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Re: How America Learned to Stop Worrying and Love Deficits and Debt by Neil Irwin
Reading Mr. Irwin’s Doctor Strangelove-esque article about whether or not deficits really matter, I was struck by this sentence, which was a paragraph in itself in the middle of his article:
“Then came the global financial crisis.”
Mr. Irwin treats the 2008/9 crisis as if it were an asteroid–completely random, unexpected, unpredictable, and beyond human volition. It was none of this. The global financial crisis was caused in large part by fiat money credit expansion, the very role of which Mr. Irwin’s article attempts to investigate. Interest rates were suppressed in the early 2000’s and continue to this day. The bitter fruits of this practice are inevitable.
This phrase in Mr. de Freytas-Tamura’s article about Irish concern over Brexit should be instructive to Irish statesmen:
“But food producers worry most that if Britain crashes out of Europe, it would open itself to cheaper goods from countries outside the European Union, making Irish firms even less competitive.”
Perhaps Ireland should open itself to “cheaper goods from countries outside the European Union”, too. Oops, I forgot…since the EU imposes very high tariffs on food stuffs from outside the EU, the only way the Irish could have access to cheaper food stuffs would be to leave the EU and reduce its tariffs. Not a bad idea, really.
Re: Dollars on the Margin by Matthew Desmond
Has Mr. Desmond, author of “Dollars on the Margin”, never heard of the “Marginal Productivity of Labor”? How about the “Laws of Supply and Demand”? No? Well, let me explain. If the productivity of one’s labor is less than the government’s arbitrarily mandated wage that businesses must pay for that labor, unemployment will result. Otherwise, capital will be consumed until the business goes bankrupt. If a price control, such as a minimum wage, is set at too high a level, demand for labor will fall and unemployment will rise. I am surprised that the supposedly knowledgeable editors at the New York Times printed an article that extols the benefits to raising the minimum wage without at least pointing out the probability of these outcomes. Sure, if one is lucky enough to keep one’s job, one lives a better life, as illustrated by the minimum wage workers that Mr. Desmond found. But Mr. Desmond failed to find two groups of minimum wage workers–those who lost their jobs due to the increase in the minimum wage and those who never got jobs in the first place.
Most of the world takes it for granted that central banks are necessary for the smooth conduct of trade, both foreign and domestic. Nothing could be further from the truth. Let’s be clear. Central banks are unnecessary barriers to commerce, harmful to economies, and enablers of war. A world of permanent peace and prosperity is impossible as long as they exist.
Unnecessary Barriers to Commerce
Through their power to control banking, central banks are unnecessary barriers to commerce. Even those who have spent their entire lives in banking, often in positions of great importance and responsibility, assume that cooperative exchange of goods and services requires a central bank’s oversight. But consider a typical trade, whether foreign or domestic. Joe Smith in the US produces widgets. Of course he desires to produce and sell as many as he can at a profit. He has willing buyers in both the US and overseas. Because he manufactures and ships his widgets from the US he is required by legal tender laws to conduct his trade in US dollars. In fact were he to refuse to accept US dollars, by law the buyer could take delivery of Joe Smith’s widgets and not pay him at all. But Joe is concerned that the US dollar is being systematically debased by the Federal Reserve Bank and that the dollars he accepts from his sales will depreciate in purchasing power before he can re-employ them to pay for the factors of production to produce more widgets. Therefore, Joe must increase his price to compensate for this currency risk.
But all this changes if the central bank and legal tender laws are eliminated. Joe can accept any form of payment to which he and his buyer agree. Since they both desire to trade, they will use whatever money is the most marketable; i.e., that money that others also will accept willingly. Gradually, sound money will emerge. It may be gold, silver, or something else, but it probably will be a commodity, a certificate (bank note), or account balance that is fully backed by a commodity (one hundred percent reserved).
The commodity itself may be used in hand-to-hand exchange for small, local transactions, but probably most exchange would be conducted no differently than today where electronic tools debit and credit bank accounts. A government controlled central bank is NOT required to settle this transaction. Any honest, private bank could do it and would do it. Nothing more is required than a book entry that increases the gold balance at Joe’s bank and decreases the gold balance at his customer’s bank, whether foreign or domestic. If Joe and his customer do not use the same bank, a third bank may be involved to settle the transaction. Such a bank is called a “correspondent bank”, meaning that both Joe’s and his customer’s banks have gold accounts there for the purpose of settlement. Many private banks perform this service today, bypassing the Fed.
