My Debate Challenge to Paul Krugman!

By: Robert P. Murphy | Thursday, October 28, 2010

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As many readers already know, last week I launched a campaign to pressure Paul Krugman into debating me. In just the first week, this sophomoric 7-minute YouTube video has generated $35,000 in pledges. At this point, I don't see how Krugman will ever live this down until he debates me on Austrian versus Keynesian business-cycle theory.

In the present article, I'll give a little background of how I came up with the idea. Then I'll point out the broader implications of this episode, which go well beyond my jousting with Krugman.

The Point, Xtranormal, and Facebook

The first ingredient for our story is a website called ThePoint.

A couple of months ago my wife explained to me how "Groupon" works. (A business will offer an amazing coupon, but only if a critical number of people opt for the deal. It is a coupon that only works if adopted by a group, hence the name.) Not only is Groupon a brilliant idea — made possible through the Internet — but it shows how real-world markets are far more adaptive than they are modeled to be in mainstream economics.

I decided to write up a Mises Daily article on all this. But while doing research, I discovered that Groupon was itself the byproduct of a more general website, ThePoint. After watching its short video tutorial, I realized that ThePoint offers libertarians a very effective way to coordinate their efforts.

At the time, I tried brainstorming, but the best I could come up with was a campaign to buy a Superbowl ad related to liberty. This type of project would be perfect for ThePoint — there would be lots of people willing to chip in $5 or $10, but they wouldn't want to waste their money if not enough people joined the cause. ThePoint's conditional framework — where your credit card is not billed until the specified objective is met — avoids this stumbling block. But since the Superbowl ad idea was not particularly earth-shattering, I moved on.

The next piece of the puzzle was the website Xtranormal, which offers a very convenient platform for quickly generating animated movies. I was vaguely aware of this site because I saw a short clip mocking Christine O'Donnell, but I assumed it took a huge investment of time. Then when Jeffrey Tucker created this cute video promoting the Mises Academy, he told me it was actually a piece of cake.

"Aha!" I thought. "If anybody can put off productive work in order to generate videos with amusing dialog, then surely it is me!" But as with ThePoint, here too I couldn't think of anything really great. So I went back to my usual routine of writing articles and blog posts.

Unbeknownst to me, these two seemingly independent ideas must have been germinating in my subconscious. For, a short while later, I watched The Social Network, the film describing the founding of Facebook. Watching young guys pursue their passion and become obscenely wealthy galvanized my inner entrepreneur. I wanted to come up with a big idea. But what?

Literally on the drive home from the theater, I conceived of my debate challenge to Paul Krugman. By soliciting pledges through ThePoint, donors would be reassured that they weren't throwing away their money. And by choosing soup kitchens across the country as the main beneficiaries (this was my original version, until I realized ThePoint could only designate one recipient of the check), what could Krugman possibly say? If we offered to pay him half the prize money, he could "be above it all." But soup kitchens?[1]

"ThePoint offers libertarians a very effective way to coordinate their efforts."

Even though I could see the potential of the campaign, I knew the mere launch wouldn't be enough. I had to explain the strategy behind it, to make sure everyone understood just what an awkward position Krugman would be in if the numbers rose above $100,000. I also knew a lot of people wouldn't understand why I wanted Ezra Klein as the moderator. (If you're curious, I settled on Klein because he had recently emailed Krugman, asking for an explanation of the various schools of thought and their prescriptions for a recession.)

At first, I thought I would have to write up an article explaining the overall strategy and answering objections. But no, that wasn't going to cut it. Nobody wants to read through a long commercial, especially a commercial with several different clauses. That's when I realized I could have two people hash it out in an Xtranormal video. It would be a much easier way to raise objections and answer them.

The rest, as they say, is history. I did some checking to make sure that ThePoint had actually handled big campaigns — unless they are complete frauds, they apparently sent a check for $10,000 to the Crohn's and Colitis Foundation of America after this guy started a campaign and sailed across the Atlantic. I also checked with the director of philanthropy at FoodBankNYC to make sure they had no objections to my plans.

Instant Success

To be honest, I didn't know if the campaign would catch on or not. It's so hard to tell which YouTube videos will "go viral" and which will fade into obscurity.

Needless to say, the success of the campaign exceeded my wildest expectations. Within the first 24 hours, it raised some $3,000, which totally shocked me. Within the first 37 hours, it had broken the $5,000 mark. Then because of this Tom Woods plug, the thing really took off, smashing through $10,000 a few hours later. The campaign broke outside standard Austrolibertarian circles, into the financial blogs, through Robert Wenzel, then Jeff Harding at Zerohedge (which also was reprinted at LRC), and most recently (as of this writing) John Carney at CNBC.

As I wrote on my blog to the readers who were excitedly watching the pledges roll in, "This isn't going to my head. I understand full well that the $5,000 raised in 37 hours is not a reflection of your love for me, but your hatred for Krugman."

Hundreds of fans of the Austrian School were joining the campaign, because they realized the wonderful corner into which Krugman would be painted. He would either have to debate someone well-versed in Austrian business-cycle theory or explain why a New York City food bank would miss out on $100,000+ in "right-wing" money. I wonder if Krugman is surprised at the intensity of the animosity? I was, so I'm betting he is too.

Broader Lessons

Besides the fun of the campaign — and the great teaching opportunity that should arise if and when Krugman breaks down and debates — there are broader lessons from this experience.

First, I want to stress the brilliant business plan of ThePoint and Xtranormal. I didn't have to pay anything to set up the campaign or to create my promotional video. These services were provided free, because their creators understand full well the importance of network effects.

Consider ThePoint. They don't really have too much overhead, except the server(s) to host the various campaigns. I didn't have to talk or even email with anyone in order to launch the campaign; the process was automated and took about 20 minutes.

As far as I can tell, ThePoint doesn't have advertisements yet. It has "Featured Campaigns," which may be a source of revenue. But as far as the Krugman debate is concerned, the only fees ThePoint will earn are the 5 percent of the pot once the money is collected. This sounds like a tidy sum, until you realize that credit cards (especially American Express) charge servicing fees that may very well average 3 percent to 4 percent, depending on the size of the individual donation. So I will be curious to see if ThePoint — like Facebook — tries to become the dominant website of its genre, and then implement "tasteful" ads.

