A comment about economics and Americans

One of the things that makes communicating our message of freedom and liberty with progressives, modern style liberals, and so many others very difficult is that they believe in so many economic fallacies. We might agree on many things with various people from the far left to the far right but often they can’t really see the situation clearly because they have never studied economics and they don’t want to. Why do they dislike economics so much? What is economics?

Austrian-Cat

Let us start looking at economics and the American citizen by looking at a few words from Lew Rockwell on the matter:

The most common misunderstanding about economics is that it is only about money and commerce. The next step is easy: I care about more than money, and so should everyone, so let’s leave economics to stock jobbers and money managers and otherwise dispense with its teachings. This is a fateful error, because, as Mises says, economics concerns everyone and everything. It is the very pith of civilization.

It is this lack of caring about economic principles that leads many Americans into false beliefs about government and what “we” should do about various problems. Rockwell continues:

This is a confusion sown by economists themselves, who postulate something called “economic man” who possesses a psychological propensity to always behave in ways that maximize wealth. Their mathematical models, predictions, and analysis of policy are based on this idea.

In the real world, however, we know this not to be the case. The world as we know involves profit seeking but also extraordinary acts of charity, sacrifice, non-pecuniary giving, and voluntarism (though I dislike that term since all commercial exchanges are voluntary too!).

How to account for these? The Austrian approach to economics dispenses with the idea of “economic man,” or rather broadens the meaning of economics to include all action, which takes place in a framework of scarcity. Scarcity requires that we economize on something in all that we do, even when wealth is not the motivation. For this reason, Austrians analyze acting individuals, not maximizing prototypes.

We have to realize that it is individual humans who act and that they respond to incentives via their subjective evaluation of the situation, even when they don’t consciously realize that they are doing so. We must analyze acting individuals and look at what they really do rather than what they say they are going to do. This message is at the heart of the Austrian School of economics.

One of my favorite writers today is professor of economics Walter Block who has been called “Mr. Libertarian” since Murray N. Rothbard passed away. He has been a fierce defender of market anarchy and normally pulls no punches with his analysis of anything that he writes about. He once wrote the following words:

For zillions of years, the human race lived in small groups of 25–50 people or so. We became hard wired to appreciate explicit cooperation: I scratch your back, you scratch mine; I’ll feed you when you’re hungry and/or sick; you reciprocate. Those who wouldn’t or couldn’t do this didn’t tend to leave their genes to the next generation. That is one of the reasons why the family is even today such a powerful institution.

However, in an economy of 6 billion, we can’t all cooperate this way. Rather, we can only cooperate through markets. That is, implicitly, not explicitly.

To illustrate this point, take the recent history of New Orleans. When Katrina struck, prices of oil, gas, milk, water, orange juice, batteries, candles and other such items catapulted. This was implicit cooperation in action. How so? Higher prices means that those first in line at the grocery don’t get everything on the shelves. Elevated prices have a rationing function; at normal costs, people would tend to stock up; if the prices are very much higher, they will in effect if not by benevolent intention leave something for others. This is part and parcel of Adam Smith’s “Invisible Hand” at work. Also, higher prices in post Katrina New Orleans would encourage, through greater profit margins, businessmen from outside of the struck area to bring these goods to those here who needed them the most. This embodies yet another aspect of Adam Smith’s “Invisible Hand.”

An example of the trouble that economic ignoramuses cause can be illuminated with many different examples, but today let me just look at a couple of food shortage examples. Allow me to point out that so-called liberals and progressives think that rising prices in a time of great shortage is a horrible thing and they usually blame “evil and greedy corporations”.  It would come as a shock to our progressive friends (I have some, no kidding) that rising prices in a time of great shortage is actually a good thing. The higher prices preform the rationing that has to happen, and does so automatically. If there is going to be a food shortage after a major hurricane then we don’t want the first people at the grocery store to clean off the shelves at regular prices and hoard it all. We want the prices to rise so that people take only what they must have at the present time. This can be hard on the poor working class as I well know being one of that class myself, but I would rather buy some expensive product if I need food rather than look at empty shelves.

The economically uneducated always seems to wonder why tomatoes cost so much more in the dead of winter than in the summer time when the local crop comes in. It is the automatic rationing function of the free-market that helps man deal with scarcity in a peaceful manner. This is not the terrible thing the progressives imagine it to be. Economics is the study of man dealing with his environment and the fact that nearly all of his wants and needs are in short supply. Economics is the study of how humans deal with scarcity. We study how man deals with his situation through purposeful action, or as von Mises called it: “Human Action”.

Simply, economics is the study of human action and if one is going to have any opinion on politics or society at all, then one needs to study economics so as not to continue to believe in the many economic fallacies that the state has showered you with via their propaganda for the entirety of your life.

So what books would make a good introduction to economics for the average person? There are so very many that I could recommend, but here are three that I find to be wonderful introductions to the subject. First up is the classic text that I think is a great introduction to anyone interested in learning about economics: Economics in One Lesson by Henry Hazlitt. This one is one of the shortest, surest ways to understand basic economics. Hazlitt was a great writer and this book is not some dry textbook. Another very good introduction to economics would be An Introduction to Economic Reasoning by David Gordon. Dr. Gordon answers the question “Why care about economics?” and then goes on to explain basic economics. Another good introduction is found in Basic Economics by Thomas Sowell. This is a primer for everyday people that explains the basics behind any type of economy.

