Tillman Talk

Austrian Economics Forum Fall '11 #4--Selling Costs, Quality and Competition

2011-12-01T15:27:00.002-05:00

As you have noticed, I have fallen woefully behind in my commentary for the Austrian Economics Forum, The Austrian Readings Group that meets at North Carolina State University. This was, in part, due to the birth of the third child. Since then, my writing has dipped off a bit. In fact, I was unable to attend the fourth session of the semester, because she was born that day. So I asked Alex Gill, the Graduate Student who basically put together and runs the AEF, to write up a summary of what happened that session. In his words…

This week we discussed Chapter Four, "Selling Costs, Quality, and Competition." Kirzner spends much of the chapter arguing against i) Chamberlin’s (early) views on product quality determination and his distinction between production costs and selling costs and ii) Marshall’s (and Hicks’s) views on advertising. Most of the chapter was non-controversial to the group since his arguments seem to follow rather directly from his notions of entrepreneurship and competition he developed thus far. For instance, on product quality he writes:

In the decision about which quality of product is to be produced the really significant aspect is not how to economize with given resources in attaining given ends, but the alertness with which the producer recognizes the kinds of goods consumers are eager to buy, the kinds of goods available technology and resources can create, and the kinds of resources that can be marshaled. It is the successful identification of relevant ends and means (rather than the efficient utilization of means to achieve ends) which marks the “right” decision on product quality. (p. 139)

No surprises here. In similar fashion, he argues that the distinction between production costs (“necessary for a particular product to be forthcoming”) and selling costs (which “alter the demand curve for that product”) is false. We can’t discuss demand for a nonexistent product, and we can’t distinguish between actions that enhance demand and actions that change the product. For the same reasons, it is a mistake to argue that advertising provides “a separate, distinct service” from the advertised product itself. In the course of his argument, though, Kirzner seems to contradict himself when he explicitly concedes (p. 155) that a “substantial portion of advertising may…be viewed as providing a service quite distinct from the advertised product.”

This statement, in fact, was the starting point for the forum’s discussion. Kirzner’s theory states that “selling effort” does not allow the separation of information into categories based on relevance or irrelevance with regard to demand determination. Indeed, the group could not even maintain that an individual could reliably make this distinction in his or her own mind. When Kirzner says that “some of that information is to be considered as inseparable from the product itself,” perhaps he should have replaced the “some” with “all.” After brief digressions on the relative merits of Kirzner and Ayn Rand’s personalities and RBC theory, we turned to page 168:

For us, the crucial question (in evaluating the claim that advertising “monopolistically” differentiates the product in the eyes of the consumer) must always be whether the advertising activities engaged in by the differentiating “monopolist,” are or are not open also to his competitors. (p. 168)

Then can trademarks be anticompetitive? Not if the trademark is viewed as a contract between the producer and the consumer and competitors are allowed to form their own trademarks. In a sense, a trademark monopolizes a particular logo, but it also conveys information to the consumer. A producer who uses another’s trademark is engaging in fraud and misrepresenting the origin of a product.

As would be expected at a gathering like this, the conversation then turned to intellectual property issues in general.

I was able to attend the last two AEF meetings and will write up and post those after I finish grading Final Exams!

The Purpose of Corporations II

2011-11-16T22:04:00.000-05:00

Every once in a while I get a comment that can be used as a teaching tool. Here is a comment I received on my post on “The Purpose of Corporations.” It may be crossing the line of proper etiquette, but I could not help myself. I have basically gone line-by-line examining the comment. The comment is in red and my responses are below them.

I can't believe a supposed doctor wrote this.

Starting an anonymous response with an attack like this is always a sign of class.

It's so woefully shortsighted and is pretty much everything wrong about the modern economy.

Then I hope that you clearly explain how shortsightedness creates an error that encompasses the whole of the modern economy.

Is the system working as you describe right now? A resounding NO!

Actually, I agree that the current system is not working as I described it. I described how a system would work in a free market. We do not live in a free market. We live in a world permeated with government rules and regulations that tip the scales in favor of some at the expense of others. I am very much in favor in getting rid of the government’s ability to intervene in the economy. Please join me in rejecting crony capitalism and crony socialism. No more bail-outs for businesses. And no bail-outs for students either.

Profits are being made with no real resource being managed.

What does this mean? Why is a real resource needed to gain a profit? The problem with this point is the word “real,” meaning that there is a dividing line between the tangible and intangible, where only the tangible matters. This idea of an objective value is simple-minded. Providing information can be a very profitable business. Education might be considered to be a business in which no real resource is being managed, so does this mean that there are no gains to education? (Remember: Profits are the surplus of the gains over opportunity costs.)

It's profit being made off of profit itself, leeching away the value of real labor resources from the working classes. That's the problem!

The idea that value comes from the labor of the working classes is clearly a labor theory of value reference. While this theory has been smashed time and again, it keeps coming back in different incarnations--like a bad zombie film. Value does not stem from any class nor does it stem from the time or effort of the labor involved. To say otherwise is to say that the amount of time working is directly related with value or the amount of effort has a direct relationship with value. (“Directly related” in this sense means the opposite of “inversely related.”) In other words, my anonymous friend is saying that the longer one works, the more valuable the output. A watch that has 1,000 labor hours is twice as valuable as a watch made with 500 labor hours. Or “he” is saying that a watch made with twice the effort is twice as valuable as another watch.

Of course, both of these propositions are ridiculous. My students earn their grade based upon the correctness of the answer and nothing else. If one student studies twice as long or works twice as hard has no bearing on the grade received. All that matters is what is put on the answer sheet. The same is true when it comes to goods and services. It does not matter if one producer worked twice as long or twice as hard as another. All that matters is the judgment of the consumer. The value of the good is a product of the consumer’s mind and nothing else. If the consumer values the good at $5, then he will be willing to pay up to $5 for it. If the consumer values the good at $0, then the amount of time and effort of the producer is irrelevant. It is all wasted.

Prices do not simply function as pieces of information, they are extremely powerful implements of social control.

“Implements of social control?” In a sense, yes of course they are. They signal to any one who wishes to use a resource its relative scarcity. It allows the user to calculate the opportunity cost of using that resource. When the price rises, it tells the users of such resources that the resource in question is more scarce. It gets users of the resource to reduce their use, conserve. The least important uses of the resource are dispensed with first. It gets users to look for substitutes. It is in this sense that prices “control” society. But in saying this it is no more control than a red stop light saying, “Stop.” If the entrepreneur ignores the price signals, he will be out of business. If I ignore the red stop light, I will likely get into a car accident.

If fact, prices are such important signals that without them very little economic calculation could be done. Society could not exist without prices. Indeed, prices are what allow societies to exist. So I suppose that in this sense, there could be no “social” to control without prices.

Who is the consumer in a stock transaction?

The buyer of the share of stock.

The answer today is really no one, there is no person deriving use from a good that is sold. The primary "use" of stocks today is as placeholders of value -- their prices.

The owner of the share derives a dividend, a portion of the profit generated by the company serving its customers. The cash flow, the dividend, is the benefit of the stock and is the reason for its ownership. The cash flow is the return on the money saved. The money saved was invested into the company. The company combines resources to serve customers. The extent to which people trade with the company is a reflection of how well it is combining resources to meet consumers’ needs, wants and desires. And not just random or trivial needs, wants and desires, but the most intense needs, wants and desires first. The value of the company is reflected in the stock, the equity. Call it a “placeholder” if you want, it does not change its nature as the reflection of how well a specific group of people are pleasing customers.

How then does a "good" get priced when its value is its price? The answer is that it cannot be priced in any way that is beneficial to an economy, by any system that makes any sense.

Again this is naïve. Here is a quick lesson in Corporate Finance…. A firm looks into the future and must project what it will do to combine resources to meet future needs, wants and desires of its customers. It creates a pro forma statement. It looks at the projected revenues and the projected costs. It creates a projection of cash flows occurring in future periods. Then it uses its opportunity cost, the Weighted Average Cost of Capital (WACC) to discount all of those future cash flows to the present. Then it subtracts the upfront costs of the endeavor. This process yields a Net Present Value (NPV) of the project. If the NPV is positive, the endeavor should be undertaken. If the NPV is negative, the firm looks for something else. The greater the NPV, the more valuable is the company’s endeavor. As the company announces its future plans, the eyes of the world evaluate the firm’s decision. If they agree that this project adds value (or more precisely will add value) to the firm, then this increase in value is reflected in the share price of the firm. Bad decisions (in the eyes of the market) lower the price of the company. The benefit of these capital markets is merely the efficient allocation scarce resources to good decision makers and away from bad decision makers. Without profit and loss, without economic calculation, without the ability to value projects and companies, there is no ability to efficiently allocate scarce resources. The opposite of the stock market is evaluating which is a better user of resources: the DMV, the Post Office, or the Judicial System? There is no method to know. But I can easily tell you which for-profit company is a better user of resources. And I can do it at a glance. We can’t even come close with bureaucracies.

This is how the global financial system has essentially turned into a gigantic casino game. And that is not good at ALL.

The idea that the financial world is the same as a casino game is an argument by analogy and wrong on its face. There is no house. When I win a chip, someone must lose a chip. It’s all just random luck based upon probabilities. Apple Inc. was not random chance. Successful corporations are not just random luck based upon probabilities. Creating a successful company is hard work and long hours. It is being “others focused.”

You have to know what will please your customers and then constantly strive to please them. And customers are fickle. They don’t tell that they are coming to your store in advance. They just show up and you have to be ready. They don’t tell you what they are looking for, but you had better have it on your shelves. They don’t tell you what they think is a good price, but if you don’t meet their price, they walk out without a word. Running a business is hard. Being successful is harder. Going global, that’s mindboggling!

And yet, we take it for granted. I expect to walk into a Walmart at 2am in the middle of rural North Carolina and buy Kiwi 3/$1! How insane is that? We need to take the time and marvel at this economic system, which has built the highest standard of living ever known in the last 5,000 years of recorded human history. Before we tear it down and decry the free market and the role of corporations, we had better take a very close look at what it is that we intend to do away with. I absolutely know that if we tear down the market economy, we sentence ourselves to a life of future poverty. I cannot and will not sentence my children to that fate.

New Posts?

2011-11-12T12:08:00.001-05:00

If you have noticed that there have not been any new posts in quite some time, you are correct. It has been a busy time and I have fallen woefully behind.

At the top of the distraction list is the birth of my third child (girl). She is doing fine, but sleep has become something of a rare commodity in the household.

Additionally, I have completely changed my approach to my Money and Banking class this semester. I decided to use Rothbard's The Mystery of Banking as the primary text and the regular textbook as the secondary source. I think that this experiment has been wildly successful. The students are enjoying the class, and they are actually reading the book! I asked one student if he managed to read Chapter 7. He said that not only did he finish Chapter 7, but that he was reading ahead and was now starting Chapter 13! It's even more amazing when its realized that we don't have economics majors at Mount Olive College! The downside of all of this is that the class is a "new prep" and has been a major consumer of my time for most of this semester.

Anyway, the NCSU Austrian Readings Groups have still been continuing and I will write up and post the results of the discussions. So there will be a #4, #5 and #6 to look forward to.

Next semester, we have agreed to open up the Readings Group. The members of the group will get to pick a week and a topic, article, paper they are working on, etc. and present it to the group and lead the discussion. I am looking forward to it.

As an aside, I recently finished reading Mises' Theory and History. I have always been fearful of that book knowing that it's a book on methodology and that I could be quickly overwhelmed. I could not have been more wrong. In fact, I found the book very readable. There were parts where one had to think about Mises' argument, but overall it was an enjoyable read. I am somewhat ashamed of my earlier fears. So note to self, never avoid reading Mises!

Austrian Economics Forum Fall '11 #3--Competition and Monopoly

2011-10-06T12:43:00.002-04:00

This week’s forum focused on the third chapter “Competition and Monopoly” in Kirzner’s book. Much of the chapter was not controversial to an Austrian audience and so there wasn’t the sort of discussion surrounding it as one might expect with a larger mix of mainstream economists.

In traditional theory, economists envision a continuum in which we place “perfect competition” on one end and “monopoly” on the other. This method of organizing our thoughts says that the most important aspect of markets is the number of firms. On the monopoly end, there is one firm, while on the other end there are so many firms that they all face horizontal demand curves. (As an aside, we really need to get rid of the term “perfect competition” and replace it with “perfect equilibrium,” because there is no competition in that model. It’s an equilibrium-only model.)

Kirzner completely rejects this approach to defining competitive markets. He wants to use “competition” in the same manner that the average person uses it: as a rivalrous process. Competition describes actions. It is a verb. The mainstream uses competition to describe states of markets. It is a noun. The result is that the mainstream cannot communicate to laymen, which Kirzner says has been a “disservice.”

With competition defined as a process, we can then apply it to the entrepreneur. When the entrepreneur recognizes a market opportunity, he is able to act. He applies means to achieve ends. If others wish to use those same means, a rivalry emerges. In a market, a bidding process arises and the one who outbids the marginal rival is able to employ those means. It is this process that coordinates the economy. The move toward equilibrium is an unintended consequence. The mainstream lacks this function in that the Robbinsian maximizer does not compete. Kirzner states

Purely Robbinsian economizing activity is never competitive; purely entrepreneurial activity always is. In other words, I am asserting, that entrepreneurship and competitiveness are two sides of the same coin: that entrepreneurial activity is always competitive and that competitive activity is always entrepreneurial (rather than Robbinsian). (p 94)

The Robbinsian maximizer merely chooses the course according to a given framework and a given set of economic relationships. In contrast the Kirznerian entrepreneur looks at the unseen and chooses based upon some factors that may be hidden or absent. The entrepreneur strives for profits and does so by out-competing his rivals. The “pure Robbinsian decision-maker is not seeking to outdistance his rivals—he is not intent on learning what opportunities they are about to available to the market in order to attempt to make available still more attractive opportunities.” (p 95)

Later (p 108) Kirzner states, “As soon as we draw the cost and revenue curves facing the firm, no matter what their shape, we have created a theoretical case in which all competitive behavior has by definition been ruled out. What is left is neither competitive nor monopolistic (in the process sense), but a problem in allocation.” This means that as soon as we assume the structure of the cost curves or the type of demand curves, we have transitioned away from anything competitive and entered into the world of the Robbinsian maximizer. I think that this analysis goes too far. In one sense I see exactly what Kirzner is attempting to draw attention to, however I do not see why a sufficiently generic supply and demand graph has to be that way. If we follow Kirzner, then even imagining curves sends us into the maximizing world. I think that an economist can look at a static graph and recognize that it is an imperfect representation of a dynamic process.

Kirzner then examines how competition can be limited. “[F]or us to speak freely of a lack of competitiveness in a market process, we must be able to point to something which prevents market participants from competing. … What is it, …, which might halt the competitive process? … Competition, …, is at least potentially present so long as there exist no arbitrary impediments to entry.” (p 97) As we can tell, there are several reservations and qualifications in his definition. Furthermore, we doesn’t define the areas of monopoly in a positive sense, e.g., “you’ll know monopoly when….” Instead, he defines a potential absence of competition in a negative sense and assumes that the result is monopoly. Personally, I do not like this approach. It seems that there is too much hedging. Is there a reason to be overly cautious? I do not know.

Later on (p 99), Kirzner gives us a better definition: “When we assert that purely entrepreneurial activity is always competitive, we are then asserting that with respect to purely entrepreneurial activity no possible obstacles to freedom of entry can exist. We can see this by recalling that purely entrepreneurial activity involves no element of resource ownership. … [B]lockage of entry into a particular activity must arise from restricted access to the resources needed for that activity. … All imaginable obstacles to entry can be reduced, in basic terms, to restricted access to resources.”

To summarize Kirzner’s position, the pure entrepreneur is a metaphysical concept. It is simply the recognition of a profit opportunity. There is no way that we can stop a person from recognizing an opportunity. As a result, all entrepreneurship is competitive and short of direct brain control, it is impossible to curtail this recognition. Thus, all anti-competitive restrictions have to occur on the level of access to resources. The restriction of access to resources is a decrease in competition. A complete restriction is a monopoly.

We talked about the implications of these concepts. There arise two types of monopolies: one created by a government action and one created through the sole ownership of a resource. While we agreed with the first, the group debated the second concept.

As an aside, it arose that private property is a legal restriction to the access of resources. I therefore have a monopoly over my car. While Kirzner does argue that monopoly “diverts the entrepreneurial-competitive process into” other markets, I know that he would not argue that we should abolish private property. (p 107) Kirzner states, “For us monopoly means the position of a producer who is immune from the threat of other entrepreneurs’ doing what he does.” (p 106) However, it seems that for Kirzner, monopoly is not necessarily a bad thing. I suspect that he will cover this in more detail later in the book.

Mises argues that intervention in the market distorts the market. When the government buys pencils, it is not disrupting the normal market process and thus this is merely a shifting in supply and demand curves. When the government imposes rules that prevent the market from doing its job, we have permanent discoordination. For example, a maximum price set below the market price will create a permanent shortage. I see Kirzner using the same logic in the background of his analysis. When a monopoly exists due to legal barriers, we see the market unable to perform its job and this is bad. If there is a monopoly that arises from ownership, then the market curves shift and the market adjusts.

The next item that we discussed was the idea of monopoly rent. This is the return that a monopolist gains because he is a monopolist. It is an addition to the return on the other factors of production, in which we are including entrepreneurial profit. We found it difficult to separate these rents from the concept of entrepreneurial profit. Luckily, Kirzner does not use it in his welfare appraisal of the monopoly. Instead, he uses “the speed and smoothness with which misallocations can be discovered and corrected” (p 112) as his basis of comparison. This definition directly parallels Mises’ definition on interventionism, where the focus (for monopoly) is directed to the obstacle to entry.

We then touched on some relatively random points. We found them thought provoking and interesting enough to comment on.

Kirzner states, “for our notion of monopoly the shape of the demand curve facing the firm is of little significance. … [T]he significance of monopoly does not relate to the theory of the firm at all. (It is because of this that the shape of the demand curve is irrelevant.)” (p 108) The importance of this comment is that the mainstream focuses on the firm (and the industry) and the consequent shape of the curves that the firms face. Austrians have long rejected this static view of Industrial Organization. Instead, we focus on the competitive process, on the action, on the verb.

Kirzner has a discussion on Monopolistic Competition, in which we basically throw the concept out. In characteristic Kirzner fashion he cannot make a strong, direct statement and instead says, “The position developed thus far in this book makes it impossible for me to accept this approving judgment on the theory of monopolistic competition.” (p 113) More directly he states, “the theory of monopolistic competition was on balance a decidedly unfortunate episode in the history of modern economic thought.” (p 114) The problem was, of course, the fact that when it threw out the old perfect competition model, it left out the competition (in the Austrian sense).

Kirzner then has a nice discussion (pp 115-117) on how only in disequilibrium does product differentiation exists. There is no reason to change product quality in a world of equilibrium.

Kirzner then delivers the one-two punch to monopolistic competition:

Thus far my criticism of the monopolistic competition view of the market has charged it (a) with overlooking the simplest available explanation of such phenomena as product differentiation …, and (b) with gratuitously advancing an alternative explanation ascribing these phenomena to the presence of monopolistic elements. … The explanation provided by the theory of monopolistic competition not only fails to recognize the disequilibrium character of the phenomena it seeks to explain, it fails even as an equilibrium theory. (p 117)

Nice.

Finally Kirzner compares his concept of the entrepreneur with that of Schumpeter’s concept. They both reject the model of perfect competition. Schumpeter does so on the grounds that entrepreneurs are disruptive to all equilibria. They create something new which then explodes all the old economic relationships. Kirzner does not deny that this occurs, but is merely a subset of his “alertness to hitherto unnoticed opportunities.” The difference then rests on Kirzner’s emphasis. He says that the primary function of the entrepreneur is to coordinate resources, the result of which is the movement towards equilibrium. For Schumpeter, the coordination process is secondary and mundane.

The next meeting has been changed. Instead of meeting in 2 weeks (October 14th), it will convene in 3 (October 21st). This development is unfortunate for me since that is the day that we have scheduled the trip to the hospital for the new (girl) baby’s arrival. Since the surgery is scheduled for the morning, in theory I could make it to the afternoon meeting. (Yeah, right!) So I will try to recruit someone to write up a summary for that session. We’ll see.

$16 Muffins, A Recipe for Bad Economics

2011-09-27T14:55:00.000-04:00

The AP posted a story where the Department of Justice paid $16 apiece for the morning muffins at a recent conference. While the author rightly condemns the government for wasting tax money, the article takes an odd turn. The article states,

"Which all kind of misses the most compelling issues. If you did spend $16 on a muffin, what would it look like? How would it taste? Is it even possible?"

It then goes on to say,

"The typical muffin baked in an institutional setting such as a hotel costs about 50 cents or less, not counting labor. If you go crazy extravagant and reach for the top-shelf organic flour, maybe some hand-harvested wild blueberries from Maine and fancy sugar, you're still going to max out around $1 per muffin on raw ingredients."

Talk about missing the "most compelling issue!" The author makes a typical economic error, which should have been learned in the most basic economics class, and that point is this: the price of any good or service is determined by the interaction of supply and demand. It is NOT determined by the price of the inputs. If the cost of materials determined the price of anything, then no business would go out of business, ever.

Let me repeat this necessary fact: Costs do not determine price.

Too many people simply do not understand this principle. Too many people think that retailers simply take wholesale prices, mark them up and then viola! Done. If we stop to think for a moment, if this were the case, then why are there sales?

Let's take a simple example...

You may have noticed that the price of corn is not that same as it was a few years ago. Today you might see ears of corn selling 3/$1, while just a year or two ago it was selling for 4/$1 or even 5/$1. A few years before that it may have even been 10/$1. Setting aside inflation, the grocer might tell you that the reason he raised his prices is because the wholesaler’s price has gone up. In other words, he says his costs have gone up.

In order to correctly analyze the problem, we need to look beyond the seen and think about the unseen. This technique is called Counter-Factual Reasoning. Counter Factual Reasoning is being able to compare the “seen” world with a hypothetical alternative. When we apply counter factual reasoning, we realize that we need to ask why the wholesalers’ price of corn rose. We begin the process of tracing the change in price to its root causes. After some thought, we realize that the problem is ultimately caused by an increase in demand. Corn has a wider variety of uses than just eating it on the cob. For example, it is used as a sweetener in drinks and it is also used to create ethanol for cars. With the increase in the number of uses for corn, the demand for corn rises. These competing uses each bid for the corn. The result is an increase in the demand for corn, which causes the wholesale price to rise. So while the grocer may tell you that the price is increasing because of supply reasons, the unseen fact is that it is really demand that is driving the price change.

I suppose that I cannot fault the author of the article for getting it wrong. I see that it was just a segue to talk about expensive muffins. But really, using economic fallacies to get to your topic, come on! Can't we do better than that?

Austrian Economics Forum Fall '11 #2--The Entrepreneur

2011-09-24T14:01:00.000-04:00

This session's Austrian Economics Forum dealt with Chapter 2, "The Entrepreneur" in Israel Kirzner's book, Competition and Entrepreneurship. We had a dozen people attend this session, in which there were three Austrian Economists with PhDs. Additionally there was Dr. Margolis, who is a close fellow traveller, and who we are very happy to have join us each week. (I wonder if there are many other regular Austrian discussion sessions with such a line up each time.)

Israel M. Kirzner

The opening question centered on whether Kirzner's construction of the "pure entrepreneur" is a useful concept. While it is obvious that Kirzner is discussing an archetype and that no such purity must exist in the real world, the central points that we were wrestling with was whether the pure entrepreneur acts and the implications derived from our conclusion. According to Mises, acting is the application of means to achieve ends. Kirzner's entrepreneur does not use means at all. Kirzner states that the entrepreneurial "decision was made before the original act of purchase...." (p. 50) He simply recognizes profit opportunities. So Kirzner's pure entrepreneur never acts, at least in the Austrian sense. Is a non-acting entrepreneur a fruitful concept in Austrian Economics? The discussion group has not reached a conclusion.