Xtranormal's business model is even more clever. It is quite simple to get a video up and running; as their slogan says, "If you can type, you can make movies." They came up with a very user-friendly interface to control the characters' behavior. (For example, the male office worker in my video throws his hands up when he says, "It's in Alabama, for crying out loud!")

Now, one component of Xtranormal's strategy is obvious enough: they insert a commercial at the end of each freebie movie, pointing people to their site. But how do they actually make money? What pays for the computing power necessary to process the user instructions and generate animated movies?

As it turns out, Xtranormal sells "xtra-points" that can be used in the movie-making process. A moviemaker can use these points to access "sets" that are unavailable to the nonpaying customers, to choose from a wider variety of costumed characters, and to have greater flexibility in the movements of the characters.

Xtranormal's overall strategy is to attract large numbers of users by making the initial process free. Then, once people are hooked and everybody has already seen various videos using the freebie material, movie makers will be inclined to actually start paying.

Intellectual Property and Funding Ideas

The most relevant lesson for Austrian economists is that we are seeing the transformation of funding mechanisms for those in the business of creating ideas. Before the rise of modern capitalism, artists and writers needed the support of wealthy patrons. But with capitalism and its "mass production for the needs of the masses," this dependence on the philanthropy of the rich receded.

The innovators of today are taking advantage of the new frontier of the Internet. Recognizing the obsolescence of "intellectual-property" laws, they are dreaming up new ways to earn a living from the production of ideas.

Yes, if the state suddenly stopped enforcing ownership claims on intangible, nonscarce things, we can imagine all sorts of potential problems. But surely these budding entrepreneurs — and thousands more rising from the ranks — are just the people to solve them.

Notes

[1]

Originally, I had also conceived of giving 10 percent of the pot to Krugman and Klein, another 10 percent to the Mises Institute and myself, and the remaining 80 percent to be distributed to food kitchens. I thought this made sense in order to help cover the monetary expenses and opportunity costs of putting on the debate. But ThePoint's setup page only wanted one named recipient of the check, and I realized it would just be cleaner if we sent it all to charity. Obviously if the debate happens, there will be revenue potential from selling tickets to people who want to see it live.

Robert Murphy is co-author of How Privatized Banking Really Works and is an adjunct scholar of the Mises Institute, where he will be teaching "Anatomy of the Fed" at the Mises Academy this winter. He runs the blog Free Advice and is the author of The Politically Incorrect Guide to Capitalism, the Study Guide to Man, Economy, and State with Power and Market, the Human Action Study Guide, and The Politically Incorrect Guide to the Great Depression and the New Deal.

Hooray, the Recession is Over!

By: Robert P. Murphy | Monday, September 27, 2010

Some days, it's embarrassing to be a professional economist. On Monday, the National Bureau of Economic Research (NBER) officially declared that our recession had ended — 15 months ago. Yes, that's right, just as more and more analysts are worried about the economy imploding again, the NBER announces that the recession ended back in June 2009. The whole episode underscores the crudity of mainstream economics.

The NBER's Announcement

To be fair, let's quote from the actual statement:

CAMBRIDGE, September 20, 2010 — The Business Cycle Dating Committee of the National Bureau of Economic Research met yesterday by conference call. At its meeting, the committee determined that a trough in business activity occurred in the U.S. economy in June 2009. The trough marks the end of the recession that began in December 2007 and the beginning of an expansion. The recession lasted 18 months, which makes it the longest of any recession since World War II. ...

In determining that a trough occurred in June 2009, the committee did not conclude that economic conditions since that month have been favorable or that the economy has returned to operating at normal capacity. Rather, the committee determined only that the recession ended and a recovery began in that month.

The committee decided that any future downturn of the economy would be a new recession and not a continuation of the recession that began in December 2007. The basis for this decision was the length and strength of the recovery to date.

If nothing else, the NBER's announcement should give serious pause to those who chastise the Austrians for their "unscientific" approach to economics. Ludwig von Mises famously argued that the economist should proceed by logical deduction, rather than by aping the method of the physicists.

Naturally, many mainstream economists mocked Mises for these ostensibly Neanderthal views; Paul Samuelson wrote, "I tremble for the reputation of my subject." It's funny, because I have a similar reaction to the opinion from our macroeconomic wizards at the NBER.

Just stop and think about what has happened: According to the NBER, the US economy went through a severe recession from December 2007 to June 2009. Now it took the NBER until December 1, 2008 to announce that the economy was in a recession — a full year after it began (according to the same NBER). And then, with this week's announcement, the NBER announced that the economy had exited the recession, a full 15 months after the fact.

The NBER Business Cycle Dating Committee is composed of some pretty prestigious names (see the list at the bottom of this article). I certainly am not suggesting that these guys are a bunch of idiots.

Rather, I am pointing out the virtual uselessness of the empirical approach when it comes to "fine-tuning" the macroeconomy. Even if we had reason to believe that government policies could overcome the failings of the free market, such interventions would be as hopeless as those of an Earth surgeon operating on a Martian patient with a remote-controlled scalpel. The information lag would be enormous.

Besides the Lags, the Definitions Are Crazy

The problem isn't simply one of delayed information. The very approach of mainstream macroeconomics — with its focus on aggregates such as "Gross Domestic Product" and "Gross Domestic Income" — is misguided, and tends to support the same interventionist policies that prolong crises.

For example, most readers probably think that the US economy was in one heck of a funk throughout the 1930s. After all, people refer to this period as "the Great Depression." And sure enough, from 1931 to 1940, the official annual unemployment rate never dropped below 14.3 percent. So the average American would no doubt have felt as if the economy were really awful for this entire period.

And yet, if you go to the NBER's chronology of business cycles, you'll see that "the Great Depression" is apparently a misnomer. There was a recession from August, 1929 through March, 1933, and then another (short) one from May, 1937 through June, 1938.

In particular, the NBER says the US economy was in a recovery from March, 1933 through May, 1937, even though the annual unemployment rates for the intervening three years were 21.7 percent, 20.1 percent, and 17.0 percent. That's a rather anemic recovery, wouldn't you say?

Let's say you are running and then break a leg. You have to crawl now, but you develop that skill and are able to get from here to there. Are you in recovery from the accident? According to the NBER, yes — so long as you are crawling faster than when you first hit the ground in agony.

