The Case Against Economic Intervention

The basic unit of all economic activity is the un-coerced, free exchange of one economic good for another based upon the ordinally ranked subjective preferences of each party to the exchange. To achieve maximum satisfaction from the exchange each party must have full ownership and control of the good that he wishes to exchange and may dispose of his property without interference from a third party, such as government. The exchange will take place when each party values the good to be received higher than the good that he gives up. The expected, but by no means guaranteed, result is a total higher satisfaction for both parties. Any subsequent satisfaction or dissatisfaction with the exchange must accrue completely to the parties involved. The expected higher satisfaction that one or each expects may not be dependent upon harming a third party in the process.

 

Several observations can be deduced from the above explanation. It is not possible for a third party to direct this exchange in order to create a more satisfactory outcome. No third party has ownership of the goods to be exchanged; therefore, no third party can hold a legitimate subjective preference upon which to base an evaluation as to the higher satisfaction to be gained. Furthermore, the higher satisfaction of any exchange cannot be quantified in any cardinal way, for each party’s subjective preference is ordinal only. This rules out all utilitarian measurements of satisfaction upon which interventions may be based. Each exchange is an economic world unto itself. Compiling statistics of the number and dollar amounts of many exchanges is meaningless for other than historical purposes, both because the dollars involved are not representative of the preferences and satisfactions of others not involved in the exchange and because the volume and dollar amounts of future exchanges are independent of past exchanges.

 

Let us examine a recent, typical exchange that violates our definition of a true exchange yet is justified by government interventionists today–subsidized, protected, and mandated use of ethanol. Number one, the use of ethanol is coerced; i.e., the government requires its mixture into gasoline. Government does not own the ethanol, so it cannot possibly hold a valid subjective preference. The parties forced to buy ethanol actually receive some dissatisfaction. Had they desired to purchase ethanol, no mandate would have been required. Therefore, including the dollar value of ethanol sales in statistics purporting to measure the societal value of goods exchanged in our economy is meaningless. This is just one egregious example of many such measurements that are included in our GDP statistics purporting to convince us that we have “never had it so good”.

 

Our flawed view that governments can improve satisfaction caused us to misjudge the military threat of the Soviet Union for decades. Our CIA placed western dollar values on Soviet production data to arrive at the conclusion that its economy was growing faster than that of the US and would surpass US GDP at some point in the not too distant future. Except for very small exceptions, all economic production resources in the Soviet Union were owned by the state. This does not necessarily mean that it was possible for the state to hold a valid subjective preferences, for those who occupied important offices in the state held them at the sufferance of what can only be described as gang lords, who themselves held office very tentatively. State ownership is not real ownership. Those in positions of power with responsibility over resources hold their offices for a given period of time and have little or no ability to pass their office on to their heirs. Thus, the resources eventually succumb to the law of the tragedy of the commons and are plundered to extinction. Nevertheless the squandering of the Soviet Union’s commonly held resources was tallied by our CIA as meeting legitimate demand.

Professor Yuri Maltsev saw first-hand the total destruction of the Soviet economy. In Requiem for Marx he gives a heartbreaking portrayal of the suffering of the Russian populace through state directed, irrational central planning that did not come close to meeting the people’s legitimate needs, while our CIA continued to crank out bogus statistics of the supposed strength of the Soviet economy upon which the Reagan administration based its unprecedented peacetime military expansion. Maltsev, an Austrian economist, was unable to convince Gorbachev’s government to allow private ownership of the nation’s resources. Without private ownership of production resources, there could be no true ordinally held subjective preferences for their rational allocation. Gorbachev’s other reforms were half-hearted and mis-implemented. They were insufficient to prevent the imminent collapse of the Soviet economy.

