Can an Economy Advance Without Savings?

According to Frank Decker, Honorary Associate at the University of Sydney Law School, it certainly can. Not only that, but eschewing savings in favor of “monetisation of assets” will yield better results! I refer to his article in Economic Affairs–Volume 37, Number 3, October 2017–, a publication of the Institute of Economic Affairs, London.

 

Mr. Decker purports to answer the question “Central Bank or Monetary Authority? Three Views on Money and Monetary Reform.” The three views examined are commodity money, state money, and money as a derivative of property. All three views are explained very well, and a beginner to the study of the role of money will learn a lot in a short period of time.

 

Commodity money is the name Decker aptly gives to money backed by gold or some other widely accepted medium of indirect exchange. Commodity money’s proponents see two major advantages–that it ends inflation and the business cycle. He quotes Mises and Rothbard to good effect.

 

State money, or money as a state liability, is fiat money that all the world knows today. Its two most famous proponents are Keynes and Friedman. State money’s main advantages, as seen by Decker, are that the state can engage in countercyclical spending and the state can fund itself by printing all the money that it needs for current expenditures.

 

Decker’s third type of money–money as a derivative of property–sounds no different than fractional reserve banking, except that the fraction of reserves required to be held by the lending banks is so low that it is not a factor of lending restraint. Decker gives the example of a business that uses its assets as loan collateral. According to Decker, the money that the bank creates is NOT created out of thin air, because it is backed by private property; i.e., the loan collateral. According to this theory, money can be created ad infinitum, because each round of loans creates new property with which to engage in another round of  property-backed money creation. If this isn’t money “out of thin air”, I don’t know what is!

 

Decker desires to find the best monetary regime to promote economic development. Of the three money systems, he settles upon a property based system with a central bank as benign overseer. His choice of this system, such as it is, shows his lack of knowledge of economic theory. In fact, he is a thorough empiricist, with all the limitations that are emblematic of trying to gather billions of facts with which to determine cause and effect. Austrian economists know that economics is a deductive science in which reliable conclusions can be drawn by using proper logic based upon irrefutable maxims.

 

Decker’s two reasons for passing over commodity money are rather astounding. He believes that commodity money would “impose limitations on civil liberties and property rights”, because “Countless episodes of monetary history show that economic actors will always find ways to monetise their assets.”. He is certain that banks will continue to engage in creating money substitutes out of thin air–i.e., paper money and/or book deposits–even though it is against normal commercial law or, under a free banking system, that money creation would be limited by normal banking presentment practices. But most damaging, according to Decker, is that commodity money would restrict a nation’s development. Astonishingly he states that “Commodity money would also retard economic development, as the monetisation of assets allows investment without the prior accumulation of savings,…”! In other words, why save when capital can be created ex nihilo at the stroke of a computer key? Counterfeiters must be wondering why they are persecuted when their actions are actually beneficial!

 

Decker equates capital with book entry capital accounts. It is as if an Iowa farmer believed that he could acquire seed corn by making an entry on his books. He would not have to save some corn from last year’s crop; he could consume it all and perhaps plant pieces of paper. Of course, this capital that Decker believes appears magically actually comes from real people giving up real assets. Frederic Bastiat’s That Which Is Seen, and That Which Is Not Seen and Richard Cantillon’s insight that money enters the economy at specific places, unduly rewarding specific individuals (the Cantillon Effect), could not be more appropriate.

 

In order for Decker to be correct he must see new factories, houses, etc. arising and believe that nothing was sacrificed to build them. But clearly that is not how the world works. The sacrifice is there, even if NOT seen. Inflating the money supply robs current holders of assets, those who sacrificed and saved, for the benefit of the earlier receivers of the new money. It is a transfer of wealth, not an increase in wealth.

 

Decker sounds like a gambling addict who counts only his winnings and not his losses. The winners are the earliest receivers of the new money, who can buy at existing prices. Later receivers see increasingly higher prices and/or lower returns on investment.

 

Today’s interest rate suppressions that favor borrowers come at the considerable expense of savers, many of whom are retired. Their standard of living deteriorates, but, since Decker cannot find statistics to record this fact, he believes that it is not happening. He fails to go that next and necessary step to consider that which is both seen and unseen, per Bastiat’s timeless insight.

 

No individual or group of supposedly wise men should ever be given the power to create money out of thin air or to manipulate the interest rate. Only commodity money, which is controlled by no one, can protect private property and perform the market’s time coordination function, AKA the interest rate. Spending requires prior savings, and savings cannot be spent twice.

 

The old saving that “there is no such thing as a free lunch” needs an addendum–Somebody always pays.

Patrick Barron

Posted in News/ Lessons | Leave a comment

Bastiat and the Hubble Space Telescope

A few days ago my wife and I watched a fascinating program on PBS. The long running Nova series featured the history and accomplishments of the Hubble Space Telescope. The program was titled Invisible Universe Revealed. This episode was composed of three parts.

