Monday, April 11, 2011

CHAPTER 1: A PARADIGM is a model of how something works.  Once you have created a correct paradigm in your mind it will help you make better decisions.  For example, is the earth flat or round?  If Columbus had a flat earth paradigm he would have stayed at home.   Your paradigms will also affect what information you believe and what you will ignore.  In psychology this is called CONFIRMATION BIAS. Once formed, paradigms are not easily changed.  People would rather ignore certain facts than have to change an established paradigm.  Facts which do not fit a paradigm create an uncomfortable feeling called COGNITIVE DISSONANCE.  To better appreciate the importance of paradigms you might want to google "Galileo". 

And finally a bad paradigm will result in decisions that do not help solve problems but usually help you create even more. A change from one paradigm to another is called a PARADIGM SHIFT. 

There are three interrelated paradigm shifts suggested in this book.  The first is organizational. The second is moral.  And the third is economic. Most people never experience even one paradigm shift in a lifetime so this is a pretty big challenge for any reader. 

In social organization theory the major competing paradigms are HIERARCHY and SPONTANEOUS ORDER.

Hierarchy is the familiar top-down management model of organizing social activity.  It is usually learned from experience.  For example schools, teams, and firms are all organized this way.  Without a leader disorder would prevail.    

Spontaneous order is based on the concept of  self-organization.  This paradigm is hard to learn by simple observation unless you are unusually perceptive. 

So what exactly is spontaneous order?  The concept can be traced back at least as far as  Mandeville's THE FABLE OF THE BEES through Adam Ferguson's A HISTORY OF CIVIL SOCIETY to the Nobel prize winning economist F.A. Hayek (who coined the phrase).   The most recent term for it is complex adaptive system (CAS).  Read this.  Click on Basic Tutorial and then on Complex Adaptive Systems.

Review Questions:  Consider highway traffic vs. airplane traffic. Why does one have a "controller" and the other not have one?  Is the economy of the United States organized more by spontaneous order or by hierarchy?  Is there a trend?  Is this trend good or bad? 

CHAPTER 2: Spontaneous order is not automatic.  Like highway traffic there must be certain organizational fundamentals.   

First there must be a rule that ties the system together.  For example all drivers in the United States drive on the right hand side of the road and stop on red.  Imagine if only half of the drivers followed this rule.  Or imagine if the rule was constantly changing according to the whims of some  hierarchical planners.   

Next there must be shared information so the indivicual units can make decisions that become self organizing.  For example, blind drivers cannot determine which side of the road IS the right hand side.

And finally there must be a negative feedback loop to eliminate persistent errors.    If you drive on the left hand side of the road and/or ignore red lights you will experience this feedback.  A rule, information, and negative feedback loops are the prerequisites for self-organization.

As children we quickly find out the difference between mine and yours when we try to take another child's toys away from them. As we mature we learn the difference between possessions and property.  This basic concept is the foundation of the philosophy of NATURAL RIGHTS.  The development of this concept has a long history and can be traced from the Stoics to John Locke to Thomas Jefferson to Murray Rothbard.  For simplicity I have left out many links in the chain.  
Look here to gain a better understanding of  natural law and natural rights.  This essay is rather long but well worth your time.

Most pardigms have competition, at least for awhile.  Once the world was thought to be flat and blood letting seemed like a good way to cure disases. The flat world paradigm that presently competes with  natural rights is UTILITARIANISM (Hey, I never said I was unbiased).  According to this philosophy natural rights are secondary to what is good for society.  The catch phrase "the greatest good for the greatest number" just about sums it up.  At least 90 percent of the professional economists in academia and 100 percent of those working for the government are utilitarians.  One reason is job security.  These economists fancy themselves as experts on helping decision makers decide what is the greatest good, therefore they are in demand to give advice.  The other reason is that most of them don't know the difference between a natural right and a positive right.  And worse yet don't care to learn. 