 

With the proviso that no exchange may harm another, as explained so well in Dr. Thomas Patrick Burke’s book No Harm: Ethical Principles for a Free Market, we are led to the conclusion that no outside agency can create greater economic satisfaction than can a free and un-coerced exchange. The statistics that support such interventions are meaningless, because they cannot reflect the satisfaction obtained from true ordinally held subjective preferences. Once this understanding is acknowledged and embraced, the consequences for the improvement of our total satisfaction are tremendous. Our economy can be unshackled from government directed economic exchanges and regulations. The “no harm” principle can be enforced by normal commercial and criminal law. For example, since one may not pollute the waters that are used by others, normal tort law, which is based primarily upon precedence, would replace costly EPA compliance regulations, which are based primarily upon statute law and bureaucratic regulation. All labor laws can be scrapped, which would reduce the cost that businesses must bear to support extensive human resources departments, which have become little more than arms of government agencies. Freedom to engage in any economic exchange that causes “no harm” would extend internationally, too. All trade restrictions would be seen to be illogical and unnecessary. Satisfaction increases with greater opportunities for un-coerced exchanges; therefore, international trade restrictions are counter-productive. The revival of the free trade movement would benefit world peace and result in fewer scarce resources directed to national defense.

 

In conclusion we see the consequences that can accrue from a better understanding of the true nature of economic exchange. Be on your guard for those who claim to be able to improve our satisfaction and protect us from harm through expansion of government coercion in the market.

Patrick Barron

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Russia takes a page out of the Paul Volcker playbook

From Zero Hedge: Russia Shocks With Emergency  Rate Hike

The move by the Bank of Russia to drastically raise rates is the first break by a major central bank in the worldwide Keynesian dogma that lower rates are required to cure almost any financial or economic problem. Paul Volcker knew better. During the waning days of the Carter administration and the beginning of the Reagan era, Fed Chairman Paul Volcker ordered the Fed to cease monetizing US Treasury debt. Interest rates peaked a just over twenty percent! The economy went into recession as twenty years of malinvestment, made possible by central bank interest rate manipulation, was purged from the economy. Folk lore tells us that Volcker raised interest rates. He did no such thing. He stopped manipulating interest rates by refusing to buy US Treasury debt with printed money, what is euphemistically called debt monetization, and interest rates rose to the level required to fund the debt markets at that time.
Volcker understood that the real economy needed savings, not more spending. Real savings must come from deferred consumer spending. Deferred spending feeds real liquidity to the loanable funds market, where capital is replenished and which leads to improved productivity via expanded specialization of labor. Prices actually fall!
Sound money was just one part of the Reagan/Bush platform of economic recovery. The other three were deregulation, lower government spending, and lower taxes, which the Reagan administration accomplished to some extent. The rest is history. The US entered into a period of rapid growth and falling inflation. Regrettably, this was the last time that the US was blessed with a Fed chairman of independence and integrity. All subsequent recessions have been “fought” with monetary stimulus, increased regulation, increased taxes, and increased government spending. Today’s Keynesian charlatans actually desire inflation, all the better to rob savers and allow the government to fund its out-of-control debt with debased money.
Apparently Russia is buying none of this nonsense of competitive currency devaluation to solve the financial attack by the West upon its economy that followed its annexation of Crimea. Putting the geopolitical issues to the side, Russia needs to tighten its financial belt, so to speak, in order to retain investment capital and increase savings. If it were really serious, it would stop interest pegging altogether, per Paul Volcker, and allow rates to rise to whatever level is commanded by the market. Does anyone want to guess to what level interest rates would rise in the US, if the Fed stopped monetizing Treasury debt? I doubt that twenty percent would be high enough.   Patrick Barron
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Dollars will come home when overseas demand to hold them drops

Spare Dollars by Alasdair Macleod
It is very interesting that Alasdair mentions that there is increasingly little need for the Petrodollar market, since most of the Middle East’s oil is going East and not West. I mentioned this in my latest essay as a possible end of the dollar as the world’s premier reserve currency. To wit, the following quotes:
“To this we should add the Middle East, most of whose oil is now exported to China, India and South-East Asia, making the petro-dollar potentially redundant as well.”–Alasdair Macleod
 