Furthermore, Kirzner argues that the pure entrepreneur receives a return for recognizing the profit opportunity. As I understand it, Kirzner argues that after all the factor payments are paid out, there is a residual. From that residual must be subtracted the implicit return to the entrepreneur’s use of his own money and his time, the opportunity costs of these subjective factors. So the amount that then remains (above the opportunity costs) is the return to the pure entrepreneur.

However, my question is, "How can a non-actor earn a return?" We speculated that the pure entrepreneur "acts" by conveying information to the resource owner. Under the Misesian definition, this is clearly a no, but even under the normal usage of "acting" it is a stretch. Later in the chapter, Kirzner references Mises article, "Profit and Loss." I found this curious because in it, Mises has sa very different definition of entrepreneur. Mises states,

"There is a simple rule of thumb to tell entrepreneurs from non-entrepreneurs. The entrepreneurs are those on whom the incidence of losses on the capital employed falls. Amateur-economists may confuse profits with other kinds of intakes. But it is impossible to fail to recognize losses on the capital employed."

A key point is that the entrepreneur acts and opens himself up to potential losses. Where's loss for Kirzner's Entrepreneur? Where is the possibility of entrepreneurial error? How does this error fit into the overall picture? Furthermore, if we are looking at the structure of the firm, where is the responsibility within the firm? Mises would say that it is the owner/entrepreneur, but it seems that Kirzner would split those functions. So would the ultimate responsibility fall on the decision-maker, the resource owner and not the entrepreneur?

So, if the pure entrepreneur does not act, is this a step in the wrong direction? The Austrians have consistently argued that the entrepreneur is central to coordinating the market. Is creating this ideal type of a non-acting entrepreneur a direction that Austrians want to take? I am not convinced that this is a proper course for Austrians. It is clear that this issue will continue to develop as we progress through the book. My thoughts are that under the standard definition of action (purposeful behavior), which is typically employed by Austrians, we should reject Kirzner's pure entrepreneur. However, I might change my mind after we finish the book.

At this point the discussion turned to why Kirzner would employ such an abstract concept. Our conclusion is that he was trying to draw the greatest possible distinction between his construct of the entrepreneur and Lord Robbins' maximizer (RM). (While Kirzner uses the RM for comparison, I have been thinking that perhaps we might want to use the Walrasian auctioneer instead.) It seems that the central reason why he wants to contrast with the RM is because the RM simply reacts and crunches numbers in response to changing conditions. So here Kirzner is arguing that the entrepreneur is better because he is discovering new conditions about potential futures. Without this recognition of discoordinations (profit opportunities) then we could at best stumble into superior (coordinating) moves. The exploitation of the profit opportunities moves the market (unintentionally) toward a more coordinated state.

There was some discussion of moving the economy toward some "Ultimate Equilibrium" but that was quickly rejected. On the other hand there is a discoordinating aspect of the actions of these owner/entrepreneurs. Schumpeter's contribution to entrepreneurship theory is that the entrepreneur is essentially a destroyer of old methods of production and a creator of new equilibria. Kirzner downplays this aspect and focuses on the coordinating role of the entrepreneur. Contrasting with Schumpeter, Kirzner sees the entrepreneur as a responder to and "not as a source of innovative ideas." (p. 74) The entrepreneur must be alert to opportunities that already exist. Cordato pointed out that in an open universe, inventing is equilibrating (in a sense), but the actions of the entrepreneur are not always coordinating, at least not in the short-run.

A causal reading of Kirzner might lead one to conclude that he rejects the creative feature of entrepreneurship, but the word Kirzner uses is "emphasis." He states, "By contrast my own treatment of the entrepreneur emphasizes the equilibrating aspects of his role." [italics added] I do not see Kirzner as completely rejecting Schumpeter’s creative-destroyer, but simply shifting the focus to the entrepreneur’s coordinating role.

We then shifted gears to address Mises’ claim that “every actor is always an entrepreneur.” (Human Action (1949), p. 253.) The reasoning is this, if all ends are subjectively determined and since these ends are necessarily projections of potential future states, then there is uncertainty surrounding the means to employ to achieve these ends. With the uncertainty, we move away from the perfect knowledge of the RM in the state of (so-called) “perfect competition,” and we move into the world of the Austrians. With this uncertainty, there is an opportunity for pure gain to come from pure entrepreneurial insight.

Margolis posed the question, "Have we lost the separation with the Robbinsian maximizer if all are entrepreneurial?" I would have to say yes. There are no given payoffs and production functions without Kirznerian entrepreneur. I do not recall who said it, but a wonderful insight was made, “Means are not given, they must be perceived.” Additionally, there is a separation between acting and reacting. The Robbinsian maximizer is clearly reacting. There are outside stimuli and the maximizer adjusts. "Robbinsian decision-making ... see ends and means as data." (p. 78 fn 34) The Austrian conception of the owner/entrepreneur is that he enters the market with knowledge and acts upon profit opportunities. The unintended consequence is the addition of information into the market and a higher degree of coordination.

So now we have it straight. The Kirznerian pure entrepreneur stands in sharp contrast to the Robbinsian Maximizer in that the RM merely reacts to outside stimuli. The Kirznerian entrepreneur differs with the Schumpeterian entrepreneur in that the primary role of the Kirznerian version is coordinating while the other discoordinates. The Kirznerian pure entrepreneur differs from the Misesian concept because the pure entrepreneur does not act and only perceives. Right?

And then we come to page 84 where Kirzner says, "It is the deliberate exploitation of perceived opportunities which is essential to the entrepreneurial role." Does this radically change Kirzner’s pure entrepreneur? Now he acts. That implies using means, which implies resources. Was the pure entrepreneur a long side step? I argued that this statement should just be thrown out. Cordato argued that the payoff is the distinction between Robbinsian maximizer and the pure entrepreneur. However, I think Palasek got it right. She pointed out that he is using “entrepreneurial role” here and not concept of the pure entrepreneur. The use of the word role does indicate that he has taken a step away from his pure entrepreneur. I am not sure exactly where this leaves us. Clearly, reading Kirzner is difficult. I am hoping that more will develop along these lines in the later chapters.

I had one further observation. The definition of the entrepreneur from the French is from entreprendre, to undertake, one who undertakes a project, or an “undertaker.” This definition of the entrepreneur follows in the tradition of Cantillon, Turgot, Say, Menger and the Austrian School. The mainstream tradition of Smith, Ricardo, Mill, Walras, and Marshall has tended to neglect the entrepreneur and his function. While Kirzner is clearly emphasizing the role of entrepreneur, his definition of the pure (non-acting) entrepreneur does not fit within older the Austrian tradition. He has broken new ground. For this reason alone, Kirzner is worth reading.

Which Economists Show Support for Obama's Plan?

2011-09-09T14:32:00.001-04:00

Today there was an article by Derek Kravitz on the AP which was entitled as "Economists Show Support for Obama Job-Growth Plan". Now which economists are those? Well, he quotes Mark Zandi of Moody's Analytics, Allen Sinai, chief economist of Decision Economics, Susan Wachter, a finance professor at the University of Pennsylvania's Wharton School, Michael Mandel, chief economic strategist for the Progressive Policy Institute, Paul Ashworth, chief U.S. economist at Capital Economics and Menzie Chinn, an economist at the University of Wisconsin. (Personally, I have only heard of Zandi before and I think he usually has it wrong.) Amazingly they say that more stimulus is what is needed. Well, maybe not Mandel. (Kravitz is not very clear on this point.) And Ashworth says that people might just save it instead of running out and spend, spend, spending it. (How horrible!) However, as we see by the article's title, the whole point is to show how much economists love Obama's plan. In fact, Chinn says that the plan doesn't go far enough.

Here's the commonality: they are all locked into the formula GDP = C + I + G + (X-M). In other words, the size of the economy is equal to Consumption + Government Spending + Investment + Net Exports. Of these components, they rightly see that consumption is by far the largest.

The only problem with this approach of looking at the macroeconomy is that it is completely wrong.

GDP is defined as the summation of all final goods and services in an economy over a certain period of time, usually a quarter or a year. Only final goods and services are counted because we do not want to double count. In other words, when we make a table, we don't want to count the table when we chop down the tree, and count it again when we turn it into boards, and again when we construct the table and then again when it goes to the wholesalers, and so on. It's one table and we only want to count the one table once. Fine. That makes perfect sense; however most economic activity does not take place at the final stages of production. That's the "Do you want fries with that?" stage. Most people and most economic activity are not there.

So what is a better approach? The Austrian Approach is, by far, better.

We need to disaggregate the Capital Structure--The Structure of Production. Only by viewing the economy as a process of production can we get an idea of how the economy works, and more importantly, how it grows.

The economy does not grow because people simply "demand" stuff. Think about it. Do you demand more than your parents, or grandparents, or people who lived 1,000 years ago? Are we rich in the US because we simply want things more than those who came before us? Ridiculous! So, if it isn't demand that has caused us to be wealthy, then it must be that other thing that economists talk about--supply.

Yes, it is supply that allows us to be wealthy. Now, let's pause as before and think about this point too. Could it possibly be that more stuff is what allows us to have more stuff? Duh! Yes of course it is. Supply has always been the limiting factor, not demand. Thus, we need to focus our attention on production.

In order to get out of these economic doldrums, we need to produce more. It is only through production that we will be able to grow. So how do we grow when starting from a depressed economy? We need to let the costs of production fall. We need to stop propping up prices and let them fall. As input prices (yes, this includes wages) fall, profitability will rise. As profitability rises, there will be more economic activity from both existing companies and new rivals.

The bottom line is that the business sector needs to cut its costs. We could let input prices fall (commodity prices are still fairly high); we could let nominal wage rates fall; and we could reduce the costs of keeping up with rules and regulations. Additionally, imagine how much productive energy would be released if we simply abolished the corporate income tax. All those wasted hours converted into productive activity. A zero corporate income tax would attract capital from all over the world to the US. The first country to do this will be the big winner and then other countries will have to do the same to remain competitive. Instead of implementing Frank-Dodd and ObamaCare, we should repeal these and even more regulatory burdens. What a boon to business and the economy! Production will grow and with it, the economy.

And remember, consumption, jobs and prosperity are a consequence of production, they are not the reason for it.

Austrian Economics Forum Fall '11 #1--Competition & Entrepreneurship

2011-09-07T15:28:00.001-04:00

We have finally kicked-off the new semester of the Austrian Economics Forum at NCSU. About a dozen of us decided that the best thing to do at 4:30pm on a Friday afternoon was discuss Austrian Economics. (I know that this is not normal behavior, but I still find that I have an overwhelming need to be there.)

We are reading Israel Kirzner's Competition and Entrepreneurship (1973). There are six sessions scheduled for this semester and there are six chapters. (That was just fortunate.) The first chapter "Market Process versus Market Equilibrium" was this week's focus. I found that I needed to remind myself several times that this is only the introductory chapter. There are a number of points that need further clarification and refinement, but Kirzner doesn't (and shouldn't) go into an in depth explanation in the introductory chapter.

The next point that I needed to remind myself was who the target audience was for Kizner. Professor Cordato gave a brief overview of the state of the profession in 1973. This was a time when General Equilibrium (price) theory reigned supreme and that all firms were either perfectly or imperfectly competitive. So the target of this book is not me. I was "raised" Austrian. I was taught from the beginning competition is a verb and not a noun. The target of the book is obviously not those professors who are locked into their ways. Then who is the target? My guess is that the targets are graduate students in economics. They are still forming their opinions on which school is correct and will be more open-minded about the different approaches.

Kirzner sees the profession completely focused on equilibrium. The dominant view is that we should be in equilibrium and, if reality differs from it, then there is an imperfection that needs to be studied and corrected (usually by government). Kirzner suggests that there is an alternative. Competition should not be studied as a state of being, for example, "the XYZ Market is in a state of perfect competition." Rather the normal, vernacular, usage of "competition" as a rivalrous process should be adopted. Competition is a verb and not a state of being. Therefore, equilibrium, while an important tool, should not be the focus of the economist. Instead the questions of "Why is there a change in prices?" and "What are the forces behind the price changes?" should dominate the economist's thinking.

Economists too often use phrases such as "market forces" to describe the market process. "Market Forces" move the market to equilibrium. Professor Margolis challenged the group by asking us to describe exactly what we mean by "market forces"? He stated that we all like to tell a story that illustrates an example of market forces, but we tend to leave "market forces" as a fuzzy concept. My thoughts are that it is shorthand for explaining how individuals have some sort of "felt uneasiness" (to use Mises' phrase) and think about how they can replace that state for a better one. Then they act. Within this analysis we are implicitly assuming time and ignorance (to use the title from Rizzo and O'Driscoll's book).

As buyers and sellers enter into the market they bring with them knowledge. As the desires of the buyers confront scarcity, a price is generated and ignorance is lessened. It is in this step-by-step manner that the market will equilibrate. Contained in this notion is an implicit ceteris paribus assumption. We need to realize that tastes, preferences, expectations, etc. need to be held constant. When we (economists using this thought experiment) start to relax the ceteris paribus assumption, we are allowing supply and demand to change and thus equilibrium prices and quantities change. Despite the fact that the equilibrium point (intersection of supply and demand curves) changes, the market forces are chasing that point around. So while equilibrium is an important theoretical concept, we might never, ever be in equilibrium. The important concept to focus on is that competition is always driving us toward equilibrium.

These driving forces then require the interaction of individuals with limited knowledge. They require that this process takes time, meaning that we do not simply jump from equilibrium point to equilibrium point. Finally, this is not an automatic or mechanical process; it requires actual people to move the market. That person is called the entrepreneur.

The Kirznerian pure entrepreneur is an ideal type. This archetype has no physicality. It is an observation of a profit opportunity. This construction is fairly controversial within Austrian circles. To me it seems strange to push it this far. Without physicality, there is no action and it then falls outside of praxeology and is therefore not a market force. (It is at this point I need to remind myself that this is the introductory chapter and there is a whole book to follow.)

We argued about the implications of the pure entrepreneur. A traditional manner of characterizing the Kirznerian entrepreneur is someone stumbles across money lying on the ground. (If this is the case, then my son is a Kirznerian entrepreneur because he found 12-cents on the ground today!) However, the act of picking up the money is a physical act and thus is not a pure entrepreneur. After much discussion, the consensus of the group was that the pure entrepreneur is an observer and accumulates knowledge. The action is separate and distinct. An interesting question was raised and so I'll throw it out to you to ponder and comment... "Is an entrepreneur only a person who finds Pareto Superior moves?"

The last issue that we discussed was the point on resource monopoly. While he defines most monopolies are a "barrier to entry" problem, Kirzner argues that resource monopolies are "very real and significant." In other words, a single owner of a resource can be a monopolist and this has consequences that are "very real and significant." I disagree. Rothbard disagrees. In fact most of the people in the room disagreed. (Some didn't vocalize one way or another, which was fine.) We thought about who else (Austrian) thinks that a single resource owner is a real and significant problem, and the only one that anyone could think of is Sandy Ikeda, at SUNY - Purchase. I like Sandy and he is usually fairly solid in his economics so I will have to ask him about this point. Furthermore, this is still just the first chapter and there is a whole chapter on monopolies coming up and so we will see how "real and significant" this problem really is.

Unfortunately, we ran out of time and closed the meeting there. If you are reading along (or even if you aren't) please feel free to post your comments and continue the discussion.

NC Sentences Citizens to Shortages and Misery

2011-08-26T13:57:00.001-04:00

We are all very aware that hurricane Irene is coming to North Carolina. As we prepare for the coming storm, the NC government has declared a state of emergency. The effect of this declaration is that law GS 75-38 comes into full effect.

What's GS 75-38? you ask. Good question. It is the NC Anti-Price Gouging law. If "the price charged by the seller exceeds the seller's average price in the preceding 60 days before the triggering event" then the seller can be fined $5,000 per violation and the injured parties can attempt redress. Additionally, the law stays in effect for another 45 days after the "triggering event" is over.

If the hurricane does hit NC and suppose that it does knock out basic services like electricity, water, etc. then what is the best way to communicate to the rest of the economy that we are in desperate need of water, etc.? The market uses the price mechanism to alert everyone that we need these supplies. The price rises and screams to the world that we need water. It shouts that we need food. It raises a ruckus that we need generators.

When these evil laws come into effect they completely shut off this market mechanism. It not only cuts off the encouraging signal to entrepreneurs to send these vitally needed supplies to NC, but it actively discourages such behavior. "If you dare go to NC, we will be watching you!"

When the price is not allowed to rise, shortages occur. That means there is nothing left to buy at any price. Period. Some people think that at least the price won't be too high. SO WHAT! If there is nothing to buy, then who cares what the price is? We have to shed this idea that a high price constitutes someone ripping someone else off.

The price is a signal. Getting mad at a high price is like getting mad at the thermometer for it being a hot day. "How dare you get so red, thermometer. I don't want it to be so hot!" Ridiculus! The price is a reflection of the scarcity of the good in question. When the price goes up, it is because it is more scarce. Without the high price, the goods are sold out and then there is nothing left. These Anti-Price Gouging laws are a sentence to shortages and misery.

Do not be fooled into thinking that the politicians are doing this to protect the "little guy." In fact the result of this law is to make the government itself (e.g., FEMA) the major supplier of relief. In other words, I am unable to look forward to my neighbors in Tennessee coming to my aid, instead I will have to rely on FEMA and the other bureaucratic state agencies to relieve my suffering and that of my family and neighbors. The bottom line is that we become more dependent on the government and less on our neighbors.

The science of political economy is a powerful tool because it demands that we look beyond the stated intentions of the politicians. It forces us to look at not just what is seen, but we need to imagine the unseen. We are forced not to be content with looking at the intended consequences, but the unintended consequences need to be considered as well. It is in this manner that we can find a true path to recovery and protect our liberties as well.

Real Meaning of Say's Law

2011-08-26T12:24:00.002-04:00

Last March I gave a talk at the John Locke Foundation in Raleigh, NC. The topic was on Say's Law. In this interview I explain the real meaning of Say's Law and contrast it with today's Keynesian point of view.

Here is the clip from that talk last March. (I also posted this last March.)

Austrian Economics Forum Fall 2011 #0--Prequel

2011-08-20T16:04:00.000-04:00

Well we are getting closer to that time of the year again, the Austrian economics reading group at NC State University! Yes more readings in Austrian economics! Who doesn't look forward to this? (Crazy people, that's who.)

For the Fall semester, we have 6 scheduled meetings starting on 4:30pm September 2, 2011 at Nelson Hall, Rm 3220.

The group, the Austrian Economics Forum, has decided to read and discuss Kirzner's classic Competition and Entrepreneurship. It was first published in 1973, the year that Mises died, the year before Hayek won the Nobel Prize and the IHS conference in South Royalton, Vermont. It has been a centerpiece of the Austrian revival of the the last 35+ years.

Since the book has 6 chapters and we have 6 meetings, we will do one chapter per meeting. I welcome you to the discussion. I will post, as best I can, a summary of the discussion and my thoughts as well. If you want to continue the discussion or bring up new points from the readings, please post them here and I will encourage the members of the AEF to comment and reply.

I am looking forward to this series of readings and to your comments.

New Yield Curve Numbers

2011-08-19T00:56:00.000-04:00

So I have been tracking the Yield Curve closely this month. The spread between the long and the short rates are closing. In other words, the curve is flattening. Right now this movement is due to the long-rates falling because the short-rates are pinned to the floor by the Fed.

The short rates I have been tracking are the 3-mo and 1-yr T-Bills. I am looking at their spread with the 10-, 20-, and 30-yr bonds. As of today (Aug. 18), the spreads with the 10- and 20-yr bonds are smaller than they were before QE2. The 30-yr spread is 8 and 9 basis points above the low, less than a year ago.

While some may argue that the spread is still fairly wide, and it is, I do not think that this is a stable gap. Some spreads this large took more than a year to close, but sometimes it has taken less than a year.

The key for reading this indicator is whether the short-rates start to rise. If they do, then that is the clear indicator we are looking for. However, this might be disguised by the Fed actively manipulating the yield curve. If it is doing this, then the yield curve is no longer a predictor of the health of the economy.

The Treasury Yields Indicate a Worsening Economy too

2011-08-07T17:12:00.004-04:00

I know that looking at short-term movements is an imprudent impulse. Nevertheless, I have been watching the Treasury Yields and the spread is dropping quickly. I put the first week of August into my spreadsheet (which is on right hand side of the screen) and the average spread between long- and short-term Treasuries has fallen by more than ~~56 basis points (more than 0.56%)~~. Okay I have found an error in one of my numbers. And as of today (August 8, 2011) the new number is just above 41 basis points (more than 0.41%).

While this may seem trivial in the face of many other economic problems, it is a clear indicator of the direction of the economy. The current spread is lower than it was ~~before~~ when QE2 began in October 2010. That's not even a full year ago! Is this a sign that the economy is trying to reassert itself over the tampering of the government? I think YES!

As this spread shrinks, we inch closer and closer to the next recession.

New Numbers Show the Economy is Worse Than We Thought

2011-07-30T20:19:00.000-04:00

As many people know on Friday July 29, the US Dept of Commerce has posted the revised numbers for the US economy. What many people may not know is that the old numbers have also been revised. The Bureau of Economic Analysis posts GDP in real dollars, i.e., they calculate an inflation index and generate the real numbers using chained 2005 dollars. How this is calculated is an interesting topic to very few and so I won’t dwell on that part here.

The interesting part is that the numbers have been revised downward, some of them by quite a bit. In Q3:2007, just before the official start of the recession the old GDP number and the revised numbers were virtually identical. ($13,268.5 billion old vs. $13,269.8 b revised)

Now we see that the drop of the recession was much larger than we originally thought. The old trough was $13,223.5 b in Q3:2008, but now the Q3:2008 number is $13,186.9 b. The old number is 0.28% higher than the new number. Curiously, since Q3:2007, this is the smallest discrepancy. The discrepancy rises to a 1.6% differential by Q4:2009. ($13,019.0 b old vs. $12,813.5 b revised)

The upshot of all of this is that we are in much worse shape than we originally thought. The bottom of the recession was deeper than we thought and we still haven’t reached the pre-recession numbers of Q4:2007 of $13,326.0 b vs. Q3:2011 $13,270.1 b.

Repudiation?!? Should We Repudiate the National Debt?

2011-07-16T14:29:00.000-04:00

After much thought on this topic, I have decided that the best way in which to deal with the $14.3+ trillion national debt is through partial repudiation. Why? It is not an easy story to tell without some context, but I will try my best to be clear.

Each year after my daughter’s birthday in May, the family heads to the beach for a week of sun and sand. Of course one of the best ways to relax is by reading economics! (At least it is for me.) My choice this time was Murray Rothbard’s A History of Money and Banking in the United States (http://mises.org/books/historyofmoney.pdf). I had just finished his four-volume Conceived in Liberty, which details the history of the colonial period through the Revolutionary War, so I thought that this would be a good complement. It was.

In Rothbard’s History, there was a section that has stuck in my mind for the past several weeks. He detailed how, in the late 1830s and ’40s, several states defaulted on their debt. (See pages 102-3.) The upshot is that we do more damage to the economy by trying to pay off the debt.

When the government spends money, it necessarily distorts the economy. When the government buys good X, resources are drawn to the production of good X by the normal market process. The unseen aspect of this governmental action is that resources are drawn away from the production of good Y. In other words, if left alone, the market would produce more Y and less X, but the government distorts the economy. It places its thumb on one side of the scale favoring one market player over another. Most often these political decisions make society worse off.

When government spends that money, the effects are immediate. However, this is only half of the story. The other half is centered on the source of that money. Government only has four ways in which to raise funds: 1) Taxes, 2) Borrowing, 3) Money Creation, and 4) the Sale of Assets. Each of these is bad and further distorts the economy.

Government taxes are never market neutral. They always penalize one behavior and create an incentive to do something else. A sales tax penalizes spending and incentivizes savings. A gas tax penalizes driving and incentivizes telecommuting. An income tax penalizes earning an income and encourages slothfulness. Etc. Each tax imposed hinders the progress of the economy and ultimately reduces living standards. If we had to tax our way out of our national debt, we would have to tax almost 100% of GDP for a year. However, even this action would just barely get us out of today’s hole. It does nothing for next year’s budget deficit.

The second manner in which the government raises funds is through borrowing. It is impossible to borrow our way out of debt. It’s like using a MasterCard to pay your Visa bill and then reversing it next month. Borrowing more is simply not an option.