Review Questions:  What are "rights"?  Do people have a right to work?  Do they have a right to an education, to healthcare, to gun ownership? 
CHAPTER 3: The next logical step after learning about natural law and natural rights is to introduce the concept of  PROPERTY.

Property is what you own.  Ownership means exclusive control.  The idea of property evolved as a way to avoid conflicts.  There are four ways to justly obtain your property.  (1) produce it, (2) exchange for it, (3) receive it as a gift, and (4) homesteading (which means being the first to discover it). 

Probably no other concept is more basic to both politics and economics than the idea of property.

Consider your self.  Who owns you?   If you answer "I do" that means you have exclusive control over your actions and implies that you also have exclusive responsibility for what you do.  Are there limits on how you can use yourself?  Should other people be able to sometimes use you for the benefit of society?  These are some of the most basic of all social questions.

Let's read (and hopefully think about) what Hoppe has to say on this subject.

Review Questions:  What is property and why is it so important?  Is there such a thing as "public" property?  How about "intellectural" property?

CHAPTER 4: Next let's turn to the key fundamental concept of MORALITY.

Morality is the difference between right and wrong. 

Some people think that expropriating an individual's property for public use (taxation) is moral under what is called the social contract theory.  Others disagree under natural rights theory.  Until a group of people share a common paradigm about what is right and what is wrong there will always be social conflict. 

EVOLUTIONARY PSYCHOLOGY gives us some insight into how an individual learns morality.  Everyone has a set of morals to guide their behavior but they are not always the same just like everyone can speak and understand a language but not always the same one.  Furthermore there are instincts like envy, the herd mentality, and suspicion of strangers that can compromise morality.  Read this to understand how humans developed a capacity for learning morality and a tendency to rationalize immoral behavior.

Review Questions:   What does morality have to do with economics?  Can you have an economic system without most people adhering to some generally accepted moral principles? 

CHAPTER 5: Moral principles are passed on from generation to generation through education and example. 

As mentioned before, evolutionary psychologists claim that the ability to learn morals, like the ability to learn language, is hardwired into our brains through an evolutionary process. 

But how do we learn what is right or wrong, moral or immoral?  Is it possible to be taught an immoral morality?

Consider the problem of getting from Point A to Point B?  If I follow your directions I will discover if they are right or wrong.  In a similar way, if we assume that the purpose of morality is to improve the quality of our lives (Point B), then we must discover from trial and error what is right and what is wrong (experience).  Or we can rely on a trustworthy source.  Hopefully we won't keep making the same mistakes over and over again. 

This process of discovery is exemplified by English common law.  Let's now turn our attention to the legal framework which codifies a societies standard definitions of right and wrong.  

Read what Bastiat has to say about the LAW.  This is relatively long but definitely worth your time.

Review Questions:  What is the difference between positive law and natural law?  Can a law be immoral?  If so, give an example.  What happens if a society that has lots of immoral laws?  Is theft immoral?  How does taxation differ from theft?  Does public education do a good job of contrasting the opposing paradigms of natural rights vs. the social contract theory?
CHAPTER 6: Paradigms, spontaneous order, natural rights, property, morality, and law.  According to Thomas Jefferson and others, human beings are born with natural rights.  However they are not born with a particular morality.  That must be learned.  Law is the process of enforcing a paticular moral system.  Morality, properly understood, is not subjective.   Spontaneous order is social organization under a moral system of natural rights.  Most people intuitively understand the paradigm of hierarchy but not spontaneous order.

Consider, for example, TAXATION. 

Ownership (having exclusive control) of your own production or what you trade for with other people is a natural right.  Note that natural does not connote good or bad.  That's a question of morality.  CHARITY is voluntarily giving up some of your property for the benefit of another person or group of persons.  Taxation is not charity. 

Taxation requires coercion (as in "your money or your life").  Is it right or wrong to take money, using whatever force is necessary, from some people for the benefit of other people? 

Currently the law comes down on the side of yes it is right and moral.  But since it is not natural for people to give up their money to benefit strangers (like a dam holding back the water from flowing down a river is not natural) this transfer requires construction and maintenance.   And this can get very expensive and complicated as you know if you have ever been audited.