“… it is possible that the eurodollar and petrodollar markets could end, forcing holders of US dollars to exchange them for goods and services in the one part of the world that must accept dollars.”–Pat Barron
 
There is “the potential tsunami of dollars just waiting for the opportunity to return to the good old US of A.”–Alasdair Macleod
And when those dollars come home, the Fed’s options will be limited between recession and higher prices. There are no other options. Patrick Barron
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Denmark joins Switzerland in mad rush to destroy its currency

Denmark promises to match the ECB’s money printing craze

First the normally sane Swiss promise to match the European Central Bank’s money printing mania. Now the Danes’ have succumbed to the same insane fever. These central bankers harbor the fallacious notion that they can “protect” their currency by debasing it. Yes, if the ECB debases the euro, Danish export goods will become more expensive in euro denominate terms. But this is only temporary; the Krone/Euro exchange rate will adjust to reflect the relative purchasing power of each currency. But all the central banks of the world are ruled by Keynesian economists, who see money printing as the cure for all ills. If you believe this, then printing more local currency to match that of your neighbor makes sense.
Read my articles Currency War Means Currency Suicide  and Value in Devaluation? that debunk this theory.
Patrick Barron
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Are these two events linked?

From today’s Open Europe news summary:

According to documents seen by Reuters, Eurozone finance ministers are considering extending Greece’s bail-out programme, due to end this year, by six months to the middle of 2015. However, a Greek government official insisted that “Greece can discuss only a technical extension [of the programme], which cannot be longer than a few weeks.”
The Bundesbank has this morning halved its 2015 GDP growth forecasts for Germany from 2% to 1%.
Of course, Greece will get its extension! The European Central Bank feels that it really has no choice except to send good money after bad. This is how hyperinflations begin, with the central bank believing that it has no choice except to continue to print money. The European Union has implicitly, if not explicitly, proclaimed that no nation can be kicked out of the EU or the European Monetary Union (eurozone) and that no nation will be allowed to default. This removes all real political pressure for any country to reform, so the only course is to print more money and pretend that reform is simply being delayed.
How long it will take Germany to come to the same conclusion? It may already have, but it has yet to muster the political gumption to admit that it joined a dishonest, impractical, and parasitical organization. Patrick Barron
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Will someone please stop this man before he hurts himself?

From today’s Open Europe news summary:

Juncker unveils his €315bn investment package for Europe
Speaking to the European Parliament this morning, European Commission President Jean-Claude Juncker unveiled his plan for a €315bn investment fund – backed by €8bn from the EU budget (underpinning €16bn in guarantees) and €5bn from the European Investment Bank (EIB). The rest of the funding will come from the private sector with the public funds acting as first loss protection for riskier investments. Juncker also called on member states to commit further funds, promising that, for each public €1 given, €15 of investment would be created. Juncker added, “If Member States chip in capital to the [investment] fund, we will not take these contributions into account in our assessments” of countries’ deficit and debt under EU fiscal rules.
This summary of EU Commissioner Juncker’s so-called “investment plan” would be worthy of discussion in an Austrian economics class. One could have the class point out all the fallacious, embedded assumptions, such as whether third parties have any insight into the real economic needs of Europe. As Ludwig von Mises pointed out a hundred years ago in his Economic Calculation in the Socialist Commonwealth, no economic calculation is possible in the absence of property rights. Since EU bureaucrats do not own the property that they will put at risk, they have no way of rationally establishing ordinal preferences. In other words, the EU will not know if it is investing to satisfy the highest needs of the market. But this is just one problem and probably not even the most onerous. There is the problem of creating money out of thin air, which ignores the importance of time preference in determining the real wishes of property owners to save more or save less and, thus, provide real savings to the loanable funds market. The problems go on and on, yet one expects that Commissioner Juncker will proceed undeterred by the few lone voices of dissent in Brussels. Patrick Barron
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The Path to the Perfect Reserve Currency