When you are ready and you have the time, there is no text in the world better than Ludwig von Mises’ book “Human Action“. In my opinion, this book by Mises is the most important work of economic or social theory written in the twentieth century. It is also the most important defense of laissez faire capitalism ever written. Yes, it is even better as a starting point for many people than the works of the great Murray Rothbard. This book is the place to find your moorings before diving into the economics, history, and libertarian philosophy of Rothbard. This book by Mises is not only a work on economics, but a full on investigation of the “science of human action.” Starting from a few principles that are a priori, von Mises deduces an entire body of economic theory. This book is highly recommended if you hope to understand the world we live in.

My friends, you should seek to understand economic thinking and you should encourage those you know to do likewise. Economics is far too important to leave to the professional economists.

Let us “occupy” our own street

I once read a quote that summed up the problem with the Occupy Wall Street movement very well. It went something like this, “blaming Wall Street for controlling Congress is like blaming the other woman for controlling a cheating husband.” So many on the left (and the “occupy” movement in particular) are looking at the small fry and refuse to look at the real force behind their discontent. Large corporations and industries hire lobbyists for a sound, solid reason and not to just toss money around. They hire lobbyists and toss money around D.C. because the central government of the U.S. is where the power and coersive force is located. They can get protection there. They can get special favors and consideration there. They can get in tight with the seat of corruption.

The “progressives” can not seem to distinguish capitalism from corporatism. The laissez-faire free market that makes the consumer the king is conflated with the fascism developed by Mussolini in Italy in the 20s. They see the fusion of big business and industry with the State as the same thing as the free-market of laissez-faire! How does someone get that deluded? Or is it that they are power seekers who want to attack freedom and liberty in any underhanded manner that they can?

occupy

Progressives love the awesome power of the coersive and brutal state and see the only problem being that their own tribe might not be in power. If the voters elect good progressives to brutalize the people then progressives are all a-twitter with delight. Of course the progressives don’t see the state domination over you as “domination” really; they see it as your re-education and, of course, it is “all for your own good” anyway.

So what about the marketplace? They see government controlling the market just like the USSR once tried to do. The fact that this led the people of the USSR into poverty and famine does not seem to bother the progressives at all. The fact that Cuba and North Korea are poster children for backwardness, poverty, and police state actions does not seem to bother the progressive a bit. Well, as long as they can envision themselves as being inside the ruling circle that is.

Libertarians, on the other hand, seek freedom and liberty so that people can do as they please as long as they don’t commit aggression against another person or his property. They see all private business under laissez-faire as having to provide the best service or good for the least amount to gain the business of the very fickle customer. We see every consumer as being the king or queen of the market. Business can not make people deal with them as the armed thugs of the state can. No, business in the freed-market must satisfy their customers in voluntary, mutual exchanges.

Murray Rothbard once pointed out that “Man has found that, through the process of voluntary, mutual exchange, the productivity and hence, the living standards of all participants in exchange may increase enormously.” It should be obvious that the “natural” course for mankind is to cooperate and to attain as much “wealth” as possible to attain the highest standard of living that is possible in this mortal plane. The Austrian School of economics, following in the footsteps of von Mises and Rothbard, have shown us that the laissez-faire freed market along with well defended property rights is the best and most sure path towards a high standard of living for all.

So how come the American progressives and the Occupy Movement continue to peddle the idea that the State should control all aspects of our life? How can they attack the warfare-state while trumpeting the welfare-state and the nanny-state? How can they continue to believe that state enforced egalitarianism is anything other than a revolt against nature?

I continue to see craziness like “tax the rich” out of people that should know that “taxing the rich” was the slogan that gave us income taxes in the first place. Now the working poor see about 50 percent of their income go to the government in one tax or the other while the rich know how to avoid taxes. The answer is not to steal from the rich, but rather stop the thief called the state from taking what little we have now.

There are those who think that if we tax and bleed business to death as the city of Detroit did then all would be peace and light. What heifer dust! The minions of the State love to play divide and conquer. They love to get one group fighting another group when it is the intervention of the state itself that is the real problem. And when it all comes crashing down? Why then they say you need to give the state even more power to “fix it”.

The answer, my friend, is still blowing in the wind. The answer is to withdraw all consent from the state and to try to educate your fellow man as to the real nature of the problem. For as many have pointed out over the centuries, every complex social problem caused by the State has a simple State solution and it is always wrong.

Progressives, Cartelists, the FED, and trust busting

Murray Rothbard wrote about the vastly wealthy in America fooling the progressives and then re-writing history as to what happened in a small article in 1999. Here is a short portion of that article:

The Federal Reserve Act of December 23, 1913, was part and parcel of the wave of Progressive legislation on local, state, and federal levels of government that began about 1900. Progressivism was a bipartisan movement that, in the course of the first two decades of the 20th century, transformed the American economy and society from one of roughly laissez-faire to one of centralized statism.

Until the 1960s, historians had established the myth that Progressivism was a virtual uprising of workers and farmers who, guided by a new generation of altruistic experts and intellectuals, surmounted fierce big business opposition in order to curb, regulate, and control what had been a system of accelerating monopoly in the late 19th century. A generation of research and scholarship, however, has now exploded that myth for all parts of the American polity, and it has become all too clear that the truth is the reverse of this well-worn fable.