So what does all this have to do with economics?  Let's go there now. 

The paradigm of spontaneous order is at a disadvantage when competing with the paradigm of hierarchy because the former requires a working knowledge of economics which in turn requires some time and effort to understand.  Ready? 

In economics there two major competing paradigms.  They are the KEYNESIAN/NEO CLASSICAL paradigm (hierarchy, utilitarianism, mathmatics) and the AUSTRIAN SCHOOL paradigm (spontaneous order, natural rights, deductive logic). 

Your chances of learning about the second one are slim to none if you take traditional college courses in economics.  When I taught at the University of Arizona I supervised 3 doctoral candidates in economics.  At this late stage in their education none had ever even heard of the Austrian School let alone being able to debate the pros and cons of this paradigm.

So what exactly IS Austrian economics?  Read this.

Review Questions:   What are the basic principles of Austrian economics?  What is the history of Austrian economics.
CHAPTER 7: Economists like to qualify their theories with the "CETERIS PARIBUS" assumption.  It means other things remaining the same.  Of course other things never do remain the same since we live in a complex adaptive system called society that is always changing. 

Mainstream economists also like to express their theories using mathematical models.  This allows them to make precise predictions which of course are invariably wrong since ceteris are never paribus.

A study of history does help but in the end doesn't prove anything.  For example, although everyone agrees there was a Great Depression in the 1930s, Keynesians contend it was caused by capitalism and would have been less severe if there had been more government intervention or at least if it had been used differently.  Austrians believe the Great Depression was brought on by government intervention (Federal Reserve policies) and prolonged by more intervention (FDR's New Deal).

So who is right?  Unlike the hard sciences an appeal to the facts cannot resolve this dispute.   If Galileo had been an economist we would still be debating his theory. 

Nevertheless history cannot be ignored.  Let's take a look at what historians could learn from Austrian School economists.  Read this.

Review Questions:  Did capitalism cause the Great Depression or did government intervention cause it?  Does your paradigm influence your answer? 
CHAPTER 8: Having already explained spontaneous order let's turn to that other non-intuitive concept in economics which is COMPARATIVE ADVANTAGE.  Then I will try to explain in simple non-graphical terms the economist's all purpose tool, SUPPLY AND DEMAND.  But before we study those concepts let me remind you that economics is a controversial subject.  No one expressed the nature of those controverses better than Murray Rothbard.  Let's see what he has to say on this subject.  Since this material is book length I suggest you start by reading only the Inroduction.  Then come back and read more later if the spirit moves you.

Review Questions: Why is economics more controversial than say physics or chemistry?
CHAPTER 9: Economics in a nutshell.  People discovered the economic benefits of specialization and trade.  To facilitate trade they discovered money.  To minimize conflicts they discovered property.  The rest is history.

Every choice involves an OPPORTUNITY COST.  When you choose A instead of B you give up any benefit you may have obtained from B.  Simple enough.  Economists call this problem "scarcity".  In other words you can't have your cake and eat it too. 

When you choose to produce X instead of Y then the value of Y to you is the opportunity cost of producing X.

Every person is an individual therefore opportunity costs vary individually.

Let's say in one hour Smith can produce either 1X or 2Y's. 

Jones can produce either 2Xs or 8Ys.  Stay with me here.

Jones has an ABSOLUTE ADVANTAGE in producing both Xs (2>1) and Ys (8>2).

However Smith has a COMPARATIVE ADVANTAGE in producing Xs because his opportunity cost is lower (2<4).

Jones has a comparative advantage in producing Ys for the same reason (1/4<1/2).  Concentrate now.  This really isn't that hard. 

After specializing according to their comparative advantages Smith and Jones agree to trade 1X for 3Ys.

This is good for Smith because with 2 hours of work he can now have 1X and 3Ys instead of 1X and 2Ys.