Much has been written lately, including by me, about the coming rejection of the dollar as the primary reserve currency of the world’s most important central banks. My prediction is based upon two things: one, that the Federal Reserve is controlled by inflationist politicians whose main goal is to monetize the federal government’s vast annual budget deficits; and, two, that the rest of the world is getting fed up with holding ever more fiat dollars of decreasing purchasing power. In the first instance, as long as the Fed can get away with printing dollars that ultimately are used to purchase federal government debt, there is no reason for it to cease federal debt monetization or for the federal government itself to balance its budget by reducing the welfare/warfare state. In the second instance, it is in the self interest of the rest of the world to find an alternative to being robbed by loss of the dollar’s purchasing power. In short, if the Fed does not stop debasing the dollar, its status as a reserve currency will continue to erode. If the Fed wants the dollar to remain the world’s reserve currency of choice, it must raise interest rates rather than print more money and the government must slash its spending to avoid imposing higher taxes. If it chooses neither of these, or in such small increments as to make little difference, then I fear the dollar is doomed as the world’s primary reserve currency.

 

The Definition of the Best Reserve Currency

 

Central banks hold reserves in order to facilitate international trade. Individuals and companies within a monopolized currency area (either an individual nation or some region, such as the euro zone) must exchange their local currency for some other nation’s currency in order to import goods and services. Likewise, individuals and companies within a monopolized currency area must convert foreign currency to  local currency in order to pay their local suppliers for producing goods and services that are sold abroad and for which they were paid in foreign currency. They do this through the central bank. Alternatively, individuals and companies may decide to conduct these exchanges in a third currency, one that is accepted in most of the world. Since the end of World War II the US dollar has performed this role, meaning that the world is willing to hold dollars (or dollar denominated assets, such as US Treasury bonds), that circulate outside the borders of the US. Thusly was developed over time the eurodollar and the petrodollar markets, for example.

 

But simply saying that the world has preferred to hold US dollars does not explain why it preferred to do so. We have lost sight of the fact that there were real reasons for the eurodollar and petrodollar markets, which transcended some mystical faith in the dollar and the US. The world simply had recognized that the dollar was the most marketable currency to hold, I believe mainly for both geopolitical (think a VERY strong military) and economic (think the most free) reasons. But now those reasons are evaporating, creating an opening for some other, better currency.

 

Definition of the perfect reserve currency

 

The market wants a currency which retains its purchasing power and can be exchanged readily for the most varied real goods, services, and assets. As long as nations issue fiat currencies, only a nation with a large internal market will find that its currency is accepted as one of many reserve currencies. If no one else will accept that currency, it always will be accepted in the monopolized currency zone of the central bank that issued it. For example, it is possible that the eurodollar and petrodollar markets could end, forcing holders of US dollars to exchange them for goods and services in the one part of the world that MUST accept dollars–the US. Holders of dollars know that they can exchange their holdings for American assets, products, and services. The American market is huge, offering lots of choice; whereas, a smaller market, such as Singapore or Russia, would have fewer assets, goods, and services for exchange against the Singapore dollar or the Russian ruble. Much has been written of late that Russia, whose economy is one tenth the size of the US,  wants to end what it calls the dollar’s “special privilege”. But there is a natural limit on the demand by central banks to hold Russian rubles, because Russia exports mainly commodities and few goods or services. Furthermore, property rights in Russian companies and other assets are not seen by the market to be as secure as those in Western countries. China’s yuan might fare better than the ruble, because China exports many more goods to the West than Russia; thus, holders of yuan would have somewhat more confidence that they could find readily marketable goods in exchange for yuan.