The problem isn't simply one of technical economic definitions differing from those of the layperson. No, the problem is that the reliance on (fairly ambiguous) aggregates gives false credit to harmful policies. For example, what happened in March, 1933 that "ended" the awful recession under Herbert Hoover? Why, that was the exact month that FDR was inaugurated.

Among other things, when FDR came into office he immediately declared a "bank holiday" and — oh yes — seized everybody's gold. By taking the United States off the gold standard, he gave the Fed the green light to deliver a quick burst of monetary inflation followed by a more general expansion:

Of course, there are plenty of macroeconomists who think that FDR's new policies really did fix the economy, and that it was only Fed tightness (combined with FDR's misguided attempts at budget austerity) that led to a relapse in 1937.

I have dealt with such empirical claims here. In the present article, I just want to point out that the NBER's techniques implicitly justify big government. For example, suppose the Austrians are right, and that the Fed's massive interventions — coupled with the federal government's absurd "stimulus" programs and other power grabs — at best will postpone the economic correction, and in fact they will make the crash that much worse.

Well, according to the way the NBER works, nobody would ever know this. Instead, "history" will record that Bernanke and Obama did indeed manage to end the awful Great Recession — specifically, in June of 2009 — but then something else came along and inexplicably wrecked things. Maybe Christine O'Donnell.

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Conclusion

The NBER's delayed calls on the start and end of business cycles are fodder for late-night comedians. The average American knew full well the economy was in trouble well before the NBER announced it, and the average American knows full well that our economy is still in serious trouble.

Worse yet, the NBER's approach justifies massive central-bank and government interventions into the economy. The "scientific" approach to macroeconomics will never yield positive results unless the diagnostic technique takes some lessons from Austrian economics.

Robert Murphy is an adjunct scholar of the Mises Institute, where he will be teaching "Principles of Economics" at the Mises Academy this fall. He runs the blog Free Advice and is the author of The Politically Incorrect Guide to Capitalism, the Study Guide to Man, Economy, and State with Power and Market, the Human Action Study Guide, and The Politically Incorrect Guide to the Great Depression and the New Deal.

Price, Profits, and Planning

By: L. Carlos Lara and Robert P. Murphy

Friday, August 20, 2010

"A bureaucrat differs from a non-bureaucrat precisely because he is working in a field in which it is impossible to appraise the result of a man's effort in terms of money.

Ludwig von Mises ⁽¹⁾

Once a market develops the use of money, entire new vistas open up for economic development. Because the money commodity exists on one side of every transaction, merchants and consumers can quickly grasp the relative scarcity of various goods and services. In other words, the use of money allows people to reduce economic operations down to a common denominator.

As in so many other areas, Hayek was one of the few economists to grasp the significance of this fact. Hayek viewed the price system in a market economy as a type of communication network, in which people "on the ground" in one area transmitted relevant information to everyone else through their buying and selling decisions. In a famous 1945 journal article Hayek wrote:

We must look at the price system as such a mechanism for communicating information if we want to understand its real function....The most significant fact about this system is the economy of knowledge with which it operates, or how little the individual participants need to know in order to be able to take the right action. In abbreviated form, by a kind of symbol, only the most essential information is passed on and passed on only to those concerned. It is more than a metaphor to describe the price system as a kind of machinery for registering change, or a system of telecommunications which enables individual producers to watch merely the movement of a few pointers, as an engineer might watch the hands of a few dials, in order to adjust their activities to changes of which they may never know more than is reflected in the price movement.

But I fear that [economists'] theoretical habits of approaching the problem with the assumption of more or less perfect knowledge on the part of almost everyone has made us somewhat blind to the true function of the price mechanism...The marvel is that in a case like that of a scarcity of one raw material, without an order being issued, without more than perhaps a handful of people knowing the cause, tens of thousands of people whose identity could not be ascertained by months of investigation, are made to use the material or its products more sparingly; i.e., they move in the right direction....

I have deliberately used the word "marvel" to shock the reader out of the complacency with which we often take the working of this mechanism for granted. I am convinced that if it were the result of deliberate human design, and if the people guided by the price changes understood that their decisions have significance far beyond their immediate aim, this mechanism would have been acclaimed as one of the greatest triumphs of the human mind.⁽²⁾

We are now beginning to see how social institutions help humans cope with the all-pervading problem of scarcity. The reason it took scholars of the caliber of Friedrich Hayek to understand the true function (and hence importance) of private property and market prices, is that these indispensable tools were not designed by anyone. Since no single person invented money, many intellectuals take its services for granted and indeed imagine a utopia which abolishes money altogether. In this context, Ludwig von Mises' famous critique of socialism is an excellent illustration of the fatal conceit.

Mises on Economic Calculation: The Fundamental Problem With Socialism

In the chronology of Austrian economists, Mises actually predates Hayek. Indeed, Hayek credits Mises' 1922 book Socialism with converting Hayek from being a socialist! In a Foreword (written in 1978) to the book, Hayek explains how he came to know Mises, and the effect he had:

When Socialism first appeared in 1922, its impact was profound. It gradually but fundamentally altered the outlook of many of the young idealists returning to their university studies after World War I. I know, for I was one of them.

We felt that the civilization in which we had grown up had collapsed. We were determined to build a better world, and it was this desire to reconstruct society that led many of us to the study of economics. Socialism promised to fulfill our hopes for a more rational, more just world. And then came this book. Our hopes were dashed. Socialism told us that we had been looking for improvement in the wrong direction.

A number of my contemporaries, who later became well known but who were then unknown to each other, went through the same experience: Wilhelm Röpke in Germany and Lionel Robbins in England are but two examples. None of us had initially been Mises' pupils. I had come to know him while working for a temporary Austrian government office which was entrusted with the implementation of certain clauses of the Treaty of Versailles. He was my superior, the director of the department.

Mises was then best known as a fighter against inflation. He had gained the ear of the government and...was immensely busy urging the government to take the only path by which a complete collapse of the currency could still be prevented. (During the first eight months I served under him, my nominal salary rose to two hundred times the initial amount.)

...Socialism shocked our generation, and only slowly and painfully did we become persuaded of its central thesis.⁽³⁾

What was Mises' "central thesis" concerning socialism, that had so shocked Hayek and his peers? In a nutshell, Mises argued that the socialist planners would find it impossible to rationally allocate society's scarce resources. Even if they had the best intentions, and even if they had at their fingertips all of the relevant knowledge from various experts, Mises argued that the socialist planners would have no way of determining whether their plans for industry were a good idea, or whether an alternative set of instructions would be better.

