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).
Monday, April 11, 2011
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?
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?
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.
http://alturl.com/22vmu
Review Questions: Is the Federal Reserve System a private or a public institution? When was it formed. Where? Why in secret?
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.
http://alturl.com/22vmu
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.
http://alturl.com/y3ig9
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?
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.
http://alturl.com/y3ig9
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.
http://alturl.com/tmnr8
Next here is Murray N. Rothbard the author of THE MYSTERY OF BANKING and other books on this subject.
http://alturl.com/2zom6
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.
http://alturl.com/xo77s
Review Questions: Why does former Congressman and Presidential candidate Ron Paul think we should abolish the Federal Reserve?
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.
http://alturl.com/tmnr8
Next here is Murray N. Rothbard the author of THE MYSTERY OF BANKING and other books on this subject.
http://alturl.com/2zom6
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.
http://alturl.com/xo77s
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).
http://alturl.com/b432a
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?
Here is Roger Garrison on Austrian Business Cycle Theory (ABCT).
http://alturl.com/b432a
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).
http://alturl.com/bkfa3
LAST WORD
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 Amazon.com.
1. FOR GOOD AND EVIL
2. COMPLEXITY
3. THE FATAL CONCEIT
4. BIONOMICS
5. THE ROAD TO SERFDOM
6. CHIMPANZEE POLITICS
7. THE ORIGINS OF VIRTUE
8. GOOD NATURED
9. THE UNCLE ERIC SERIES
11. THE ETHICS OF LIBERTY
12. THE MORAL ANIMAL
13. CHAOS
14. THE NOBLEST TRIUMPH
15. MAKERS AND TAKERS
16. THE MYSTERY OF BANKING
17. EGALITARIANISM AS A REVOLT AGAINST NATURE
18. THE HISTORY OF CIVIL SOCIETY
19. THE GOD OF THE MACHINE
20. THE THEORY OF MORAL SENTIMENTS
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).
http://alturl.com/bkfa3
LAST WORD
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 Amazon.com.
1. FOR GOOD AND EVIL
2. COMPLEXITY
3. THE FATAL CONCEIT
4. BIONOMICS
5. THE ROAD TO SERFDOM
6. CHIMPANZEE POLITICS
7. THE ORIGINS OF VIRTUE
8. GOOD NATURED
9. THE UNCLE ERIC SERIES
11. THE ETHICS OF LIBERTY
12. THE MORAL ANIMAL
13. CHAOS
14. THE NOBLEST TRIUMPH
15. MAKERS AND TAKERS
16. THE MYSTERY OF BANKING
17. EGALITARIANISM AS A REVOLT AGAINST NATURE
18. THE HISTORY OF CIVIL SOCIETY
19. THE GOD OF THE MACHINE
20. THE THEORY OF MORAL SENTIMENTS
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