 

The first third of the program explained how the astronomers secured funding for the space telescope and successfully built and launched it. Senator William Proxmire, Democrat from Wisconsin, had the space telescope in his sights. From 1975 to 1988 the senator awarded his monthly Golden Fleece Award for egregiously wasteful spending. According to Nova, funding for Hubble was secured when Nancy Roman, Chief Astronomer-to-be, pointed out, apparently to the satisfaction of Congress, that for the cost of a night at the movies, every American would enjoy fifteen years of astronomical revelations. Hubble was launched by the Space Shuttle on April 24, 1990 and deployed a day later. That’s when the real problems began.

 

The second part of the program was devoted to the thrilling repair conducted by astronauts on the orbiting telescope. Construction faults in the giant reflecting mirror made the telescope unusable. Incredibly these faults were not discovered until the telescope was in earth orbit. Nevertheless, the telescope was fixed, and this is the best part of the program. From diagnosing the problem, agreeing upon a feasible fix, to astronauts practicing the repair in a giant water tank (20 months of training!), and finally conducting the repair in space, the viewer is astonished at the knowledge, dedication, and skill of everyone associated with this NASA program.

 

The third part of the program attempts to sell the results of the Hubble program to the viewers. In my opinion, this is the weakest part of the program. The astronomers do their best to get the viewer excited about the things that they themselves feel are important, explaining difficult concepts in lay terms and showing beautiful pictures taken by Hubble. But for this viewer, it just didn’t work. And here is where my economist side started thinking about Frederic Bastiat’s timeless essay That Which Is Seen and That Which is Not Seen.

 

The astronomers seem truly excited that now they can answer two questions that (they claim) have perplexed mankind from time immemorial; i.e., how old is the universe and how many stars are there.

The answer is 13.7 billion years. The number of stars is a so large that it’s beyond human comprehension:  2 with twenty zeroes behind it, which is called 200 quintillion! There are 200 billion galaxies in the universe and each galaxy has 100 billion stars. (I must confess that these questions have not caused me to lose even one minute of sleep…ever.) Furthermore, the telescope has revealed many facets of the universe that are of great interest to astronomers. Did you know that the universe is expanding at an ever increasing rate; that there are black holes at the center of all galaxies, and that there is a previously unknown force, called black energy, which makes up seventy percent of all the “stuff” in the universe? Me neither, but I must confess that, even after learning of my ignorance of these matters, I’m still not clear how my life has been made better. And this is where Bastiat comes in.

 

Even though the program honestly gives some air time to the skepticism the astronomers faced in order to secure funding, it makes no attempt to show that all that money and all that new knowledge has translated into even a smidgen of the improvement of mankind and how the project meets even the most expansive description of the proper role of government. Bastiat would point out that all that funding came at a cost, even if a relatively small per citizen cost, of real improvement in mankind’s satisfaction. Each citizen did NOT have some higher satisfaction met, otherwise government funding would not have been necessary. Furthermore, the small-per-citizen cost argument used by Nancy Roman to justify the spending really doesn’t stand up to serious analysis. If every American gave me just one cent each year, I could live very well and no one would be able to say honestly that his satisfaction was impaired even in the smallest way much less foregoing a night at the movies. You can see that almost any specious program can be justified by this type argument.

 

I dare say that a survey of most Americans would find that few know anything about the Hubble Space Telescope and its accomplishments to improve mankind’s knowledge of the universe. In fact I question that the Hubble Space Telescope has done one positive thing for the improvement of mankind beyond the satisfaction felt by the very few in the astronomy field. Pure knowledge may be important in some way to those who seek it, but why force others to forego even the smallest satisfaction in order to provide it to an elite few?

 

So, should and would the Hubble have been built? This question cannot be answered unless individuals are allowed to fund it voluntarily and not have government coercively extract the funds from them through taxes. Perhaps some very wealthy individuals could have been convinced to fund the project. Maybe some sharp Madison Avenue marketers would have developed a program to raise the funds from a vast, interested citizenry. Furthermore, there is such a thing as pursuing an end before its time has come. Perhaps a Hubble-type telescope could have been placed in orbit a few years later at a greatly reduced cost, a cost that could have been borne by private donors. Who knows. But we do know that the Hubble Space Telescope has reduced the quality of our lives in a small way that can never be recovered. Personally, as much as I was impressed by the Hubble’s accomplishments, I would have preferred a night at the movies.

Patrick Barron

Posted in News/ Lessons | Leave a comment

The Economic Benefits of Ending the Fraud of Fractional Reserve Banking

Fractional reserve banking (FRB) is fraudulent. It should be prosecuted as a crime rather than accepted as normal practice under current banking laws. Any society that respects property rights and the rule of law would not allow it. For those unfamiliar with the term fractional reserve banking or not quite confident of its complete meaning, let’s cover some basics.

 

What Is Fractional Reserve Banking?