In contrast, what actually happened was that business became increasingly competitive during the late 19th century, and that various big-business interests, led by the powerful financial house of J. P. Morgan and Company, tried desperately to establish successful cartels on the free market. The first wave of such cartels was in the first large-scale business — railroads. In every case, the attempt to increase profits — by cutting sales with a quota system — and thereby to raise prices or rates, collapsed quickly from internal competition within the cartel and from external competition by new competitors eager to undercut the cartel.

During the 1890s, in the new field of large-scale industrial corporations, big-business interests tried to establish high prices and reduced production via mergers, and again, in every case, the merger collapsed from the winds of new competition. In both sets of cartel attempts, J. P. Morgan and Company had taken the lead, and in both sets of cases, the market, hampered though it was by high protective, tariff walls, managed to nullify these attempts at voluntary cartelization.

It then became clear to these big-business interests that the only way to establish a cartelized economy, an economy that would ensure their continued economic dominance and high profits, would be to use the powers of government to establish and maintain cartels by coercion, in other words, to transform the economy from roughly laissez-faire to centralized, coordinated statism. But how could the American people, steeped in a long tradition of fierce opposition to government-imposed monopoly, go along with this program? How could the public’s consent to the New Order be engineered?

Fortunately for the cartelists, a solution to this vexing problem lay at hand. Monopoly could be put over in the name of opposition to monopoly! In that way, using the rhetoric beloved by Americans, the form of the political economy could be maintained, while the content could be totally reversed.

Monopoly had always been defined, in the popular parlance and among economists, as “grants of exclusive privilege” by the government. It was now simply redefined as “big business” or business competitive practices, such as price-cutting, so that regulatory commissions, from the Interstate Commerce Commission (ICC) to the Federal Trade Commission (FTC) to state insurance commissions, were lobbied for and staffed with big-business men from the regulated industry, all done in the name of curbing “big-business monopoly” on the free market.

In that way, the regulatory commissions could subsidize, restrict, and cartelize in the name of “opposing monopoly,” as well as promoting the general welfare and national security. Once again, it was railroad monopoly that paved the way.

For this intellectual shell game, the cartelists needed the support of the nation’s intellectuals, the class of professional opinion molders in society. The Morgans needed a smokescreen of ideology, setting forth the rationale and the apologetics for the New Order. Again, fortunately for them, the intellectuals were ready and eager for the new alliance.

The enormous growth of intellectuals, academics, social scientists, technocrats, engineers, social workers, physicians, and occupational “guilds” of all types in the late 19th century led most of these groups to organize for a far greater share of the pie than they could possibly achieve on the free market. These intellectuals needed the State to license, restrict, and cartelize their occupations, so as to raise the incomes for the fortunate people already in these fields.

In return for their serving as apologists for the new statism, the State was prepared to offer not only cartelized occupations, but also ever-increasing and cushier jobs in the bureaucracy to plan and propagandize for the newly statized society. And the intellectuals were ready for it, having learned in graduate schools in Germany the glories of statism and organicist socialism, of a harmonious “middle way” between dog-eat-dog laissez-faire on the one hand and proletarian Marxism on the other. Big government, staffed by intellectuals and technocrats, steered by big business, and aided by unions organizing a subservient labor force, would impose a cooperative commonwealth for the alleged benefit of all.

And that transformation of a “roughly laissez-faire economy and society” to one of “centralized statism” came just in time to begin over a century of war and empire expansion that continues until this day. We have seen how the government can use the central bank to inflate money and pay for things they could never get with just taxes or borrowing (as bad as these two are). The main point of that Rothbard post is the idea that the progressives brought you the wonders of central banking which funds endless war and control by the rich.

ETFSigns6

Steven Horwitz Professor of Economics at St. Lawrence University tells us:

Like other legislation of that era, the Fed was a government intervention supported both by ideologically-motivated and well-meaning reformers and by the industry being regulated. Rather than being this as some sort of unique conspiracy to take control of the US monetary system, it was a story very similar to those found in the history of everything from railroad regulation, to meatpacking regulation, to the regulation of monopolies and trusts as historians from Gabriel Kolko onward have documented. Unique historical factors in the monetary system affected the particular form the Fed took, but its broad history places it squarely in the tradition of the Progressive Era. If the Fed is the product of some nefarious conspiracy, so is a whole bunch of other legislation passed around that time.

The Fed emerged not as a response to failures of a free market in banking, nor as the result of shadowy banking conspiracies, but instead as a response to the failures of the National Banking System (1863-1913) that preceded it. The US banking system has never been a free market, as the National Banking System (NBS) was itself a response to pre-existing state-level regulations on banking. Under the NBS, and many of the state systems that came before it, banks were subject to three major regulations: 1) limits on the ability of banks to operate branches; 2) minimum reserve requirements; and 3) requirements that banks that produced currency buy up certain bonds or other financial assets as collateral.

The first and third of these regulations were particularly problematic. The limits on branching varied. During the pre-Civil War years, branch banks of any kind were illegal – banks could only operate one office. During the NBS, interstate branching was illegal, as no state would allow branches of banks chartered in other states to open up in that state, and some states still prohibited banks from opening branch offices within their state. The result was a banking system with few inter-bank institutions and too many banks that were too small and not sufficiently diversified, and therefore overly prone to failure.