The third method is money creation. The money that we use today is a fiat money, which is backed by nothing other than the “full faith and credit of the United States Government” (whatever that means). In other words, dollars are backed by nothing. When the Fed creates money, it pulls it out of a big, black hole of nothingness. Where did it come from? Nowhere. How much can it pull out? As much as it wants. There is an infinite supply available. We could, if we wanted, pay off the national debt tomorrow. However, by doing so, $14.3 trillion dollars would be created and dumped into the economy. The dollar might suffer a slight (!) problem of devaluation. [Yes, that was sarcasm.] Prices would, consequently, skyrocket! Furthermore, each newly created dollar has non-neutral effects that jam price signals, redistribute wealth to those with the new money, and sow the seeds of another business cycle. Since this approach is a de facto tax that is hidden from most people, this tends to be the method governments have historically chosen to get themselves out of their debt hole.

The fourth method government uses to raise money is the sale of assets. In the 19th-century, the US government sold western land and used that money to partially finance its activities. Today the US government has reversed its policy of selling assets and is instead acquiring land for various reasons (environmental, military, etc.). While selling assets has the most merit of the four in several aspects, it will not even be considered as a viable option because of this policy reversal. Furthermore, it just isn’t big enough. A one time sale cannot overcome a perpetual expenditure.

So that leaves us with a large dilemma. We have a government that cannot control its spending and we have a national debt that cannot be possibly paid back without wrecking the economy. Even if we used a combination of tax increases, money creation and asset sales, we won’t have enough to fix the mess. At each moment, there is only a finite amount of taxable wealth in the US. If government extracts the wealth through money creation, it can’t extract that same wealth with an additional tax.

The least harmful alternative is partial debt repudiation. In other words, default on some of the debt. Think about what that means for a moment. (Really, take a moment and think about it.) We have spent so much that we cannot pay back our creditors. As I read in Rothbard’s History, we have been in this position before. Here is how Rothbard reports Americans’ reaction to public debt in the 1840s:

“The British noted in wonder that the average American was far more concerned about his personal debts to other individuals and banks than about the debts of his state. In fact, the people were quite willing to have the states repudiate their debts outright. Demonstrating an astute perception of the reckless course the states had taken, the typical American response to the problem, ‘Suppose foreign capitalists did not lend any more to the states?’ was the sharp retort was, ‘Well who cares if they don’t? We are now as a community heels over head in debt and can scarcely pay the interest.’” (page 102)

The same can be said today. Should we really feel bad for those who have purchased government bonds? They are the ones who have been feeding the monstrously, reckless actions of the government. When they get (partially) burned, will they be willing to finance more government debt? Of course not. Suppose the Chinese decide not to lend any more to the US government. Is this really so bad? The government would have to deal with its future overspending.

Fundamentally, there is the issue of justice. Some people loaned the government their money for a return. Why should they have assumed that there was zero risk? When I invest in any other venture, there is always default risk. Why should the creditor to the government get to live under different rules?

Furthermore, why should the average American be punished through higher taxes or a devalued currency for the politicians’ inability to restrain spending? It is like, as Mises once point out, being hit by a truck (the impact of the initial governmental spending) and then to fix the problem, we put the truck into reverse and run the guy back over. All to make it better! The economy was already distorted by the initial spending and then the problem is compounded by funding the spending. Additionally, politicians spend these funds on projects designed to keep themselves in power. Even the programs wrapped in the cloak of magnanimity, like welfare and social security, are designed to make us dependent upon the government and their reelection.

Rothbard’s History demonstrates how the repudiations of the 1830s and ’40s did not cause the sky to fall. In fact, the return to sound money coupled with a liberalization of the economy spurred a tremendous amount of growth. Rothbard:

“It is evident, then, that the 1839–1843 [monetary] contraction was healthful for the economy in liquidating unsound investments, debts, and banks, including the pernicious Bank of the United States. But didn’t the massive deflation have catastrophic effects—on production, trade, and employment, as we have been led to believe? In a fascinating analysis and comparison with the deflation of 1929–1933 a century later, Professor Temin shows that the percentage of deflation over the comparable four years (1839–1843 and 1929–1933) was almost the same. Yet the effects on real production of the two deflations were very different. Whereas in 1929–1933, real gross investment fell catastrophically by 91 percent, real consumption by 19 percent, and real GNP by 30 percent; in 1839–1843, investment fell by 23 percent, but real consumption increased by 21 percent and real GNP by 16 percent.” (page 103)

So how much should we repudiate? I don’t know. The amount should be big enough to scare reality into the investors of US Treasuries (and hopefully politicians), but not too big that it wipes out the retirement funds of those looking for the “safe” investment. Perhaps the Treasury should declare that they will pay 80-cents on the dollar, but that just rolls the clock back a few years (back to only $11.4 trillion!).

The sad reality is that without fundamentally changing the way the government spends, there is no solution. The four largest expenditures made by the government are (from greatest to least) 1) Social Security, 2) Medicare + Medicaid, 3) Defense and 4) Welfare. We can’t really print our way out of the mess, because Social Security payments, etc. are indexed to the CPI. We can’t grow our way out either, because they’re also linked to growth rates.

So repudiation is not a complete solution. It is a part of an overall solution of (real) spending cuts, economic growth and debt repudiation. It is clear that we cannot continue on this path. Politicians are like water—they follow the path of least resistance. Politicians will try to avoid making a decision, and the longer they delay the worse the problem becomes. The reality is that there are no more fixes to be done. We are out of financial gimmicks. The day of financial reckoning is upon us and maybe we can kick the can down the road another election or two, but be prepared for higher taxes, currency devaluation and possibly debt repudiation.

ASC Paper - "The Liquidation Phase and Profit Margins" Posted at Cobden Centre

2011-07-08T16:19:00.004-04:00

My friend, Harry Veryser, and I wrote a paper for this year's Austrian Scholars Conference. It is hosted each year by the Ludwig von Mises Institute in Auburn, AL. This year's paper is entitled "The Liquidation Phase and Profit Margins: Getting Back to Breakeven." It is now posted by the Cobden Centre in the UK. Here is the link: http://www.cobdencentre.org/2011/06/the-liquidation-phase-and-profit-margins/

And their home page is here: http://www.cobdencentre.org/

Please feel free to leave as many comments as you desire. ;-)

Introduction to Austrian Economics Lecture

2011-07-08T15:43:00.003-04:00

I have been gone for quite some time (hence the lack of new posts), but I am back now. For a week this summer I lectured at FEE's summer seminar--Introduction to Austrian Economics. I presented three lectures: Praxeology, Supply and Demand; Capital and Interest; and Austrian Business Cycle Theory. The last of these lectures is now up on Fee.tv and is found here: http://youtu.be/49rMeA1gyO0.

I don't know how to post the PowerPoints that correspond with the lecture. As soon as I learn how to do that, I will get them up. For now, you can just e-mail me at PCwik@moc.edu and I will send you a copy.

***Update*** I think I have learned how to link to the PowerPoint. Please click HERE.

Or watch it here:

Economic Distress Index Update

2011-06-16T14:43:00.001-04:00

For the first time since May 2010, the Economic Distress Index has crossed above 50 points. Anything above 46 is considered to be economic distress. The US has been above 46 since May 2008. (The NBER dates the recession beginning in December 2007 and lasting through June 2009.) It peaked at 62.8 in June 2009. From there it fell to 48.0 in December 2010, but has been rising steadily since.

Voluntary Taxation

2011-05-28T22:21:00.000-04:00

While I normally do not post articles to this blog, I was struck by the delicious irony that this article detailed. It's entitled, "Will They Tax Themselves More?" by Donna Martinez.

In North Carolina, we are facing a large budget deficit and since we have a balanced budget amendment, we must either raise taxes (fat chance!) or cut spending (finally?). As a result, the special interest groups are howling about the cuts to their largess. Anyway, all of this is now solved by House Bill 887. If passed, it will allow tax payers to redirect some or all of their refunds to special government accounts earmarked for specific spending. For example, if you think that the arts are being cut too much, then you can waive your refund and send it to the special account for the arts. The same goes for education and several other "priority" programs.

Will the special interest groups donate their refunds to these funds? Will they convince others to do the same? Time will tell, but I wouldn't hold my breath waiting for it to happen.

Special interests need and want your money. They view the state as a parent making sure that the children share all that they have. I view it the same way that Frederic Bastiat did over 160 years ago--it is legalized plunder. (Or here for the pdf version.)

Economic Distress Index--Is the Economy Worsening?

2011-05-18T10:30:00.002-04:00

On the right side of this page, you will see the Economic Distress Index that I have created. It was suggested by my friends at FEE to create an updated version of the famous Misery Index of the late 1970s. I update it as the data comes in.

As I have been tracking it, I have noticed that the economy tends to be in distress whenever the index is above 46. This has not been scientifically determined. If anyone would like to work on this data set, I am willing to work with you. Just e-mail me at: PCwik@moc.edu.

The point of this post is that the index has been falling from its high of 62.8 in June 2009 to the recent low of 48.0 in December 2010. Since the new year, the Distress Index has been climbing. We are now at 49.6. While this may be an aberration, it may also be the start of the next trend.

Is the economy headed toward another recession? Is the economy worsening?

My training tells me that before an economy can make a solid recovery, we need to liquidate the malinvestments that have been built up in our economy. So far I see little evidence that we have cleaned out much malinvestment. In fact, I think that we have quite a bit more that needs to be liquidated.

While I tend to be optimistic, I don't see the evidence of anything more than a lumbering economy that is burdened down by these malinvestments. The translation is that we cannot have healthy growth until we clear these out. With stimulus bills and government programs designed to prop them up, I think that this anemic growth will be around for a few more years.

Austrian Economics Forum Spring 2011 #5--Intro. to Austrian Monopoly Theory

2011-05-16T15:12:00.000-04:00

The final session of our Austrian Economics Forum took place at Dr. Cordato's house. He and his wife, Dr. Karen Palasek, made a really nice dinner for us, but the ground rules were that we had to talk economics before anything else. (Were they afraid we wouldn't talk economics while eating? Clearly an unfounded fear!)

This session's reading was "A Critique of Neoclassical and Austrian Monopoly Theory" by Dominic Armentano, found here http://oll.libertyfund.org/title/106/6041. This is a chapter in the book New Directions in Austrian Economics edited by Louis Spadaro (1978).

The Armentano reading was a straight forward, introductory article to monopoly theory from an Austrian perspective. Cordato added several personal comments about Armentano. The one anecdote that struck me was that Armentano had formulated much of his criticism of the Neo-Classical Monopoly Theory long before he became (or even really studied) Austrian(ism).

The major, traditional Austrian criticism of standard Monopoly Theory rests upon the definition of the market. Monopolies are defined as a single seller without any close substitutes. However according to Austrian theory, a substitute can only be defined in the mind of the user of the goods. When Saran Wrap first came out there was nothing else like it. So were there any substitutes? Actually yes, there were many because the relevant market was "What can I put my sandwich in so I can take it to school/work?" The substitutes were wax paper, tin foil, aluminum foil, paper bags or even Tupperware. None of them look like Saran Wrap, but they are all substitutes. Or an example I use in my class is that helicopters and closed-circuit cameras are substitutes. Of course, physically they are nothing alike. However, if we are trying to learn about traffic congestion during our morning commute, then they are substitutes.

Furthermore when it comes to defining the market, we can define it in such a way that we are all monopolists. I am the only one who supplies my labor. Or if we broaden the definition, then there is no such thing as a monopolist.

At the end of our abbreviated discussion (we were hungry), we agreed that the Rothbardian definition of monopoly was the best. Rothbard uses the old definition of a government created monopoly privilege. If there is a law, legal restriction, etc. that forcibly prevents others from competing, then that is a monopoly. Otherwise, there is no monopoly. There are two objections to this. The first is a natural resource monopoly. I find this problematic. If there was such a monopoly, as soon as it sells some to anyone else, there arises a potential competitor. From this point we start to get into some rather strangely concocted hypothetical situations. "Suppose under the following circumstances...blah, blah, blah." If we need to resort to such narrow assumptions, then we are not really describing the world around us and have started to play mental games. There's nothing wrong with mental games. In fact most of the leading economic journals are full of such things. Just please don't waste my time on them.

The second objection is that of a natural market monpoly where a firm is so good at what it does, no other firm can compete. To which I ask, "What's the problem with that?" From a consumer's point of view this is great! They offer better prices, better quality, better locations, better service, etc. On every single vector of competition, this firm is better. If it lags in any one of these areas, then a niche market can arise.

Neo-Classical economic theory relies far too much on counting the number of firms that are competing. To them "competition" is a state of being. It is a noun. Austrian Theory rejects this view and says that competition is a rivalrous process. The only way that relative scarcities (prices) can be discovered and determined is through competition--real competition. It only takes one producer and an open market for there to be competition. The supposed monopolist must compete against potential competitors, otherwise, they will soon appear. Leonard Read once said that trying to stop competition in a free market is like standing in a river with a broom, trying to sweep the water away. For an instant, the water is brushed aside, but then it comes rushing back in.

Austrians view competition differently. We view it in the same way that sports teams do. In order to know the outcome, we need to play the game. This is why Austrian Economics has been gaining so much attention in other business fields like Strategic Management.

Cordato is hoping that the next semester (Fall) will follow the course of more Microeconomic stuff. I'm thinking that we should look at Mises's Theory of Money and Credit so that we can finish it in 2012, the 100th anniversary of its publication. I don't know the direction, but I am sure that it will be a fun ride.

Keynes vs. Hayek Round Two Video

2011-05-02T15:57:00.001-04:00

The long awaited sequel to the Keynes vs. Hayek rap is out.
Enjoy.

Here is the original first video:

Austrian Economics Forum Spring 2011 #4--Austrian B-Cycle

2011-04-12T15:46:00.004-04:00

***I know that it has been some time since the last Austrian Economics Forum update. The reason is that I missed a session. I heard that it was nice. Everyone went outside and sat on the grass and discussed economic theory. The lesson is, of course, never to miss an AEF meeting!***

This session's discussion centered on two readings: Richard E. Wagner, "Austrian Cycle Theory: Saving the Wheat while Discarding the Chaff" The Review of Austrian Economics, 12(1), 65-80, 1999; and Walter Block, "Yes, We Have No Chaff: A Reply to Wagner's 'Austrian Cycle Theory: Saving the Wheat While Discarding the Chaff'" The Quarterly Journal of Austrian Economics, 4(1), 63-73, 2001.

I was rather disappointed by both of these articles.

The first thing that caught my attention was the very condescending tone of the Wagner article. He refers several times to the "canonical" version of the Austrian Business Cycle Theory (ABCT). It is as if he thinks that there is no independent thought among Austrians, that there is no debate, and that if one doesn't hold to the "cannon" then they are out of the Austrian club. How ridiculous! It's insulting and demeaning.

There are two major criticisms that Wagner puts forward in opposition to the ABCT. They have both been argued and reargued for decades. Wagner is apparently unaware of these debates or he simply has chosen to ignore them.

The first criticism can actually be traced to Gottfried Haberler. Haberler wrote a summary of the different theories of the business cycle for the League of Nations. This work was then converted into the book Prosperity and Depression (1937). Joe Salerno presented a paper at the 2011 Austrian Scholars Conference on Haberler's portrayal of the ABCT. Salerno makes the point that Haberler mistakes the malinvestment theory for one of an inefficient use of resources.

Here is Haberler's story. The Central Bank expands credit and pushes down interest rates. As a result, entrepreneurs are misled into investing in the earlier stages of production.

So far the story is right, but it is missing an important element. Haberler's story is that we start with the Structure of Production at point A. When the new, (lower) interest rates emerge, we slide out to point B. When the market recognizes the mistake, we slide to back to point A. Thus Haberler and those who have followed his characterization of the ABCT have dismissed the ABCT as an inadequate theory. If this were all that the ABCT was, then I would also dismiss it as a simple theory of a misallocation of resources and the resetting of them.

The ABCT is not simply a theory that sloshes capital goods from late stages of production to earlier stages and back again. What Haberler is missing is the bi-directional signal of the interest rate. The ABCT is a theory that contains both malinvestment at the higher stages of production and overconsumption! The modern, Garrisonian version looks like this:

Here we see what John Cochran calls "The Dueling Structure of Pro- duction." (See QJAE 4(3), p. 19, 2001.) When the interest rate falls it sends a signal not only to investors and entrepreneurs to invest more. It also tells consumers that the return on savings has fallen. As a result, income saved falls and income consumed rises. Thus, the structure of production is split and torn apart in two directions. For the mainstream macroeconomist, he sees C (consumption) and I (investment) increasing together, which is solid GDP growth. Unfortunately, this information is misleading. The modern macroeconomist is misled due to the overaggregation of his statistics.

The invested capital also has various degrees of specificity and substitutability. As a result, the conversion of the malinvestment into sustainable capital structures can be long and difficult. It is that conversion process that is the recession.

The second objection that Wanger raises against the ABCT centers on expectations. There is an old objection to the ABCT that says, "if people knew the ABCT, then when they look at the actions of the Central Bank, they could adjust and avoid the Boom and the Bust." This logic is built upon Haberler's mischaracterization of the ABCT. The ABCT is not about sectoral shifts in resources. It is about soldifying liquid capital into specific production methods and then breaking them up as the malinvestments are revealed. Furthermore, the Austrians model money as being non-neutral and so even if an entrepreneur had the knowledge of what has happening, the Cantillon effects are unavoidable.

Block centers his criticism of the Wagner article on this particular point. The best argument he makes is that, "those who shift resources from the lower to the higher orders of production [will do so] in response to a lowering of the loan rate of interest, even if they know this emanates from Fed machinations, not a change in time preference, and thus [it] can only be temporary." While the argument is correct, Block does not hammer the point.

In my opinion the best explanation on why entrepreneurs must expand with lower credit, even if they know that it will lead to a boom / bust cycle, is found in Carrilli and Dempster, "Expectations in Austrian Business Cycle Theory: An Application of the Prisoner's Dilemma," The Review of Austrian Economics, 14(4), 2001. They set the problem up as a prisoner's dilemma in which the global solution may look like no one should borrow the new credit and invest, but the local solution is that they must. With money being injected sequentially into the economy and injected at specific points, the non-neutral Cantillon effects show that those who get (and use) the new money first are the big winners. Those who get the money last (or choose not to use it) lose.

Say's Revenge: Living in Keynes' Long-Run

2011-03-21T22:40:00.002-04:00

I gave a talk at the John Locke Foundation today, which I thought went rather well. It is called, "Say's Revenge: Living in Keynes' Long Run." Here is a clip from the talk:

For the full video please go here:
http://lockerroom.johnlocke.org/2011/03/21/saying-what-say-said-rather-than-what-keynes-says-say-said/
or here:
http://jlf.streamhammer.com/speakers/paulcwik032111.mp4

A Gold Currency for North Carolina?

2011-03-17T14:16:00.000-04:00

In a recent N&O article (found here), it is reported that a state legislator, Glen Bradley-R Youngsville, has introduced a bill to create a State currency backed by gold and silver. The reporter is perplexed by such an odd bill, and he basically ridicules the sponsor. In the article, he talked to an economist at the State University, the Democratic State Treasurer and a Democratic State Legislator. (I guess that's "Fair and Balanced.")

While I know that this bill is going nowhere today, it is worth thinking about. What would happen if a state decided to go on the gold standard without the rest of the nation? (I know that the bill says gold and silver, but bimetalism is a whole different set of problems, so let's just focus on the gold standard.)

The advantages of a gold standard, at least nationally, is that it forces the government to live within its means and is a brake on hyperinflation. Additionally, it reduces the ability of the Federal Government to grow the Welfare/Warfare state. While it might not eliminate the business cycle, it does help reduce the artificial bubble (boom) the preceeds the painful, but necessary, liquidation process.

Why should a State like North Carolina consider it? The benefit of owning a currency that is not depreciating is obvious to the guy who has the gold coins in his pocket. In fact, I'd rather be paid in such a currency. Furthermore, the adoption of a sound currency would mean a big positive jump in investment into the NC economy. If the people of the state adopt the gold currency, then it would attract businesses the world over who are afraid of doing business in a coming hyperinflation. (While those in power cannot forsee a collapse of the US dollar, does not mean that such a thing is all that far off. I doubt the Germans in 1922 forsaw the inflation awaiting them in the next year.) And finally, since the State already has a balanced budget rule, the impact on the budgetary process would be small.

The problem of going it alone, when we have legal tender issues, is that of Gresham's Law. The law says that with legal tender laws, bad money drives out good money. (It also says, but is less commonly known, that good money drives out bad money in a competitive market.)

So, unfortunately, Gresham's Law will fully apply to North Carolina. Why? Suppose that Bradley is correct on the dollar's purchasing power falling through the floor. Now to pay my taxes I have the choice of choosing between using a state gold coin or a depreciated dollar. I will always choose to pay in the least valuable currency. So I will hoard the state gold coins and spend the increasingly devalued fiat dollars.

Unless...

The only way that the Gresham's Law will work to the advantage of the state gold coins is if it is allowed to compete with the US paper dollar. If the paper dollar and state gold coins value are fixed, then the paper money will drive out the gold. However, if value of the state gold coin was allowed to float against the paper dollar, then it would, indeed, drive out the use of the paper money. Not entirely, of course, but to the extent that residents of North Carolina can demand payment in gold coins, it would.

And that is the catch. The paper dollar says that it is good for all debts public and private. So that means you have to accept it. If the buyer can force the seller to accept the paper, then there is no chance of its success.

Getting Back to Breakeven: ASC 2011 paper

2011-03-15T15:20:00.000-04:00

This past weekend, I attended the Austrian Scholars Conference at the Mises Institute in Auburn, AL. There were many papers presented and I plan on commenting (later) on several of them on this blog.

Many have asked for a copy of the paper I presented with Harry Veryser. The link to it is here or you can find it here: http://www.moc.edu/images/uploads/tsb_files/The_Liquidation_Phase_and_Profit_Margins_Getting_Back_to_Breakeven.pdf

Failure is a Necessary Option

2011-03-07T20:05:00.000-05:00

An often repeated and overused phrase is, "Failure is not an option." How ridiculous! In fact, the reverse is not only true, but it is a necessity.

One major problem with the public school system is that failing schools do not close. In fact, a failing school usually gets more funding the next year in order to "turn it around." Ask yourself if this policy really makes long-term sense. What sort of incentives are being created when failing schools are given expanded budgets? An axiom in economics is that people respond to incentives. If we pay people more for failing schools is it any wonder that we get failing schools?

In the private sector, the customer is sovereign. The customer chooses what to buy (or not buy) and no one can force such a decision on another. An entrepreneur who is able to please his customers receives continued business as his reward. Hopefully, with proper management, profits also accrue to the entrepreneur. However, if the company does not please the customer, regardless of reason, the business suffers. Maybe there was rudeness, maybe the product was shoddy, or maybe the price was too high, the reason doesn't matter because the end result is the same: the loss of business. When the customer is not pleased with the entrepreneur, he takes his business elsewhere. The entrepreneur had better shape up quickly or the venture will close its doors and the resources will be transferred to others who are better at satisfying customers.

The continuous process of pleasing customers continually shifts resources to those who are the most efficient users and most effective satisfiers. This phenomenon is relatively new; it has only been around for the last couple of hundred years. During this short period of history, we have achieved higher living standards for more people than at any other point in recorded human history.

When we step away from the market and into the world of public provision of goods and services, we see that it operates by a whole different set of rules. In the public sector, the government collects the revenue to operate the institution. However, it can't simply hand someone billions of dollars and say, "Go educate some kids." Along with the dollars come the rules and regulations. These reorient the focus of the employees and managers away from "customer" and toward the rulebook. Additionally the same system strips away all vestiges of competition between providers of education. The children are assigned schools; the parents are not allowed to choose. Imagine if such were the case with phone and Internet providers. (Actually I can imagine it, because it was the law of the land for decades. What was the result? Poor quality, high costs, lack of convenience, ugly phones, and attaching an answering machine was considered illegal because it was "installing a foreign device.")