 

All financial transactions must be settled ultimately by an exchange of standard money, otherwise known as “reserves”. Reserves in the US are composed of federal reserve notes (good old paper money in your wallet, piggy bank, retailers’ cash register tills, or bank vaults) plus reserve account balances held by banks at their local Federal Reserve Bank that may be exchanged for federal reserve notes on demand. The important point is that reserves are not the same thing as the money supply. The money supply is composed of the cash outside bank vaults plus demand (checking) accounts at banks. A financial transaction is not complete until reserves are exchanged. For example, accepting a check from your neighbor for selling him your used car is not final settlement, because reserves have not yet been exchanged. The check might bounce. Or the bank upon which the check is drawn might become insolvent ; i.e., it does not have and cannot raise the reserves with which to pay you, the check’s payee, even though the bank balance of the payor, your neighbor, was at least as large as the check.

 

Most people assume that their money held at banks can always be exchanged for reserves, but such is not the case. Under a fractional reserve banking system banks are not required to keep one hundred percent reserves. Rather, they keep a fraction of their obligation to you in reserve (thus, the name “fractional reserve banking” system), under the assumption that not all depositors will want their money back at the same time.

 

How can this be? If you deposit a dollar into your account at the bank, isn’t the bank required to keep that dollar in its vault or at its own reserve account at its local Federal Reserve Bank? The short answer is NO! The bank is allowed to lend most of that money to someone else and keep only a fraction in reserve in order to satisfy your withdrawal request! This is fraud. Through the lending process the bank has created money out of thin air. It is not backed by one hundred percent by reserves. If too many depositors demand their money at the same time, the bank would not be able to satisfy all withdrawal requests. It would not have sufficient reserves to do so. It’s as simple as that. Any other commercial business that accepted your property with the promise to return it to you and then lent that property to someone else would be guilty of fraud. But banks are allowed to do just this! Hard to believe, isn’t it!

 

Some present the argument that FRB should continue, because the depositor should have the freedom to take the risk that, if the bank should fail, his money might not be returned to him upon demand or perhaps not at all. But the ethical issue is not about the depositor’s choice but the payee’s risk in accepting a check drawn on an FRB bank. The depositor may have sufficient funds in his bank account, but the bank itself might not have sufficient reserves to honor the check. How is the payee to know? It is against the law in most states for a payor to knowingly pass a check that exceeds the funds in his bank account. Why then do we accept as part and parcel of the fractional reserve banking system that the bank itself is not required to hold sufficient reserves to honor all its obligations?

 

FRB Gives Rise to Regulation and Government Money Printing

 

Volumes of bank regulation, armies of bank regulators, and government money printing have arisen because banks are allowed the privilege of fractional reserve banking. Bank runs were common occurrences before the federal government forced all banks into its deposit guarantee program (the FDIC), itself a fractional reserve institution in that it has a mere fraction of the reserves to honor the vast deposit balances of American banks. During the so-called subprime lending crisis of 2008, so many banks failed that the FDIC itself ran out of reserves (which it had obtained via mandatory premiums from the banks) and had to be bailed out by the Federal Reserve Bank itself, which resorted to the time honored practiced of all counterfeiters by creating reserves out of thin air.

 

Bank regulation, enforced by the above mentioned armies of regulators (surely you did not think the government would have just ONE regulatory agency for banks!), attempts to do the impossible, to wit, prevent bank loan losses. FRB expands the money supply, which itself causes disruption to the structure of production, an unsustainable boom, and the inevitable crash. This so-called business cycle is not some sort of inevitable consequence of normal business exuberance or lack thereof, but is caused by FRB credit expansion by banks, a phenomenon well explained by Austrian school economists and labeled by them as the Austrian Business Cycle Theory (ABCT).

 

In the absence of fractional reserve banking, the banks would not be able to expand credit beyond the funds actually saved by its depositors. (Wouldn’t that be something!) There could be no disruption to the structure of production; thus, there would be no need for bank regulations or regulators. All funds placed in demand accounts would be secured one hundred percent by reserves. Depositors who wished to earn interest on excess saved funds would open savings/investment accounts with the banks or some other institution specially formed for profitable investment of the public’s savings. These investment accounts would not be insured by anything other than the banker’s capital account and his reputation for sound lending. Loan losses would be borne by the banker to the extent of his capital account and then the savings fund itself. Naturally, the depositor’s demand funds would be completely secured by the bank’s reserves. Only the funds placed in the bank’s savings/investment accounts would be at risk. Bankers with poor lending acumen would find themselves quickly out of business rather than receiving bailout money from the government. Such bailout money itself comes from Federal Reserve money printing, which itself exacerbates the boom/bust business cycle!

 

Conclusion

 

Ending fractional reserve banking would restore the rule of law to the banking system, end the need for expensive and harmful bank regulation, and eliminate the boom/bust business cycle. Bank demand deposits would be backed one hundred percent by reserves, which any competent local auditor could verify at little expense. Banks found in violation of this law would be seized by state authorities and the officers charged with a crime – the crime of counterfeiting. Unnecessary bank regulatory agencies would be shut down, because they would have nothing to do.