The bond collateral requirements were also a problem. Before the Civil War, they often served as a form of crony capitalism as some states required that banks buy the bonds of railroads and other nominally private enterprises instead of, or in addition to, government bonds to serve as collateral. In the NBS, federally chartered banks were required to buy federal government bonds as a way of financing the Civil War. Regardless of whose bonds were required, forcing banks to purchase bonds when they want to expand their issues of currency became a problem as the required bonds were sometimes found to be either worthless or in short supply. One result was periodic currency panics that continued throughout the century.

In this episode of twisted fate, we see the progressives built the very edifice that they would then spend more than a century decrying. Now that is irony. They were had by a shell game played by the most wealthy class in America and they lost even as everyone celebrated their apparent victory. The central factor that the progressives failed to understand is that the monopoly is a product of government privilege and does not arise via laissez-faire free market forces. The “leaders of industry” got tired of so many newcomers competing successfully with them and their business concerns and so looked to government to protect them.

Friedrich von Hayek won the Nobel Prize for his theory of the business cycle and that theory puts the blame for the boom-bust business cycle squarely on the shoulders of the government and its controlled banking system. When government encourages bank credit expansion through its central bank and control of the banking system, this causes price inflation as well as increasing malinvestments. Most importantly this credit expansion encourages unsound investments in capital goods and underproduction of consumer goods. In spite of this knowledge, most Americans still believe that the monopoly control of their money by government is somehow a “good thing”. The progressives were fooled into giving the government the means whereby they could finance a world wide empire as well as dominate the domestic economy to everyone’s disadvantage.

It was the same thing with the idea that the government needed to be in the “trust busting” business. This hoary old canard hangs on till this day and you will hear it anytime you talk to a progressive or even most public school educated Americans. They really think that without their protector government the corporations would grow without bound until only a few, or even just one, dominated the whole world. They simply don’t understand competition nor have they read the history of the USA in the 1800s and 1900s. If they did understand, they would realize that it is government itself that helps the largest corporations to grow and dominate us. (crony-capitalism)

Big-business interests did try in the late 1800s to establish predatory high prices and reduced production and failed to do so. They tried the mergers that modern liberals tell us would lead to their total control of the people without government to stop them; and yet, they tried and the large business interests all failed due to market forces.  In every case the merger collapsed due to competition just as Hayek, Rothbard, and Mises have demonstrate must happen. Even hampered by the intervention of government through protective tariffs the market nullified these attempts by private concerns to create monopoly. And so the state was called upon to do by force, coercion, and intimidation what the big business moguls could not do by themselves.

The American big business leaders knew well that governments can hand out monopolies. The knew about the English monopolies in the period just before the industrial revolution. As Rothbard has pointed out; the creation of monopolies reached its climax in the reign of Queen Elizabeth. He quoted the words of historian Professor S.T. Bindoff, “… the restrictive principle had, like some giant squid, fastened its embracing tentacles round many branches of domestic trade and manufacture,” and “in the last decade of Elizabeth’s reign scarcely an article in common use – coal, soap, starch, iron, leather, books, wine, fruit – was unaffected by patents of monopoly.”

In the 1900s, as in America today, we have seen that lobbyists use the lure of monetary gain to obtain government sponsors to fight for their petitions for grants of monopoly. The American businessmen knew that using the law to secure their place was far easier and safer than competition! And once granted their privileges the monopolists proceed to loot the public just like Ma Bell of old. Now don’t be fooled, today’s grants of monopoly are crafted to make it look like they are promoting competition even as they do the exact opposite. There are many “barriers to entry” into an industry and mountains of expensive regulations that hold down new competition and allow the businesses protected to whine about “government regulation” even as those very regulations protect them. The propaganda of the government, lobbyists, and big business is far more sophisticated than is was in the 1900s and the manipulators are still fooling the common man — especially the “progressives”.

Ironic evil is the evil good men do while they think they are doing good. Many well meaning but economically ignorant men and women have helped get the USA to this sad juncture in its history. I hope more people will study Austrian Economics and arm themselves with the knowledge of how the world really works. Ron Paul has tried his best to explain economics to the masses and has done a great job of it; but all of us need to study more and to tell our friends and family.

Basic Economics of Money and Inflation for the Distracted

Introduction and Medium of Exchange

Economics is often called “the dismal science” but it is not really dismal nor is it hard to understand. Economics can be made to look hard or boring but that is the job of government paid teachers and they do it to keep people from understanding how the state is screwing them over.

We are in hard economic times at present in the USA and some economists have called it a “recession”. It is called a “recession” because the word “depression” which was used for most of our history is so scary to the modern man, given “the great depression”, that we are afraid to use the word anymore. We are also seeing prices rise and that hurts everyone, but it hurts the poor the most. People wonder what causes these things, but before answering that large question one must first start with some basics and the first one might as well be “money”. So, what in the world is this thing called money? Why do we even need it? Have not many people called money the “root of all evil”?

Once upon a time people would use barter to obtain the goods and services they needed. That is, two individuals each possessing a commodity or a service that the other party needed would enter into an agreement to trade so that both would be better off than before the trade. It was not always simple even with just two people, consider if you had a horse and I had a dozen eggs — that does not seem to be a fair trade most of the time. This direct form of barter does not provide the transferability and divisibility that makes for efficient trading. Another example is the one if you have cows but want apples. Then you need to find someone who has apples and the desire for your beef. What if you find someone who has the need for beef but no apples and can only offer you shoes? To make the trade now the two of you need to go find a third party, or more people, who want to trade to see if something can be worked out. This is very confusing and inefficient.