The market economy solves this problem through the profit-and-loss test. In a capitalist society, every scarce resource—including capital goods such as tractors and factories—is subject to private ownership. This allows the formation of market prices for every unit of every resource. When an entrepreneur in a market economy wants to know if he is running a successful business, he has a simple and objective criterion: He can see if the revenues from his customers are greater than his expenses. If they're not, that means the entrepreneur is losing money, and in a market economy an unprofitable operation is soon shut down.

Now the socialists looked upon this practice with scorn. After all, money isn't everything! Who is to say that a particular firm making diapers, for example, shouldn't continue turning scarce resources into more boxes of diapers, even past the point of profitability, in order to help struggling mothers with infants? The socialists thought the accountant's "bottom line" was an arbitrary quirk of a market economy, and that it didn't correspond to anything "real" that would exist in a socialist world.

Yet Mises demonstrated that the socialists were simply wrong. Although there are limits to the guidance given by monetary accounting, Mises pointed out that it gives people some guidance. Think about it: When a particular enterprise is unprofitable, it means that the owner is spending more money on inputs than his customers are willing to spend on the outputs. Loosely speaking, we can say that the owner is destroying wealth, because he is transforming resources of a high market value into finished products of a lower value.

Mises explained that the market prices of the "means of production" were not arbitrary, but instead reflected their relative scarcities. For example, a pound of copper (as of this writing) fetches a higher market price than a pound of aluminum. This isn't some irrelevant factoid of capitalist countries, but instead refers to a genuine relationship between the difficulty in producing copper vs. aluminum, compared to the uses people have of the two different materials. The reason entrepreneurs can afford to pay so much more for a pound of copper, is that there are some products that can be made with copper and not aluminum, and consumers are willing to pay for these products.

In Mises' view, the entrepreneur in a market economy acts as a "mandatary of the consumer," meaning that he acts as the consumer's agent or representative. Armed with a knowledge of how much money consumers will spend on various goods and services, the entrepreneurs enter the markets for raw materials, labor, and other resources and engage in a bidding war with each other. A high price for a pound of copper, compared to a low price for a pound of aluminum, is the market's way of signaling that copper is more important for pleasing consumers, and that entrepreneurs should exercise more care when using it in their operations.

It is this framework that led Mises to trumpet the notion of "consumer sovereignty," which claims that the real power in a capitalist system does not lie with the capitalists, as the Marxists believed:

The capitalists, the enterprisers, and the farmers are instrumental in the conduct of economic affairs. They are at the helm and steer the ship. But they are not free to shape its course. They are not supreme, they are steersmen only, bound to obey unconditionally the captain's orders. The captain is the consumer.⁽⁴⁾

Mises went on to say that not only was the consumer the one in charge, but that he was a fickle commander at that:

The real bosses [under capitalism] are the consumers. They, by their buying and by their abstention from buying, decide who should own the capital and run the plants. They determine what should be produced and in what quantity and quality. Their attitudes result either in profit or in loss for the enterpriser. They make poor men rich and rich men poor. They are no easy bosses. They are full of whims and fancies, changeable and unpredictable. They do not care a whit for past merit. As soon as something is offered to them that they like better or is cheaper, they desert their old purveyors.⁽⁵⁾

Now that we understand Mises' conception of the profit-and-loss system, and how it leads entrepreneurs in a capitalist economy to cater to the desires of the public, we can grasp his critique of socialism. In a socialist society, the State nationalizes all of the "means of production," including the capital goods and natural resources such as farmland and coal mines.

Because the State is the sole owner of the means of production, there can be no market prices for them. Yet this means there can be no monetary calculation, and consequently no way of determining whether the resources being used up in a particular operation could be better deployed elsewhere in the system.

For example, the socialist planners might order a group of comrades to take a certain amount of rubber, steel, electricity, and so forth, in order to produce 500 automobiles. After the fact, there is simply no way for the planners to know whether the output was "worth it." So long as the cars were suitably engineered, the planners would know that the subjects were better off with the cars than without them; in other words, the cars would be valuable. But the true question was whether the cars would be more valuable than other potential goods that could have been produced with the resources that were used up while making the cars.

Thus we see the fundamental problem with socialism. Before Mises, the debate over the "planned economy" had centered on incentives. To wit, in a system that followed the communist principle, "From each according to his ability, to each according to his needs," would the workers actually push themselves as hard as they do under capitalism? In other words, if the State took all the production and threw it into one giant pie, to be distributed in a way that didn't depend on each person's contribution, then wouldn't the overall pie shrink?

Compelling though this objection may have been, the socialist theorists claimed that the greed and self-centeredness of the average man was due to his growing up in a capitalist system. Once socialism had swept the world, they claimed, a new "Socialist Man" would emerge who enjoyed producing for his strangers as much as for his own family.

In this context, we see how powerful Mises' critique was. Mises concedes for the sake of argument that every worker and factory manager faithfully obeys the orders of the central planners. He also concedes for the sake of argument that the planners have all the relevant technical and practical knowledge in every single industry in the economy. Even so, because they lack market prices, the socialist planners have no means of feedback, no means of determining whether their grand plans are using resources efficiently. As Mises summarizes in his grand treatise Human Action:

The paradox of "planning" is that it cannot plan, because of the absence of economic calculation. What is called a planned economy is no economy at all. It is just a system of groping about in the dark. There is no question of a rational choice of means for the best possible attainment of the ultimate ends sought. What is called conscious planning is precisely the elimination of conscious purposive action.⁽⁶⁾

More than any other school of economists, the Austrians recognize the social function of market prices and profit-and-loss calculations. Despite its flaws, the capitalist society—in which private individuals buy and sell the means of production in an open market—is the only one that can possibly yield an efficient use of scarce resources. Of course entrepreneurs in a market economy make mistakes all the time. But the crucial point is that their mistakes are registered as such by the suffering of losses. There is no such feedback in a socialist system of outright central planning, and thus no mechanism to bring the planners' decisions into alignment with the ever changing conditions of production and the tastes of the consumers.