 

This reform to the banking system is so simple that it will be opposed by all the parasitic government agencies now promising to prevent something that they themselves cause; i.e., the boom/ bust business cycle and bank losses that harm depositors and cripple the economy. Nevertheless, let us pursue this reform with all the confidence and courage of Ludwig von Mises that we are doing the right thing and will not be deterred.

 

Patrick Barron

 

Recommended reading:

 

The Mystery of Banking, by Murray N. Rothbard

 

The Austrian Theory of the Trade Cycle and Other Essays, by Richard M. Ebeling

 

The Essential von Mises, by Murray N. Rothbard

 

Posted in News/ Lessons | Leave a comment

Disgust at the LBJ Library

Recently my wife and I spent a morning at the Lyndon Baines Johnson Presidential Library in Austin, Texas. The damage done by this big bully is incalculable. His library reminds us of the start of the blizzard of government expansion during Johnson’s presidential term, which lasted from the Kennedy assassination in October 1963 to his decision not to run for a full second term in 1968, which usually is attributed to his failure to end the war in Vietnam.

 

Johnson was an admirer of FDR and was determined to revive and complete what he believed should have been integral parts to FDR’s New Deal. Johnson called his program The Great Society. As if ignorance of the consequences of this socialist expansion of domestic control by government was not enough, LBJ expanded the war in Vietnam, promising America both Guns and Butter. Even today we live with this expansion of government domestic programs and seemingly never-ending wars as the modern Welfare/Warfare state.

 

The Johnson Treatment

 

I called Johnson a big bully in the paragraph above. I believe my assessment is justified by what actually is celebrated at his presidential library. The displays proudly explain and document “the Johnson touch” in print, photograph, and actual recorded telephone interviews. Johnson was a big man who towered over most people. He had a habit of getting very close to someone, leaning over at the waist, and forcing his partner in conversation to bend over backwards to avoid an uncomfortable encounter with LBJ’s face. There is a large picture of Johnson giving Supreme Court Associate Justice Abe Fortas this “Johnson Treatment”, literally face-to-face. Fortas, who was a long time LBJ supporter, appears to be taking the “Treatment” in good humor, but it is easy to see how it would be almost impossible to keep one’s dignity with the president of the United States performing this obviously uncomfortable act.

 

Surprisingly the JBJ Library celebrates the Johnson Treatment with recorded phone conversations. One conversation was with powerful US Senator Richard Russell, a long time LBJ colleague. Johnson wanted Russell as his personal eyes and ears on the Warren Commission, tasked with investigating the Kennedy assassination. In the recorded phone conversation we hear Russell politely tell LBJ that he is honored but that he has no respect for Supreme Court Justice Earl Warren and must decline the offer. LBJ then badgers and bullies Russell into accepting the position. He says that he wants Russell to ensure that the commission does not investigate whether the Russians or Cubans had any role in the assassination. Russell’s vociferous objection in writing to the Warren Commission’s “single bullet” theory seemed to justify his opinion of Warren and the commission. The commission’s staffers jumped through rhetorical hoops to claim that the report had the unanimous approval of all members.

 

That Which Is Seen and That Which Is Unseen

 

The library is full of typical memorabilia. The entrance has a huge display of pens with which Johnson signed hundreds of pieces of mostly domestic legislation. For example, Johnson authored and signed sixty pieces of legislation that effectively federalized education. Of course, the library is full of specious statistics that attempt to “prove” that all this legislation was effective, citing, for example, that the poverty rate decreased and that the percentage of Americans with college degrees increased. Even if one accepts such “facts” at face value, an Austrian economist would point out that all such so-called advances came at the cost of diverting resources from other, more highly sought preferences. Education is an economic good, as is healthcare, retirement savings, food, etc. If Americans valued higher education so much, they would have applied more of their limited resources to this end. The LBJ library ignores the cost, including the social cost, of all these programs and gives the impression that government supplied goods and services could be provided without any change in the nation’s production of other goods and services. Thus, the famous “Guns and Butter” claim that we can have it all…a claim that survives to this day.

 

Perhaps the most enduring legacy of the LBJ years is that his Guns and Butter policies put the US on a path that ended the gold exchange standard, agreed upon at Bretton Woods in 1944, by which the US pledged to honor central bank dollar convertibility to gold at thirty-five dollars per ounce. In the 1950’s Eisenhower’s budget deficits were very modest and he actually balanced the budget for a short time. But Johnson’s Guns and Butter policy caused huge deficits and prompted unprecedented money printing by the Fed. The Austrian economists in Charles de Gaulle’s France understood the consequences–that the US did not actually have enough gold to honor central bank redemptions at thirty-five dollars per ounce–and began a run on the US gold supply that eventually drove the US off the gold standard in 1971. (Let me make it clear…the French did NOT cause the run on the US gold supply. The Fed caused the run by printing dollars to pay for LBJ’s Guns and Butter policy.)