All three banks–Joe’s bank, his customer’s bank, and the private intermediate bank–would be subject to normal commercial law that prohibits fraud. Joe expects that his bank and his customer’s bank have enough gold either in their own vaults or probably held in their names at a private, correspondent bank to satisfy their purchases and receipts. Regular audits by reputable audit firms would ensure against fraud. These firms would verify that each bank has enough gold on deposit to back their demand deposits one hundred percent.
Now, please tell me…where does government come into this transaction except to provide an honest court system in case of fraud or the occasional contract dispute?
People Trade, Not Nations
All trade is conducted by people. The statistics that aggregate a nation’s companies’ foreign purchases and sales are irrelevant and serve only to perpetuate the fiction that countries trade and not people. This leads to the completely fallacious claim that a nation whose companies and people sell more abroad somehow “wins” or benefits from trade and, likewise, that the nation “loses” if its companies and people in the aggregate buy more abroad than they sell. This fiction survives only because each nation has a central bank to control foreign exchange and legal tender laws that require its captive populace to use its ever depreciating currency. But if Joe Smith sells widgets to Honda Motors in Japan, each party benefits or the trade would not have occurred. Honda Motors’ bank account diminishes by the amount of the purchase and Joe Smith’s bank account increases. The reverse would be true if Joe Smith bought raw materials from a Mexican company. If each party benefits as expected from the trade, wealth is increased for the parties involved in the trade. Where in this transaction is the rationale for government control via a central bank and legal tender laws? Well, we all know the answer–government itself benefits by using the central bank to divert wealth to itself for wars and welfare.
Political Borders Are Irrelevant to Trade
The irrefutable observation that people trade and not nations leads to the epiphany that political borders and politically based trade statistics are irrelevant, meaningless, not necessary, and ultimately harmful. So-called “trade deficit” statistics lead to calls for monetary debasement to spur foreign trade and even protectionist policies to reduce purchases from people and companies in foreign lands. But such trade is no different than buying produce from a local farmer. You and your local farmer both benefit, just as Joe and his Mexican supplier of raw materials benefit. The world is made more prosperous. The truly tragic consequence of keeping national trade statistics is that such irrelevant yet seemingly important data can lead to international tensions. Today we witness our political leaders branding individual nations to be predatory because their people and companies sell more goods to Americans than Americans buy in return. But where is the predation if one ignores national borders? Buying raw materials from Mexico is no different than buying produce from a local farmer.
Misunderstanding International Trade Can Lead to War
As an informative thought experiment consider what would change if Hawaii were not the nation’s fiftieth state and had remained a sovereign nation. Would the impact on the US trade balance of the other forty-nine states composing a slightly reduced US have any meaning from the fact that the US purchased pineapples from Hawaiian farmers who now would be branded as foreigners? Of course not! The same is true if Alaska had remained part of Russia and had not been sold to the US during our Civil War. Would our industries be worse off due to the fact that the oil from Alaska was produced by Russian citizens and not American citizens? Of course not! The oil is the same economic benefit, regardless of who produces it. Think this is unimportant? Consider that there is the potential for military conflict in the very far north over future oil exploration. Russians, Canadians, Norwegians and most ominously Americans all claim sovereignty over these heretofore untapped oil reserves and vow to keep out companies headquartered in foreign lands. This is reminiscent of the imperial wars that racked the European powers for centuries as each tried to monopolize world trade. World War II was caused in large part by the Japanese attempt to control all trade in Asia at the expense of the old colonial powers. Since 1945 the Japanese economy has benefited immensely from simple trade without the need to control its trading partners politically. This should be a lesson to today’s world leaders, but don’t hold your breath.
A world of peace and increasing prosperity depends upon strictly limiting the ability of governments to interfere in international trade through their central banks and legal tender laws. Eliminating both would expose many economic fallacies that purport to characterize international trade as a competition between nations with their own citizens either winners or losers depending upon whether they are net exporters (winners) or net importers (losers). Central banks not only are barriers to trade and prosperity, they are fomenters of international tension and even war. Time to scrap them. Remember, the US did not have a central bank between the Age of Jackson–after President Andrew Jackson was successful in preventing the renewal of the charter of the Second Bank of the United States in 1837–and just prior to the Great War in 1913 when the Federal Reserve System was founded. During this era, despite fighting a civil war, the US economy grew probably at the greatest rate of any economy in the history of the world.
I have a sure fire way not only to minimize but completely eliminate scandals over government subsidies. Eliminate the subsidies!
You are welcome,
You ask, where is a Volcker-like Fed chairman today? The answer is that no president would appoint one and no government really wants one! Governments want easy money and will appoint only a Fed chairman who will succumb to money printing. Frankly, I believe that it is impossible to make a fiat currency sound. Here’s why:
- As I stated above, no government really wants sound money, because governments are the main beneficiary of easy money.