_____________________________________

¹Ludwig von Mises, Bureaucracy, p. 53, available at:

http://mises.org/etexts/mises/bureaucracy/section1.asp. Accessed June 4, 2010.
² Friedrich A. Hayek, "The Use of Knowledge in Society" (1945), American Economic Review, XXXV, No. 4, pp. 519-530, available at: http://www.econlib.org/library/Essays/hykKnw1.html. Accessed June 4, 2010.
³Hayek, Foreword to Ludwig von Mises, Socialism (Indianapolis: Liberty Fund, 1981), pp. xix and xxi.
⁴Mises, Bureaucracy, p. 226.
⁵Mises, Bureaucracy, p. 227.
⁶Mises, Human Action (Auburn, AL: The Ludwig von Mises Institute, 1998), p. 696.

L. Carlos Lara is President of United services and Trust Corporation, a Management Consulting Firm specializing in Business Consulting, Corporate Trust Services, Corporate and Private Seminars and Speaking Engagements. Visit him or contact him at www.usatrustonline.com.

Robert P. "Bob" Murphy runs his own consulting business and maintains an economics blog at ConsultingByRPM.com. He is the author of several economics books for the layperson, including The Politically Incorrect Guide to the Great Depression and the New Deal (Regnery, 2009). Murphy is an adjunct scholar with the Ludwig von Mises Institute.

No Business Starting a Business: Overcoming the Road Blocks to Starting IBC

by M.Z. from Kansas.

We really had no business starting a business! The following story is the reality of how my family had no business starting a business, the road blocks we faced in starting it, and how behind each road block was blessing after blessing that resulted in greater determination to continue in what we started. In reality this is the Zimmer family IBC (Infinite Banking Concept) story.
Back in April 2004 my wife, Jeni, and I found ourselves on a road we didn't want to go down. In short, I had been laid off from my job and in August 2004 we transitioned back to Kansas City from Oklahoma City to make a fresh start. I had no jobs lined up and Jeni had nothing lined up either. As God ordained I was able to land a job in Kansas City in October 2004. You do the math - I had nothing for eleven weeks after arriving in KC while Jeni had the income of a school crossing guard supervisor. Those were challenging days! The next two years were spent in a rental duplex and then eventually a bigger duplex in the neighborhood that we really wanted to be in. We were able to buy that half duplex with no money down. Still, by July 2008 we found ourselves nearly $17K in credit card debt and getting no where with minimum payments. We needed a plan. But before we instituted any plan - we prayed.
After prayer and hitting reality we first decided - no more credit cards and we thought of the quickest route to repayment. We settled on consultation with Consumer Credit Counseling Service (CCCS). They assessed our income and ability to pay back the debt to our creditors and we were quickly on the road to no credit card usage and doable monthly payments to CCCS (now Apprisen Financial Services). After this we knew it would be a long road to just be debt free of the credit card payments. CCCS told us it would be a little over four years. Not real encouraging, but we were on the right track. The very next month, September 2004, I would have THE MOST fortuitous, I believe most Divine, connection with another piece to our financial freedom puzzle.
I'm sitting at KCI Airport around 6:45 AM headed to somewhere. I decided it was time to read my "devotional for busy dads" daily reading. As I get half way through a guy sits down next to me and he begins reading, what I perceived to be, his Bible. We struck up a conversation about the Bibles were reading and so forth. The conversation led to what our vocation was and where we were headed and why. A short 30 minutes later the world of Infinite Baking Concept had unfolded in my heart and mind and was I jazzed! You see, I hadn't met just any ordinary business man shucking a sweet pie-in-the-sky financial pitch. I met a man that I knew in my heart was a follower of Christ and I knew, yes I knew, he was speaking some financial truth into my life. Jeni and I had been praying for more to the financial freedom puzzle than simply debt elimination and after 30-40 minutes with Mr. Mike Everett of Alpha and Omega Financial Services, Inc. I was on my way to a different universe in terms of my families financial dreams!
Yet, the questions and challenges seemed plentiful. As I watched the video that Mike gave me in the airport and as I did read the book (Becoming Your Own Banker by Nelson Nash) that he recommended I buy, I was wondering about IF my wife agreed to even listen to me about IBC and allow Mike to make his in-home presentation, could we do this IBC thing? Could we do it? Would we even have the funds to start such a venture? Would my wife, a daughter of a traditional bank board member, go for those "out of the box" idea? Could we sustain debt reduction and funding IBC simultaneously? why would my pastor say, "Don't do it?" And what about our growing kids and their needs and two cars that pretty much suck the financial life right out of a guy (and they did in the summer of 2009)?
Well, Mike came into our home and about 15 minutes into his presentation light bulbs were flashing, truth was unfolding, doubts were being erased and when Mike excused himself Jeni and I were utterly convinced that God had indeed sent Mike into our lives to reveal financial truth to us. Now for the hard part. We had committed to this road, but the money, what about the money to start? Amazingly we did gather the necessary funds we needed to start my $10,000 annual policy, and with very little borrowing I would add. We found funds in places we didn't know we had money and in the following tax season only paid about $340 of taxes on the funds we had secured to start our IBC.
Year one came and went with way too much money being spent on car repairs and things looked spooky going into our November annual premium payment. With the very little we paid into the premium and a conventional unsecured loan from our local bank, we paid year one! What a relief! We felt so excited to meet this goal and at this point be down to nearly $6K in credit card debt due to a second season of using our IBC funds to pay off debt. Then a day I'll never forget came into play that would affect our lives and our son's life for as long as we will live. On December 21, 2009 we found ourselves in Children's Mercy Hospital in Kansas City in a room with doctors around us explaining that our son indeed has Diabetes Type 1. What a shock to us. This was a huge road block in so many ways, but we are people of trust in our God. And so, after all bills have been processed and now we know what we need to pay, we again, continue with our focus of staying on the IBC path, knowing that not even diabetes is going to stop us from reaching our financial goals. In addition, God provided both my wife and I second jobs in the evenings (beginning May 2010) that pay very well so we can quickly pay off medical bills, and then with great hope, we desire to also use this money to fund IBC in year three beginning in November (which is also the dates we will have eliminated our entire $17,000 of credit card debt)!
So, life in it's ups and downs, with ill children, broken down cars, parents who seem skeptical that their kids have gone on some crazy wild financial goose chase, and two people who don't make a lot of money, but put it to good use, has afforded us a hopeful financial future. We hope to pay for college tuitions and fees, additional cars, vacations, and house repairs through IBC. I know we have no business thinking like that right now, but because we started our IBC, one day we'll say we had no business starting a business, but we're so glad we did!