 

Vietnam Exposed the Limits of the Johnson Touch

 

The LBJ library openly shows us that Johnson never had a method for winning the war in Vietnam or extricating the US from what became known as a quagmire. In another telephone recording from early in his administration library visitors hear LBJ tell a partisan that he doesn’t know how to win or how to bring the troops home honorably. That is a very bitter revelation to someone who had comrades in arms who died in Vietnam and others who endured captivity in the infamous “Hanoi Hilton”. Repeatedly Johnson tried to get the North Vietnamese to a peace conference. This is pure LBJ hubris, convinced that everything is negotiable and that he can use the famous Johnson Touch on Ho Chi Minh. His pathetic bombing pauses to signal our desire to negotiate merely convinced the North Vietnamese that American involvement eventually would end.

 

What Have We Learned?

 

Apparently, not much. Today Johnson’s Guns and Butter policy is alive and well. Few, if any, Great Society programs have been repealed. The federal government continues to wage war in faraway places and promises ever more goods and services, funded by fiat money set free from any semblance of a gold standard. There is no talk of eliminating any domestic programs or ending any of our wars. On the contrary our government seems determined to provoke new wars in Korea and possibly with Iran and even Russia. The legacy debt for all the federal government’s programs–i.e., the unfunded obligations emanating from the government’s entitlement programs–has been calculated to be well over a hundred trillion dollars. It is clear that it can be paid only nominally and not with money of even today’s reduced purchasing power. So, was LBJ’s presidency a success? Unfortunately for America, LBJ would say yes!

Patrick Barron

Posted in News/ Lessons | Leave a comment

My letter to Trains Magazine re: $10 billion in wasted capital

October 3, 2017

 

Trains Magazine

P.O. Box 1612

Waukesa, WI 5317-1612

 

Re: “Time Is Up”, by Bob Johnston (October 2017 edition)

 

Dear Sirs:

In response to Mr. Johnston’s article about the real impact, if any, of the government’s 2009 $10 billion infusion to states and Amtrak for the benefit rail passenger service, it is obvious that this massive spending had no real long term impact. Let’s just look at several reasons why:

 

  1. The money was NOT invested by private individuals who expected to reap a decent return. It was simply a political handout with dubious goals (get America working again?…who knows?). No one ever expected that the money would be returned to the treasury with interest. And herein lies the problem. Ten billion dollars was diverted from the real economy to politically connected cronies. That’s $10 billion of capital that was wasted instead of $10 billion of capital that would have been invested profitably by the private economy.

 

  1. The states and Amtrak do NOT have a business plan for revitalizing rail service; all they have is a pie-in-the-sky wish list. Wishes are not plans. Business plans can be evaluated according to some criteria; wishes cannot be evaluated by any objective standard. Therefore, spending to satisfy wishes become nothing more than exercises in political power and political log rolling (you vote for my expenditure and I’ll vote for yours. Neither of us care one whit about the soundness of these expenditures).

 

  1. Amtrak will NEVER be profitable until it is privatized. The only way to determine whether Amtrak can be profitable is for people to invest their own money with an expectation that it will be returned to them with interest. If no one wishes to purchase Amtrak, then Amtrak should be shut down, pure and simple. To keep it going under the present conditions requires a constant infusion of public money, which represents a diversion of capital from sound investments. Instead of capital accumulation via private investment, America suffers capital consumption. It is akin to spending one’s savings on personal consumption instead of investing in productive assets. Instead of a future of independence and dignity, one finds oneself living as a dependent of some sort (relatives, the government, private charity).

 

Patrick Barron

20 McMullan Farm Lane

West Chester, PA 19382

Phone: 610-793-3605

Email: PatrickBarron@msn.com

Posted in News/ Lessons | Leave a comment

Free the Arctic!

From the Sunday, August 27th New York Times:

Russian Tanker Completes Arctic Passage Without Aid of Icebreakers

A new Russian tanker with a reinforced hull has cut shipping time from Europe to Asia by thirty percent. One would think that such an event would be hailed by all who desire the betterment of all mankind, but such is not the case. Canada and other nations object, claiming great swaths of the Arctic as sovereign, territorial waters. How foolish! The nations of the world should unite to grant homesteading rights to any entity that uses the arctic for erecting structures, such as oil derricks, and also to grant free passage for any ships to traverse the area for commercial purposes. For Canada to claim sovereignty over great swaths of the Arctic is akin to Spanish Conquistadors planting the Spanish flag in a square foot of beach and claiming an entire hemisphere as property of the Spanish crown.