What if most people wanted salt and you had extra salt? You could barter for needed goods by offering some of your salt for whatever you wanted or needed. If you wanted to get just enough beef for the week from the farmer in town, the two of you could decided on a fair exchange rate between salt and pounds of beef. This works if the farmer thinks that many other people, who have things he needs, also value the salt and will also take it in trade. In this way the salt would be traded just so he could trade the salt with others since everyone needs salt.

In the “new world” of colonial America colonialists used beaver pelts, tobacco, whiskey, dried corn, and other items as currency for transactions. These commodities were chosen for many reasons. These commodities were widely desired and easy to trade with, but just as importantly they were also durable, portable and easily stored. Tomatoes are the fruit of the gods, but they go bad so fast that one could not use the delicious tomato as a trading commodity.

Since these commodities were used to trade for goods and services, one could say that these commodities formed the basis for exchanges. Heck, one could even say that they were a medium of exchange“. That, by the way, is how most experts define the word “money”. What would be the best commodity to be used as money? One needs to look for the commodity that is easy to exchange and it needs to not deteriorate for long time periods. The commodity chosen also needs to be easy to carry around and store.

What did the ancient world decide to use for money? Gold and silver. Both metals last a long, long time as they don’t rust away like iron. Both metals have inherent value in the arts and in the jewelry trade. Both items are in sort supply so that the law of supply and demand does not diminish the value of either for the most part. Gold and silver do have problems. How much do you have in your sack? How to weigh it? How pure is that “gold” anyway? Gold dust is easy to divide up and that helps a bit, but it is still a pain to have to weigh out gold every time you buy a darned happy meal for the kids at that fast-food joint.

Money, Coins, and Inflation

Consider How Much things cost in 1974

Year End Close Dow Jones Industrial Average 616
Average Cost of new house $34,900.00
Average Income per year $13,900.00
Average Monthly Rent $185.00
Cost of a gallon of Gas 55 cents
Average cost new car$3,750.00
Samsonite Case $62.00

It would be very difficult to talk the new car dealership out of a new car for only $3,750 today! Why do prices rise? The progressive often says it is simply “corporate greed”. That answer is wrong of course, but what does cause prices to rise? To answer that we need to look at “money” more closely.

If you take a look at the “coins” in your pocket change you will see that the dime, quarter, and the half dollar all have little groves on them. That was to prevent anyone (the government most often) from clipping off a bit of the edge before passing it along. No one would do such a thing today of course since the “coin” in not really a “coin”, but rather it is a token. The US government stopped issuing “coins” in 1965. They issue tokens instead.

The “coin” was invented by the ancients to overcome the problem of how to trade conveniently in gold or silver. The real coin is a disk of precious metal, usually gold or silver. This coin has three things stamped on it; the weight of the coin, the fineness of the metal, and the name of the mint where it was manufactured. The name of the mint is called the “hallmark” and it became the “brand name” and naturally some brands were trusted more than others just like today. Notice that the object did not need any government backing as the object itself was of a certain value regardless.

The Romans had a silver coin called the Denarius. It was a 940 fine silver coin, which means it was 94% silver and 6% base metal for strength. The Romans had a welfare program as well as a warfare program and continually needed money, so when they collected taxes they started clipping off a bit of metal from each coin and minting new coins. The groves on a coin called “reeding” is there to prevent this sort of theft of metal. That was not enough so they started counterfeiting by melting the coins and adding base metal to reduce the silver content which allowed them to mint new coins from the stolen silver. This is called “debasing” the money. The Denarius went from 94% silver in 54 AD to under 50% by 200 AD and then to 1% silver by 250 AD and therefore became nearly worthless. It would have to take 94 coins to equal the silver content of one non-counterfeited coin.

The middle ages saw a mint in Czechoslovakia introduce and then produce a coin called a Joachimthaler that was popularly called a “thaler” because, hell, who can pronounce those Czech names anyway? It was a one ounce silver coin and became so popular, trusted, and demanded that the very name “thaler” came to mean the same thing as one ounce of fine silver. As language changes the name “thaler” became “daler” and later on it became “dollar”. The “Dollar” was defined in the mind of the people of Europe as one ounce of fine silver.

Paper Money and Inflation

We have seen how government counterfeited by debasing the precious metal content of the coins when the government took in coins via taxation. Now we will look at “paper money” and the debasing of that commodity.

Once upon a time when real gold and real silver were the coin of the realm, it was difficult to keep all of your money with you. Gold and silver are metal and they are heavy! It is also dangerous to haul around all of your money due to the robber that might take it from you. There were money warehouses where one could store his gold and silver, and these became known as banks. There was a fee for the storage and you got a receipt for the metal that you deposited in the bank. These receipts became known as “bank notes“.

Sometimes two men would arrive at a fair price on a trade and one would just give the other the correct amount in bank notes rather than go to the trouble of going to get the actual gold or silver from the money warehouse. With reputable banks this worked out very well indeed. Thus the idea of “paper money”, which was just trading receipts (which were just claim tickets or IOUs) became accepted.

In the USA the government issued a one dollar bank note called a Silver Certificate up until the 1960s. The government promised to redeem the paper bill with once ounce of fine silver upon demand. Until the 60’s the US Dollar was valued throughout the world as very good money and the phrase “sound as a dollar” meant that one was in good shape. In the 60s the US government started issuing fake coins (“token” is the technical term) that you can see in your own pocket today. The government also started issuing Federal Reserve Notes which were not backed by anything and could not be redeemed for Silver. Now you may wonder how this came to be. It was not just some experiment, rather it was necessary. You see, the US government had been engaged in a massive fraud and had issued far, far more Silver Certificates that it had silver to redeem the paper with. So, they changed the rules of the game by issuing paper backed by nothing. So what gave these pieces of paper any value at all? The “legal tender law” is what.