- No one who works in the Federal Reserve System, as did Paul Volcker for many, many years before becoming chairman, is a true proponent of sound money. If Volcker were honest and really wanted sound money, he would not work for the Fed. Volcker was president of the NY Fed. He knew how the system worked and would have quit if he truly didn’t believe in it. In other words, anyone who works for the Fed is an inflationist. It’s only a matter of degree. Volcker did print money, only he didn’t print as much as either his predecessors or his successors.
- The political pressure to inflate is irresistible. No one can ignore it. Even if you or I were appointed Fed chairman, we would inflate. If we did not, we would be removed for some reason.
- If we really wanted sound money, we would abolish the Fed and force banks to abide by normal commercial law, which would require them to back their deposits with a commodity. Once an organization is given the power to inflate the currency, inflation is exactly what will happen. In other words, “A person or entity that CAN print money WILL print money.” So don’t give any person or entity the power to print money! It would require an act of Congress to eliminate the Fed anyway, which is not likely to happen.
- You ask why Paul Volcker didn’t peg the dollar to gold at some higher level. The answer is that he had no power to do so, even if he wanted to do that. Furthermore, Volcker was not chairman in 1971, when Nixon took the US off the gold exchange standard. This act by Nixon just proves that the real power over the currency is political.
- My conclusion is that only political action can restore the dollar, not administrative action. In other words, the American people must want sound money. Barring a complete collapse of the dollar, as happened to the French assignat, this is not likely to happen.
There is nothing that another nation can do to harm another through trade. If a nation foolishly chooses to manipulate its currency to spur exports, it gifts goods to its trading partners. If it restricts imports to spur domestic industries, it harms its own citizens while leaving potential trading partners in the same position as before, which is NOT a definition of harm. The only policies that our government need adopt are unilateral free trade externally and laissez faire economics internally. Our motto should be “We will mind our own business and set a good example to others.”
From today’s Open Europe news summary:
Ireland demands level playing field in any Brexit deal
Speaking at a meeting of the European People’s Party (EPP) in Helsinki yesterday, the Irish Taoiseach, Leo Varadkar, said that Ireland wants the future relationship between the EU and UK “to be as close as possible” but added that it “must provide a level playing field and the integrity of our single market must be upheld.”
Elsewhere, Reuters reports that the European Commission also stresses the importance of such a commitment, quoting one EU official explaining that “It is important that Britain would not undercut our own products on our own market in the all-UK Irish backstop.”
Meanwhile, Cabinet Brexiteers have reportedly warned Prime Minister Theresa May that obligations on a level playing field “would mean a single market through the backdoor.”
Here you have the EU position in a nutshell. The EU is to be a closed trading bloc in which its citizens will be forced to buy shoddy, overprices goods produced within the bloc. Why the rest of the sovereign nations of the EU have remained in this blatantly inhumane association for so long is mystifying, except that continental Europeans have experienced many centuries of governmental dictatorships under many forms rather than the Anglo-Saxon tradition of the common law and government being responsible to the people.
Fareed Zakaria’s review of the Adam Tooze book Crashed: How a Decade of Financial Crises Changed the World is a typical Keynesian whitewash of a deeply flawed monetary and regulatory system. Like Tooze, Zakaria sees the Federal Reserve Bank as the hero in “saving the financial system” that was going into free fall in 2008. But why was it going into free fall, and was the Fed’s massive, multi-trillion dollar bailout really the answer? To agree with Tooze and Zakaria is to condone monetary counterfeiting pre-2008 and even more monetary counterfeiting thereafter. One of the prime purposes of sound, as opposed to fiat, money is to allocate scarce resources. The Keynesians do not admit that resources are scarce. They equate the medium of exchange, in this case fiat dollars, with real capital. Yes, fiat dollars can be increased to unlimited amounts at the click of a Federal Reserve Bank computer, but real resources and real capital must be accumulated by hard-working people. Zakaria and Tooze–and the rest of the Keynesian dominated Main Stream Media like the New York Times–fail spectacularly to understand the distinction.
In a recent post I explained that China’s manipulations of its own currency hurt only herself and not her trading partners and, therefore, retaliatory tariffs were not warranted and would be self-defeating anyway. China harms herself by causing her own money supply to expand, which destroys capital through malinvestment and causes prices to rise domestically. Retaliatory tariffs cause American goods to rise in price, resulting in a recession and general lower standard of living. Few economists claim otherwise.