The Role of Social Institutions

The Role of Social Institutions
(Excerpt from book: How Privatized Banking Really Works)

To understand our civilization, one must appreciate that the extended order resulted not from human design or intention but spontaneously: it arose from unintentionally conforming to certain traditional and largely moral practices...

—Friedrich Hayek

Social institutions are relationships and behavioral practices that allow humans to better cope with the problems of life in this world. At the most general level, institutions can include staples of society such as the family and the moral code, but institutions can also include fairly trivial examples such as the practice of tipping or giving gifts on birthdays.

Institutions provide a framework of continuity and predictability that allows people to more accurately plan their activities. In particular, institutions help us interact with each other by imposing a sense of stability and order onto the initially chaotic jumble of life. We all understand that parents and teachers need to provide a "routine" for young children, but ironically we adults need routines ourselves for modern civilization to be possible. We go through our routines of going to work, buying items from the store, going home to live with our family members (or roommates), and of course we directly communicate with each other with the institution of language—complete with its rules of grammar and definitions that everyone in the community shares.

The Fatal Conceit

One of the scourges of the 20th century was the arrogant belief by many intellectuals that they could overturn the inherited social order and remake society from scratch. In their view, if the existing customs and social practices couldn't be justified on a purely "rationalist" basis, then they were obviously obsolete and should be jettisoned in favor of new, "scientific" principles.

We have put these terms in quotation marks because in reality, it was incredibly irrational to try to revamp society from scratch, and it was very unscientific to try to substitute the time-tested traditions with new practices dreamed up by idealistic revolutionaries. Friedrich Hayek, one of the most celebrated Austrian economists and winner of the 1974 Nobel Prize, termed this hubris the fatal conceit. In his book The Fatal Conceit: The Errors of Socialism, Hayek writes:

[The socialists] assume that, since people had been able to generate some system of rules [in society] coordinating their efforts, they must also be able to design an even better and more gratifying system. But if humankind owes its very existence to one particular rule-guided form of conduct of proven effectiveness, it simply does not have the option of choosing another merely for the sake of the apparent pleasantness of its immediately visible effects. The dispute between the market order and socialism is no less than a matter of survival. To follow socialist morality would destroy much of present humankind and impoverish much of the rest.

The tragic mistake of the socialist reformers of the 20th century was in thinking that they could retain the bounty of free-market capitalism, while correcting its alleged faults such as inequalities in wealth or periods of high unemployment. But by overturning the traditional rules of property rights, the socialists did not create a utopia. Instead they unwittingly paved the way for the most murderous regimes in human history, whether on the "left" (Stalinist Russia and Maoist China) or the "right" (Hitler's Germany, where the Nazi Party was the National Socialist Party).

The Results of Human Action, But Not of Human Design

One of Hayek' major insights was that the fatal conceit of the socialist intellectuals led them to believe that simply because a social institution was created by humans, that it was therefore designed by them and could, in principle, be redesigned as a new and improved institution. Especially before witnessing the horrors of totalitarianism, many "good men" believed that a better world could be created if only the smartest, most humane men put their heads together and crafted a better plan for society. Instead of the anarchic market system, in which goods and services were produced on the basis of profit, the socialists wanted the State to organize all production in the service of people. It was simply the reincarnation of Plato's vision of rule by the philosopher kings.

Besides their naïve trust in those who would seize power in a socialist State, the intellectuals committed a basic mistake in their analysis. As Hayek repeatedly argued, these intellectuals overlooked the capacity of social institutions to tap the dispersed knowledge of the entire community. So rather than relying on a few of the "smartest guys in the room" to design a new society from the top-down, the inherited social institutions effectively solicited input from everyone, both brilliant and dull. The combined knowledge and experience of the entire community was always better than that of any small sample of individuals, even if those individuals were the best and the brightest.

It was understandable that the socialist reformers overlooked this key insight; it took a scholar of Hayek's brilliance to flesh out the point during his long career. Hayek devoted articles and books to the study of spontaneous orders, referring to self-organizing systems that exhibited predictable patterns, even though nobody deliberately set about to create such an orderly pattern. Borrowing a phrase from the Scottish moral philosopher Adam Ferguson, Hayek said that in a social context, spontaneous orders were "the product of human action, but not of human design."

What did Hayek mean by this odd phrase? He was underscoring the crucial fact that some of our most important institutions—including spoken language, our rules of morality, and the market economy itself—are obviously not "natural" creations, but instead are clearly the result of human beings. On the other hand, we can't scour the history books to find out which wise king, or group of scholars, invented the English language, or rules of morality, or the operation of the capitalist system. The earliest economists saw the hand of God behind these orderly outcomes, but both theist and skeptical writers understood that human beings on their own did not design such institutions.

Before tackling the more complex spontaneous order of the modern market economy, let's start with a simple example: a path through a forest. When a newcomer begins a hike in the forest, he will likely take the path of least resistance, meaning he will follow the well-worn trail that others have already created. Now this path or trail is clearly the result of human action; the branches were not removed by beavers, and the foliage on the ground was not eaten away by cows. Even so, we don't need to assume that the first human to stumble into the virgin woods, deliberately set out to create a path to serve subsequent travelers.

On the contrary, it's almost certainly the case that the first person to wander into the forest picked his way through it, looking for the most advantageous route. He obviously would walk around large trees, would avoid prickly bushes, and wouldn't walk into a deep river. But what the pioneer would be doing, quite unwittingly, was make it easier for the next person to follow in his footsteps. Perhaps he would carry a machete and hack away the branches as he stumbled along this maiden voyage; this would make it much easier for the next person to take the same route.

Gradually, over the decades, and especially if hundreds of people had to walk through this particular forest, a "good" route would be discovered. Its excellence would be enhanced every time another person walked along it, for each such passage would stamp down any weeds attempting to grow in the dirt trail, and would snap any small branches that had ventured into the corridor.
This hypothetical path through the forest would thus clearly be the result of human action, and yet not of human design. All of the hikers collectively contributed to its creation, over the course of decades, even though each individual hiker was acting in his own interest and in fact probably had no idea he was assisting all subsequent hikers.