The idea of “legal tender” goes back to Kublai Khan who issued pieces of paper that said they were 20 ounces of gold! He passed a law that said if you refused to accept such a piece of paper you would forfeit your life. (the Khan’s were not very warm and fuzzy) Other governments after that time tried other versions of “legal tender” and the USA settled upon the idea that one accepts the unbacked paper for a debt or the debt is canceled. In other words, if I owe you $100 and offer US money for the debt you have to accept it or the debt is legally canceled! Neat, eh? This allows the US government to print up all the money they dare to print up. The only thing holding back the government from printing up Billion Dollar Notes by the truck load is the law of supply and demand leading to hyperinflation.

FDR stopped gold coins in the 30s, silver coins and paper Silver Certificates were done away with in the 60s, and the constitution says that all this is illegal. The document says the the government can not “make any Thing but gold and silver Coin a Tender in Payment of Debts”. But we don’t follow the constitution any more so few care about this small problem.

Paper Money and Runaway Inflation

We have looked at how governments could debase the currency and steal money even if the currency were gold or silver coins. This was a time honored way for the government to steal money to pay for wars and welfare, without high taxes which can lead to unwanted unrest among the population. Ah, but paper money, now there is a concept that turns out to be a wonderful concept for governments to loot the public. If a government prints more money, then the money already in circulation is worth less. With paper money not tied to any redeemable amount of precious metal, the government may print as much as it deems it needs to do. Heck, sometimes it prints too much money even if it has “promised” to redeem the paper currency for solid precious metal. Governments sometimes don’t tell the truth, perhaps you have noticed this.

Inflation is an increase in the money supply. Inflation leads to rises in price because the increase in the amount of money in circulation has made all the old money worth less than it did before. As an example, if I were selling apples for a dollar a piece today, and the rate of inflation were 10% then I would have to rise my price to $1.10 by the end of the year just to keep at the same level I was before. I have not raised my price in real terms; I have only kept up with inflation. So, how high can prices go? How fast can it happen? Has it ever happened in real countries on the planet earth before? Let us look to history for answers. Wikipedia has an excellent list of countries that have experienced hyper-inflation. See it here.

In Germany in 1914 the cost of a pound of butter was a little over one Mark. By 1918 the cost had risen to 3 Marks. By 1922 a pound of butter was 2,400 Marks, and the next year it went to 6,000,000,000,000 Marks. Yes, one pound of butter went from a Mark to six Trillion Marks in 9 years. One egg in 1914 was under a Mark and 9 years later it was 80 Billion Marks. This level of inflation is such a society killer that governments have tried to cause runaway inflation in the economy of their enemies during wartime.

In the 1920s the German government bragged about its efficiency at printing money. They had twelve printing operations running 24 hours a day pumping out new currency! How could anyone set a fair price for something? If I sold a farm for 3,000 marks to you one year, it might cost 3 Trillion to buy one like it a few years later! How can society run in this sort of chaos? I believe that most humans can understand the evils of runaway inflation. The only people who would want such a thing (mistakenly) are those so deeply in debt that forcing even a large debt to become mere pocket change is a “good thing to them personally”. (assuming they give up eating food that is)

Money, Inflation, and the Central Bank

Money is a crucial part of our economy and our society. Untold numbers of voluntary exchanges enable a division of labor in society. Everyone benefits because the division of labor allows for all of us to be much better off than we would be if we had to be self-sufficient which would reduce us to a pitiful standard of living.

As Rothbard noted:

Money is different from all other commodities: other things being equal, more shoes, or more discoveries of oil or copper benefit society, since they help alleviate natural scarcity. But once a commodity is established as a money on the market, no more money at all is needed. Since the only use of money is for exchange and reckoning, more dollars or pounds or marks in circulation cannot confer a social benefit: they will simply dilute the exchange value of every existing dollar or pound or mark. So it is a great boon that gold or silver are scarce and are costly to increase in supply.

But if government manages to establish paper tickets or bank credit as money, as equivalent to gold grams or ounces, then the government, as dominant money-supplier, becomes free to create money costlessly and at will. As a result, this “inflation” of the money supply destroys the value of the dollar or pound, drives up prices, cripples economic calculation, and hobbles and seriously damages the workings of the market economy.

The natural tendency of government, once in charge of money, is to inflate and to destroy the value of the currency.

So how does the American system of today work? In modern central banking in the USA, the central bank is called the “FED” The FED is granted by the force of law the monopoly of the issue of bank notes. These ‘bank notes’ are identical to the the government’s paper money. If the my bank needs to get cash for its customers, it must go to its own checking account at the FED which is, in effect, the bank’s own bank. It turns out that banks keep deposits at the FED in its checking account and these are its “reserves”. It may then leverage that amount by ten fold.

Here’s how the counterfeiting process works in today’s world. Let’s say that the Federal Reserve, as usual, decides that it wants to expand (i.e., inflate) the money supply. The Federal Reserve decides to go into the market (called the “open market”) and purchase an asset. It doesn’t really matter what asset it buys; the important point is that it writes out a check. The Fed could, if it wanted to, buy any asset it wished, including corporate stocks, buildings, or foreign currency. In practice, it almost always buys US government securities.