This is also good for Jones because in 2 hours of work she can now have 10Ys and 2 Xs instead of 8Ys and 2Xs.

The implications of this simple example are enormous.  Both parties benefit.  It is a win-win game. 

That is why when you trade with someone it is appropriate for both to say thank you.  Mutual benefit.

Comparative advantage is the basis for specialization.  Specialization is the basis for trade.  And trade is the basis for mutually beneficial human relationships. 

In a simple primitive barter economy with only a few products this would be the end of the story. 

But what if there are millions of people and millions of products.  This could get complicated. 

How complicated could it be you ask.  Read this essay and you'll see.

Then read this one.

Review Questions:  If  Mr X has an absolute advantage in producing both A and B can Ms Y have a comparative advantage in producing  either A or B?  Explain. Why dont' we need a Pencil Czar to coordinate the production of pencils?  If we did have a pencil Czar would we have any pencils?

CHAPTER 10: Highly integrated constantly changing economic choices need to be coordinated.  Enter first MONEY and then THE PRICE SYSTEM.  

Money is anything that is generally accepted as a medium of exchange.  Tobaccco leaves, beads, stone monuments, cigarettes, and other items have been used.  People finally discovered the benefits of using gold as money and pretty much stuck with it. 

First there were bags of gold.  Next came gold coins.  Then paper money backed by gold.  Then paper money NOT backed by gold (major change). Then demand deposits.  And most recently electronic fund transfers. 

Prices are determined by supply and demand.  More demand leads to higher prices and more supply leads to lower prices.  If you know the price of any two items you can calculate the opportunity cost of your choices.  For example if product A costs 5 dollars and product B costs 10 dollars then the opportunity cost of 1B is 2As.

But why would product A cost you 1/2 as much as product B.  That's where competition comes into play.  Sellers want the highest price they can get but they know that other sellers will get your business if they charge too much.  On the other hand buyers want the lowest price they can pay but they know that other customers might pay more if they offer too little.  This interplay of forces results in high prices for items when there are relatively more buyers and low prices when there are relatively more sellers.

There's a little more to it than this but you get the general idea.

When demand increases, ceteris paribus, prices rise.  This signals sellers to produce more even if the product costs more to produce.  And vice versa.  When supply decreases, ceteris paribus, prices rise.  This has the effect of rationing some buyers out of the market.  And vice versa. 

Thus prices serve as information so that sellers know when to produce more or less and buyers know when to buy more or less.  All without having a price czar to coordiante these decisions.

Another function of prices is to eliminate wasteful surpluses and shortages.  If there is too much being offerred for sale in relation to the number of buyers, prices fall.  If there is too little being offerred in relation to the number of buyers, prices rise.  And this of course takes place without having an allocation czar.

Think of the price system as the eyes of the drivers who must constantly receive information from their surroundings in order to navigate from Point A to Point B.  

Bastiat once asked this famous question:  How does Paris get fed?   No food czar?  No central plan?  No bureaucrats and agencies to tell people what to produce, how to produce it, and who will get it. 

Review Questions:  If a surplus exists will that cause competition between buyers or sellers.  Will this result in the price going up or down.  How about the same question with a shortage?  Can you think of several examples of government price control?  Does government regulation of prices and production interfere with spontaneous order and therefore create inefficiency and disorder?  If the answer is yes, then why do it? 
CHAPTER 11: Most mainstream textbooks talk about how "we" decide what to produce, how to produce it, and for whom to produce it.  According to METHODOLOGICAL INDIVIDUALISM this is a meaningless question .  A better way to phrase the question is who will produce what for whom and how. 

The first person to produce a new product or produce an old product in a new way is called an ENTREPRENEUR.  The word means risk taker in French but a better description would be discoverer. 

How does one know what products should be produced and how?  The answer is trial and error.  Complex adaptive systems have NEGATIVE FEEDBACK LOOPS.  When an entrepreneur decides to produce a product that costs more to produce than the revenue it brings in he will discover that he has made a mistake.  Remember the role of prices here.  Price>cost make money and produce it.  Price<cost lose money.  Do not produce.   