Our public education problems are far too complex to simply say that the answer is competition between our schools, but don't discount that simple phrase too quickly. Imagine the impact the following three changes would have on our public schools:

allow parents to choose which school to send their child to;
attach the dollars to the child so that a school's budget is based upon the number of students that enroll at their location; and
allow schools that cannot cover its costs to close and be sold.

Such a proposal will cause the teachers' and administrators' unions to howl, but I am not concerned with protecting their jobs any more than I am concerned about protecting McDonald's workers' jobs when I go to Burger King. In fact, our university system has this feature and it seems that we have a large and diverse set of higher educational institutions.

Competition will weed out the bad teachers and they should lose their jobs. Competition will weed out the bad administrators and they should lose their jobs. Competition will weed out the unnecessary overhead and reward quality. It will reward good schools, good teachers and good administrators.

Many think that competition is scary because some producers are winners and some are losers. Unfortunately, too many people think this way. I say "unfortunately," because this thinking is backwards. There is too much focus on the providers and too little attention paid to the customers, the children. When there is competition, the customers are the big winners. And, paradoxically, the only way that we can guarantee a successful school system is if we make failure not only an option, but a necessity.

Austrian Economics Forum Spring 2011 #3--Non-Neutral Money

2011-03-04T16:23:00.000-05:00

This session we had three readings: “The Non-Neutrality of Money” by Ludwig von Mises (1938 [1990]), “Neutrality of Money” by Don Patinkin (1987/1989) and “The Problem of Monetary Equilibrium,” by J.G. Koopmans (1936). We started with Mises’ article and, sadly, ran out of time before we could really get into the Koopmans piece. The Koopmans piece is a lecture that he gave at the LSE on June 15, 1936. The copy we used comes from Professor Richard Ebeling. He hopes that it will be soon published as a journal article. We shall see.

The idea of money's non-neutrality seems to be fairly straight forward, while the idea of neutral money is the idea that seems to be alien. Nevertheless if we examine the economics profession, the idea of non-neutral money is almost summarily rejected or, on a good day, it is given some lip service--and then tossed aside. So what is neutral money and where does the idea come from?

In the mid-1700s, David Hume (Scottish philosopher and teacher of Adam Smith) was arguing against mercantilism. Mercantilism was the political economic doctrine that held that a nation is richer if it has more gold and silver. These riches could then be transformed into military power and then ultimately into national supremacy. Hume argued that the wealth of a nation could not be simply measured by counting the amount of money (gold and silver) that existed in the economy. He said that ultimately wealth was found in the goods and services in a country and not the amount of money. For example, suppose that an economy doubles its money supply overnight. Is it doubly as rich? The obvious answer is, "No, all that changes is prices."

So far the neutral and the non-neutral money theorists agree. The next step is where the two groups part company.

The neutral money theorist says that if the money supply doubles, then all prices will double. The modern version of this position is that the "Price Level" doubles. In other words, on average, prices will double.

The non-neutral money theorist says that this analysis is drawing conclusions with assumed facts. The neutral money supporter is implicitly assuming his conclusions: increasing the money supply has no effects on anything real.

So let's get into the details of the debate.

First of all, the Austrian asks what is meant by the "Price Level"? Mises explicitly rejects the metaphorical use of the term "level." It conjures up an image of a pool of water in which water is added or withdrawn. The height of the water in the pool then reflects the change in the injections--i.e., a doubling of the amount of water, doubles the height of the pool's level. Money is not diffused into an economy so quickly. Hayek has said that instead of water, we might envision the pouring of honey. Mises argues that positing all prices and wages simultaneously rising or falling to the same extent simply cannot be assumed.

Patinkin, on the other hand, argues that nothing other than exactly that can occur. He sets up a general equilibrium model of an economy and then increases the money supply by "k." He then shows, mathematically, that in order for all the equations to reequilibrate, all prices and wages must increase by exactly "k." The assumption is made at the moment when we assume unique general equilibrium conditions. If there is only one solution for general equilibrium, then of course the only solution is to change prices by "k." However, that is a huge assumption that is never (rarely?) justified. In his defense, Patinkin does admit that in the short-run there may be some non-neutral effects, however, his argument is that the long-run patterns must reemerge.

But, let's take Patinkin at face value. The entire focus of Austrian analysis is on the short-run effects of monetary injections and their distortionary effects. So, why should the Austrian even take the bait and argue the implications of a hypothetical long-run, which will never emerge? Furthermore, as we will see below, the role of heterogeneous capital will make returning to an original hypothetical long-run equilibrium impossible.

So then what is the Austrian position and why is it so important?

The Austrians do not view money as some mystical numeraire that simply measures the height of purchasing power. Instead, money is a good that is also subject to the same laws of diminishing marginal utility (demand) and increasing opportunity costs (supply) that govern all other goods and services. Since the valuation of money is governed by marginal appraisals and the goods and services purchased are also governed by marginal appraisals, then the concepts such as "Price Level" and "velocity" must be viewed with extreme suspicion. Indeed, Mises outrightly rejects the use of either. Mises states,

Monetary problems are economic problems and have to be dealt with in the same way as all other economic problems. The monetary economist does not have to deal with universal entities like volume of trade meaning total volume of trade or quantity of money meaning all the money current in the whole economic system. Still less can he make use of the nebulous metaphor "velocity of circulation." He has to realize that the demand for money arises from the preferences of individuals. ... Money is never simply in the economic system, ..., money is never simply circulating. ... The decisions of individuals regarding the magnitude of their cash holdings constitute the ultimate factor in the formulation of purchasing power.

As a result, it makes no sense to aggregate all of the money into a graph containing Money Supply and Money Demand to determine the "Purchasing Power" of money. Furthermore, the Austrians reject the "equation of exchange," MV = PQ.

So without such mechanisms for analysis, what is the proper method for examining macroeconomic and monetary problems?

The Austrians use a stepwise approach. Austrians argue that money is injected into specific points into the economy and that these injection effects have specific impacts and implications. Suppose that the central bank creates and injects new money into the economy. Economists agree that this money creation favors debtors and harms creditors. Additionally, economists agree that a signal extraction problem might emerge; that it is a hidden tax and can distort the incidence of the tax code; and that it can blossum into hyperinflation, which can be very difficult to reverse. However, the Austrians focus on the emergence of the Cantillon Effects.

If the central bank creates $100, it is injected into the economy and not scattered evenly throughout it. As a result the first person (firm, institution, etc.) to get the new money has an advantage over everyone else. He is able to obtain $100 worth of goods and services at today's prices without first contributing to the general welfare. The buyer who uses this new money competes against everyone else in the economy. The effect of his purchases is an increase in the demands for those specific goods, resulting in the prices for those goods inching up. Now those who have the new money are able to buy goods and services with only some prices slightly higher. The effect ripples through the economy. As the new money passes from person-to-person, prices inch up as a real goods and services are exchanged.

While this process continues there are those people who do not yet have the new money. Nevertheless, the prices that they face are rising. Their real wealth falls. Thus, there is a real wealth transfer from those who get the new money last to those who got the new money first.

The next step is to add heterogeneous capital to the analysis. To the degree that capital has specificity, these distortionary effects create illiquid malinvestments. As these malinvestments are built up in the economy, their removal becomes more difficult. This idea is the underlying framework for Austrian Business Cycle Theory.

None of these issues emerge if money is assumed to be neutral. Indeed, many economic problems become difficult to analyze when neutral money is assumed. This is probably why Mises concludes his article with this important observation:

I wish to emphasize that in a living and changing world, in a world of action, there is no room left for a neutral money. Money is non-neutral or it does not exist.

Austrian Economics Forum Spring 2011 #2--Capital and Interest

2011-02-16T15:54:00.002-05:00

At the end of the last post, a few questions were posed. Namely, "What are the necessary and sufficient conditions for the formation of interest rates?" "What determines the height of interest rates?" and "Can productivity influence the height of interest rates?"

The Clark/Knight position has been adopted by mainstream economists for several reasons. At the top of the list is the point that homogeneous capital is easier to model than heterogeneous capital. With homogeneous capital, the interest rate must equal the value marginal product of capital. With this equality, we need only to look at what constitutes supply and demand in this market.

For the Clark/Knight position, there are two sides that need to come together to create an interest rate. The first is the subjective side of time-preference. Some people are natural born savers while others need to spend as soon as they get it into their hands. Knight says that the demand side is the subjective, "time-preference" side. (As an aside, Knight must be thinking of not the loanable funds market, but of the bond market. Otherwise, his analysis on pages 421-422 is backwards. So the demand for bonds, or the "desire to save money" is the time-preference side.) The other side, the supply side, is the "'technical' side of the situation." The supply of bonds, or the demand to borrow money, is based upon the objective productivity of capital. Knight argues that this is the same analysis that is found "any elementary text-book," which shows "the relation between utility and cost." He argues that there is no difference between the interest rate market and a goods market, where the supply of goods is objective and the demand for them is subjective. He says that it is the same as the Marshallian scissors that create the market equilibrium price and quantity.

The Austrians have a different view of equilibrium, not only in the interest rate market, but in the regular goods and services markets as well. On the demand side of any market, the mainstream and the Austrians agree that it is governed by subjective preferences. In the (Knight's) bond market, it is time-preference, and in any goods market, it is subjective utility. However, on the supply side of a goods market, Austrians argue that it, too, is governed by subjective preferences and not objective factors. Of course, objective factors-like the amount available-do contribute to the final market price, but the core of the supply side of the market is still rooted in subjective utility.

Let me explain. From the Axiom of Human Action, we can deduce the Law of Diminishing Marginal Returns when we posit that we live in a world of scarcity. Due to scarcity, we are forced to choose. We choose according to our preference scale. As we work down the scale, the marginal benefit of the next item picked must be less than the one above. It is from the Law of Diminishing Marginal Returns that we deduce the demand curve.

The derivation of the supply curve and the derivation of the demand curve have similar beginnings. Again we recognize that we live in a world of scarcity and are forced to choose. However, instead of starting at the top of the preference scale and working our way down, we work in reverse. We start at the bottom and work our way up. We ask what is the opportunity cost of the item that has the lowest utility. Now if we lost that item, we ask what is the opportunity cost after that loss. From this analysis, we derive the Law of Increasing Opportunity Costs. It is from this law, that we are able to derive the Law of Supply and the supply curve. Thus, both sides of the market are determined by subjective valuations. (For more on this see my lecture on Praxeology, Supply and Demand.)

So the Austrian position is that for goods markets, both demand and supply are subjectively determined. It is not the meshing of the subjective on one hand and the objective on the other. So, it should come as no surprise that the Austrians reject the Clark/Knight position that interest rates are created by the combination of subjective forces on one side and objective forces on the other. Instead, Austrians have argued that Time Preference is the dominant force on both the demand and supply sides.

The title of this is the Pure Time-Preference Theory (PTPT) of interest rates. This theory is not without criticism and does have some flaws that need to be worked out, but the general idea is that time-preference fulfills "the necessary and sufficient" requirements for interest rates to emerge. The difficulty of this is found in the qualifying restriction of "ceteris paribus."

What exactly is held constant and what is not? During the discussion, one person argued against time-preference because there are certain things that he desired in the future, but did not want them now. Rothbard uses the example of a person wanting breakfast at breakfast time (the future) and not in the evening (now). And he also uses the example of a person who wants ice in the summer (the future) but not in the winter (now). Rothbard argues that these examples violate the ceteris paribus restriction. Not everything else has been held constant. The person who doesn't want breakfast now, isn't hungry now. However, he will be hungry in the morning. What's changed? Well, his appetite has changed. Additionally, the person who doesn't want ice now is comparing to different seasons and thus not holding everything else constant. What's changed? The seasons have changed.

All that time-preference is attempting to say is that people prefer sooner to later, holding everything else constant. The trick is in holding all those other things constant. Mises says that time-preference is a praxeological category of action. In other words, its just how humans are built. The debate over the finer points on this issue can be brought up at another time.

Austrians present the case that time-preference is not only a necessary condition for the formation of interest rates, it is also sufficient. Money does not have to be present for the formation of interest rates. Neither does exchange have to occur or even for there to be more than one person to have an interest rate govern intertemporal actions.

In Böhm-Bawerk's The Positive Theory of Capital (the second of three volumes on capital and interest), he states that the productivity of capital not only influences the height of interest rates, he argues that it is the most important factor. Ingo Pellengahr (1996) argues that Böhm-Bawerk was not contradicting his earlier work. (In the first volume he explicitly rejects the productivity theory of capital as the core of interest rates.) Pellengahr states that Böhm-Bawerk was actually asking two separate questions. In the first volume, Böhm-Bawerk was asking an essentialist question, "What is the origin and fundamental core of the formation of interest rates?" In other words, he was examining the necessary and sufficient conditions for the formation of interest rates. In the second volume, he changes his focus to a functionalist question of what influences the height of interest rates. Several Austrians have agreed to this distinction. However, this position of compromise is rejected by Fetter, Mises, Rothbard and Kirzner.

The Pure Time-Preference approach argues the case in this way...

First, we have to make a distinction between rents and interest return. Every factor of production earns a return—a rent. This return (rent) is the price that must be paid to a factor of production, which equals its marginal product. Thus, every factor earns a rent that is equal to its marginal product. Suppose that there is a machine that can produce a return of $10,000/year for 10 years. Why is the price of this machine not $1,000,000 today? The answer is that the future values need to be discounted back to the present. Marginal productivity explains the height of the factor’s rental price. However, it does not explain why these rents should be discounted across time.

Rothbard (1977 p.7) explains it this way, “Roundaboutness is an important aspect of the productivity of capital goods. However, while this productivity may increase the rents to be derived from capital goods, it cannot account for an increase in the rate of interest return, that is, the ratio between the annual rents derived from these capital goods and their present price. That ratio is strictly determined by time preference.”

And so most Austrians reject the idea that changes in productivity and roundaboutness determine the height of interest rates. Of course, we might want to qualify it by limiting the analysis to real interest rates in equilibrium, as opposed to nominal rates in disequilibrium. Nevertheless, it seems that the debate amongst Austrians is more a definitional problem than that of an outright rejection of Böhm-Bawerk's analysis.

There is one last point to be made. In the Kirzner article, he says that there does not exist a detailed criticism of Mises on Böhm-Bawerk's theory of capital and interest. He is wrong. Mises does critique Böhm-Bawerk in Nationalökonomie, pages 439-444. That section has been translated into English and appears at the end of the book Mises Made Easier, by Percy and Bettina Bien Greaves, pages 150-157.

Austrian Economics Forum Spring 2011 #2--Prologue

2011-02-10T16:35:00.001-05:00

This past session was one of the more exciting for me because it dealt with one of my favorite topics, Capital and Interest Theory. There were about 10 of us in attendance this week (Cordato, myself and about 8 students). There were two readings for this session: Frank Knight's book review of Mises' Nationalökonomie, "Professor Mises and the Theory of Capital," and Israel Kirzner's response to that article, "Ludwig von Mises and the Theory of Capital and Interest."

Knight's article was published in Economica in November 1941, and instead of actually reviewing the book he launches into a large discourse on Austrian Capital and Interest Theory. It is rather bizarre for a book review to focus on only one issue, but this is not the only instance of Knight doing this. Knight was asked to write the introduction to the English translation of Menger's Principles of Economics (1950). It was one of the most vitriolic introductions I have ever read, or even heard of. Instead of praising Menger and his unique contributions economic science, he launched into another attack on Austrian Capital and Interest Theory. (Subsequent editions have jettisoned this introduction in favor of a laudatory piece by Hayek.)

Before jumping into the articles, some background is necessary. Austrians and the mainstream have clashed on this topic several times before 1941. In 1889, Eugen von Böhm-Bawerk published his second of three volumes on capital and interest, The Positive Theory of Capital. It was translated into English in 1891. He argues in favor of the use of heterogeneous capital in model formulation and a theory of interest rates, which are the product of time-preference and the productivity of capital. (The influence of the productivity of capital on interest rates is still a topic of debate in Austrian circles today.)

In response to Böhm-Bawerk, John Bates Clark wrote an article called, "The Genesis of Capital" in November 1893. In it, he argued that capital should be considered as a homogeneous fund. Imagine a self-perpetuating pool of water that has some water flowing in and some water flowing out. The difference of these two flows determines if the level in the pool rises or falls. Instead of focusing on the actual water in the pool, all that is needed is for the economist to focus on the height of the water level.  The same should be done with capital, we simply measure the volume, the inflow and outflow; and determine if we are accumulating capital or depleting it.

Böhm-Bawerk replied to this position in January 1895 and argued that production has a structure, which is based upon the complementarities and substituabilities of the capital goods.  When the types of capital goods change, the structure of production must also change. So capital must be modelled in a heterogeneous manner. Clark responded in April 1895, to which Böhm-Bawerk countered in July 1895, which was then rebutted by Clark in October 1895. Neither side yielded and the divide remained. The debate cooled-off for about 10 years and then in November 1906, it cycled through another very similar round of back and forth without really settling the issues.

The other major point of debate between the two sides centered on the nature and formation of interest rates. This debate has changed because the modern Austrian position is no longer represented by Böhm-Bawerk, but rather by Fetter, Mises and Rothbard. We'll come back to this discussion in the next post.

For a second time, the debate died down, for about 20 years. It wasn't until the 1930s, that the debate reemerges between Hayek and Knight. Hayek argued that heterogeneous capital is the best way to examine economic phenomena, while Knight agreed with Clark's position that heterogeneity is completely unnecessary. (One of the best articles representing the Austrian side during this exchange is Hayek's "The Mythology of Capital.")

Earlier in 1941, Hayek published his The Pure Theory of Capital. While it is just pure speculaiton on my part, I think that Hayek's book must have been weighing on the mind of Knight as he wrote his review of Mises' book. (Knight even mentions Hayek's book in a footnote--p. 420.)

In the light of this background, we now come to the focus of this forum. We started by asking the questions, "What is necessary and sufficient for the formation of interest rates?" "What determines the height of interest rates?" and "Can productivity influence the height of interest rates?" At the outset, only Cordato and I argued that productivity cannot influence the height of interest rates. By the end, several more joined our side.

The answers to these questions and more will be in the next post...

Stop Me, Before I Engineer Again!

2011-02-03T14:11:00.000-05:00

This post is based upon the local newspaper's article: "Citizen Activist Grates On State Over Traffic Signals" found here.

Here's the summary of the story. In North Raleigh, the city is going to widen a few streets and some nearby residents would like additional traffic signals to ease the new traffic patterns. The group petitioned the City Council. The City Council agreed and said if the DOT agrees, then the signals will go up.

The DOT said that the traffic conditions did not warrant new signals. So, the residents put together a report for the DOT and not only did the DOT reject it, the Chief Engineer for State DOT said that the report contained "engineering-quality work in a report that was not signed by a licensed professional."

"When you start applying the principles for trip generation and route assignment, applying judgments from engineering documents and national standards, and making recommendations," that's technical work a licensed engineer would do, the chief engineer said.

Then the DOT has asked the Engineers Licensing Board to investigate the residents who wrote the report! The Executive Director of the board said that the investigation will take 3 to 4 months. He said there is a potential for violation if DOT and the public were misled by "engineering-quality work"- even if the authors did not claim to be engineers.

If the author of the report, a resident who simply wants a traffic light, is found to have practiced engineering without a license, the director said, the likely action would be ... drum roll please ... a letter telling him not to do it again.

How much money are we going to waste pursuing this mockery of justice? All to assuage a bruised ego and to protect this fiefdom?

In North Carolina, we have more than 183 professions that require a license. There are some doozies on this list like: Cemetary Sales Contractor, Chick Dealer, Boxing/Kickboxing/"Toughman" Promoter, Egg Dealer, Electrologist, Embalmer, Fee-Based Practicing Pastoral Counselor, Fruit and Vegetable Handler, Histologic Technician, Librarian, Public Weighmaster, Recreational Therapist, Senior Parachute Rigger, and so on. You can find them listed here.

And the list continues to grow because later this year, a license will be needed if you want to braid hair for money.

The state carves out these little areas of benefit for special groups, all to the detriment of the general public. Each of these licenses creates a mini-fiefdom, a protected class. These licenses do not protect the customer. They protect the producer from competition.

Competition is the consumers' best friend. It is high time to repeal these licenses and open the economy to competition. Let the consumer determine who the best egg dealer is. Let the market determine who the best Fruit and Vegetable Handler is.

Or to put it another way, do you think that we can really live in a society with an unlicensed librarian? I'm thinking, "Yes, we can!"

Austrian Economics Forum Spring 2011 #1

2011-01-28T21:54:00.004-05:00

It is a new year and a new series in our Austrian Economics Forum. This semester we are not simply reading through a single book. We are attempting to put together topical readings each session. On one side will be the Mainstream approach and then there will be the Austrian counter point to it. We are hoping that this will generate interest outside of the few dedicated Austrians at NCSU.

The first set of readings centered on Methodology. The article supporting the mainstream approach was Milton Friedman's "The Methodology of Positive Economics." Unfortunately, there was a mistake in the copying of this article and only the first two sections were made available. Nevertheless, the discussion on this article lasted about 75 minutes, leaving us with only 15 minutes for the second article!

It is amazing how seriously Austrians take Methodolgy. The unfortunate thing is that the rest of the economics profession does not take methodology seriously. In fact, most economists never even consider methodology. It is my contention that even if the Austrians were able to demolish every argument in favor of positivism and were able to replace it with the Austrian approach, there would be few converts to the Austrian School. Sadly, the profession just doesn't care.

So the discussion centered on the typical arguments that Austrians raise when discussing this subject. How can postivists really believe in hypothesis testing? How can the science move forward if we are only observing? Is introspection merely a tautological definition or can something be learned and understood? Why should the social science of economics attempt to mimic physics? Etc.

My thoughts on this subject can be found here in my "Methodology" presentation for FEE in 2010.

The more interesting article was the second. We chose Roderick Long's "Realism and Abstraction in Economics: Aristotle and Mises versus Friedman" in the Quarterly Journal of Austrian Economics, vol. 9, no. 3, Fall 2006. It is found here.

We only had 15 minutes left to discuss this article and apparently we all agreed with it, there seemed to be little hope for any discussion. We found two major points that were particularly noteworthy.

The first centered on a quote by Peter Winch. Winch's example runs something like this.... Suppose that a positivist has no knowledge of the Chinese language. He is given "data" in the form of newspapers, articles, etc. From this data he is able to predict which "words" are fairly likely to occur in the near future. We can test the "power" of his "theory" by the basis of how well it predicts. However, there is still no understanding of what is actually being said. To test an economic theory on the basis of how well it predicts follows this example. There is no deeper understanding other than complex pattern recognition. This is why the Austrians have argued so passionately in favor of introspection.

The second point is borrowed from Guido Hülsmann. Hülsmann says that the big divide between the Austrians and the mainstream is the Austrian emphasis on the use of the counterfactual method. For example, what happens if there is a price floor compared to if there is no price floor?

Bastiat uses this approach in the story of the "Broken Window" and Hazlitt makes ample use of it throughout his Economics in One Lesson. This method is absolutely critical in most Austrian theorizing. However, to a mainstream economist, once you step outside of the principles level, this method of reasoning disappears.

Next time, the articles are Frank Knight's "Professor Mises and the Theory of Capital," Economica, Nov. 1941, pages 409 - 427; and Israel Kirzner's response in "Ludwig von Mises and the Theory of Capital and Interest," reprinted numerous times and is found here.

Addendum: Over the weekend, I was chatting with Richard Ebeling and we have come to the conclusion that Positivists do indeed engage in "counterfactual" thought. Actually, all that they do is count the facts!!!

Moore Nonsense on Taking and Giving

2011-01-18T18:32:00.008-05:00

To start the new year, I have been receiving free movie channels through a promotion. On one of them, Michael Moore's movie, "Capitalism: A Love Story" came on. Since there is no way that I'd ever pay to watch one of his movies, free was about the right price. I soon discovered that even free was too much.

Either the first or second sentence out of Moore's mouth was this, "[Capitalism] is a system of taking and giving." It is mind-numbing how completely wrong this is. Capitalism, or rather the free market, is a system of giving and giving.