 

Gold backing adds to a currency’s marketability

 

But there is one step that small market countries or those with questionable dedication to defending property rights could take that would enable them to make their currencies attractive to hold nonetheless. They could tie their currencies to gold. Gold backing provides two important assurances to potential holders. One, gold cannot be inflated at the stroke of a key on a central bank computer; therefore, the currency could not be debased and would retain its purchasing power. And, two, gold is acceptable intrinsically anywhere in the world. The holder of a gold backed currency can look beyond ultimately exchanging his currency in the issuer’s monopolized currency zone; he can exchange the currency for gold and spend it on real assets, goods, and services anywhere in the world.

 

Guaranteed gold redemption provides even greater currency marketability

 

But the risk to a holder of gold backed currency has not yet been completely removed. Two further hurdles need to be crossed. One, the holder needs to know that the issuer of the gold backed currency is not secretly issuing currency that is not backed by the commodity, what Mises calls “fiduciary media”. At the Bretton Woods Conference  in 1944 the US promised to maintain a dollar to gold ounce ratio of thirty-five to one. The International Monetary Fund was established at the same Bretton Woods Conference and charged with ensuring that the US honored the agreement, but it failed to do so. The US issued so much unbacked (fiduciary) media that the Fed suffered a run on its gold reserves as the US’s trading partners scrambled to redeem US dollars for gold at the promised price. Therefore, an issuer of a gold backed currency needs to open its books to periodic and random independent audits.

 

But even independent audits are not completely sufficient. Complete confidence in a currency requires that the holder be able to take possession of the actual specie without incurring undue cost. For example, the gold might be held in a remote or possibly dangerous location, such as Moscow or Tehran. Worse yet, the currency issuer might refuse to redeem its currency for specie upon demand even though it had honored its promise not to issue fiduciary media. For example, holders of rubles might not be allowed to take possession of the physical gold in Moscow, even though independent auditors had established that the ruble had not been debased by the Russian central bank. This risk could be mitigated by the currency issuer establishing gold redemption centers in many, convenient places around the world. These redemption centers would promise to surrender specie upon demand for any issuer willing to contract with it to do so and by the currency issuer moving sufficient specie there to reassure the market.

 

Sound money conveys no special privilege on the issuer

 

Sound money–i.e., money that is backed one hundred percent by specie and for which provisions have been made for safe and dependable redemption–actually conveys no special privilege upon the issuer but, rather, an obligation. The “special privilege” that critics of the dollar have expressed  refers to the Fed’s ability to debase its currency. Were it not allowed to do so, the Fed would become simply another market participant producing a good or service desired by the market. In a sound money environment, If the market discovered that the Fed had debased the dollar, demand to hold dollars would quickly erode. The market’s demand to hold dollars would fall and its demand to hold other, sounder currencies would rise. Once found to be issuing fraudulent, fiduciary media–i.e., media not backed one hundred percent by specie–international demand to hold dollars might never return, because the Fed’s reputation for honesty had been destroyed. I fear that the dollar’s reputation has been destroyed. It is no secret that base money in the US has risen tremendously, from $569 billion in March 2000 to $4,083 billion in September 2014. In that time the Fed’s inventory of gold has remained the same at 261.5 million ounces. This abuse of the market has opened the door for others. If any country could convince the market that its currency was sound, by following the principles outlined above, international demand to hold that currency would rise, supplanting the dollar as the world’s primary reserve currency. Furthermore, it would be doing all international market participants a favor. Remember, providing a sound currency conveys an obligation to the issuer to honor its promises; it does not convey a privilege to cheat the market by printing unbacked currency.

 

The benefits that accrue to issuers of sound money are all ancillary. For example, the British pound represented more than the fact that it was backed by specie redeemable upon demand. The convertible British pound was representative of a nation that honored the rule of law, fair dealing, honesty, and prudence. British law was exported to the world, as was its form of government, because the world recognized that these institutions were part and parcel of its financial and economic success. British bankers, lawyers, and businessmen gained in statue and real wealth because they upheld these values. The redeemable British pound was a daily verification of trust in everything British. In other words, Britain led by example, and the example was the British pound.

 

But we’re not at the perfect reserve currency yet!