If he has any money left after this painful lesson he may be able to try again.  Trust me I know about this from experience. 

Of course things are constantly changing.  Once it was profitable (revenue>cost) to produce records and record players.  Now it's not. 

The system is dynamic.  New products and methods of production replace old ones.  This is known as economic development and is both a source of risk and reward for the entrepreneur. 

Profit and loss.  Success and failure.  The carrot and the stick.  The  important point here is  that all this is done without an economic czar.

Review Question:  Did the relavtive inefficiency of the economic system of the old Soviet Union compared to the economic system of the United States have anything to do with using hierarchy to organize economic activity rather than spontaneous order.  If yes, explain.
CHAPTER 12: For those who are interested in more detail there are textbook explanations of elasticity, utility maximizing consumer behavior, profit maximizing business behavior, and other topics.  None of this is necessary to understand how an economic system organizes itself spontaneously.  You have already learned enough to understand this important concept.  We tend to take this marvelous system for granted because it usually works smoothly but like the human body do not mistake smooth for simple. 

One of the mistakes of mainstream economics is to divide the study of economics into macro and micro components exclusively.  What is therefore excluded is the macro-micro connection which is how the individual parts work together in a coordinated and integrated fashion.  In other words, the study of spontaneous order. 

Of course planners have superimposed a partial hierarchy on the otherwise self organizing parts of the system.   So next we need to study the methods and consequences of such policies.. 

Review Questions:  Isn't macro just a large number of micro events?  Does spontaneous order have a macro and a micro component?
CHAPTER 13: The first thing most students are taught in macroeconomics is how to measure aggregates such as total production, total income, unemployment, and the price level. 

They are not of course taught that aggregation is a flawed economic concept.  For example producing more consumer goods does not have the same economic impact as producing more capital goods.  Producing some types of capital goods does not have the same economic impact as producing other capital goods  Yet both add equally to total production, income, and employment. 

The English economist Keynes said it is demand that creates supply.  The French economist Say said that supply creates demand.  That is a fundamental difference in paradigms.  Keynes approved of borrowing and spending to increase current production. Say encouraged saving and investment to increase productivity in the future.    Do you want more now or more later?  Opportunity cost.

Keynes was a central planner which means organization by hierarchy.  Say thought that leaving the economy alone so it could organize itself spontaneously was the best idea.   In the 1930s classical economics based on Says Law began to be replaced by Keynesian economics.  When I studied economics in college during the early 1960s there were no courses in macroeconomics since the professors had learned their economics before Keynes became so popular. 

The purpose of aggregate statistics is to provide information to the central planners so they can try to manipulate the economy in one direction or the other.  In a natural rights/spontaneous order economic system there would be no central planning and therefore this information would not be worth the cost of obtaining it. In other words the Bureau of Economic Analysis would go out of business. 

However if it's statistics you want go to John Williams website to get an unbiased report. 

Review Question:  What would happen if the government suddenly stopped gathering macroeconomic data?  No price indices.  No unemployment rate.  No GDP numbers. 
CHAPTER 14: Aside from outright government ownership of the means of production like the TVA or the post office and regulatory agencies (FTC, FDA, OSHA, EEOC, ETC, ETC, ETC) there are two other ways of meddling with a NRSO social system..  One is called FISCAL POLICY and the other is called MONETARY POLICY.

Of course in a NRSO (natural rights and spontaneous order) society there would not be any taxation, government spending, or fiat money.  People would specialize according to their comparative advantages, trade for mutual benefit, and have real money that could not be created by accounting entries and computers.

Job opportunties with no licensing, taxation, or regulations would abound.  Unemployment would be tempory and minimal. 

Prices would fall gradually as productivity increases like they did in the 1800s.  People would not have to speculate in unpredictable high risk ventures such as stocks in order to protect their economic futures.

Savers would be rewarded for providing financial capital to investors and entrepreneurs would be free to create new products and  new ways of producing old ones.