Now it's true, the path might not be "optimal" from the viewpoint of a park ranger who conducts a helicopter survey of the entire forest. The ranger might lament the fact that the path goes a certain way, rather than another. Even so, taking the world as it is, the ranger realizes that it would be too confusing to try to "fix" the path. It would take a lot of manpower (with machetes and axes) to clear the "better" path, and then the ranger would have to set up fences or other obstacles to induce people to stop using the original, convenient path.

Our simple example of a path through a forest is a good metaphor for the Austrians' insights on the institutions of a market economy. We will outline some of the most important ones in the following chapters. But it is important to keep in mind that even though we will discuss the role or "function" of each institution, and how it helps humans deal with the economic problem of scarcity, that even so these institutions were not consciously invented by any human being.

By Robert P. Murphy, Ph.D. | Monday, June 21, 2010

Notes:
(1) Friedrich A. Hayek (ed. W.W. Bartley III), The fatal Conceit: The Errors of Socialism (Chicago: The University of Chicago Press, 1988) p. 6.
(2) Hayek, The Fatal Conceit, P. 7.

Money

Money
(Excerpt from new book: How Privatized Banking Really Works)

"Money is such a routine part of everyday living that its existence and acceptance ordinarily are taken for granted. A user may sense that money must come into being either automatically as a result of economic activity or as an outgrowth of some government operation. But just how this happens all too often remains a mystery."

—Federal Reserve Bank of Chicago¹

It is an error to think that everybody in society truly understands money, how it originates, how it functions, or even the concept that it is simply a medium of exchange. When we take the time to seriously consider the subject of money and ask ourselves the same kind of questions the young child asked in the opening chapter of this book, we come full circle to realize that money is the common denominator of virtually everything on this planet. Virtually everything is expressed within the terms of this one system. Most, if not all, of our relationships with other entities and other humans involve money. Even time is expressed in terms of money. If the goal of this text is to help bring clarity to all of the hidden aspects of the money problem, then we must start with the more basic facts about money and move along a deliberate line of thought that eventually addresses our concern. The idea is to make sure we inform everyone, because everyone's full understanding is important to our cause.

A good place to begin our basic study of money is by physically examining it. It is true that in our current times money in one sense has become invisible. Often moving electronically at the speed of light it does not even posses a physical body. Typically it is most often seen as numbers on a ledger on some account balance, your account or theirs. Nevertheless, all forms of our current money must convert back to our paper currency and coins. An economist would refer to our money as fiat money, electronic or otherwise. Our first query will be, "Why fiat money?"

First of all, the word fiat is defined as a "declaration by supreme law or a formal authorization, a command." By fiat, the supreme law of this land has declared this paper note to be legal tender for all debts public and private. Study the small print at the top left hand corner of this familiar piece of green paper. Simply put, this is officially our medium of exchange, the only money we can use—period! We may use a check, online banking or even credit cards to pay for things, but ultimately all payment transactions are denominated in reference to these paper dollars. To clarify further, if a creditor owes you money and you refuse to accept this currency in payment, that creditor's debt to you, by law, is simply canceled.

Notice also at the very top of our dollar bill the wording Federal Reserve Note. Again, very simply, the note indicates clearly that it was made and distributed by the Federal Reserve, our country's central bank. Obviously, we know that this is printed money because it is paper and ink. We also determine by observation that it certainly appears official. It is elaborately adorned with authoritative images that express the full faith and strength of the U.S. government. However, we shall soon see that there is nothing federal about it and there is no reserve.

Now compare the first dollar bill with the one below.

This dollar, which circulated in 1957, looks exactly like the dollar on the previous page except for this one very important distinction. At the very top we see that this dollar has written across it SILVER CERTIFICATE. We also read the following: "This certifies that there is on deposit with the Treasury of the United States of America, one silver dollar, payable to the bearer on demand."

That is quite a distinction. In case the reader isn't sure, let us be crystal clear: There is nothing backing our current currency. By that we mean that its precious metal convertibility has been removed, gradually at first, but over time permanently. This process actually began when President Franklin D. Roosevelt, in one of his first acts in office, declared as illegal the use of gold as money in 1933. It was pronounced a crime for any citizen to continue using gold as money, a law that was strictly enforced by a stiff fine, even imprisonment. Furthermore, President Roosevelt demanded that all gold be turned over to the government, to be stored and locked in a vault under armed military protection. The gold vault is known as Fort Knox and is located in the state of Kentucky.

Our coins were at one time made of 97% pure silver. Today they are merely tokens made of cheap metal. When we say that our money has lost 95% of it value since the early 1900s, we are speaking of its loss of purchasing power, but also of the fact that it has been un-linked from precious metals—real money.

One other significant point needs mentioning. The U.S. once owned a large share of all the gold in the world, but today the amount actually in U.S. possession is unknown. No outside agency has been allowed inside Fort Knox in many decades to audit the gold bullion held there. Obviously none of this is good news. Understanding how and why we have wound up in this situation is of supreme importance to us today. We will learn more specifics later, but for now these facts should not be forgotten.

A Brief Tour of America's Early Monetary History

There were two large-scale experiments with fiat money in our country's early history. Both times illustrated the danger of giving politicians control of the printing press. The first episode occurred during our country's infancy. During the War of Independence, the desperate Continental Congress began paying its debts in fiat money called Continentals. At one point, General Washington complained to Congress that it took a wheelbarrow of Continentals in order to buy bread for his starving soldiers. People would not readily accept Continentals as money, simply because they knew it was not real money. (The reader may have heard the phrase "not worth a Continental.") They knew it was paper fiat money whose convertibility to a precious metal was questionable.

Indeed this early disaster with fiat money greatly influenced the Founding Fathers. G. Edward Griffin describes some of the commentary at the Constitutional Convention:

Oliver Ellsworth from Connecticut, who later was to become our third Chief Justice of the Supreme Court, said, "This is a favorable moment to shut and bar the door against paper money. The mischief of the various experiments which have been made are now fresh in the public mind and have excited the disgust of all the respectable parts of America."

George Mason from Virginia told the delegates he had a "mortal hatred to paper money." Previously he had written to George Washington: "They may pass a law to issue paper money, but twenty laws will not make the people receive it. Paper money is founded upon fraud and knavery."