Suppose you go to the store because you want to buy a snack for a dollar. In order for you to give up the dollar, which do you have to value more: the snack or the dollar? The answer is the snack. In order for a trade to occur, what does the guy behind the counter have to value more: the snack or the dollar? His answer has to be the dollar. If both sides of the exchange value the dollar more, there would be no trade. Also if both sides value the snack more, again there would be no trade. We trade because each side values what they gain more than what they are giving. Trade requires unequal valuations. Since value is in the eye of the beholder, meeting this requirement is not difficult.

When we trade both sides say, "Thank You" because both sides are giving and benefiting.

A system where one side gives while the other side takes also has a name: it is called stealing. It is a system where one side has no choice in the matter while the other side has all the power. An example of this relationship is the one between the individual and the state. The individual must give whenever the state decides to take. Try not paying your taxes and see what happens.

The relationship of giving and taking is between unequal parties. The relationship between giving and giving is necessarily between equals, since both sides can walk away from the trade at any time. The ability to refuse and say, "No" is the most fundamental power that an individual has in expressing one's individuality.

In his movie, it's clear that Michael Moore thinks that we were harmed by the national bail-outs of the large banks and corporations. I completely agree that this was a disgrace and that it never should have happened. These banks and corporations should have been left to fail. However, the bail-outs weren't market phenomena, rather they were the actions of the state repeatedly intervening in the economy. The government took tax money and gave it to these institutions.

Furthermore, the underlying cause of the economic crisis wasn't too little government, it was that there was too much. The free market has a system of natural checks and balances that prevent massive business cycles. It is when the government disrupts this system, that bubbles form and burst. Those that cannot see the past the immediate and are unable to look at deeper causes blame "capitalism" in a knee-jerk reaction.

Michael Moore's movie was just that—a classic case of haphazard economics and laziness. He could learn much from Henry Hazlitt's single lesson:

[T]he whole of economics can be reduced to a single lesson, and that lesson can be reduced to a single sentence. The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups.

On things to come...

2011-01-04T17:11:00.002-05:00

With the start of the new year and new semester, it looks like there will be some energy for the NCSU Austrian Economics Forum. This semester we are planning to do some comparing and contrasting. We are going to pick two presenters of a topic. One person will present the Austrian perspective and the other will present the mainstream's side.

I am looking forward to this format. I hope that it will bring in more students and appeal to a wider base. I find that when we are challenged by another to defend our position, we are much better for it.

I do not know what the readings are as of yet (or even the topics!), but as soon as I do, I will be posting them.

In Defense of Economists

2010-12-18T13:21:00.001-05:00

It’s that time of the year, Christmastime. This is the time of year when people say that the spirit of Christmas should center on giving and not on receiving. Two of the top Classic Christmas cartoons are “A Charlie Brown Christmas” and “How the Grinch Stole Christmas.” They both have the same moral. Materialism is bad. They say that we should stop focusing on the stuff and look to the deeper, true meaning of Christmas.

It is at this point that economists get scorned. Many, too many, think that economics (and by default economists) is all about (and only about) stuff, and consuming stuff in particular. Economists have pointed out that many firms don’t break even until the first day after Thanksgiving. It is the day when many firms climb out of the red and into the black, hence “Black Friday.” The implication is that if we didn’t have Christmas and all the buying of (needless?) stuff that goes along with it, then many of our businesses would never see an annual profit. Furthermore, Keynesian economists have defined the size of the economy, GDP, in a way that emphasizes consumption. The formula for GDP is consumption spending + investment spending + government spending + spending on net exports. Of these factors, consumer spending is the largest and if that dips, then so does our measurement of GDP. Therefore, too many people conclude that we should spend, spend, spend, and economists are accused of being the chief cheerleaders for this. While there are some economists that in fact cheer on consumption for consumption’s sake, Austrian economists do not.

To an Austrian economist, economics is a value-free (or value-neutral) science. The Austrian economist should not care if the economy is rapidly expanding, slowly growing or even contracting. His job is to study the economy and try to figure out how it works. If someone asks the Austrian economist, “Will this policy enhance or diminish future growth,” the answer is not the economist injecting his own values into the debate. This is what Mises and Kirzner mean by economics being a “Wertfreiheit” or value-neutral science. As an individual, the economist can step out of his role as a value-neutral scientist and suggest goals such as economic growth or unemployment reduction. However as an economist, as a scientist, it really should not matter if a person or a society consumes at a high rate or saves at a high rate. So it is rather silly to assume that all economists are cheerleaders for materialism and ever expanding rates of consumption.

To an Austrian economist, economic growth does not mean that there has to be more stuff. Austrian economics has long taught that value is subjective and cannot be compared between individuals. Thus, an economy may be better off if it takes fewer resources and less time to make the same amount of stuff. This is certainly true for individuals. We call that free time, or leisure hours. If you got the same pay for working fewer hours, would you consider yourself better off? Now imagine that for the entire economy. We are clearly better off, but not consuming more stuff.

That being said, as an Austrian economist and as a thinking individual, I prefer higher rates of future economic growth. Although to an Austrian economist, expanding future economic growth does NOT mean expanding our rates of consumption today. In fact, it means exactly the opposite. For the economy to grow in the future, it will need capital. In order for capital to be freed up for more roundabout production methods, more resources must be invested instead of consumed. In other words, that means there must be an increase in savings, not consumption.

These new methods of production are more complex and more roundabout, but are used because they either cut down on the amount of resources needed, cut down on the amount of work hours needed, or both. This process frees us up to do more or allows us enjoy leisure time. It is a major benefit of growing economy. It allows us to take time off and enjoy the Christmas holiday. Without a market economy, our holiday might not be as cheery or bright.

So have yourself a very merry Christmas, and think about the benefits that a market economy provides. I know I will.

Cwik Interview on Mises.Org

2010-12-16T10:28:00.001-05:00

In yet another shamless promotion of myself, my interview by the Mises Institute has been posted to their web site. I think they have done a nice job.

They started with some easy questions, but then there were some that I had to do some thinking about.

The link is here: http://blog.mises.org/14889/faculty-spotlight-interview-paul-cwik/

I hope you enjoy it.

The Terrible Red Line

2010-12-03T17:04:00.001-05:00

I live in a town next to Raleigh: Garner, North Carolina. For several decades the highway has looped around Raleigh and not unlike other growing cities, another loop has been planned for. This outer loop has been planned for the past 20 years. As a result, land has been set aside and businesses have planned for future traffic over these past decades.

It was much to everyone's surprise that at the beginning of September several other routes were added to the map for consideration. These additional routes are known as the Red, Blue and Purple Lines. Within a period of six weeks, the transit authorities met with communities and an overwhelming number of citizens stated that the original Orange Line was the one everybody preferred. At the end of the initial six-week period, the Blue and Purple Lines were removed from the map.

The Red Line, the route that literally passes through my neighborhood, the route that will be about six or seven houses away from my house, was not removed as an alternate to the original Orange Route.

Why?

There is a mussel that lives in a river on the south side of the nearby lake. It is on the endangered species list. There is no sign of it on the streams and creeks on the north side of the lake. (Nevermind that the mussel is found all along the eastern seaboard of the U.S.; where North Carolina is just the southern most edge of its habitat.) As a result, thousands of homes could be destroyed so that the mussel isn't disturbed.

There are many things that an economist could use here for comment: the value of unowned mussels, the competing interests of dividing a town, the destruction of many, many homes and businesses, the diminution of private property rights and the ascension of "community/environmental" standards, the economics of urban planning, etc.

Instead of recapping any of those subjects, I want to describe last night's meeting.

Last night there was a meeting with the Mayor, the engineering firm and my neighborhood. (This was just one of a series of such meetings.) What struck me was the absolute helplessness that my neighbors and I felt. We were up against raw, naked power and there was nothing that we could do but talk, be upset and grow angry.

The people who have the ultimate authority in the decision were nowhere around. We could only question the engineering firm that has no power or authority whatsoever. The ultimate decision will be made be a small group of people, who I will never know. The decision will be made without my knowledge. The location will be unknown to me. I am merely a pawn, and an inconvenient one at that.

This is the fate that happens whenever we place our faith and our fate into the hands of the government. The bureaucrats have their rules and regulations and, to them, I am no longer a citizen or an individual. I am merely something to be dealt with.

Such a dehumanizing system is not "bad" or "evil." It is simply the nature of bureaucracy. Mises wrote one of the best books on this subject, simply titled Bureaucracy. It is found here. I highly recommend chapter 2, "Bureaucratic Management."

The relationships between individuals is distinctly different between the market system and a system of bureaucracy. In a market system of private property, I must treat the person with whom I wish to trade with respect, as an equal. If I do not, there will be no trade.

In a system of bureaucracy, there is no such relationship. It is not a relationship between equals. A bureaucratic relationship is one of power and powerlessness. As we move toward National Health Care, as we move toward a increasing regulation over our finances, as we move toward the centralization of power in the hands of fewer and fewer people, we move away from a nation of equals. We move toward a nation comprised of those who have power and those who do not.

I hope that we can recover our lost Liberty. It was not too long ago that private property was at the top of the list of protected rights. Now with the Kelo case, and other eminent domain cases giving power to governments, our Liberty is in increasing jeopardy.

Finally, I am reminded of the Bugs Bunny cartoon, "No Parking Hare." It is about building a freeway through Bugs Bunny's home. After a series of fights, the road is moved because, as Bugs says, 'The sanctity of the American home must be preserved!'"

Adding to the Blog

2010-11-30T10:09:00.003-05:00

As I learn more about the capabilities of this tool, I will add to this site. You may have noticed a few additions. On the left-side, I have added links to the lectures I presented at FEE this past summer. Clicking on a link will take you to the page with the audio and PowerPoint presentations. Below that are links to the popular posts and down further is a listing of subjects that the posts cover.

On the right-side, I have added two pages. The first is the Economic Distress Index. If one clicks on it, you can either look at the entire graph from 1967 or just the last 14 years. There are also links to the data. There is also a link to an explanation of the index.

The second is a graph of yield curve inversions. Again, you can look at the entire graph from 1953 or just look at the last 10 years. Yield curve inversions are one of the best predictors of an on-coming recession.

My goal is to continue to improve this blog and post articles that tend to examine economic problems from an Austrian perspective.

You are, as always, very welcome to post comments as you wish.

The Real Thanksgiving Story

2010-11-19T15:29:00.000-05:00

The first Thanksgiving is not a story of dumb whites who came to the New World to conquer and spread disease amongst the idyllic, nature-loving natives.

It is, instead, a story of the triumph of Capitalism over Socialism.

There have been several retellings of the first Thanksgiving, I have linked to Richard Ebeling's recounting last year. Thomas DiLorenzo writes an excellent account in the third chapter of his book, How Capitalism Saved America.

This year I found a nice YouTube version that does a good job. It explains why private property rights saved the pilgrims and triumphed over the collectivist ideal.

I find Thanksgiving to be one of the best holidays for exactly that reason.

Austrian Economics Forum Fall 2010 #5—MegaPost

2010-11-11T14:57:00.008-05:00

Socialism is a failure, but why does it keep coming back? That’s the perennial question. In the latest Austrian Economics readings Group forum at NC State University, we discussed the final Hayek readings on socialism. In particular, "Socialist Calculation II: The State of the Debate (1935)" and "Socialist Calculation III: The Competitive 'Solution.'" These are chapters 8 and 9 in Individualism and Economic Order.

To Hayek, the problem that faces an economic system is one of coordination. How do individuals coordinate their actions with one another without the guidance of a central planner? And if there is a central planner, then will that system be able to incorporate all of the information necessary to not waste resources while satisfying the most intense wants and desires of the consumers? Will the people who live under a central planner still be able to choose their own consumer goods, or will goods just be rationed to them? Will workers get to choose where they work or will they simply be assigned their station in life?

Hayek begins by pointing out that the Russian experiment is a failure. The people are more impoverished than under the Czarist régime. Turning to the theoretical side of the debate, Hayek focuses on the mathematical approach to solving the production and distribution questions. In order to calculate the correct solution, the knowledge of opportunity costs is needed. More than mere “technical” knowledge is needed to run an economy. Just because we know how to build something does not answer the question of should it be built at all.

Furthermore, there is a need for the knowledge of consumer goods. Consumers’ tastes and preferences are continuously changing and the central planner, to be successful, will need some sort of feedback mechanism to incorporate the changes. Bureaucracies move too slowly to accomplish this task. The bottom line of this analysis is that the market processes the information that the central planners cannot. In order to achieve some sort of solution, consumer sovereignty has to be sacrificed. Consumers no longer can choose what they prefer; must simply take whatever goods and services that are placed before them.

In the conclusion, Hayek seems to have left the door open to the possibility of a workable socialist solution. Hayek states,

“that today we are not yet intellectually equipped to improve the working of our economic system by ‘planning’ or to solve the problem of socialist production in any other way without very considerably impairing productivity. What is lacking is not ‘experience’ but intellectual mastery of a problem which so far we have learned only to formulate but not to answer. No one would want to exclude every possibility that a solution may yet be found. But in our present state of knowledge serious doubt must remain whether such a solution can be found.”

I argued that unlike Mises, Hayek is leaving the door open. Cordato said that he thought the Hayek was being gracious towards his academic colleagues. While this may very well be the case, this is not how the debate progressed in the 1940s. The chief rivals to the Austrian challenge, like Lange, thought that Hayek was retreating from Mises’ position that socialism is impossible, even on paper.

It was at this point in our discussion that I read from an article that was published in 1948. The article, “Socialist Economics” was published by the American Economic Association in a collection of papers entitled, A Survey of Contemporary Economics. The article was written by Abram Berson, at that time he was a professor at Columbia University and earned a Ph.D. from Harvard. So his interpretation of the debate is not some fringe interpretation, it was, basically, the mainstream of the time. Furthermore, Bergson cites, not just the two articles that we read for the readings group, but he also cites “The Use of Knowledge in Society,” and Schumpeter and Mises as well.

Here is what Bergson says,

“To come finally to Mises, there are two questions to ask: What does he say and what does he mean?

“On the first question, let Mises speak for himself:”

Then there is a lengthy quote from Mises on how without private property there can be no market and no prices and then no economic calculation. Mises concludes, “Exchange relations between production goods can only be established on the basis of private ownership of the means of production.”

[back to Bergson]

“As to what Mises means, there appear to be two views. According to that which seems to have gained the wider currency, Mises’ contention is that without private ownership of, or…a free market for, the means of production, the rational evaluation of these goods for the purposes of calculating costs is ruled out conceptually. With it goes any rational economic calculation. To put the matter somewhat more sharply than is customary, let us imagine a Board of Supermen, with unlimited logical faculties, with a complete scale of values for the different consumers’ goods and present and future consumption, and detailed knowledge of production techniques. Even such a Board would be unable to evaluate rationally the means of production. In the absence of a free market for these goods, decisions on resource allocation in Mises’ view necessarily would be on a haphazard basis.

“Interpreted in this way, the argument is easily disposed of. Lange and Schumpeter, who favor this interpretation of Mises, point out correctly that the theory is refuted completely by the work of Pareto and Barone. …

“According to the other interpretation of Mises, which has the authority of Hayek, the contention is not that rational calculation if logically inconceivable under socialism but that there is no practicable way of realizing it. Imputation is theoretically possible; but, once private ownership of the means of production has been liquidated, it cannot be accomplished in practice.

“Hayek’s own thinking and that of Robbins, seems to be along these lines. Lange, who interprets the views of Hayek and Robbins as being in reality a retreat from the original position of Mises, considers that his own analysis refutes their argument…”

In the second reading, Hayek argues that it is the Socialists who have changed their arguments. And it is he who is chasing after them. Hayek states, “[I]t is surely unfair to say, as Lange does, that the critics, because they deal in a new way with the new schemes evolved to meet the original criticism, ‘have given up the essential point’ and ‘retreated to a second line of defense.’ Is this not rather a case of covering up their own retreat by creating confusion about the issue?”

So each side accuses the other of retreating and shifting the debate because of the other side’s inability to respond to the criticism. Personally, I am less interested in who shifted first. What does interest me is the shift in the debate. I agree with the first Bergson interpretation of Mises that under Mises’ analysis, socialism is unworkable, even on paper. I think that Mises’ argument that grounds itself on the fundamental foundation of socialism—communal property—is the stronger argument, because it attacks the very core of socialism. There is simply no getting around it. Either there is private property and a market that guides production or there is a central planner who controls it all.

I find it amazing that Bergson so easily dismisses the first interpretation of Mises. Bergson, Lange, Taylor, etc, all say that Mises was answer by Pareto and Barone. However, in the second reading, Hayek cites Pareto and shows that Pareto “expressly denied” the mathematical solution. Bergson obviously read this article and makes no attempt to address this point. Why?!?

I liked the second article more than several other people in the group. In section 5 of the article, we can clearly see the famous phrase “the circumstances of time and place” appear before the “Use of Knowledge” article. We also see an early sketch of the “man on the spot” concept a few paragraphs later.

One last point in the article that needs attention comes at the end of section 6. Hayek points out that under central planning there will be no improvements made. He states, “Any improvement, any adjustment, of the technique of production to changed conditions will be dependent on somebody’s capacity of convincing the SEC (Supreme Economic Council) that the commodity in question can be produced cheaper and that therefore the price ought to be lowered. Since the man with the new idea will have no possibility of establishing himself by undercutting, the new idea cannot be proved by experiment until he has convinced the SEC that his way of producing the thing is cheaper. Or, in other words, every calculation by an outsider who believes that he can do better will have to be examined and approved by the authority, which in this connection will have to take over all the functions of the entrepreneur.”

Innovation and creation will die under central planning. There is no incentive for the bureaucrat to take a risk. Bureaucrats, are by their nature, the opposite of risk-takers. They are the opposite of entrepreneurs.

For more on this debate, I found an article written by Murray Rothbard. It is found here:
http://www.lewrockwell.com/rothbard/rothbard132.html

Hayek vs. Keynes Rap Sequel Preview

2010-11-10T12:11:00.001-05:00

Earlier this year a rap video between Hayek and Keynes called "Fear the Boom and Bust" was posted on YouTube. It was wildly successful. You can find it here. With all good things, a sequel is in the works. Here is a sneak peak of a live duel between Hayek and Keynes.

Ron Paul on the Fed

2010-11-09T15:52:00.000-05:00

There was an article yesterday on CNBC.com "Fed Will 'Self Destruct,' Policy 'Deeply Flawed': Ron Paul."

Ron Paul is very much in tune with the Austrian perspective of the economy. He argues that the Fed's actions are in the wrong direction and that when he becomes chairman of the committe that oversees Monetary Policy, his approach will be very different. He is in favor of opening up the dollar to domestic competition. Competitive currencies would allow individual citizens the ability to escape from the mismanaged, inflationary policies of the Fed set forth in the post-gold standard era.

To read this article, it is here: http://www.cnbc.com/id/40068994/

Twisting the Yield Curve--Again!

2010-11-03T15:58:00.000-04:00

The more things change, the more they stay the same.

Today the central bank of the US, the Fed, has announced that it will buy 600 billion dollars worth of “longer-term” Treasuries. By the end of second quarter 2011, they are planning on buying $75 billion in 30-year bonds per month. (I suppose that 20-yr bonds would also fall under the heading of “longer-term” as well.) They again hope that this additional liquidity, “stimulus” will jump start economic growth.

The Fed also announced that they will target Fed Funds rates between 0.00% and 0.25%. This is eerily similar to an announcement they made on March 18, 2009. In that announcement they said that they were going to target Fed Funds rates between 0.00% and 0.25% and inject $850 billion into the economy. $300 billion were to go into the purchasing of longer-term Treasuries. I have already described how such a scheme is pure folly here. In that article, I also pointed out that it didn’t work when they tried it in the Kennedy Administration. Have we started to notice a pattern forming?

It is odd to find that we have tried this before and have not achieved the desired result. The key to impacting the so-called “real economy” by using expansionary monetary policy is by catching people unaware. If businesses see how much is injected and when, then they will adjust in anticipation of the injection. In other words, the only effect that the monetary stimulation will have is the immediate devaluation of the currency.

Cwik in Polish

2010-10-26T14:31:00.000-04:00

I just received an e-mail from the good people at the Fundacja Instytut Ludwiga von Misesa (the Polish Mises Institute, http://mises.pl). They tell me that my article "Austrian Business Cycle Theory: Corporate Finance Point of View” is now translated into Polish! How cool is that!? (There is a comments page with a discussion (so far) on time preference and interest rates.)

The new title is “Austriacka teoria cyklu koniunkturalnego z punktu widzenia finansów przedsiębiorstwa,” and it can be found here: http://mises.pl/blog/2010/10/22/p-f-cwik-austriacka-teoria-cyklu-koniunkturalnego-z-punktu-widzenia-finansow-przedsiebiorstwa/

The pdf can be found here: http://mises.pl/wp-content/uploads/2010/10/ATCK-z-punktu-widzenia-finansow-przedsiebiorstwa.pdf

The original can be found here: http://mises.org/journals/qjae/pdf/qjae11_1_4.pdf

Investing Social Security Funds arises from the Dead (Just in time for Halloween?)

2010-10-26T12:52:00.000-04:00

Today I was listening to the radio and a story came up stating that Andy Stern, former President of SEIU (the state employees union), suggested that in order to keep Social Security solvent, a portion should be "invested" into the stock market. So I looked for the story and sure enough it is found on the Huffington Post here. (Okay the article is from the end of June, but I heard it today, hence the Halloween reference.)

As mentioned in the article, this idea was once proposed in the Clinton Administration. This idea was bad then and it is bad now. Fortunately in May 1999, I wrote an article on the dangers of "investing" Social Security funds into the stock market. That article, "A Socialist Stock Market?" is found here.

Here are a few paragraphs...

Murray Rothbard once asked Ludwig von Mises at what point on the spectrum of statism can a country be designated as "socialist." To his surprise, Mises said that there was, indeed, a clear-cut delineation: the stock market.

Mises said, "A stock market is crucial to the existence of capitalism and private property. For it means that there is a functioning market in the exchange of private titles to the means of production. There can be no genuine private ownership of capital without a stock market: there can be no true socialism if such a market is allowed to exist."

A corollary to this idea is that if the government is allowed to "invest" in the stock market, then the economy can no longer be called market-based. President Clinton has proposed a plan to use up to one-fourth of new Social Security funds to buy shares in our stock markets. The danger of this plan may not be as obvious as his previous health-care plan, but they are just as serious. The justification for this argument is that the Social Security system is unstable and will face financial strains in about 2014 and will be exhausted by 2032. There are a few options that the Washington elite have deemed as "solutions." Most of these ideas are politically unpalatable. The first is an increase in taxes. Over time, the needs of the Social Security fund will be so high that it will stifle the entire economy. There have been some projections showing FICA taxes as high as 82 percent in forty years.

The second option is to reduce the "benefits" being paid out by the fund. This action is also politically unacceptable. The third alternative is to somehow increase the rate of return on the current surpluses to cover the future. The thinking in the Clinton administration is simplistic at best. The plan assumes (wagers) that the stock market will continue to increase (forever) at rates high enough to meet the projected needs.

The fundamental problem that the Clinton administration ignores is that the Social Security program is based on what is called a Ponzi Game or a pyramid scheme. You have probably seen this if you've ever received a chain letter that states, "Send money to the first five people on the list, remove the first person's name, and place yours at the bottom." In other words, the first people in the program (those at the top of the pyramid) are currently getting money from the new people enrolling (those who are at the lower stages of the pyramid).

Social Security works in the same way. Those who are retired are receiving money from those who are currently working. As long as the base of the pyramid is expanding at a geometric rate, the system will continue to function. However, U.S. demographics show that after the baby-boom generation, the base of the pyramid shrinks. It is mathematically impossible to continue the Social Security program indefinitely.

The best solution is to phase out the Social Security program by taking two steps.

The rest of the article is found here: http://mises.org/freemarket_detail.aspx?control=27.

Austrian Economics Forum Fall 2010 #4

2010-10-21T14:58:00.000-04:00

This past Friday, the Austrian Economics Forum met for the fourth time this semester at North Carolina State University. This week we covered the 7th chapter in Hayek's book, Individualism and Economic Order. This chapter is actually the introductory chapter of Hayek's edited collection Collectivist Economic Planning. It is called "Socialist Calculation I: The Nature and History of the Problem." The other reading was written by our own Dr. Roy Cordato called, "Knowledge Problems and the Problem of Social Cost." It was published in the Journal of the History of Economic Thought, Fall 1992.