Review Questions:  What would happen to the economy in the short run if government planners stopped trying to regulate it.  In the long run would most people be better off or worse off?  (the $64,000  review question).   
CHAPTER 15: Surprisingly enough macroeconomic planning started with an enterprising goldsmith.  Let's call him Mr.Locks  (you may have heard of his daughter Goldie).

Mr. Locks was an artisan who fashioned things out of gold.

He had a secure storage facilty for all that valuable gold.

One day someone came to him and asked him if he would store their gold in a safe place for a fee.  He said yes and that is how Mr. Locks became a banker. 

He gave the person a warehouse receipt for the gold he had in storage.

Over time Mr. Locks noticed something rather odd.  Most of the gold was staying in his storage facility.  Instead of taking gold out people would just sign over their warehouse receipts which therefore became money.

The receipts were money because they were backed by gold which was the real money.

Then Mr. Locks had a bright idea.  If only say 25 percent of the deposited gold was ever demanded for delivery why not create some more warehouse receipts and "lend" them out for an interest payment.  Now let's see.  How many can I create? 

After doing some calculations he came up with the formula 1/r where r is the ratio of gold on deposit to warehouse receipts.  In this case r is 25/100.  1/r is 100/25 or 4.  Economists call this the MONEY MULTIPLIER.  Stay with me here.

Since 1000 dollars of warehouse receipts was already out there, Mr Locks decided he could create 3000 more and still have enough gold to back the claims on his gold  (1000/(1000 + 3000) = 25 percent.  And thus the principle of FRACTIONAL RESERVE BANKING was born.

Review Questions:    Isn't fractional reserve banking fraudulent since more than one claim is issued on the same asset?
CHAPTER 16: Now let's talk about how much money Mr. Locks can create.  It depends on two things.  How much gold he has in reserve (monetary base) and what the withdrawal percentage is (r). 

An increase in gold reserves or a decrease in the withdrawal percentage would allow him to "create" more money. 

Can you calulate how much money he could create if he had 2000 dollars worth of gold and r was equal to 10 percent?

If you said 18,000 dollars go to the head of the class.  2000 x 1/r -2000 = 18,000.

Stay with me here.

Another way of looking at this is that if he creates 18,000 plus the original 2000 that makes 20,000.  10 percent of 20,000 is 2,000.  Therefore he will be able to meet the gold withdrawal requests (as long as the withdrawl ration remains at 10 percent).  A very BIG if.

Of course if people find out that all their receipts cannot be redeemed in gold he will become a very unpopular goldsmith.

Skip ahead 400 or so years.  The United States Federal Reserve is our goldsmith with a few small changes.

First money is no longer backed by gold.  That idea went out gradually but finally ended for good in August of 1971 when Nixon closed the gold window.  Funny, it seems like things have been going downhill ever since. 

People use their federal reserve notes (formerly warehouse receipts) as money because they have no other choice.  It's called FIAT MONEY and you have to take it because of the LEGAL TENDER LAW.   

Second instead of Mr. Locks determining what he thought was a safe ratio the ratio is set by the Federal Reserve.  For most banks it's now 10 percent. 

And lastly the Federal Reserve is not limited by the amount of gold in their vaults like the goldsmith was.  Imagine if Mr. Locks had the power to create gold.  He would have been a very rich man. At least until gold became worthless because there was so much of it.   

The Federal Reserve cannot only control the amount of money in the system (and therefore the price of money which is the interest rate) they can also provide money to Congress when taxes and bonds sold to the publie are not enough to finance expenditures.  This makes things like war and welfare easiser to sell to the public since no increase in taxes is required. 

Review Question:  When the Federal Reserve creates money "out of thin air" isn't that essentially the same thing as counterfeiting except that it's legal? 
CHAPTER 17: OK, now we know that the Federal Reserve System can literally create money.  Why would they want to do that?