Let’s assume that the Fed buys $10,000,000 of US Treasury bills from some “approved” government bond dealer (a small group), say Shearson Lehman on Wall Street. The Fed writes out a check for $10,000,000, which it gives to Shearson Lehman in exchange for $10,000,000 in US securities. Where does the Fed get the $10,000,000 to pay Shearson Lehman? It creates the money out of thin air. Shearson Lehman can do only one thing with the check: deposit it in its checking account at a commercial bank, say Chase Manhattan. The “money supply” of the country has already increased by $10,000,000; no one else’s checking account has decreased at all. There has been a net increase of $10,000,000.

But this is only the beginning of the inflationary counterfeiting process. For Chase Manhattan is delighted to get a check on the Fed, and rushes down to deposit it in its own checking account at the Fed, which now increases by $10,000,000. But this checking account constitutes the “reserves” of the banks, which have now increased across the nation by $10,000,000. But this means that Chase Manhattan can create deposits based on these reserves, and that, as checks and reserves seep out to other banks (much as the Rothbard Bank deposits did), each one can add its inflationary mite, until the banking system as a whole has increased its demand deposits by $100,000,000, ten times the original purchase of assets by the Fed. The banking system is allowed to keep reserves amounting to 10 percent of its deposits, which means that the “money multiplier” – the amount of deposits the banks can expand on top of reserves – is 10. A purchase of assets of $10 million by the Fed has generated very quickly a tenfold ($100,000,000) increase in the money supply of the banking system as a whole.

All economists agree on how this process works. They might disagree on the effects of this process, but all agree on the above process as described.

The US Dollar is worth about 1% of what is was in 1913 when the FED was established. This comes about because the FED continually produces more “money” and the law of supply and demand will mean that each dollar is worth less than it was before.

The 1974 Nobel Prize in Economic Science went to the Austrian free-market economist Dr. Friedrich A. von Hayek. It was for the Hayek theory of the business cycle that puts the blame for the boom-bust cycle squarely on the shoulders of the government and its controlled banking system and it completely absolves the free-enterprise economy from the blame.

When a government’s central bank causes the expansion of bank credit by inflating the money supple it causes price inflation. But that is not all it does; it causes malinvestments, unsound investments in capital goods, underproduction of consumer goods and many other errors in economic judgment which are caused by all the “easy money” coming into the economy. Then, when that “easy money” stops as it always does — a depression is the result. By the way, in the ’20s the economist von Mises warned of the coming depression which was being caused by the intervention of the government. His call was on target, was it not?

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Money Velocity and Inflation

We have seen that the central bank is the main engine of inflation and that inflating the currency leads to higher prices and the boom-bust cycle. But we need to look a bit closer at how the inflationary cycle works. That means looking at a thing called “velocity”, or fast money!

Economists talk about “velocity” and they mean the speed at which money is changing hands. For example, imagine I sit 20 people around a table; each has a dollar and a pencil. Each buys a pencil from the guy to his left with his dollar. Every dollar was used one time and so “velocity” was one. Now imaging the same situation but there is only one dollar. Mr. Jones has that dollar and buys a pencil from the guy on his right and the guy on the right does the same all around the circle. Twenty pencils have been sold and one dollar was used 20 times. Hence, “velocity” is 20. So we see that a small amount of money can do the same job as a large amount of money given the right conditions. Professionals define “velocity” as M/PQ but that hurts my head to think about. This post is about understanding the concepts not hiding them in econ-speak.

The dollar responds to the law of supply and demand and when demand for the dollar falls then people are more willing to spend the dollar than hold it. They buy more goods and services and keep less dollars. On the other hand, if demand for the dollar rises then people then to buy less and keep more dollars. Get it? So, we see money demand is what causes changes in velocity. Economists look at “velocity” to figure indirectly the demand for dollars at a given time. Simple really.

Now we can look at the three stages of inflation. Let us imaging you want to buy a new aluminum mountain bike.

If the prices are stable (1) and the item has been the same for a long time, say $600, then there is no real hurry to get one and you hope that the price might fall a bit and you can pick up a bargain. But instead the price rise (2) to $650 and you decide to buy the darn thing before it can go up any more! Your good friend does the same and he was not even going to get one until Christmas! Then the price goes up steeply (3) to $1,000 and you buy another one as an investment because bikes look to be a better deal than holding dollars.

In the first stage the velocity was low and you held on to your dollars. In the second stage velocity has gone up and you spend dollars. Velocity is going up. In the third stage everyone is looking to get “stuff” and not hold dollars and velocity is way up. Velocity is always very high in the third stage of inflation. There are many examples of this that a person could look at; the USA in the 70s would be a good example. The depression of the early 80s was the correction from the economic mismanagement of the 70s. Remember that inflation goes through three stages, caused by money demand, and one can look at velocity to see what stage a country is in.

Fractional Reserve Banking

It is impossible to understand our modern economy without looking at our fractional reserve banking system, so let’s first see how the fractional reserve process works without a central bank.