Since Roy was with us that afternoon, we began with his article. It is a critique of Ronald Coase's famous 1960 article, "The Problem of Social Cost." The Coase article is important because it has given rise to the Chicago (University) Law and Economics program.

Essentially what Coase's article says is that the right to property is an important institutional factor in the efficiency of the market. Coase argues that we should first set property rights and see if it creates an efficient solution. If it does not yield an efficient outcome and when there are no transaction costs, then through trading by affected parties, the system will naturally move to an efficient system. However if there are positive transaction costs that prevent these negotiations from taking place, then what is now called "the Coasian Judge" will step in and redistribute the property rights so that the highest valued use of the resources is obtained. For Coase's system, property rights are a variable to be manipulated. Manipulated how? Well, the judge will simply look at the various prices and make an economic calculation and reassign the rights.

Cordato objects to this entire process. He uses Hayek's arguments on knowledge to say that there is a fundamental flaw in this logic. The flaw is this: The judge assumes that the prices that he is using are equilibrium prices. Only equilibrium prices contain the correct information about the relative scarcity of goods and services. Disequilibrium prices do not contain such information. We can take the argument a step farther and say that if the economy is in general equilibrium and prices are truly equilibrium prices, then why is there a dispute in the first place?

It has been 18 years since this article appeared. I asked Cordato whether he has seen much literature that condemns the Coasian approach from the Austrian point of view. He said other than some work by Walter Block, he has seen very little. So, what does Coase have to say about these criticisms? Well, nothing. To our knowledge, he remains silent on these issues.

A great paper topic was generated by this discussion: the application of Public Choice theory to judges. In North Carolina, we elect judges, why should we not apply standard Public Choice theory to the so-called Coasian judge?

During the discussion I brought up a point to clarify what we mean by "prices contain information." I posited that there is a parcel of land that is currently owned by the state. Scenario A is that we suppose that it is given to one person. Scenario B supposes that the plot of land is divided into 100 units and given to 100 individuals. Wouldn't it be better to follow scenario B because it contains the "information" of 100 individuals instead of just one person? Wouldn't Hayek like the second scenario based on his information and knowledge arguments?

The answers to these are "No." Karen Palasek rightly pointed out that Hayek does not mean quantity of information, that more people's subjective preferences are better. Hayek's focus is on the coordination of information. Hayek is focusing on how well and how quickly the subjective information is incorporated. The subjective preferences themselves and who is participating is a not the focus of the problem.

Unfortunately, Hayek did not have a fully articulated ethical system on which to rest the rights to property. Unlike Rothbard or Rand who had articulated ethical systems, Hayek cannot make the same sorts of policy recommendations. All that he can ground his arguments on are the efficiency of coordination.

The second article discussed was Hayek's introduction to the Socialist Calculation Debate to the English speaking world. Hayek's retelling of the intellectual drift from laissez-faire to Marx is excellent. The laissez-faire economists of the 19th century had a fundamental flaw, the labor theory of value. The logical extension of the labor theory of value leads straight to Marx. So, the economists of the Marginalist Revolution and immediately thereafter, put aside the popularization of economic's insights on competition and wealth generation, and instead concentrated on reworking the foundation of economics. This foundational work, while absolutely necessary, was technical work which excluded the average reader. As a result, the popular field was left wide open to the Marxists, the German Historical School, etc.

According to Marxist thought communism is inevitable. It would come about by the "material productive" forces of history. As a result, there was little questioning of how a communistic society would operate. In fact, as Hayek points out, to raise such a question was to question "scientific socialism" and called for stigmatization of the questioner. Hayek further argues that there is no predestination in the evolution of institutions and that institutions can certainly regress.

The article then sets up the collection for which it was originally written. We had little discussion on the later sections of the article, and decided that we would get to the center of the arguments next time.

For the next meeting, we are to cover chapters 8 & 9 in the book. They are "The State of the Debate (1935)" and "The Competitive 'Solution'" (1940).

30-second Spots

2010-10-14T16:50:00.001-04:00

Many of my students have approached me and have said something like, "Why don't you run for political office since you know all this stuff?" (Usually, it is not said too sarcastically.)

My comment back is that I do not think there is any way to explain a complex economic topic in a 30-second commercial. Nevertheless, I am curious about what could be condensed into a 30-second ad. I am not thinking about political ads. What I am most curious about is an economic ad.

I would like to ask for recommendations of ideas, topics, etc. that should be done. Have you seen anything like on YouTube (or any other site) that achieves this goal? Please send me the links. If I find some good ones, I'll post them.

Austrian Economics Forum Fall 2010 #3

2010-10-07T13:39:00.000-04:00

The last readings group covered Hayek's articles "The Meaning of Competition" and "'Free' Enterprise and Competitive Order." In my opinion the first is brilliant and the second, well, maybe it should not have been published. The group also seemed to be of the same opinion--the second article made too many concessions.

The first article, "The Meaning of Competition," was originally a lecture presented in 1946 at Princeton University. If I am recalling correctly, in the late 1940s, Hayek was on a lecture tour of the United States for two reasons. First, he was very popular due to his book The Road to Serfdom. Based on the popularity of this book, he was asked to go on a speaking tour to promote it. Also at this time, his home life was becoming increasingly unhappy. He was moving towards a divorce and, as a result, he was looking for a new position outside of the LSE. (He eventually moved to the University of Chicago, 1950-1962.)

"The Meaning of Competition" takes the model of perfect competition to task. In fact, he completely trashes it. He starts by examining the perfectly competitive model's assumptions. He, of course, focuses his attention on the assumption of perfect or "complete" knowledge. Hayek argues that by making this assumption, the economist has assumed away the very problem that he is to answer. It is only through the competitive order that relative scarcities can be discovered. It is only through a market price system that this knowledge can be communicated. It is the price system that economizes on what and how much needs to be communicated to create a efficient economic system.

Hayek argues,
"The function of competition is here precisely to teach us who will serve us well: which grocer or travel agency, which department store or hotel, which doctor or solicitor, we can expect to provide the most satisfactory solution for whatever particular personal problem we may have to face."

During the group discussion, I presented the following argument. For the economist, the relevant cost of any decision is always the opportunity cost. In a world of perfect knowledge, the marginal cost is the opportunity cost of the resource. When we remove the idea of perfect knowledge, opportunity cost and marginal cost are no longer the same. In fact, the entrepreneur should completely set aside the Average Variable Cost curve, the Average Fixed Cost curve and the Marginal Cost curve, because they are not the relevant basis of decision.

For example, suppose an entrepreneur is faced with the choice of project A and project B. Suppose further that the expenditures for both projects are $100. The revenue for project A is $150 and the revenue for project B is $120. Since the rate of profit for A is higher (50% versus 20%), the entrepreneur will obviously pick project A. What is the cost of this decision? It's not the $100. The cost, the opportunity cost, of his decision is not being able to get the 20% return from project B. Now suppose that the expenses for project A climbs from $100 to $110. The rate of profit falls to about 36%. Now even though the entrepreneur's expenses have risen, the cost of the project (the opportunity cost) has remained exactly the same! The cost is still the 20% that the entrepreneur is unable to get when he chooses project A.

(I'm not sure if everyone agreed with this line of thought or not, because they were fairly quiet. I suppose that it might be something that people need to sit with and think through.)

Hayek then drops the assumption of homogeneous goods and states the obvious--we live in a world with a spectrum of unalike products. For Austrians, products are substitutes or complements not because they look a certain way or have a certain physical similarities. For example, helicopters and closed-circuit cameras can be substitutes. How so? When a news station wants traffic updates, it can either send out a helicopter to monitor the traffic or it can use the cameras that now watch traffic flow. They are substitutes, not because cameras and helicopters look like each other, but because they are able to yield the same result. In a world where goods are not homogeneous, in a world where cameras and helicopters can be substitutes, the perfectly competitive model is completely inadequate.

Hayek concludes the article with:
"Competition is essentially a process of the formation of opinion: by spreading information, it creates that unity and coherence of the economic system which we presuppose when we think of it as one market. It creates the views that people have about what is best and cheapest, and it is because of it that people know at least as much about possibilities and opportunities as they in fact do. It is thus a process which involves a continuous change in the data and whose significance must therefore be completely missed by any theory which treats these data as constant."

The second article was the last one written for this book. It was written for the 1947 Mont-Pélerin conference and it was presented as the beginning of a discussion group. As a result, it raises many questions and answers very few. The conference was the first for what is now called the Mont-Pélerin Society. The purpose of the group was to gather the few remaining classical liberals, draw a line in the sand and determine the best course of action to promote liberty and oppose collectivism.

I confess that I like the beginning of the article. Hayek illustrates how there is this tendency for popular governments to cater to special interest groups, take over certain "responsibilities" of the citizens, gather power and control the masses. Hayek argues that we need to take a long-term perspective. A free society cannot be built overnight; people must be educated about liberty, responsibility and the importance of private property. Hayek then argues that we cannot simply chant mantras of private property and liberty. There needs to be more.

It is after this point that the wheels fall off.

Hayek argues that we need to think about the extension of the traditional concept of property to areas such as patents, copyright, trade-marks "and the like." Hayek then argues that maybe we shouldn't have patents and trade-marks. At first, I thought that this is similar to today's controversy in Austrian circles on the topic of Intellectual Property (IP) Rights. However, Hayek continues further along this line of reasoning. By questioning the "blind" extension of property rights to areas such as IP, we should further question the "blind" extension of property rights and "freedom of contract" to other areas such as corporations and limited liability organizations. Hayek then argues that it is the proper role of government to step in and limit corporations. In fact, it is "the duty of government to protect the individual against organized groups [corporations]." Hayek further states, "There may be valid arguments for so designing corporation law as to impede the indefinite growth of individual corporations...." Hayek then argues that we should also scrutinize labor unions and their collective power.

In the final section, Hayek opens the discussion to taxation. While he warns against the negative incentives that taxes cause, he also says, "I ought to add that inheritance taxes could, of course, be made an instrument toward greater social mobility and greater dispersion of property and, consequently, may have to be regarded as important tools of a truly liberal policy which ought not to stand condemned by the abuse which has been made of it."

I find these passages astonishing. Maybe Hayek is attempting to be thought provoking to generate a discussion for a panel, but I doubt it. Hayek is making these claims in front of the first Mont-Pélerin meeting, a meeting to stem the tide of collectivism, a meeting attended by the leading classical liberal thinkers. I wonder what Mises thought of this paper. I think that passages such as these may have been the cause for some to split Hayek into Hayek I (the good one) and Hayek II (the not-so-good one).

There is no question that Hayek was a champion for liberty. His writings have done much for the promotion of free markets. However, Hayek was only human and could make mistakes. He regretted not reviewing Keynes' General Theory. I suspect that he wouldn't place this article on a pedestal either.

Our National Debt, the Age of the Universe and Our Future

2010-10-05T11:38:00.000-04:00

There has been a lot of controversy centered on the size of the U.S. National Debt and rightly so, because it has never been a larger number. Today, the national debt is approximately $13,550,000,000,000 dollars. Such a large number needs context. I could say that if we stacked a trillion $1 bills on each other that this stack would stretch around the Earth 2.72 times. Unfortunately, that boggles the mind, especially if I say that our debt is 13.55 times that. Clearly, we need another way to understand the vastness of this number.

Using the Hubble Space Telescope, scientists have a clearer picture of the origin of the universe. Scientists estimate that the universe is approximately 13.7 billion years old. When we compare the age of the universe with the size of our national debt, our national debt is a 1,000 times larger. In other words, if we had spent about $1,000 a year, every year, since the beginning of time, we would have a number about the size of our national debt. Or, suppose you had spent $2.71 a day, every day, since the universe began. You would have spent as much as our current national debt.

How did the debt get so large if there was a surplus in the Clinton years? It is true that the federal government collected more tax revenue than it spent in the late ’90s and national debt shrank, however the debt did not fall to zero. (The last time the national debt was zero was in 1836, under President Andrew Jackson.) We have since had budget deficits—with each borrowed dollar adding to the debt. With the TARP funds, bail-outs, stimulus injections, and other spending programs, there is little wonder that the resulting deficits are so large.

There are three ways that we can get ourselves out of this hole. The first is to monetize the debt. In essence, this means that we can convert the debt into dollars and pay everyone we owe. In fact, this can be done tomorrow. How? Quite simply, allow the central bank of the U.S., the Federal Reserve, to buy up all the existing debt. Let it buy up all the T-Bills, Treasury Notes and Bonds—all of it. Dollars would replace the outstanding debt. Where would the Federal Reserve get all this money? The answer is simply that the Fed would get it out of a big black hole of nothingness. The dollar isn’t backed by anything—not gold, not silver, nothing but the “full faith and credit” of the United States (whatever that is). That means the Federal Reserve can just create money at will. It can create an infinite supply. It doesn’t even need to print new bills. The Fed could simply type numbers into a computer account and it’s done.

What is the problem with monetizing the debt? When $13.55 trillion new dollars hit the economy, the banking system multiplies the new dollars by a factor of a little more than 9. That means the money supply will swell by more than $120 trillion. (The current size of the money supply, as measured by M2, is $8.7 trillion.) If we took this route, we would be well on our way to hyperinflation. There have been several historical instances of hyperinflation, which wipes out life savings and destroys resources that form capital. The most famous instance was the German hyperinflation of 1923. Prices were rising so fast that people had to be paid multiple times a day. When workers were paid mid-morning, the men would run to the gates to give the money to their wives so that they could buy something before the money became worthless. Inflation was so bad that the price of a cup of coffee tripled by the time one finished drinking it. And this was happening for all prices! Germany could not continue with this situation. It had to abandon the Paper Mark and eventually switched to the Reichsmark.

The second way out of this deficit is to increase the amount of tax revenue that flows into the Federal Treasury. This approach has failed miserably for two reasons. The first is that the politicians always seem to find ways to spend all the additional money brought in and leave us no better off. The second reason is that increasing taxes is like having the economy drop an anchor. Taxation slows the economy, stunts business activity and penalizes the behavior of entrepreneurs. As a result, the higher tax rates take a larger percentage from a smaller pie, leaving a small and short-term increase in the revenues flowing into the Treasury followed by a drop-off in tax revenue a year or two down the line leaving a large debt and a stagnant economy.

This leaves the third option: a cut in spending. By a cut in spending, I don’t mean what politicians have been calling a cut, “a reduction in the rate of spending.” I mean, “Stop the car, put it in reverse, and back it up.” We need to cut spending to levels that are below our revenues. This will constitute many broken promises and real pain. The federal government has made very large promises. In fact, the size of the Unfunded Liabilities for the federal government exceeds $110.7 trillion. In other words, just to fulfill the promises already made, another $110.7 trillion are needed in the bank collecting interest right now. (U.S. GDP is only $14.5 trillion.)

So where can we cut our spending? If we look at the amount that we have spent on national defense this year (and I mean all of it), add up the total money spent on all the branches of the military—including equipment, personnel, operations, the wars in Iraq and Afghanistan—we have a year-to-date total of a little more than $527 billion. That is a lot of money and there are certainly areas that could be cut. Yet, if we look at how much we have spent on Social Security over the same period of time, we see the total to be above $534 billion. Furthermore, if we look at Medicare and Medicaid, that number is nearly $604 billion. Unlike defense spending, Social Security, Medicare and Medicaid are currently considered “Non-discretionary” budget items, so radical structural changes are needed to fix this problem, as well as the courage to solve this deficit issue.

I recently heard a good analogy. Imagine that you received some terrible news: your child has an awful, horrible disease. This disease will cause a lot of pain and suffering and could possibly result in the child’s death. Any parent’s natural reaction would be to fall to one’s knees and pray to God, “Give it to me. I will take the pain. I will suffer the burden, but please spare my child.”

Our National Debt is that disease. Why are we so willing to pass on the pain and suffering to the next generation, to our sons and daughters? Why are we so unwilling to bear the burden of our past excesses? The country is already broke. At this point, we are simply piling on. We have to address this issue now; it is getting worse. We have to look in the mirror and ask ourselves, “What kind of a person am I? What am I willing to do? What am I willing to sacrifice?” It has come to the point where the only way to fix this problem is through a sacrifice in today’s comforts. Will we try to spare our children from this disaster or will we impose this debt on them for our own comfort today? What are we willing to sacrifice for our children? What are you willing to sacrifice?

Mises' "Latest" Book

2010-09-30T15:00:00.000-04:00

Bettina Bien Greaves is a living treasure. She has worked for decades at the Foundation for Economic Education (FEE) and attended just about every lecture that Mises gave at FEE and at NYU. She would take shorthand notes of all that he said. Today she is converting those notes back into text. She has recently come out with a synthesis of several Mises lectures. It is called: Ludwig von Mises on Money and Inflation: A Synthesis of Several Lectures. You can find the book here and for sale here.

I am so excited about this that I am posting a short chapter below. It is called, "The Constitutional Side of Inflation." Enjoy...

When we talk about these things we must not forget that they do not have only an economic side; they also have a constitutional side. You may say that government is the most important institution. The government is very important in many regards. Perhaps one overrates the importance of the government, but one does not overrate the importance of good government.

Modern constitutions, the political systems of all nations that are not ruled by barbarian despots, are based upon the fact that the government depends financially upon the people, indirectly upon the men that the voters have elected for the constitutional assembly. And this system means that the government has no power to spend anything that has not been given it by the people, through the constitutional procedures which make it possible for the government to collect taxes. This is the fundamental political institution. And it is a fundamental political problem if the government can inflate. If the government has the power to print its own money, then this constitutional procedure becomes absolutely useless.

Our whole political system is based upon the fact that the voters are sovereign, that the voters are electing Congress and other such institutions in the various states that rule the country. We call the United States a democracy because the rule of the country is in the hands of the voters. The voters determine everything. And this distinguishes the system, not only from the despotic systems of other countries, but also from the conditions as they prevailed in earlier days, in countries that already had parliamentary institutions and parliamentary government, at that time. However, there has developed, especially in the last decade, a problem of constitutional law, that is whether the government must get the approval of the people through Congress when it wants to spend, or whether the government, because it is established and has at its disposal a number of armed men, is free to spend as it wishes, simply by increasing the quantity of money. People must realize that the question is “Who should be supreme? The parliaments elected by the voters, who can restrict government spending by refusing to grant the power to tax? Or institutions that want to override the interests of the people by increasing the quantity of money to expand government spending and so do away with the prerogative and independence of the individual voter?”

If we do not succeed in restoring the monetary system that makes the individual independent to some extent of the interference of government institutions, government banks, government monetary authorities, government price ceilings, and so on, we will lose all the achievements of the free market and of the free initiative of the individuals, whatever methods of constitutional law we follow. If the government can inflate whenever it wants to spend, it can take away from the people without their agreement everything, their purchasing power, their savings, and so on. From this point of view there disappears even the fundamental principle which everybody sees as the difference between a Communist government and a government based on the idea of individual freedom, the preservation of free markets and the ability of the people to control the government.

If you look at the constitutional history of England in the 17th century, you learn that the Stuarts had problems with the British Parliament. The conflict consisted precisely in the fact that the Parliament was not prepared to give to the King of England the money he needed for purposes of which the Parliament didn’t approve. The people disapproved of a great part of the government expenditures and Parliament was not anxious to impose taxes. The Stuart kings wanted to spend more than Parliament was prepared to give them. If the King at that time, in 1630 let us say, had asked one of those who are considered experts today in government finance, “What can I do? I don’t have the money!” the “expert” would have said, “Unfortunately, your family, the Stuarts, came too early to their position as rulers. Two hundred years, three hundred years later, it would be much easier for such a government as you want to rule the country. A printing press would have been sufficient to make it possible for your government to spend all the money it needed to have an army and the other things needed to protect the King against the people.” But the poor Stuarts were living in an age in which the technique of producing paper money had not been developed to a considerable extent. Charles I couldn’t inflate, you know. There was no solution for him; he could not engage in deficit spending. This was the undoing of the Stuart family and the Stuart regime. And in the conflict which originated out of this, one member of the Stuart family lost his life in a very disagreeable way—Charles I lost his head. (fn1) And the Stuart family as such lost the crown of England. What the poor Stuarts didn’t have was the facility of the printing press as it exists today.

The monetary problem we have to struggle with today is the problem of paying for government expenditures which are not accepted or, let us say, not approved, by the people. The conduct of government affairs, public affairs, is not different from the conduct of the financial and monetary conduct of private affairs. If the government wants to spend, it has to collect the money; it must tax the people. If it doesn’t tax, but increases the quantity of money in order to spend more, then it brings about an inflation. The difference between the conditions in 18th century England and the conditions in other countries, let us say for instance in Russia, consisted of the fact that the Russian government was free to take away from its subjects what it wanted while the British government was not. The British government had to comply with the provisions of a set of laws that limited the amount of money the government had the right to collect from its citizens. And it had to spend this money precisely according to the wishes of the people.

All our constitutional laws and our system of government are based upon the fact the government is not permitted to do anything that violates this system of laws representing the moral and actual ideas and philosophies of our people. But if the government is in a position to increase the quantity of money, all these provisions become absolutely meaningless and useless. If it is said that the government has to spend, is entitled to spend, a definite amount of money for keeping people in prisons, this means something. There is a definite reason for its spending. All our legal provisions are influenced to some extent by the fact that this is the amount of money which is given to the government for this purpose. But if the government is in a position to increase the quantity of money to use for its own purposes, then all these things become merely a theoretical expression of something which has practically no meaning at all. We must not forget that all the protection given to individuals through constitutions and laws disappears if the government is in a position to destroy the meaning of every inter-human relation by undermining the system of indirect exchange and money which is called the market. And this is much more importantthan any other problems we talk about today. It is the interference of the government with violence that has spoiled money, that has destroyed money in the past, and that is perhaps destroying it again today.

Some years ago you could frequently read quotations saying that Lenin said that the best method to destroy the free enterprise system would be to destroy the monetary system. Now a professor in Germany has demonstrated that Lenin never said this. But if Lenin had said this, it would have been the only correct thing that he ever said.

The monetary problem which we have in this country, which you have in every country today, is the same—to keep the budget in equilibrium, to balance income and outgo, revenue and expenditure without printing an additional quantity of banknotes, without increasing the quantity of the monetary units. This is not only a problem of economics. It is also the fundamental problem of constitutional government, you know. Constitutional government is based upon the fact that the government can only spend what it has collected in taxes. And it can only tax the people if the people accept it by the vote of their representatives in parliament. And in this way the voters are the sovereigns. The problem of monetary management in a modern country cannot, therefore, be separated from the constitutional problem, from the doctrine that says that all problems of government, all governmental matters are decided ultimately by the vote of the people. Whether you call this democracy or popular government doesn’t make any difference. But there is no monetary or budgetary problem that can be separated from the constitutional problem of who rules the country, who determines ultimately what has to be done in the country.

Fn 1 Charles I was beheaded on January 30, 1649.

Recessions and Recoveries

2010-09-28T14:35:00.001-04:00

Two weeks ago the National Bureau for Economic Research (NBER) announced that we are out of the recession and have been since June 2009. So, how does this recession compare to previous recessions?

The earliest date that the NBER uses is 1854. The average length of a U.S. recession between 1854 and 2010 is 17 months. If one uses post-WWII data, the average length of a business contraction is 10 months.

If we compare the current recession, which started in December 2007, with that of previous recessions, we see that the duration is longer than either average. Now that the NBER says we hit bottom in June 2009, we have had 19 official months of recession.

We are now entering the 34th month since the beginning of the recession and many are questioning whether we have truly hit bottom. While I believe that we have stopped falling, I think that the so-called recovery has started yet. In fact, there are signs that the recovery is still far off. For example, private investors are unwilling to make a move until they have a clearer understanding of the government's next regulatory moves. This situation precisely mirrors investors' sentiments in the 1930s.

The Bush administration reigned over the first 14 months of this recession. By historical averages, we should have been recovering by inauguration. What does this tell us? It says very clearly that the Bush administration made the wrong move by bailing out banks and propping up failing businesses.