Patrick Barron

Posted in News/ Lessons | Leave a comment

The Real EU aim in Brexit Talks

From today’s Open Europe news summary:

German MEP says EU wants to punish UK in Brexit talks

Writing in The Times, German MEP Hans-Olaf Henkel argues that the European Parliament Brexit negotiator, Guy Verhofstadt, and the EU’s chief Brexit negotiator, Michel Barnier, want to “punish” Britain in the Brexit talks. He adds, “The reason is simple. They would seek to make sure that Brexit is such a catastrophe that no country dares to take the step of leaving the EU again.” Henkel stressed that he would like the UK to stay a member of Euratom but warned if it chooses to do so it would “will mean paying in and abiding by the rules, as Britain does now, and accepting the jurisdiction of the European Court of Justice when it comes to overseeing Euratom.” Henkel is a member of Germany’s far-right AfD party.

Source: The Times 

The only tool that the EU can wield is to forbid the importation of British goods. But that is self-defeating. The EU punishes its own citizens by forbidding them from purchasing British goods and services. I doubt that the EU will try to forbid its exporters from selling into the British market, so the European Central Bank will accumulate British Pounds. It’s tantamount to selling someone a good or service and telling him that you promise never to cash his check.

Pat Barron  

Posted in News/ Lessons | Leave a comment

Why Sound Money Does Not Need a Central Bank, Only the Rule of Law

The money that all nations use today is composed either of reserves created by a central bank and/or credit money created by banks via fractional reserve banking. In the first case, a central bank can create reserve money via open market operations, whereby the central bank buys an asset–any asset–with reserves that it creates out of thin air. These reserves land in a bank and allow the banking system to create credit money in multiples of the new reserves via the fractional reserve lending process. Both methods of money creation are fraudulent, if done by any entity other than a central bank, in the case of open market operations, or a bank member of that central bank system, in the case of fractional reserve lending. All nations have thrown the rule of law out the window for these monetary counterfeiters.

 

A sound money system does not sanction counterfeiting money, either via creating reserves out of thin air or via creating credit money via fractional reserve lending. In a sound money system there is only commodity money; i.e., gold, silver, bails of tobacco, etc. Commodity money may be spent, as in using gold or silver coins in everyday transactions, or other receipts may be exchanged which represent commodity money that is stored in a safe and trusted facility. Issuing a coin that does not contain exactly the weight and purity as represented is fraud in a society governed by the rule of law. Issuing certificates or bank receipts in excess of the stored commodity also is fraud in a society governed by the rule of law.

 

A society governed by the rule of law does NOT exempt any entity, including the government itself, from the law. Thus, a central bank that creates reserves out of thin air is committing a crime, as recognized by Sir Robert Peel in his famous Bank Charter Act of 1844. A member bank that pyramids these reserves into multiples of credit money via the lending process is committing a crime, as cogently explained by Jesus Huerta de Soto in his Hayek Memorial Lecture at the London School of Economic in 2010.

 

In a free society governed by the rule of law any entity can create money and offer its use to the public. I can offer the public the use of my wife’s delicious quart jars of homemade pickles as money, either in direct exchange (for example, a jar of pickles for a box of nails at our local hardware store) or as indirect exchange (a certificate that may be redeemed for a jar of pickles upon demand). However, I have violated the law if I hand over a jar that I claim contains my wife’s pickles but instead contains something else. Likewise, I have violated the law if I issue more certificates for my wife’s pickles than jars of pickles in her larder, which fraud would be revealed should too many people try to redeem their certificates at my house.

 

Of course, for transactions among people who do not know one another personally, unlike the local recipients of my wife’s pickles, a more generally accepted commodity would be used and certificates and/or book entry receipts would have to be issued by more widely known entities. For example, Citibank or Bank of America might issue gold certificates and maintain book entry gold accounts that would be generally accepted by a wide group of strangers as long as these strangers had confidence that Citibank or Bank of America had not engaged in fraud. Gold in their vaults equaled the certificates plus book entry accounts to the gram.

 

All that is required to convert to the rule of law is the repeal of legal tender laws granting special exemptions from normal commercial law to the central bank and its system of member banks. The reverse of Gresham’s Law would prevail. i.e., sound money would drive out bad.

Patrick Barron

Posted in News/ Lessons | Leave a comment

No Nation Can Harm Another Economically

My recent Mises Daily Article titled Two Common Objections to Unilateral Free Trade drew some criticism that I would like to answer.

 

Unilateral free trade rewards the country that adopts it

 

Several commented that my use of the term “unilateral” negated my argument. They resurrected the argument that free trade is beneficial to both parties only if both agree to remove trade barriers to the other’s products. Otherwise, the party that removes its trade barriers suffers economically by having its industries destroyed by the party that keeps its trade barriers in place. This argument stands all of economics on its head by asserting that consumers are required to support producers; whereas, the purpose of production is to meet consumer demand. If one producer, whether domestic or foreign, wishes to lower its price, accept a lower return on capital, obtains an agreement from its employees to work for less, and thusly is able to capture more market share, no one is harmed. Even if a government taxes its citizens in order to provide subsidies to some producers, this is no concern of the consumers or producers in another country. It is no business of anyone other than the taxpayers of the subsidizing government. These people have a legitimate gripe, for they are being robbed to pay privileged insiders within their own country. Producers in the country that lowered its trade barriers have the choice to redirect their capital to other uses and employees have the freedom to work in other industries. The country’s cost of living drops, and its standard of living rises. Even those workers temporarily unemployed will benefit from this lower cost of living.