Let us imagine we start a bank, called Stolen Booty, and invest $10,000 of cash to get the darn thing going. I now “lend out” $100,000 to some people, for whatever purpose they have in mind. But how can I “lend out” far more than I have? It works like this; with my original 10,000 I then open up a checking accounts that add up to $100,000 which I lend out to customers. I can charge a lower rate of interest than savers would charge if they were handing out money that they had worked for. I don’t have to save up the money myself, but simply can counterfeit it out of thin air. Before the 20th century, I would have issued bank notes, but the Federal Reserve now has a legal monopoly on the issuing of note issues. Since demand deposits at the Stolen Booty Bank function as equivalent to cash, the nation’s money supply has just, by magic, increased by $100,000. The inflationary, counterfeiting process is under way.

But without government support there are some severe hitches in this counterfeiting process. Firstly, why should anyone trust me? Why should anyone accept the checking deposits of the Stolen Booty Bank? Why do they not just use RedState Bank instead? Or a bank backed by the Koch Brothers? But even if I were trusted and able to con my way into the trust of the gullible, there is another severe problem. Since the banking system without a central bank is competitive the people I loaned money to would spend it (why else did they borrow it?) in various places and the bank notes would end up in a competitor’s bank. Say RedState Bank had $50,000 of my bank’s paper and decided to cash it since they don’t want any bank notes from other banks. Now what? I don’t have $50,000. I only have my original “reserves” of $10,000 so I am finished. Bankrupt. I am out of the money supply game and should go to jail.

As you can see under free competition without government support and enforcement there is very limited opportunity for fractional-reserve counterfeiting and this is why under “free banking” in the past the reserves were supposed to be 100% and were nearly that at all times in honest, respected banks.

Central Banking

The bankers themselves set out to get the government to cartelize their industry. This was by means of a central bank. Central Banking began with the Bank of England in the 1690s. Central banking came to the United States by the Federal Reserve System of 1913. The FED was greatly welcomed, in particular, by investment bankers such as the Morgans who by this time were moving into commercial banking as well. Banksters were in on this idea from the get-go.

Today the FED, our Central Bank, is granted the monopoly of the issue of bank notes. These bank notes are now identical to the government’s paper money and so is money in this country. A bank puts a deposit in the FED and then can issue up to 10 times that amount because we have a fractional reserve system. The FED backs this scheme by law as we have seen. By the way, the originally written or printed “bank notes” were, in fact, warehouse receipts for gold or silver kept in a warehouse as opposed to the intangible receipts of bank deposits today. Neat how we bastardized that term is it not?

Who benefits? This system was set up to inflate the money; but who benefits? Why the largest debtor benefits by making a debt smaller in real terms all the time. So who is the largest debtor in our country? Why the US government is. Coincidence? The banksters also benefit by getting the money first before the inflationary effect; plus the effects of the FED scheme mentioned above. But the benefits also include the minions of the central government who are paid by the central government with the looted wealth.

The whole of economics

The 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 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. ~Henry Hazlitt

Hazlitt alerted us to the problem, we often don’t look at the whole picture and the long term effects. The law of unintended consequences tells us that we really do need to try to look ahead and see what may or may not come of our actions. Any human on planet earth could do much worse than to take the time to read Henry Hazlitt’s book “Economics in One Lesson“. Thomas Sowell has long echoed Hazlitt’s ideas in his nationally syndicated columns and in his many top selling books. Sowell writes that as a nation we often don’t look to see what the effects are of any proposed action on groups other than the target group and also don’t think about the effects of these actions have over time on the target group. What is the cascade of effects?

It is easy to show “good” effects on one group as you hide the bad effects on other groups. As Dr. Sowell pointed out:

“The government can always save 10,000 jobs — at a cost of 50,000 other jobs. If the jobs that are saved are in one industry, represented by vocal spokesmen, and the 50,000 lost jobs are spread thinly across the country in two’s and three’s here and there, then this is a good deal for the politician who becomes a hero to those 10,000 voters whose jobs he saved. This is obviously not a good deal for those who lose their jobs but they may not even know why. Moreover, when they are not concentrated in one place or in one industry, they are unlikely to come to the attention of the media. So they don’t count politically.”

That Thomas Sowell quote is an example of not looking to see what effects an action has on all groups. This is just more vote buying by the rulers who pull the levers of government power. The actions they take invariably are counterproductive and inherently unfair to the majority even as the rulers make it look otherwise. As H. L. Mencken observed long ago, “There is always an easy solution to every human problem — neat, plausible and wrong.”

Government is never going to do your investigation into these matters for you since they are trying to keep you like a mushroom: in the dark and covered with crap. It is your job to educate yourself and to seek out those who have studied real economics and can help you understand the way the world really works and not be fooled by the demagogues.

Hazlitt also pointed out the main problem we have in trying to reason with the collectivists, socialists, and progressives who all believe in some form of Marxism. He wrote:

The whole gospel of Karl Marx can be summed up in a single sentence: Hate the man who is better off than you are. Never under any circumstances admit that his success may be due to his own efforts, to the productive contribution he has made to the whole community. Always attribute his success to the exploitation, the cheating, the more or less open robbery of others. Never under any circumstances admit that your own failure may be owing to your own weakness, or that the failure of anyone else may be due to his own defects – his laziness, incompetence, improvidence, or stupidity. ~Henry Hazlitt

I think Hazlitt has hit the nail on the head with that quote. I don’t see how I could add much to it here today. The collectivist has great envy of the others who are out in the world getting things done. They are full of hate towards those that they see as “exploiting” the people; often by offering them things to buy. The fact that people buy these things of their own free will matters little to them. Why? Read the quote again.