It is now more than 20 months since the Bush administration has left office, and the current government has also done much to hamper any prospect of recovery. The Obama administration has not unleashed the economy (and reverse the Bush agenda), but instead, it has further shackled it. By supporting TARP and the Bush bank bail outs and adding to the situation the GM bail out, the ineffective stimulus package, a new health care burden and more financial regulation, the Obama administration has set us on a path towards economic stagnation. The looming fear is whether the stagnation will be coupled with Jimmy Carter style inflation.

It is time to recognize that taxing, spending and regulating are not the instruments for economic recovery. Money creation, artificially lower interest rates and government accumulation of debt are sending us down the wrong road.

Governments at all levels are stalling the recovery and it seems that no one trusts the market enough to let it do its job.

Perhaps we should listen to our 30th President Calvin Coolidge:

“The people cannot look to legislation generally for success. Industry, thrift, character, are not conferred by act or resolve. Government cannot relieve from toil. It can provide no substitute for the rewards of service. It can, of course, care for the defective and recognize distinguished merit. The normal must care for themselves. Self-government means self-support.”

Austrian Economics Forum Fall 2010 #2

2010-09-21T13:45:00.000-04:00

It seems as though I am running a little behind in my updates for our discussion group. At the last meeting we discussed Chapters 2 & 4 of Hayek's Individualism and Economic Order.

The first article we covered was "Economics and Knowledge." The article comes from a Presidential address before the London Economic Club in November 1936. It was reprinted in Economica in 1937. This article is significant because it is the first attempt he makes in describing the role and importance that prices play in our economy. He addresses the question, "With the absence of a central planner, how is it that people cooperate?" How do we coordinate our actions? And more fundamentally, how do economists view and model this process?

Hayek focuses on what the economist assumes, and particularly, what the economist assumes the people in the economy know. There is knowledge, data, which needs to be conveyed from one corner of the economy to the other. Can knowledge be assumed to be "perfect" and known by all? Hayek answers that knowledge is limited and divided. This article sets him on the path of developing his concept of "spontaneous ordering."

There is one aside that I'd like to point out with regard to this article. Hayek is questioning whether markets tend to equilibrate. At the end of section 9, I think that we can see that Hayek agrees with market equilibration. However during these years 1936-37, Ludwig Lachmann was Hayek's student at LSE. I think that it is clear that he was influenced by this thinking and led him down the path of rejecting market equilibration.

The second article is one of Hayek's most famous articles, "The Use of Knowledge in Society." It was published in the American Economic Review in 1945. Here Hayek expands on his earlier question by asking,

"What is the problem we wish to solve when we try to construct a rational economic order? On certain familiar assumptions the answer is simple enough. If we possess all the relevant information, if we can start out from a given system of preferences, and if we command complete knowledge of available means, the problem which remains is purely one of logic."

Then he forcefully argues,

"This, however, is emphatically not the economic problem which society faces. ... The reason for this is that the 'data' from which the economic calculus starts are never for the whole society 'given' to a single mind which could work out the implications and can never be so given."

In this article, Hayek argues that knowledge is dispersed and must be that way. He refers to the knowledge of "time and place." There is no manner to communicate to a central planner all the knowledge that is necessary to have an efficient economy.

There is no substitute for simply reading this very short article. It is found here. Nevertheless,...

The first thing that Hayek discusses is the different types of knowledge. He says that there are scientific knowledge and the knowledge of the particular circumstances of time and place. He argues that not all knowledge is something that can be communicated to a central planning board. While Hayek is absolutely correct and he is not saying that he has a complete taxonomy of knowledge categories, I think that the category of tacit knowledge should also have been included in his discussion. Tacit knowledge is the "learning-by-doing" knowledge that is easily seen in the world of art and music.

The next big thing that Hayek demonstrates is the economy of knowledge that is found in a price and that this information moves the economy. Hayek uses an example of a Tin Mine. Suppose that you use tin in your production process and the price of tin increases. What do you do? You cut back on your use of tin and look for substitutes. But not only does the price tell the entrepreneur in which way to move, but it also tells him the magnitude. If the price of tine goes up 3-cents, it's no big deal. If the price of tin goes up 300%, then it is a big deal. All of these actions are done without evening knowing what the root cause was. The only thing that is known is that tin is relatively more scarce and the economy needs to adjust.

The next point that Hayek makes is that prices allow the individual to link himself into the greater economic order. The price system sends to him enough information to make decisions and those decisions have effects on present and future price formation. It is through this process that prices lead to coordination. Paris gets fed! How? Through each individual, acting in his own self-interest, making decisions on what and how much to buy, and what and how much to sell, we get food to major population centers. The best short story that illustrates this point is "I, Pencil" by Leonard Read of FEE.

Finally, I think that one of the most neglected points that Hayek makes is the fact that without prices, civilization could not exist. Paris would starve without prices. There is no other substitute for prices. The Russians, under Lenin, tried it and it was a disaster.

There is no substitute for reading this article. It's short--only 11 pages in the AER. So get reading!

It's official! The Recession is over...Just in time for the second dip?

2010-09-20T11:53:00.001-04:00

The National Bureau of Economic Research (NBER) has long ago deemed itself as the official determiner of recessions--when they begin and when they end. Today, they have announced--that which I have been saying since at least March 2010 is true--that the recession ended in June 2009. Here is the link.

So with this incredibly after-the-fact announcement, we find ourselves with national unemployment at 9.6% and North Carolina at 9.7%. Additionally, we are seeing that the housing market is collapsing (again). More importantly, we see that firms are expecting the other shoe to fall soon. The Fed has done more than most thought they would. The stimulus has now proven to be a failure. The national debt is sky high. Social Security, Medicaid and Medicare are unsustainable. In the face of this, the federal government is burdening the economy with more rules, regulations and taxes.

I am certain that we are in a pause between two painful economic episodes. Many expect the next election will sort everything out. I am not quite so hopeful. The country does need to turn back toward that which works--markets. However, I do not see that turn any time soon.

Initially, the Great Depression was merely a bad economic downturn. In fact, it wasn't even as bad as the initial drop in 1920. In stepped Hoover and made a bad situation worse. He turned the country away from markets and sent us down the wrong path. FDR campaigned against Hoover's crazy spending, but unfortunately not only did he not keep his promise, he increased spending and regulations!

If we can survive FDR's National Recovery Act, we can survive the current federalization of the economy. The question is how long will it be until we realize that this path leads us to failure. How long will it take until we turn back to markets and prosperity?

Is There Another Recession Around the Corner?

2010-09-09T15:35:00.006-04:00

The best indicator of a recession has been the Term Structure of Interest Rate, better known as the “yield curve.” When the yield curve inverts, the economy slips into a recession approximately 4 - 6 quarters later. For my explanation of why this occurs, you can read my article here: http://pcpe.libinst.cz/nppe/1_1/nppe1_1_1.pdf or you can read the full dissertation here: http://mises.org/etexts/cwik-dissertation.pdf.

The yield curve has been making some troubling signs. Typically, the yield curve has an upward slope, and it looks like this:

However, when the economy reaches the upper turning point and is poised to fall into a recession, the short-term end rises relative to the long-term end. When this happens, it is called an inverted yield curve. We can plot the slope of the yield curve by simply taking the difference between the long and short ends. When the yield curve is upward sloping, the difference is a positive number. When the yield curve inverts, we have a negative number.

Here is a chart illustrating this difference over the past ten years:

(You can click on this picture for a close up.)

As we can see, the difference is falling again. The 10 year – 3 month spread dropped more than a 110 basis points from a recent high of 3.69 in April to 2.54 in August. The 10 year – 1 year spread dropped almost a 100 basis points from a recent high of 3.40 in April to 2.44 in August. The 20 year – 3 month spread dropped 101 basis points from a recent high of 4.37 in April to 3.36 in August. And the 30 year – 3 month spread dropped almost a 100 basis points from a recent high of 4.53 in April to 3.64 in August.

Each of these indicators fell by about 100 basis points in only 5 months, from April to August. This is a very sharp decline. The Fed has been absolutely flooding the market with as much money as the market can take. Many economists think that the Fed is running out of room to maneuver. 3-month T-Bills are under .20% and have been since April of 2009. 1-year T-Bills are now under .25% and with the Fed stimulant, there is a continuing downward trend. The question on the table is how long will this untenable situation remain?

When we see short-term interest rates start to rise, we will not the long-term rates follow suit. I am expecting to see the yield curve continue to flatten. If trends continue as they are, we are staring at a potential second dip in this recession.

Austrian Economics Forum Fall 2010 #1

2010-09-07T15:28:00.001-04:00

August 25th was the kick-off to a new season of Austrian Economics readings! (Did you expect me to say football? Hardly!) This semester we are reading Friedrich A. Hayek’s Individualism and Economic Order. The first two readings were: “Individualism: True and False” (Chapter 1) and “The Facts of the Social Sciences” (Chapter 3). (The book is found here: http://mises.org/books/individualismandeconomicorder.pdf)

There were about a dozen students attending the session. Professor Margolis and I were also there, but unfortunately Roy Cordato and his wife Karen Palasek were out of town. The session started slowly and found its footing as we got moving. I noticed that several of the students received their copy of the book when they arrived that afternoon, so I suspect that many of the students had not read the articles for discussion. I am hoping that the next session will have more student participation.

In the first chapter “Individualism: True and False,” Hayek begins by stating that there are really two definitions of individualism. At their root, they each have the word “equality” in common, but from this point the two branches of thought diverge and lead to positions that are not merely incompatible with each other, but are in direct conflict.

Readers of Hayek will recognize the first strand of thought as the traditional classical liberal view of the individual who has the same equal rights as any other individual. This individual has the liberty and the responsibility to chart his own life’s course. Such a position has been demagogued and characterized as one where the individual lives in isolation and must be completely self-sufficient. While some individuals choose to live this way, this lifestyle is not what Hayek is trying to explain. Hayek attacks this argument as the straw man for which it is. Instead, Hayek argues that in order for a society to work, individuals must be free to pursue their own goals. In fact, he contends that civilization itself would collapse if people were not able to freely choose their associations and their methods for achieving their goals.

The second strand of thought comes from the Descartes/Rousseau tradition. They exalt the individual and praise “Reason.” For them, “Reason” is superior to all other forms of human thought. As a result, we should be able to rationally plan society and free ourselves from many pitfalls. Hayek argues that before we start to tear down the institutions that hold society together, we must first understand their role.

A basic tenant in economics is to look beyond what is seen. The economist and social scientist must also look for and think about the unseen. In the unseen parts of institutions, there is knowledge and information that is essential to a well functioning society. To tear down these institutions also tears apart these unseen aspects. Hayek states, “the great lesson which the individualist philosophy teaches us on this score is that, while it may not be difficult to destroy the spontaneous formations which are the indispensable bases of a free civilization, it may be beyond our power deliberately to reconstruct such a civilization once these foundations are destroyed.”

My take on these two world views comes down to the manner in which we see ourselves. Do we see ourselves as fallen beings or as risen apes? When the Age of Reason was ascending, the Western world viewed mankind as fallen beings. “We are imperfect and each capable of great evil. This sinful side of our human nature needs to be checked and balanced.” Thus, the constitutional framers sought to prevent the gathering of power into any one institution’s or person’s hands.

The Descartes/Rousseau world view is that mankind is perfectible. With the rise of Darwinism in the 19th century, we see the push for a collectivism that is perversely (and paradoxically) based on individual reason. “Mankind grew up from the primordial ooze and rose above all other creatures. Why it only stands to Reason that there is no limit to the perfectibility of our nature and society. Every social ill can be cured if we put enough power into the hands of a person who has the ‘right Reasoning.’”

The second article was probably a little too technical for the students who did not have a chance to read it before hand. It wasn’t something that one could pick up as we went along. I found that the article fit well with Mises’ praxeology despite Hayek’s pleas to consider the empirical. I think that the characterization of the Praxeologist deducing the whole of economics from an armchair in an ivory tower to be a straw man. In praxeology, empirical observations are absolutely necessary. For example, we need to know if the society has money or a central bank. These assumptions are based on empirical observation.

In the course of the discussion of the article, there arose the point of whether we can know what another is thinking. And the answer is that of course, we cannot; but that is okay. I, as a social scientist, don’t have to know that person ate breakfast because he was hungry. I can reasonably infer that. In fact, technically, I don’t know that when I see the color red that another person also sees exactly what I see. All that is necessary for understanding is that we agree that the color is “red.” In the same way, I can never know what another is thinking, feeling or experiencing, but I can come “close enough.” In fact, if no one could ever come “close enough” then language would be impossible. The discussion then centered on: how an economist, as a social scientist, is supposed to do his job.

The next readings are Chapters 2 and 4 in the book: “Economics and Knowledge” and “The Use of Knowledge in Society.” These two articles have helped made Hayek famous to economists and social scientists. I look forward to this upcoming discussion group. I just hope that more people will be willing to discuss it.

US Debt and The Age of the Universe

2010-08-14T09:45:00.006-04:00

The size of the US debt has been a growing concern for most citizens. Every new spending measure enacted piles on more debt.

Recently, it occured to me that the size of our debt is about 1,000 times larger than the age of the universe.

The US national debt is approximately $13,325,000,000,000.
The age of the universe is approximately 13,700,000,000 years.

In other words, if we spent about $1,000 a year, every year, since the beginning of time, we would have a number about the size of our national debt.

Or suppose you spend $2.66 a day, every day, since time began, then you will have matched our national debt.

Something to think about.

Cwik on Mises.org

2010-08-13T13:43:00.003-04:00

Here is a link to my article that appears on today's Mises.org.

The title is "Social Insecurity."

I hope you like it.

Introduction to Austrian Economics is Posted (Now Complete!!!)

2010-08-09T11:29:00.006-04:00

FEE has now posted all four of my lectures on Austrian Economics. Here are the updated links.

Introduction to Austrian Economics
Lecture #1: Menger and the Early Austrians

This lecture covers the thoughts and ideas that found the Austrian School of Economics. It includes the work of Carl Menger [1840-1921], Eugen von Böhm-Bawerk [1851-1914], Friedrich von Wieser [1851-1926], David I. Green [1864 - 1925], Philip Wicksteed [1844-1927], and William Smart [1853-1915].
The link for the audio page is here.
You will also find the link for the PowerPoint on the same page or you can directly access it here.

Lecture #2: Methodology
To my delighted surprise, this lecture received the most attention by the students. It starts with a brief discussion of the Methödenstreit. It then critics Modern Positivism/Empiricism. Finally, it presents the Misesian Praxeological view and the relation between theory and history.
The link for the audio page is here.
You will also find the link for the PowerPoint on the same page or you can directly access it here.

Lecture #3: Capital and Interest
This lecture begins with the questions posed by Böhm-Bawerk. It then provides an introduction into Austrian Capital Theory and the Structure of Production. It then presents the traditional Austrian theory of interest. And then draws comparisons between the Austrian view and the Neo-Classical view of capital and interest. A proper understanding of capital and interest theories is critical to understanding business cycle theory.
The link for the audio page is here.
You will also find the link for the PowerPoint on the same page or you can directly access it here.

Lecture #4: Business Cycles
This lecture is a more advanced presentation of the Austrian Business Cycle Theory. In the tradition of Roger Garrison, extensive use of graphs is made. The lecture then demonstrates how that simply adjusting the money supply, adjusting prices, or spending money to boost aggregate demand are all inadequate to create an economic recovery. The key to an economic recovery is liquidation of malinvested capital and creation of new and proper capital structures.
The link for the audio page is here.
You will also find the link for the PowerPoint on the same page or you can directly access it here.

A License for what...?

2010-08-09T10:02:00.019-04:00

Here was a nice story about a lady who has decided to feed many Hummingbirds. However, during the story, my jaw hit the floor. It's at about 1:13. See if you can catch it.

It's where she says, "Of course, you know, I have to have a license to buy sugar. They think I'm bootlegging or something."

What?!?! The State of North Carolina says that you have to get a license to buy sugar?!?! Are you kidding me?

The erosion and loss of Liberty...

Cwik Lectures at FEE in 2010

2010-07-28T11:02:00.015-04:00

This summer I had the opportunity to give eight lectures at two of FEE's Summer Seminars. The first seminar was called "Freedom University" and the second was "Introduction to Austrian Economics."

FEE is in the process of posting the lectures in both audio and video forms. (As they become available, I will update this post.)

The lectures are either new or very much reworked from last year's presentations. There is significantly more content in the lectures.

In addition to the lectures, I have also provided FEE with the PowerPoint Presentations that I used.

I hope you like them. Please give me feedback one way or the other.

So here is the lineup with the appropriate links:

Freedom University
Lecture #1: Praxeology, Supply and Demand
This lecture starts with the foundational building blocks of economics: the Human Action Axiom and derives Supply and Demand curves, a model of the market and finishes with a comparison between the mainstream's derivation of demand curves with that of the Austrians.
The link for the audio page is here. You will also find the link for the PowerPoint on the same page or you can directly access it here.

Lecture #2: Competition and Entrepreneurship
This lecture looks at how markets are able to solve the problems of how we transform raw materials into goods and services, but not just randomly. We need to create useful goods and services, but again, not just randomly useful goods and services. We want to create goods and services that satisfies the most intense wants and desires of the consumers without wasting resources. The lecture concludes with a comparison of the Austrian view of competition with that of the mainstream.
The link for the audio page is here. You will also find the link for the PowerPoint on the same page or you can directly access it here.

Lecture #3: Business Cycles
This lecture is at an introductory level and is not very technical. The lecture focuses on the causes of the business cycle as well as the cures.
The link for the audio page is here. There was no corresponding PowerPoint with this lecture.

Lecture #4: Current Economic Events
This lecture was opened up so that, during the week, students could request topics that interested them. The first part of the lecture deals with the Economic Crisis in Greece. The second part focuses on the economic situation in the US. And the third part centers on the Yasuni National Forest in Ecuador.
The link for the audio is page here. There was no corresponding PowerPoint with this lecture.

Introduction to Austrian Economics
Lecture #1: Menger and the Early Austrians
This lecture covers the thoughts and ideas that found the Austrian School of Economics. It includes the work of Carl Menger [1840-1921], Eugen von Böhm-Bawerk [1851-1914], Friedrich von Wieser [1851-1926], David I. Green [1864 - 1925], Philip Wicksteed [1844-1927], and William Smart [1853-1915].
The link for the audio page is here. You will also find the link for the PowerPoint on the same page or you can directly access it here.

Lecture #2: Methodology
To my delighted surprise, this lecture received the most attention by the students. It starts with a brief discussion of the Methödenstreit. It then critics Modern Positivism/Empiricism. Finally, it presents the Misesian Praxeological view and the relation between theory and history.
The link for the audio page is here. You will also find the link for the PowerPoint on the same page or you can directly access it here.

Lecture #3: Capital and Interest
This lecture begins with the questions posed by Böhm-Bawerk. It then provides an introduction into Austrian Capital Theory and the Structure of Production. It then presents the traditional Austrian theory of interest. And then draws comparisons between the Austrian view and the Neo-Classical view of capital and interest. A proper understanding of capital and interest theories is critical to understanding business cycle theory.
The link for the audio page is here. You will also find the link for the PowerPoint on the same page or you can directly access it here.

Lecture #4: Business Cycles
This lecture is a more advanced presentation of the Austrian Business Cycle Theory. In the tradition of Roger Garrison, extensive use of graphs is made. The lecture then demonstrates how that simply adjusting the money supply, adjusting prices, or spending money to boost aggregate demand are all inadequate to create an economic recovery. The key to an economic recovery is liquidation of malinvested capital and creation of new and proper capital structures.
The link for the audio page is not yet posted. The PowerPoint for this lecture is forthcoming.

The Prodigal President (and the rest of us too!)*

2010-07-28T10:56:00.002-04:00

*This article appears as an Editorial in July 28th edition of The Garner Citizen News and Times here.

I cannot recall the first time that I heard the story of the prodigal son. I know that I have heard this story at least once a year in church and I am sure it has been more than that. For the longest time I thought that “prodigal” meant that the son returned. So I thought that the title meant that the story was about a returning son. I could not have been more wrong. Recently, the true definition of the word “prodigal” was brought to my attention. According to Dictionary.com, the definition is “wastefully or recklessly extravagant.”

In other words, the story is about the wasteful son, who asks for his fortune upfront and then spends it all in a reckless and extravagant manner. What was known to the people that Jesus was telling the parable to, and unknown to me, was that being prodigal was acting sinfully. Every one knew that spending everything on trifles and then borrowing, spending that, and then trying to spend even more, was just flat-out wrong.

It is amazing how much the world has (and has not) changed. Today, Americans are encouraged to spend, spend, spend. We are encouraged to run up credit card debt and purchase luxury items like new TVs, stylish clothes and nice gadgets. The tax code is designed to discourage savings and thrift. It is designed this way purposefully.

The dominant economic philosophy that governs the writers of our tax codes is the Keynesian economic philosophy. In the Keynesian point of view, GDP and Aggregate Demand are everything. According to economists, Aggregate Demand is defined as the summation of Consumption, Investment, Government Spending, and Net Exports. The largest component in this list is consumption. Therefore, the government “encourages” us, by manipulating the tax code, to spend our money on consumer goods, especially in a recession.

The government wants us to be a “prodigal populace.” (I think that they have been largely successful.)

Continuing along the Keynesian train of thought, since we are in a recession, it can be concluded that there is simply not enough Aggregate Demand. Thus, we need to increase one of the variables to boost our GDP. The variable most easily manipulated is government spending.

The Congress has been more than a willing accomplice to increasing government expenditures. The Federal Budgets have been as follows: $2.7 trillion (2007), $2.9 trillion (2008), $3.5 trillion (2009), $3.7 trillion (FY2010). In less than four years, we have expanded the annual Federal Budget by another trillion dollars. Meanwhile we have increased the national debt to well over $13.1 trillion. Despite these record levels, there are many in Washington that say that this is not enough.

We are clearly living in an age of the “prodigal politician.”

Finally, we come to the piece of news that recently caught my attention. The White House announced that through the $862 billion stimulus package that was passed in 2009, somewhere between 2.5 and 3.6 million jobs have been “saved” or created. I have no idea how one calculates a “saved” job, but let’s assume that these numbers are true. In fact, let’s assume that the larger number of jobs (3.6 million) is the correct number. So, how much did we spend per job? (The math isn’t all that hard.) The answer is $239,444.44 per job!

We can easily see that this is a policy package that was created by a “prodigal President.”

Why? Because, the jobs created by the stimulus package must be some of the nicest jobs in the world. I think that I would like to have a $239,444 job. In fact, with all of this excessive, wasteful and reckless spending I’ve been doing recently, I think that a job that pays $239,444 is the only way I will be able to start to pay my bills. Then again, maybe I should just go ahead and spend it all anyway. But if I did that, would I then become a prodigal Paul?

Are We Still in a Recession?

2010-07-21T16:01:00.008-04:00

If you ask an economist for a technical definition of a recession, you’ll probably get an answer that limits the experience to a decline in output. In fact, once the economy hits bottom, then every small increase thereafter is called “the recovery.” Here is what a business cycle and a recession look like:

The recession is the shaded area that begins at the top of the business cycle and ends at the bottom of the trough. If one asks a non-economist about this definition, they’d tell you that there was something clearly wrong here. A non-economist is most likely to describe a recession as not being over until at least the time when we recover to the trend line. Anything before that, we have a “depressed” economy.

(It’s funny to see how dogmatic the economics profession is on this point, especially when we mix politics in with these definitions.)

If you ask an economist how long the Great Depression lasted, you will get the answer that it started in 1929 (Spring 1929, if it’s a good economist) and that it ended around 1939/1940. However, if we truly look at the data, we see the following ups and downs over this period.

As indicated in the graph, the shaded areas indicate recessions. What we see is that, technically, there was no such thing as “the Great Depression,” but rather a steep, prolonged recession, a slow recovery, followed by another recession.

Does this graph seem similar to what we are currently experiencing?

Will there be a second recession? Will this be called the Second Great Depression by future economists? Only time will tell.

It was for these reasons that I have helped to create the Distress Index and update it monthly. You can see it on the left hand side of this blog. It helps us to see where we are in the greater schema of the economy. Any number above a 47.0 seems to indicate that there is a fair amount of distress in the economy.

So check back frequently to see the updates.