It seems that everyone is in favor of free trade, as long as it is the other guy who must compete with foreign products. When it comes to their own products, the most typical response from American manufacturers begins with the caveat that “although free trade is beneficial most of the time, it causes harm under certain circumstances.” There follows a convoluted chain of cause-and-effect purporting to prove that lower priced foreign goods would hollow out America’s key manufacturing industries and turn America into a second class nation.
The purpose of this brief response is to counter these claims and explain why understanding economic theory is vital to the argument in favor of free trade.
There are two books which address the fact that we cannot experiment with an economy the way that physical scientists do. We must use logic to form irrefutable conclusions of what MUST happen, even if we cannot see it! The first is Frederic Bastiat’s early nineteenth century classic That Which Is Seen, and That Which Is Not Seen. Henry Hazlitt’s updated the book a hundred years later in order to appeal to modern readers. His Economics in One Lesson employs a series of short stories to illustrate that one must always consider the economic effects of an intervention on all and not just a few actors, plus, that one must look to the long term effects of an intervention and not just the short term effects.
So, let’s use logic to consider the effects of China’s economic interventions on itself and its trading partners who do nothing to retaliate against China in any way.
- China uses its capital in an inefficient way. Outright subsidies to any industry must be paid by someone. The very fact that China believes that it cannot compete in certain industries to its own satisfaction without subsidies is an admission that these industries are inefficient. Therefore, Chinese internal subsidies are transfers of capital from more efficient industries to less efficient industries. Put another way, if the targeted industries already were very efficient, more capital would flow to these industries and subsidies wouldn’t be necessary.
- Monetary expansion to fund an industry causes overall higher prices and malinvestment. This is the classic Austrian Business Cycle Theory. China may very well expand its steel industry, for example, with monetary expansion, but such action will disrupt the time structure of production and result in a higher price level and a recession. Other factors of production that feed the Chinese steel industry will rise in price, necessitating another round of currency expansion, which will lead to even higher prices and another recession. It’s a vicious cycle that can end only with an end to currency expansion.
- China’s overall economy will be less developed, weakening the impact of subsidies to targeted industries. Because capital is stripped from more efficient industries, China’s ancillary industries will be less developed, harming the targeted steel industry indirectly. Public infrastructure may be less than it would be otherwise, for example. The many business-to-business goods and services that feed the steel industry will lack the capital to expand. The workforce may lack adequate education. The list is endless. China’s economy will lack coordinated growth, as was so apparent in the moribund economies of the old Soviet bloc. The point is that something must be sacrificed to aid the targeted industry. Of course, this is a classic Bastiat “Not Seen” scenario.
- American products get cheaper and gain market share. It may be true to some small extent that the steel industry, for example, may not be able to expand and may even contract in the face of equal quality Chinese steel that can be purchased at lower prices. But all the many American manufacturing firms that USE steel will have a lower cost of production and, therefore, will be able to expand their markets. Again, something has to give; i.e., the Chinese may be able to sell more steel to American manufacturers, but these manufacturers can sell more finished goods into the world market.
- American industries benefit from the general expansion of all levels of production. This is a corollary to number three above but opposite. Because the companies that use cheaper Chinese steel reduce their costs, passing along the savings to customers in the form of lower prices, passing along the increased profits in the form of dividends to shareholder, increased investment in their own firms, or a combination of above. The reason for this beneficial prospect is that America becomes more capital intensive, and that capital came in the form of a gift from China.
- Chinese subsidies actually become subsidies to Americans’ standard of living. The purpose of production is consumption. Although we may give lip service to how much we love our jobs, what we really mean is that we are satisfied with the life style that we can obtain through meaningful labor. I truly doubt that many of us would work if we were not paid. Chinese subsidies allow us the option to work less for the same standard of living or work as long yet enjoy a higher standard of living because our pay goes further. We workers have more options. For example, as we become richer through Chinese subsidies, mothers may opt for part time work instead of a full time job, or they may leave the workforce altogether. Fathers may decide to pursue lower paid but less stressful careers. Let us not forget that leisure is a valuable good in and of itself.
Finally, the idea that all subsidies can be eliminated worldwide and businesses can compete on a level playing field is a foolish idea. What is the definition of a subsidy? Is it government provided healthcare? How about a state or municipality forgiving business taxes in order to entice industries to expand or relocate? If the government builds a super highway near a plant, is this a subsidy? Likewise, industries in many developed economies decry the fact that undeveloped countries have lower environmental standards, worker safety requirements, and worker rights. Periodically one reads that the European Union is threatening a member for having taxes that are too low and, thus, provide an indirect subsidy.
Capitalists must accept all of these interventions by foreign governments as part of the unknown and uncontrollable factors of conducting business and not lobby their own governments to take self defeating economic reprisals. Unilateral free trade is the best and only real option.