One of the first things the Federal Reserve did was to help finance WWI.  Then WWII.   Then the welfare society, Then more wars.  You get the idea.  From a politicians point of view it certainly beats raising taxes if you want to get reelected. 

Another function of the Fed is to attempt to promote economic stability, to lower unemployment, to increase economic growth, and to protect the value of the dollar.

First there was the Great Depression, then the stagflation of the 1970's, twelve or so recessions, the dollar is now worth about 2 percent of its 1913 purchasing power, and we may be on the edge of another Depression.  Since 1970 economic growth has slowed by about 33 percent. 

If I were grading this performance I don't think it would deserve an A. 

A new function of the Federal Reserve is to help the government bail out failing businesses.  Having the power to create money has it's benefits if you are on the receiving end.  But woe to the people who have saved their dollars expecting to use them later.  Those dollars become less and less valuable in exchange until ultimately they may  become completely worthless.  Germany in the 1920s..  Continentals, greenbacks, and confederate money are all examples of this process.

Read this.    

Review Questions:  Is the Federal Reserve System a private or a public institution?   When was it formed.  Where? Why in secret? 

CHAPTER 18: Before we look at the third paradigm shift (can you recall the first two?) necessary to understand how hierarchy interferes with social order let's review what you have learned so far.

First, economic systems are capable of organizing themselves.  They are examples of complex adaptive systems. 

Second, a prerequisite for this social order to florish is the moral system called natural rights.  People own themselves and their justly acquired property.  They have a right to defend their life, liberty, and property.  There are no other rights such as a right to this or that.  Rights defined that way (sometimes called POSITIVE RIGHTS) are just claims on other people's lives and property.  This is, of course, a formula for social conflict and disorder.  Gun control is a current but certainly not the only example of the conflict that occurs when utilitarians use anti-natural rights means to achieve social goals.  Of course the question still remains.  Is it worth it?  Now we are back to a question of right and wrong. A question of morality and values.  Read this.

Mainstream economists do help to explain some of the unintended consequences of intervention but leaves unexamined the question of natural rights.  This is the result of separating political philosophy from economics. 

Without political philosophy you cannot understand natural rights.  Without natural rights you cannot understand spontaneous order.  Without spontaneous order you cannot understand economics.

Another recent example of  the consequences of interfering with the natural order of the system is the Federal Reserve's interest rate and money supply policies which helped to create the housing boom and bust. Austrian economists believe Federal Reserve policies are now prolonging the necessary adjustments to restore the system to balance and thus making future adjustments more severe.  Think of many small earthquakes versus one really BIG one to get the idea.  

Review Question:  Is it a mistake to teach economics without also discussing political philosophy?  If so, why?  

Sunday, April 10, 2011

CHAPTER 19: There is no better example of the disorder created by trying to manipulate a complex adaptive system than the havoc caused by central banking. 

So let's take a closer look at the central bank of the United States which is called the Federal Reserve System.  The Fed is so important as an example of the difference between trying to manage the economy through hierarchy versus allowing spontaneous order to do the organizing that I have included 2 lengthy videos and another essay on the subject.  Here are two lectures and an essay concerning the Federal Reserve.  Rather long but very interesting.

First let's listen to G. Edward Griffin who is the author of THE CREATURE FROM JEKYLL ISLAND.

Next here is Murray N. Rothbard the author of THE MYSTERY OF BANKING and other books on this subject.

And finally here is what Gary North has to say about the FED.  The tone of this essay illustrates how controversial economics and economic policy can be.

Review Questions:   Why does former Congressman and Presidential candidate Ron Paul think we should abolish the Federal Reserve?
CHAPTER 20: Now that you have learned something about the Federal Reserve System let's take a critical look at the consequeces of trying to manipulate the economics system from the point of view of an Austrian economist. 

Here is Roger Garrison on Austrian Business Cycle Theory (ABCT).