I am Doomed

2010-07-15T15:28:00.003-04:00

I have been told that you don’t really know anything until you experience it first hand. While this might not always be the case, it is certainly true when it comes to raising children. Is it a rewarding experience? Yes. Is it a necessary experience? Absolutely. Nevertheless, having one child is not a good indicator of how hard and time consuming raising two children can be.

During this past week, I have had a revelation. I am doomed, at least in regards to the new rationed health care system that we are soon going to enjoy. During this past week, my wife scheduled an appointment with her hairdresser. Since she is a stay-at-home Mom, I try to accommodate these outings as best I can. So I got to play Mr. Mom at home. In fact, it started out rather nicely. The wife dropped the boy off at his half-day preschool, so it was just me and the three-year old girl for the morning. Breakfast, playing, reading, lunch all went smoothly.

Then the carpool brings the boy home. However, he is sporting a fashionable band-aid on his hand. Apparently, at preschool, he was running, fell into the mulch and embedded a 0.5 – 0.75 inch splinter in his palm. It looked like it was removed, but I couldn’t really tell. So while he had his lunch, I called the injury expert—my Mom. After lunch and an inspection by Grandma, it was determined that a call to the pediatrician was necessary.

So I called and got a message that they were out to lunch until 2pm. I then impatiently waited an hour and called again. Shortly after 2pm, I got through and talked to a machine. After not pressing numbers 1-8, I got a person who then said that the next available appointment was at 4:50pm. From a larger perspective, I suppose that this is perfectly reasonable, but I have discovered that I am not very good at waiting. I am a fairly impatient person when it comes to the service industry. All I could think of was that this appointment was about three hours away.

And then it struck me, I am doomed when socialized medicine becomes reality. The most distinguishing feature of socialized health care is the incredible amount of waiting one has to do.

You see, scarce resources need to be rationed. There are so many people that want the services and there is less than that available. If there were more available than people wanted, then the resource wouldn’t be economically scarce; it would be a free good. The economic question that arises is how do we divvy up the resources to the people who want them? There are a number of methods to do this distribution: according to need; first come, first served; a lottery; by force; according to merit; or by the market.

With the sole exception of the market, all of these methods ignore supply incentives. In other words, when there is an increase in demand none of these, except for the market solution, will communicate to the producers that more is needed and reward those who produce that extra amount. The non-market methods of distributing goods and services translate an increase in demand into an increase in non-pecuniary costs, like, for example, standing in line. Instead of creating more health care services, the lines just get longer and longer.

So I suppose that I should be thankful that I was able to schedule an appointment for the same day. I think that in the not too distant future, I will be able to think back nostalgically and think, “Do you remember when you could call a doctor’s office and make an appointment for that same day, instead of days (weeks, months, whatever) later like we have today?”

What I do know is that I will not be able to skirt the system. My wife will have to take charge of this as well. She has the comparative advantage when it comes to bribery. She lived in Eastern Europe that had freshly thrown off the yolk of communism. While they were striving for freedom, there were several industries that had not been completely adjusted to the market.

Here is the story that she likes to tell… She was skiing, hurt her neck and decided, later, that she needed to see a doctor. Making an appointment in the official manner would have taken months. So some of her friends, had friends who knew people, who set up an appointment for her. It required a bribe—coffee. Apparently, coffee was rare and expensive at this time. However you can’t do what I would have done and say, “Here’s your bribe, may I now see the doctor?” No, that wouldn’t do. Instead there is a whole art to bribery. What my wife was told to say was, “As I was walking to the office, I noticed this coffee in the store window and thought that you might really enjoy it, blah, blah, blah….”

So this analysis leads me to an inevitable conclusion. I have no patience to wait for health care services and I have no bribery skills. So in the coming years, when socialized health care takes over, I am doomed. Now some young entrepreneur might sense an opportunity here. How about a class on how to bribe? If my wife offered such a class, I could then send her into the work force and permanently become a stay-at-home Dad. Oh my! That might even be worse. I am so doomed.

Leonard Read and the Love of Liberty - Jeff Riggenbach - Mises Media(Audio File)

2010-06-15T12:58:00.001-04:00

For the past two weeks, I have had the priveledge to lecture at the Foundation for Economic Education (FEE).

Coming soon, there will be the posts of my eight lectures and the accompanying PowerPoints.

In the mean time, please listen to this less than 20 minute overview of FEE.

Leonard Read and the Love of Liberty - Jeff Riggenbach - Mises Media(Audio File)

Austrian Economics Reading Group Session 6 Spring 2010

2010-05-03T11:54:00.005-04:00

The last two readings were Murray Rothbard’s “The Austrian Theory of Money” and O’Driscoll and Shenoy’s “Inflation, Recession, and Stagflation.”

Rothbard’s article touches upon several issues: Non-Neutral Money, Mises’ Regression Theorem, the absence of money in an ERE, future issues to explore, and the definition of money.

The non-neutrality of money is one of the most important contributions that the Austrian School has made to the field of Macroeconomics. Unfortunately, it has almost been universally ignored by the mainstream. It is easier to define neutral money and then compare non-neutral money to it. Neutral money is the idea of money having no real effects when it is injected into the economy. The neutral money theorists usually assume a magical helicopter that doubles the money supply over night. People wake up to see that they all have more money, but since everybody has double, nothing real is affected. All that happens is a doubling of prices. Non-neutral money states that such a story is not only wrong, but dangerously misleading. Money is, instead, injected into the economy at specific points and then spreads out from those injection points. The people with the new money are able to enter into the market at current prices and use the new money to bid resources away from their alternative resources. In a stepwise, sequential fashion, prices rise but not in a uniform manner. Those that get the new money first benefit and those who see prices rise, but do not have the new money lose real wealth. In other words, there is a real wealth transfer from those who get the new money last to those who get the new money first.

Mises’ Regression Theorem is the solution to what was called “The Austrian Circle.” When looking to apply marginal utility theory to money, it is noticed that people hold money, not because they use it as a good, but because it is the medium of exchange. In other words, they hold on to it because of its exchange value. Money is held because it has preexisting purchasing power. As Rothbard asks, “if the demand for, and hence the utility of, money depends on its preexisting price or purchasing power, how then can that price be explained by the demand?”

The solution is what is called The Regression Theorem. Mises argued in The Theory of Money and Credit that we need to go back to the point where this commodity money has not yet money. On the day before it was money, it had use value. Then on the next day it had both use value and exchange value. Thus there is no discontinuity as exchange value grows.

Rothbard also pointed out that in a world of perfect knowledge, there is no need for money. Some of the future issues that Rothbard suggests exploring are (1) How to return to gold; (2) free banking vs. 100% reserves; and (3) how should we really measure the money supply. It was on this last point that Rothbard’s America’s Great Depression received its most significant criticism. Obviously, this is a topic for further discussion.

The second essay presents the standard Austrian Business Cycle Theory (ABCT). While this was written in the mid-1970s, it presents the core in a comprehensive manner. Nevertheless, when considering the different areas of Austrian Economics, it is clear that the ABCT has been tremendously improved upon. There are really three levels of exposition of the ABCT today. The first is the basic story placed in the context of artificial boom leading to bust. I have done this here. Then there is the undergraduate level that is found in Roger Garrison’s Time and Money. Then there are the graduate-level articles written in the journals like The Quarterly Journal of Austrian Economics and The Review of Austrian Economics.

Overall, the NCSU Austrian Forum was good. I look forward to next semester’s line up. I am hoping that there will be more students to attend the sessions, but for me the benefit is from forcing myself to read.

Unfortunately we did not cover the text completely, but you are welcome to comment on the remaining articles in this forum.

Austrian Economics Reading Group Session 5 Spring 2010

2010-05-02T15:01:00.004-04:00

I have been remiss in my chronically of the Austrian Economics Reading Group for the entire month of April. We covered two readings in each session.

In the 5th session, we covered F. A. Hayek’s second chapter of Prices and Production, which can be found here (pages 223-252); and we also covered Ludwig Lachmann’s article “Complementarity and Substitution in the Theory of Capital” found in Capital, Expectations, and the Market Process, pp. 197-213, which can be found here.

Prices and Production was originally a series of four lectures that he presented at the London School of Economics. The talks were so successful that he was hired to teach economics, which he did from 1931 until 1950.

The power of the second chapter stems from the presentation of what is sometimes called “the Hayekian Triangle.” This was not the first time an economy was depicted in this fashion. Jevons and Wicksell did it before him; and Böhm-Bawerk had also described an economy as ripening stages of capital. However, Hayek's presentation was clearer and established the triangle as an appropriate tool for analyzing the macroeconomy.

The key to the structure of production, the triangle, is that there are definite stages of production. Some things need to be produced before other things can be made. (You can’t assemble a bookcase until after the tree has been cut down.) While the stages are not time specific, nor do they have to have a certain length (of time), they do establish a sequence. Thus, the economist who uses the triangle can represent distortions to the structure of production. For example, the Austrian economist can argue that during a boom, there is a malinvestment (and an over-investment) in two stages, namely the earliest and latest stages, while there is a malinvestment (and an under-investment) in the middle stages. No other economic school has such a conception. The Real Business Cycle Theorists come close, but do not rival the sophistication of the modern Austrians.

The second article might be one of most important overlooked articles in the Austrian literature. Lachmann points out that not only are capital goods substitutable, but they are more often complements. In fact, most capital arrangements consist of complementary capital goods. For example, suppose that I have an axe to cut down the tree and a truck to haul it to the saw mill. The axe and the truck are not substitutes. This point may seem obvious, and it is. However, outside of Austrian economics, capital goods are all perfect substitutes. Capital is reduced to a letter, “K,” and then is assumed to be continuous so we can take the second derivative of it.

Unfortunately, there were no Neo-Classicals who attended that session and so we all just agreed with one another. I was hoping for some debate, but alack and alas, it was not to be.

I will soon cover the last of our Austrian Economics Reading Sessions.

NBC's "Parenthood," Actual Parenting and Economics

2010-04-16T01:10:00.006-04:00

This television season NBC came out with a show called "Parenthood." I have two small children and thought I'd give it a chance. In last week's episode (#7--4/13/2010), two points struck me and the more that I think about them, the more unhappy I am with this show. They are both typical Hollywood mischaracterizations that shouldn't surprise me, but for some reason they struck a nerve.

Both of these points center around one character, Julia Braverman-Graham (played by Erika Christensen). The first incident centers on her niece's career day. The niece (Haddie) is supposed to shadow a family member and observe them at work. Since Julia is a high-powered corporate attorney, the experience has left Haddie infatuated with becoming a lawyer. The problem is that the mother (Kristina) feels diminished because she is only a stay-at-home mom. Mom attempts to impress Haddie by showing her some of the important work she did as a legislative deputy. Needless to say, Haddie is not impressed and Mom is saddened. The Hollywood-style resolution to the problem comes about when Dad takes Haddie for a bike ride and they end up at a park. The father explains that the park's existence is due to her mother's work forcing some company to make this concession during the permitting process.

One might think that I am upset because it is implying that only government is protecting green space and stopping evil corporations. Well, yes I am upset about that, but it's really secondary.

What really is chewing in my gut is that Mom only has worth because earlier in her life she did something outside of the home. In this episode, they could have talked about and highlighted or dare I say celebrated how important a stay-at-home mom is. That raising children and teaching the next generation values and civility are so important that extra income and outward status are foregone. Perhaps the creators, writers and producers of this show forgot that the name of the program is "Parenthood." I would have thought that a show with such a name might think that being a parent might be a good and celebrated vocation. Then again that's Hollywood thinking.

The second point comes from the conversation between the lawyer (Julia) and the niece (Haddie). As they chat at the exclusive restaurant for lunch, they talk about how Julia got interested in the law. Julia admits that it was because of the civil rights controversies. Haddie asks if that is interesting work. Julia says that the work she does centers on corporate mergers and acquisitions and not on civil rights issues.

Later in the episode, Juila talks to her husband about leaving the practice and going into this more worthy, more honorable field of law (civil rights law) and about getting out of the greedy, dirty, and rotten corporate law. (Okay, so that's my interpretation of the conversation, but you get the point.) The husband protests, "You love crushing little companies." Julia replies, "I know, I know, but what kind of person loves that?"

Again what is wrong here is that we only see half the picture. We need to take it the extra step. Suppose that a large company sees potential profit in the product of a smaller company. The larger company wants to acquire the smaller company. Now how does it do it? Let's assume that the small company is privately held. The large corporation negotiates a price, gives the owner a whole bunch of money, and then gains ownership and takes control.

In a market economy, the small company owner has complete freedom to take or reject the offer. The large company wants the owner to sell, so they need to offer a high price, but not too high a price. For every dollar spent on the acquisition, there will be one less dollar available to transform this small company into a large company. There will be one less dollar for new capital equipment, one less for marketing, one less for customer service and quality assurance. The large company needs to offer enough to get the owner to sell, but not so high that the project is no longer profitable. Julia's job is to make sure there is enough capital (money) left over after the acquisition so that it can be transformed into a large, profitable company that can serve ever more customers.

So am I surprised that Hollywood got it wrong again? No. I'm just a little disappointed, but then again, it did provide inspiration for this post.

Is Cwik Finnished?

2010-04-15T14:00:00.003-04:00

Last year I presented a lecture on Freedom Basics at FEE. Here is the video with Finnish Subtitles!

Vapauden perusteet from observant on Vimeo.

I need to thank Petri Kajander for making this possible. Here is the video with the transcript below (in English).

Dumbest Use of (Non-)Economic Principles?

2010-04-13T15:59:00.006-04:00

Every once in a while I come across something that is so profoundly dumb, that I know that it cannot be true. This was the case when I saw the Headline: "Flush with water, Raleigh could soon raise rates again." I have touched upon this topic before in the post "Circling the Drain." However, this time the problem is exactly the opposite to the previous problem.

The municipal water system for Raleigh and the six neighboring towns says that since the drought of 2007/2008, water consumption is down 7%. This comes as no surprise because many people installed rain barrels and are using other water saving techniques. During that drought, we were not allowed to wash our cars, get a glass of water at a resturant without asking for it, or even allowed to properly water our lawns. Many of these regulations have been lifted, but many people have kept their conservation habits. (At my house, we are switching over to a grass that uses much less water. We have been letting the Fescue grass die while allowing the Bermuda grass to take over.) With this decrease in water usage, our main reservoir, Falls Lake, is actually one foot above full.

Everyone, especially conservationists, should be happy. And everyone is happy. That is everyone except the Public Utilities Department. The P.U. Dept. is funded by water and sewer fees and their revenue is falling with the decrease in consumption. Their problem is to increase water usage and thereby increase their revenues. They should want to sell more water. The answer may seem obvious, and it is, except to the P.U. Dept. What does the P.U. Dept want to do instead? (So here it comes, ready for it?) The P.U. Dept wants to raise the water rates!

Now I may just be an economics professor, but I do know that demand curves slope downward.

This is a demand curve. It shows the relationship between prices and the quantity that consumers want to buy. When the price goes up, people are going to buy fewer goods. When the price of gasoline went up to $4/gallon, people cut back on the amount that they consumed. When we were in the drought, economists argued that raising the water rate would encourage people to use less water.

On the other hand, if the producer wants to increase sales, the producer will cut prices. Let's pretend that inventory has been increasing and it's time to clear some shelf space, what do you do? You have a sale. In other words, a price cut will encourage more people to buy more. Even the word "sale" should make this point fairly obvious.

The same works for water. If we raise the rates (price) for water, we will not be decreasing the surplus of water! If anything, we will be incentivizing people to reduce their water consumption even more!

During the drought, the water authorities said that we couldn't raise the rates to decrease water consumption, because it would unduly burden too many people. Now, because revenues are down, has this concern been thrown out of the window? It shows where the government's priorities lie. They care about their budgets first and the voters second. (I don't know where you fall if you aren't even a voter.)

In my earlier article, I called for a true privatization of the water supply. Only under a market, can we avoid the backward thinking of bureaucracies and get a system that serves the customers.

Austrian Economics Reading Group Session 4 Spring 2010

2010-03-29T14:15:00.005-04:00

The NC Austrian Forum met for the fourth time this past Friday (March 26, 2010) and discussed “Equilibrium Versus Market Process,” by Israel M. Kirzner and “On the Central Concept of Austrian Economics: Market Process,” by Ludwig M. Lachmann.

There were unfortunately almost as many professors as there were students—fortunate if you’re one of the students. There were only 2 graduate students and three undergraduates. Hopefully, now that Spring Break is behind us, there will be more next time.

One of the first issues that were brought up was by Stephen Margolis. He thought a critical point was when Kirzner asks, “If no one raises or lowers price bids, how do prices rise or fall?” In the model of perfect competition, the solution is through perfect knowledge. No adjustment process is necessary because we are always in equilibrium. However, that is not the world in which we live. So then how does it get done? Without the actions of the entrepreneur, it doesn’t get done. We also looked at what several principles economics textbooks had to say and it was not encouraging.

Kirzner next draws a distinction between Robbins (Robbinsian) and Mises (Misesian) conception of economics. As Kirzner states,

“Lord Robbins defined economics as dealing with the allocative aspect of human affairs, that is, with the consequences of the circumstance that men economize by engaging in the allocation of limited resources among multiple competing ends. Mises, on the other hand, emphasized the much broader notion of purposeful human action, embracing the deliberate efforts of men to improve their positions.”

Here we see the fundamental difference: for Neo-Classicals it is a simple, static maximization problem. For Austrians on the other hand, it is the searching for means to accomplish ends through time.

For Kirzner, the entrepreneur is the key to the market moving toward equilibration. While we might not ever get to such a point in the real world, the fact that the market equilibrates allows us to engage in comparative analysis.

In the next article, Lachmann rejects this position. He argues that each transaction might coordinate one person’s plans, but at the same time it might throw another’s plans into chaos. Thus, there is no such thing as moving closer to equilibrium for there is no such thing as equilibrium outside of the static state.

In Lachmann’s words, “The market process is the outward manifestation of an unending stream of knowledge. This insight is fundamental to Austrian economics. The pattern of knowledge is continuously changing in society, a process hard to describe. Knowledge defies all attempts to treat it as a 'datum' or an object identifiable in time and space.”

While it is hard to deny such a position, it also leaves one in a state of economic nihilism. How does one conduct any comparative analysis if everything is kaleidic?

Lachmann argues, “To say that the market gradually produces a consistency among plans is to say that the divergence of expectations, on which the initial incoherence of plans rests, will gradually be turned into convergence. But to reach this conclusion we must deny the autonomous character of expectations.”

I agree that we do have to deny the autonomous character of expectations. I think that expectations are shaped by experience. In a market setting, if one raises price and expects to sell more units, then that person will not be in business for too long. The nature of our expectations is shaped by how the market works. Expectations cannot be random and to the extent that Lachmann means this, he is wrong.

What do you think?

On a separate note, the NC Austrian Forum decided not to cover the next two readings on Capital Theory because the readings assume some background knowledge of people and issues. As a result, the two readings for next week will instead be: F. A. Hayek, (1935) “The Conditions of Equilibrium between the Production of Consumers' Goods and the Production of Producers' Goods,” Prices and Production, 2nd edition, Lecture 2, pp. 32-68. (The pdf is for the whole book, so don't just hit "print.") The second one is, Ludwig M. Lachamann (1977) “Complementarity and Substitution in the Theory of Capital,” Capital, Expectations, and the Market Process, pp. 197-213. Again, the pdf is for the whole book, so don't just hit "print."

Then we will cover Rothbard’s article “The Austrian Theory of Money,” and O’Driscoll and Shenoy’s article “Inflation, Recession and Stagflation.” These will round out the semester and then it will be on to Fall Semester. (Wow, time has moved fast!)

Austrian Economics Reading Group Session 3 Spring 2010

2010-03-29T13:05:00.004-04:00

For the third session of the reading group, I was unable to attend because I was instead at the Austrian Scholars Conference at the Ludwig von Mises Institute in Auburn, AL. At the third meeting the readings, “Philosophical and Ethical Implications of Austrian Economics” by Israel M. Kirzner and “Praxeology, Value Judgments, and Public Policy,” by Murray N. Rothbard, were discussed.

The two articles center upon the economist’s ability to practice a Wertfreiheit or value-free economic science. The reason for this question is one of power and limitations. Suppose that the economist can say something like Policy X will not work, in the same way that a chemist can say one oxygen atom and one hydrogen atom cannot make water, then that economist must be listened to. However, this situation is never the case. The economist either has to use his own value set of “goods” and “bads” or he has to adopt that of his client. The result is that there are no objectively good or bad policies, not even on issues like price controls or even market equilibration.

My thoughts on this are that as long as one is clear about their point of view, then that will minimize misunderstanding. However, if someone is looking to discredit you and says that you’re a "free market economist" and so of course you'd support.... Well, there’s really not a whole lot one can do, because they’re just looking to attack you personally. So why not just be up front about it and then deal with those attacks as they come up?

I am sure that there were many interesting points that were made on these readings, but unfortunately I was not there. Maybe if you have thoughts on this, you’d like to leave some comments? You are always welcome to do so.

Democracy in America?

2010-03-22T20:38:00.003-04:00

On the day after the "Health Care" legislation was "passed," I am reminded of a lengthy quote by Alexis de Tocqueville. It comes from his book, Democracy in America. This quote comes from the second volume, written in 1840, section 4, chapter 6, "WHAT SORT OF DESPOTISM DEMOCRATIC NATIONS HAVE TO FEAR." It is well worth reading the whole thing.

"I seek to trace the novel features under which despotism may appear in the world. The first thing that strikes the observation is an innumerable multitude of men, all equal and alike, incessantly endeavoring to procure the petty and paltry pleasures with which they glut their lives. ...

"Above this race of men stands an immense and tutelary power, which takes upon itself alone to secure their gratifications and to watch over their fate. That power is absolute, minute, regular, provident, and mild. It would be like the authority of a parent if, like that authority, its object was to prepare men for manhood; but it seeks, on the contrary, to keep them in perpetual childhood: it is well content that the people should rejoice, provided they think of nothing but rejoicing. For their happiness such a government willingly labors, but it chooses to be the sole agent and the only arbiter of that happiness; it provides for their security, foresees and supplies their necessities, facilitates their pleasures, manages their principal concerns, directs their industry, regulates the descent of property, and subdivides their inheritances: what remains, but to spare them all the care of thinking and all the trouble of living?

"Thus it every day renders the exercise of the free agency of man less useful and less frequent; it circumscribes the will within a narrower range and gradually robs a man of all the uses of himself. The principle of equality has prepared men for these things;it has predisposed men to endure them and often to look on them as benefits.

"After having thus successively taken each member of the community in its powerful grasp and fashioned him at will, the supreme power then extends its arm over the whole community. It covers the surface of society with a network of small complicated rules, minute and uniform, through which the most original minds and the most energetic characters cannot penetrate, to rise above the crowd. The will of man is not shattered, but softened, bent, and guided; men are seldom forced by it to act, but they are constantly restrained from acting. Such a power does not destroy, but it prevents existence; it does not tyrannize, but it compresses, enervates, extinguishes, and stupefies a people, till each nation is reduced to nothing better than a flock of timid and industrious animals, of which the government is the shepherd.

"I have always thought that servitude of the regular, quiet, and gentle kind which I have just described might be combined more easily than is commonly believed with some of the outward forms of freedom, and that it might even establish itself under the wing of the sovereignty of the people.

"Our contemporaries are constantly excited by two conflicting passions: they want to be led, and they wish to remain free. As they cannot destroy either the one or the other of these contrary propensities, they strive to satisfy them both at once. They devise a sole, tutelary, and all-powerful form of government, but elected by the people. They combine the principle of centralization and that of popular sovereignty; this gives them a respite: they console themselves for being in tutelage by the reflection that they have chosen their own guardians. Every man allows himself to be put in leading-strings, because he sees that it is not a person or a class of persons, but the people at large who hold the end of his chain.

"By this system the people shake off their state of dependence just long enough to select their master and then relapse into it again. A great many persons at the present day are quite contented with this sort of compromise between administrative despotism and the sovereignty of the people; and they think they have done enough for the protection of individual freedom when they have surrendered it to the power of the nation at large. This does not satisfy me: the nature of him I am to obey signifies less to me than the fact of extorted obedience. "
The rest is found here.