesterday, “[It is] inevitable that the ECB goes even further in its non-conventional monetary policies, by finally proceeding to the purchase of public debt securities if the euro doesn’t go down and growth doesn’t return within the eurozone.”
As much as I hate to admit it, I agree with M. Montebourg.  The European Central Bank will do whatever it chooses, regardless of treaties solemnly and carefully negotiated and presented to national electorates.  Implicit in his statement is the overarching Keynesian assumption that prosperity will return to Europe by driving down the value of the euro in relation to all other currencies. The ECB is not alone.  All central bankers are engaged in a policy of mutual self-destruction of their currencies.  No one in a position of power anywhere seems to question this basic assumption.  But if this assumption is correct, why did not Zimbabwe become a prosperous country by devaluing its currency, the Zim dollar?  Patrick Barron
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I’ll punish you by starving my own people!

From today’s Open Europe news summary:

EUobserver reports that Russia has retaliated against the signing of a new trade treaty between Moldova and the EU, by banning the imports of processed beef, horse meat, lamb and pork from Moldova.
EUobserver
Who suffers here?  Of course the Moldovans lose a customer, but one can assume that they will sell their food products to someone, perhaps even themselves.  There will be a temporary glut of these food products on the Moldovan market, so one can expect prices to fall until more lucrative external markets are found.  The real losers here are the Russian people, who no longer can purchase these food products.  Their standard of living will decline as they spend more on substitute products or do without.  I doubt that the Russian leaders care anymore about their people’s plight than did America’s leaders in boycotting Iranian oil.
Patrick Barron
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Helping with the difficult transition to private life

From today’s Open Europe news summary:

The Irish Independent reports that outgoing European Commissioner, Maire Geoghegan-Quinn, is entitled to a total €432,000 EU pay-off over the next three years to help her adjust to life after Brussels.
According to Wikipedia, this lady has been out of public office for only two years since seceding her father in the Irish parliament in 1975 when she was twenty-five years old.  Therefore, she will need substantial financial help with this difficult transition to private life. But for some reason I do not think she will have any problems peddling the political influence that she has gained in the last forty years.  Patrick Barron
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Bank of England Governor will hold back the tides

Re: The new normal is 2.5%, not 5% benchmark interest rate

 
Mark Carney, Governor of the Bank of England:

“Why is that the case? Things have changed. Households have a lot of debt. The Government is consolidating its financial position. Europe is weak. The pound is strong. The financial system has been fundamentally changed – it has to carry a lot more capital, it has lot carry a lot more liquidity insurance and it will pass on those costs to borrowers. “As a consequence of all those factors, in order to bring the economy back to full employment, in order to get inflation at target, the new normal is materially lower than the old normal.”

Notice that Mark Carney does not offer a real reason that interest rates cannot rise to 5%, only that it would be inconvenient for borrowers and the ever hopeful “This time its different” theme. Therefore, it won’t happen. Really? Sometimes it is inconvenient for the tides to rise, so perhaps Mr. Carney could be named Governor of Tides and hold them back.  His assumption, of course, is that interest rates are determine solely by central banks and that market forces are irrelevant.  Patrick Barron

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