 

Concentrate solely on freeing one’s own economy

 

Others commented that my use of the term “unhampered market” negated my argument. I pointed out that there is always more work to be done and that there is opportunity for all in an unhampered market. These commentators pointed out that no country has an unhampered market; therefore, unilateral free trade would cause permanent unemployment. This makes two false assumptions. One, that workers can only train for one job in a lifetime and, two, that it is futile to lower barriers to employing capital and labor efficiently in one’s own country. The obvious proper response is to insist that one’s own government allow its citizens full economic freedom and not waste its time trying to persuade other governments to adopt economically sound policies. If other countries wish to punish their own citizens, that is their business and not ours. In fact we are made richer by their poor policies which provide us with subsidized products.

 

Conclusion

 

The only just policy that any government can take is to free its own economy to allow its citizens to purchase any legal product no matter where produced. This provides investors and workers with the only government help they need; i.e., the freedom to employ their capital and labor wherever it may achieve the greatest return. A nation’s citizens will enjoy the highest possible standard of living that adopts low taxes, the few regulations that merely support normal commercial law to protect citizens from fraud, and sound money to allow producers and consumers alike to correctly value their present transactions and expected future returns.

 

A corollary to freeing a market economically is to reduce public expenditures that discourage rational actors from engaging in socially destructive behavior. Welfare payments of all kinds, taxpayer supported public schools, unsound and unfunded government mandatory retirement schemes all reduce socially beneficial behavior. In fact our nation’s so-called immigration problem would go a long way to being solved if neither immigrants nor native born citizens had access to welfare, so-called free public schooling, free or subsidized housing, etc. on demand, nor could they trespass on either public or private property. This may not solve the immigration problem to everyone’s satisfaction, but it would be a huge step in the right direction.

 

The only economic problems that this country or any country faces come from its own misguided attempts to thwart the free market within its own borders. Stop complaining about what other countries are doing for the simple reason that they cannot harm us. Our economic future lies in our own hands.

Patrick Barron

Posted in News/ Lessons | Leave a comment

Two Unfounded Objections to Unilateral Free Trade

 

Recently I forwarded to my circle of friends what I considered to be a concise and accurate argument in favor of unilateral free trade. The author was Professor Don Boudreaux of George Mason University, writing in his daily blog Cafehayek.com. He responded to Mr. Daniel Dimiccio, former CEO of Nucor Steel, who was defending tariffs on foreign steel. Professor Boudreaux explained that arguments in favor of tariffs place all of economics on its head; i.e., that consumers were required to support producers rather than the other way around.

 

After sending Professor Boudreaux’s article, I have been hearing two common objections to his article from friends who consider themselves generally to be in favor of free trade, even unilateral free trade. The first objection I will call the Donald Trump objection; i.e., that imports have cost Americans good paying jobs, from which the nation has never recovered and cannot recover as long as we allow imports to replace American made products. The second I will call the essential industries objection; i.e., that there are some products that America must produce itself, no matter what the cost or inefficiency, in sufficient quantities to ensure access to these products in time of war.

 

Objection number one: Free trade causes unemployment

 

The first objection is easiest to dismiss, for it attempts to refute the “Law of Comparative Advantage“, postulated exactly two hundred years ago by the great English economist David Ricardo. Peaceful cooperation among peoples of the earth has no limit. Just as we Pennsylvanians find it advantageous to import pineapples from Hawaii rather than attempt to grow them ourselves, Americans find it advantageous to import many goods from people who just happen to live in foreign countries. Absent government intervention to restricts one’s own citizens from entering into peaceful cooperation to produce any legal product or service, all will find employment and all will be wealthier. A simple example will suffice. Let’s assume that Michael Jordan, the greatest basketball player of his generation (and perhaps of any generation) desired a new home. Let’s also assume that Mr. Jordan was a skilled carpenter, electrician, plumber, etc. Would Mr. Jordan become wealthier by quitting basketball for a year or two at the height of his career in order to build his own home? Of course not. Even if we assume that Mr. Jordan not only was a skilled craftsman but just happened to be the best craftsman in the world, he still would be wealthier paying less skilled workmen to build his new home while he earned much higher wages playing basketball. The corollary is that even those who are less skilled in ALL things can find useful employment in an unhampered market.  This is the “Law of Absolute Advantage“, a corollary to the “Law of Comparative Advantage”.