 

So far we have assumed that only central banks can issue money that would be accepted by international traders as a reserve currency. But there still is one risk to holders even of fully redeemable, gold backed currency–the risk of sovereign suspension of gold redemption by all (or most) of the major central banks. This is exactly what happened at the start of World War I. Regardless of the reason for suspension of gold redemption, a central bank would be protected from court action by its national government. National governments hold the monopoly of coercive force within their sovereign area, so holders of the currency could be denied redemption there, although they might have access to partial redemption of gold held at remote locations. However, a private issuer of a redeemable gold backed currency would have no such protection and national governments would have little incentive to provide it. Courts in many countries could attach the assets of the currency issuer and even bring criminal charges of fraud against the principals, a risk that central bank bureaucrats need not face. Therefore, the  ultimate reserve currency is one that is issued by private institutions, such as international banks.

 

Conclusion

 

The world needs honest money founded in law to which men everywhere can seek justice in the protection of their trade, property, and wealth. Honest, sound money is representative of an entire society’s dedication to the rule of law, fair dealing, prudence, and reliability. There is no secret to sound money, only dedication to providing its ready and convenient redemption. The nation that adopts these principles will thrive.

Patrick Barron

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Planning begins for a euro-free Europe

From today’s Open Europe news summary:

In an interview with RTL, Dutch Finance Minister Jeroen Dijsselbloem admitted that the Dutch government looked at what would happen if plans to save the euro “didn’t succeed”. His predecessor Jan Kees de Jager added separately that the Netherlands had worked on the issue with Germany and that teams of experts looked at how the Guilder could be reintroduced.
Notice that the Dutch are consulting with Germany in planning for the demise of the euro. In my opinion the Dutch would not reintroduce the guilder; they would decide to become a deutsche mark country, as would many other European countries…perhaps all of Europe eventually. This would herald the beginning of the end of worldwide monetary inflation by central banks. If the US, Britain, China, and Japan did not stop debasing their currencies, demand to hold these currencies as central bank reserves would fall precipitously because international companies would want to settle their trades in the best currency available; i.e., the deutsche mark.  Patrick Barron
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Tax Avoidance is NOT Tax Evasion

From today’s Open Europe news summary:

The Telegraph reports that David Cameron is expected to use the G20 gathering of world leaders this weekend to press for greater sharing of tax information to crackdown on avoidance. Open Europe’s Raoul Ruparel is quoted in City AM discussing Luxembourg’s tax agreements with multinationals – the details of which were leaked – and the implications for European Commission President Jean-Claude Juncker.
The G20 nations are determined to harmonize taxes the world over at a high rate and allow no legal escape anywhere. British prime minister David Cameron is the latest world leader to succumbed to the siren call of being able to milk his people for an even greater share of the fruits of their toil without fear that they will seek legal protection elsewhere. What these parasites on the people’s wealth have in common is a fear of tax competition. They give lip service to the benefits of competition in the private sector, and most countries have criminal laws against economic collusion, yet they fear competition for themselves in the realm of taxes and law.  Patrick Barron

 

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Europe 25 years after the fall of the iron curtain

01:38:28
Added on 11/12/14
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Many thanks to my friend Dr. Philip Bagus for forwarding the link to me. In addition to the address by former Czech president Vaclav Klaus, there were excellent presentations by Dr. Bagus of King Juan Carlos University in Madrid, Mr. Mach of the Czech Republic, and Richard Sulik of Slovakia.

Dr. Bagus’ informed the audience that almost one hundred years ago Ludwig von Mises explained the impossibility of socialism in his Economic Calculation in the Socialist Commonwealth. If Europe had listened to Mises, think of the misery it would have avoided, including that of today. His talk starts at the 58 minute mark. Dr. Bagus is author of the very influential The Tragedy of the Euro, which explains that the euro is misconstructed and will suffer the same fate as any inadequately protected commonly held resource.  Patrick Barron
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