James Wilson of Pennsylvania said: "It will have the most salutary influence on the credit of the United States to remove the possibility of paper money."

John Langdon from New Hampshire warned that he would rather reject the whole plan of federation than to grant the new government the right to issue fiat money.

George Reed from Delaware declared that a provision in the Constitution granting the new government the right to issue fiat money "would be as alarming as the mark of the beast in Revelation.²

Needless to say, the original signers of the Constitution did not think they were creating a federal government that had the right to give green pieces of paper the force of legal tender. The clause granting Congress the power to "coin money" and "regulate the value thereof" has been as heroically strained (in order to justify the government's debasement of the dollar) as the other modern misinterpretations of the obvious intentions of the signatories. Griffin explains:

In view of the fact that gold and silver coin was specifically defined as the only kind of money to be allowed, there can be no doubt of what was meant...To coin money meant to mint precious-metal coins. Period.

The second half [of the clause] is equally clear. Both in the Constitution and in the discussions among the delegates, the power to regulate the value of gold and silver coin was closely tied to the power to determine weights and measures. They are, in fact, one and the same. To regulate the value of coin is exactly the same as to set the nationally accepted value of a mile or a pound or a quart. It is to create a standard against which a thing may be measured....

The intent, therefore, was simply for Congress to determine the exact weight of a precious metal that would constitute the national monetary unit.³

To drive home the point that the Founders did not think the new Constitution gave the federal government the power to issue fiat money, consider the following thoughts that George Washington wrote in 1789:

We may one day become a great commercial and flourishing nation. But if in the pursuit of the means we should unfortunately stumble again on unfunded paper money or any similar species of fraud, we shall assuredly give a fatal stab to our national credit in its infancy.⁴

During Washington's first term as president, his Secretary of the Treasury Alexander Hamilton proposed the creation of a central bank (the First Bank of the United States). This raised the fierce ire of Secretary of State Thomas Jefferson, who declared: "A private central bank issuing the public currency is a greater menace to the liberties of the people than a standing army." We see that the Founding Fathers, were they to view present-day America, would be shocked on many levels.

Despite the awful experience with Continentals during the War for Independence, both sides in the Civil War (or what is also known as the War Between the States) succumbed to the temptation to rely on unbacked fiat money to pay their expenses. The price inflation in the Confederate states was appalling, and even in the North the public became disillusioned with the rapidly deteriorating "Greenbacks" until they were once again linked to precious metals after the war.
Anytime sound money, as in gold, circulates alongside paper money not backed by a precious metal, the people tend to hoard the sound money and spend the bad money. This phenomenon was first discovered in the 1500s and is known as Gresham's Law: "Bad money drives out good under legal tender laws." When the government forces merchants and creditors to accept debased money as if it were equivalent to the genuine article, everyone trades away the inferior version. No one wants the paper money. No one saves the paper money. The people will hoard the good money each and every time. This partly explains FDR's confiscation of citizens' holdings of gold in 1933.

Once again, our nation is using a paper money not redeemable in precious metals. Federal Reserve Notes now circulate in our economy totally free from its main competitors, gold and silver. It is officially legal tender and it is the only money we can use. Even more noteworthy, today all countries in the world use fiat money. Here and abroad we are completely off the gold standard. Universally it is all nothing more than paper and ink.

The Bretton Woods Agreement 1944

After World War II, the United States emerged as a world superpower. Using this powerful influence the U.S. formulated and drove into acceptance a new global monetary system at the conference in Bretton Woods, New Hampshire in 1944. In contrast to the classical gold standard, in which every nation's currency was convertible by anyone into a specified weight of gold, the new system enshrined the U.S. dollar as the anchor upon which all other fiat currencies were based. Rather than stockpiling bars of gold in their vaults as reserves, foreign central banks were encouraged to use U.S. dollars as their "reserves."

Under the Bretton Woods agreement, the U.S. dollar itself was still backed up by gold, at the official exchange rate of $35 an ounce, thus providing a firm foundation to the entire system. However, unlike the practice during the classical gold standard, in the new arrangement only central banks had the right to turn in their paper dollars for gold bullion. American citizens would never again regain the ability—stripped from them by FDR—to turn their dollars in for gold. Thus one of the most potent checks on inflation had been removed.

As stated earlier, the United States had a huge stock of gold reserves after World War II and began pursuing a highly inflationary course much to the dismay of foreign countries. As the dollar weakened because of these monetary activities, gold started flowing out of the country in large amounts as foreign governments cashed in their dollars for gold. It reached a crisis point by 1968, and in 1971 President Richard Nixon took our dollar totally off gold and declared the Bretton Woods agreement null and void. At this point, the U.S. dollar—and by extension, the currencies of other world powers—was an asset unto itself, having no link to the precious metals. At this point, the only restraint on the printing of new paper dollars was the discretion of Federal Reserve officials. There were no formal checks left on their appetite for inflation.

Many people expected that the entire international monetary system would collapse after the breakup of Bretton Woods. Surprisingly it didn't. Some historians speculate that U.S. military might and fears of an outbreak of World War III kept other governments in check, continuing to use the U.S. dollar as the world's reserve currency even though they never would have agreed to the arrangement originally without the dollar's backing by gold. In any event, the U.S. experience of "stagflation" during the 1970s showed that the tie to gold—weak though it was under Bretton Woods—had restrained inflation. After Nixon removed the last shackles, the U.S. suffered from an orgy of dollar printing.

L. Carlos Lara | Tuesday, July 6th, 2010

L. Carlos Lara is President of United services and Trust Corporation, a Management Consulting Firm specializing in Business Consulting, Corporate Trust Services, Corporate and Private Seminars and Speaking Engagements. Visit him or contact him at www.usatrustonline.com.

Notes:
(1) Federal Reserve Bank of Chicago, Modern Money Mechanics: A Workbook on Bank Reserves and Deposit Expansion (1994), p. 1. Available at: http://www.rayservers.com/images/ModernMoneyMechanics.pdf. Accessed June 3, 2010.
(2) G. Edward Griffin, The Creature From Jekyll Island (Westlake Village, CA: American Media, 2002), p. 315.
(3) G. Edward Griffin, The Creature From Jekyll Island, pp. 317-318.
(4) Quoted in Griffin, p. 323.