 

The Law of Comparative Advantage is also revealed once producers create a surplus. Savings produces capital, which produces more wealth when individuals are allowed to engage in the productivity enhancing division of labor via trade. The resulting products and services cost less than previously, yet employment is not destroyed. It is transferred to better uses, which enrich all. Both sides expect that trade is beneficial and must be allowed to freely trade their surplus product. The political location of individuals engaged in such trade is completely irrelevant to the wealth enhancing benefits of trade.

 

The logical conclusion of restricting international trade for just one or two so-called threatened industries is the demand that all products be protected. Advocating an autarkic society is to argue in favor of the fallacy of composition; i.e., that what might be good for one industry–for example, allowing domestic steel producers to extort higher prices from customers–cannot be extended to all industries.

 

This is akin to standing in a giant circle with everyone picking the pocket of the person in front while having his pocket picked in return.

 

The source of our societal problems, even those correctly identified, such as persistent unemployment, must be found elsewhere. As Ludwig von Mises would advise, one must find the proper means to arrive at the ends desired. If the US really does suffer from collapsing industries, restricting trade is not the solution but will exacerbate the problem. In other words, trade restrictions to cure unemployment are the wrong cure and will cause even more harm to society.

 

Unfortunately in modern day America there are many suspects to which one can assign economic decline. American industry is hampered by a panoply of regulatory red tape and outright restrictions at federal, state, and local levels. One needs only to consider the effects of the Environmental Protection Agency, the Occupational Health and Safety Administration, the Federal Food and Drug Administration, not to mention similar agencies at the state level, plus the disaster that is public education (regulated mostly by the states) and ever increasing regulations on economic life at the local level. (My tiny township government in southeast Pennsylvania recently informed us homeowners that we needed to obtain a township issued permit in order to resurface our driveways. So, now I need government permission to maintain my home in good repair!)

 

Objection number two: Essential industries must be protected

 

This is the national security objection; i.e., that the US must maintain a minimum production level of essential war related products. This is not an argument in favor of economic efficiency. Quite the opposite. Furthermore, little or no evidence is offered that nations have lost wars due to running out of essential products, although it undoubtedly is true that denying the enemy all kinds of goods and services does reduce a nation’s war-making capability. Nevertheless, one can make a good case that this concern is unlikely to be a factor by taking a closer look below the surface of this argument.

 

Stating the “essential industries” case:

Let’s assume that China wants to drive US steel manufacturers out of business. It succeeds by offering US steel users–manufacturers of buildings, bridges, autos, etc– high quality products at low prices for an extended period of time. After US steel production has been reduced to zero, China suddenly refuses to sell steel to us and, as a consequence we cannot build essential war material that requires steel components. We surrender to China, withdraw our military protection to allies, and/or accede to China’s demands, whatever those may be.

 

The response:

Note that for a long period of time, perhaps years or even decades, China must subsidize steel production, which drains its public coffers and actually reduces its own war making capacity. (China can’t build its own battleships, for example, if it is subsidizing construction of ours.) In the meantime, the US enjoys an increase in its standard of living. We build up our country in many ways, from new and improved bridges to a revitalized domestic auto industry (remember, cheap, high quality Chinese steel is subsidizing US car makers). Now China embargoes steel shipments to the US and makes threats of some kind. Our modern battle fleet, the product of cheap Chinese steel, is at our immediate disposal.

 

Meanwhile, our modern infrastructure, built with cheap Chinese steel, allows us to rush stockpiled war material, also built with subsidized Chinese steel, to our fleet and onward to our overseas bases and the battle area. We then gear up for the possibility of a protracted war by placing orders for steel with the other thirty-odd nations of the world who are eager to sell us high quality steel but who have been shut out of the American market by subsidized Chinese steel.

 

Now, I ask you…is this not the more likely scenario?

 

Importing subsidized products–perhaps especially products essential for war–increase a nation’s war making capacity rather than diminish it. We build up all aspects of our nation’s economy, including the defense sector, by using products with the best combination of quality and price, whether imported or not. Doing so allows us either to spend less for the same level of defense or increase our defense by spending the same amount of money but getting more war material in return. Our theoretical potential enemy has actually helped us defend ourselves and our vital interests abroad.

 

Conclusion

 

In conclusion, these two common objections to unilateral free trade do not stand up to closer scrutiny. For two hundred years David Ricardo’s Law of Comparative Advantage has informed us that in an unhampered market economy all will be employed to the limit of their capabilities. Furthermore, rather than reduce a nation’s security, imports of what we might consider to be “essential materials” actually enhance our security. We need to tax our own citizens less for the same level of security while building up our nation at the expense of potential enemies.

 

Let us end such nonsensical worries and trade freely with the world, especially with those whom we might currently fear, such as China. It wasn’t that long ago our nation feared Germany, Japan, and even Great Britain. It’s good to remember that peaceful cooperation provides its own momentum for everyone.

Patrick Barron

Posted in News/ Lessons | Leave a comment