Review Question:  Which do YOU think is a better explanation for our current economic problems: the Keynesian model which suggests we need more deficit spending and extremely low interest rates or the ABCT?
CHAPTER 21: To finish up here are a few words on economic relationships between people in different countries.  The economics is basically the same.  People specialize in their respective areas of comparative advantage which gives them a competive advantage when it comes to selling their products or services at a price that is higher than their opportunity costs but lower than their competitors who have higher opportunity costs.  Got that?

Specialization leads to trade, only this time the trade takes place over some artificial line called a BORDER which separates one group of hierarchical central planners from another group.    Nevertheless it is still mutually beneficial and like all honest trade it tends to foster good will and good relationships.  Remember both parties to a trade should say thank you.

Inside the various borders there are different monies and different ways of interfering with natural rights and spontaneous order.  International trade involves not only trading goods and services for money but also trading money for money.

The amount of foreign money you can buy with one unit of domestic money is called the EXCHANGE RATE.  A dollar, for example, might buy you 1 English pound, or 2 German marks, or 3 French francs.

Exchange rates are determined like all prices by the forces of  supply and demand.  It's just a little more complicated.

When demand for the dollar rises (exports plus capital inflows) relative to supply the price goes up because of the resulting shortage (buyers compete).  This is called an APPRECIATION of the currency.  If the supply of dollars goes up relative to demand (imports plus capital outflows) the price goes down because of the resulting surplus (sellers compete).  This is called a DEPRECIATION of the currency. 

When a currency appreciates foreign goods and services become cheaper.  Imports therefore increase but also exports will decrease. This spontaneously resolves the imbalance.    Depreciation of a currency also resolves an imbalance but the effect on imports and exports is reversed.  

In the past, exchange rates have sometimes been set by the government which of course results in disorder.  When this disorder gets bad enough the official exchange rate will have to be changed (usually after controls have been tried and failed).  An official depreciation is called a DEVALUATION.  It makes buying foreign products more expensive (imports) and makes domestic products cheaper to foreign buyers (exports).

Bureaucrats keep track of money going in and out of countries using what is called the BALANCE OF PAYMENTS accounts.  This is actually unnecessary since countries do not export or import (methodological individualism) but once again it gives the planners information which they can use to try to improve on the natural order of the system.  Which of course never works. 

So this brings us full circle.  What can be done to improve on the natural spontaneous order of an economic system?   The answer should not surprise those who have studied thus far.  Can you guess it?

And a last footnote.  Intervention breeds more intervention.  It is cumulative.  At some point spontaneous order will ultimately break down due to the lack of flexibility, inoperative negative feedback loops, and lack of pertinent information caused by the increasingly complex regulations..  We get closer to that tipping point every day.  Unfortunately the more disorganized things become the more people want a central planner to "run" the system to make it work better.  This is like taking more of some medicine that made you sick in the first place. 

As the breakdown becomes visible to almost everyone people will naturally turn to their leaders to fix things and make them better.  The great paradox here is that the more we do to try to fix the problem the worse it gets.  Unfortunately since we live in a democracy and few people understand the economics of spontaneous order or subcribe to the moral system of natural rights the most likely scenario is for us to do things that will create even more disorder and conflict. 

Review Question:  Do borders serve any useful purpose from an economic point of view?

FINAL Review Question:  Watch this video. Do the farmers have a natural right to sell their cheese to anyone they want to or does the government have a right to regulate the production and sale of cheese to ensure consumer safety?  Use what you learned in this book to help you decide.   And try not to get too emotional about it (evolutionary psychology again).


Paradigm shifts tend to occur suddenly but usually only after sustained periods of cognitive dissonance when the theory and the facts tend to contradict each other.  For most people it is easier to ignore facts that don't fit your paradigm instead of giving up on a theory that you have believed for a long time and may have even taught to other people.  Therefore paradigm shifts are not common.  In my case the stagflation of the 1970s was not consistent with the total income/total expenditure Keynesian Cross model.  So I started reading and one book lead to another and then another.  I began to study not only economics but also political philosophy and history.  Here are a few of the books that had a big influence on my thinking.  All of them should be available on my favorite shopping website