Monetary Policy, the Federal Reserve, and the National Debt Problem

by Richard M. Ebeling

(The following testimony was delivered before the House of Representatives Subcommittee on Domestic Monetary Policy and Technology, chaired by Congressman Ron Paul (R-Texas), on “Monetary Policy and the Debt Ceiling: Examining the Relationship between the Federal Reserve and Government Debt,” in Washington, D.C. on May 11, 2011)

“I place economy among the first and most important virtues, and public debt as the greatest of dangers to be feared . . . To preserve our independence, we must not let our rulers load us with public debt . . . we must make our choice between economy and liberty or confusion and servitude . . . If we run into such debts, we must be taxed in our meat and drink, in our necessities and comforts, in our labor and in our amusements . . . If we can prevent the government from wasting the labor of the people, under the pretense of caring for them, they will be happy.”

Thomas Jefferson

Government Debt and Deficits

The current economic crisis through which the United States is passing has given a heightened awareness to the country’s national debt. After a declining trend in the 1990s, the national debt has dramatically increased from $5.7 trillion in January 2001 to $10.7 trillion at the end of 2008, to over $14.3 trillion through April of 2011. The debt has reached 98 percent of 2010 U.S. Gross Domestic Product.

The approximately $3.6 trillion that has been added to the national debt since the end of 2008 is more than double the market value of all private sector manufacturing in 2009 ($1.56 trillion), more than three times the market value of spending on professional, scientific, and technical services in 2009 ($1.07 trillion), and nearly five times the amount spent on non-durable goods in 2009 ($722 billion). Just the interest paid on the government’s debt over the first six months of the current fiscal (October 2010-April 2011), nearly $245 billion, is equal to more than 40 percent of the total market value of all private sector construction spending in 2009 ($578 billion).

This highlights the social cost of deficit spending, and the resulting addition to the national debt. Every dollar borrowed by the United States government, and the real resources that dollar represents in the market place, is a dollar of real resources not available for use in private sector investment, capital formation, consumer spending, and therefore increases and improvements in the quality and standard of living of the American people.

In this sense, the government’s deficit spending that cumulatively has been increasing the national debt has made the United States that much poorer than it otherwise could have and would have been, if the dollar value of these real resources had not been siphoned off and out of use in the productive private sectors of the American economy.

What has made this less visible and less obvious to the American citizenry is precisely because it has been financed through government borrowing rather than government taxation. Deficit spending easily creates the illusion that something can be had for nothing. The government borrows “today” and can provide “benefits” to various groups in the society in the present with the appearance of no immediate “cost” or “burden” upon the citizenry.

Yet, whether acquired by taxing or borrowing, the resulting total government expenditures represent the real resources and the private sector consumption or investment spending those resources could have financed that must be foregone. There are no “free lunches,” as it has often been pointed out, and that applies to both what government borrows as much as what it more directly taxes to cover its outlays.

What makes deficit spending an attractive “path of least resistance” in the political process is precisely the fact that it enables deferring the decision of telling voter constituents by how much taxes would otherwise have to be increased, and upon whom they would fall, in the “here and now” to generate the additional revenue to pay for the spending that is financed through borrowing.

But as the recent fiscal problems in a number of member nations of the European Union have highlighted, eventually there are limits to how far a government can try to hide or defer the real costs of all that it is providing or promising through its total expenditures to various voter constituent groups. Standard & Poor’s recent decision to downgrade the U.S. government’s prospective credit rating to “negative” shows clearly that what is happening in parts of Europe can happen here.

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The Gold Standard and Monetary Freedom

by Richard M. Ebeling - via Carlos Lara (www.usatrustonline.com)

(This talk was delivered at a debate on whether "American Should Adopt the Gold Standard," sponsored by the Atlas Economic Research Foundation and the Forum for Citizenship and Enterprise, held at Northwood University on March 29, 2011)

The severity of the current economic crisis has been serving as a catalyst for reconsideration of some fundamental questions about economic policy. This has included the size and role of government in society, the national debt burden and the unsustainability of various entitlement programs, and the relevancy of fiscal "stimulus" for economic recovery.

It has also thrown up into sharp relief some crucial flaws in the nature and workings of the prevailing monetary system. The central question, I would argue, is whether or not we should continue to leave monetary and banking policy in the discretionary hands of central banks and the monetary central planners who manage them.

Central Banking as Monetary Central Planning

And make no mistake about it. Central banking is monetary central planning. The United States and, indeed, virtually the entire world operate under a regime of monetary socialism. Historically, socialism has meant an economic system in which the government owned, managed, and planned the use of the factors of production.

Modern central banking is a system in which the government, either directly or through some appointed agency such as the Federal Reserve in the United States, has monopoly ownership and control of the medium of exchange. Through this control the government and its agency has predominant influence over the value, or purchasing power, of the monetary unit, and can significantly influence a variety of market relationships. These include the rates of interest as which borrowing and lending goes on in the banking and financial sectors of the economy, and therefore the patterns of savings and investment in the market.

If there is one lesson to be learned from the history of the last one hundred years -- during which the world and the United States moved off the gold standard and onto a government-managed fiat, or paper, money system -- is the fundamental disaster of placing control of the money supply in the hands of governments.


Government Abuse of Money and the Benefits of the Gold Standard

If is worth recalling that money did not originate in the laws or decrees of kings and princes. Money, as the most widely used and generally accepted medium of exchange emerged out of the market transactions of a growing number of buyers and sellers in an expanding arena of trade. Commodities such as gold and silver were selected over generations of market participants as the monies of free choice, due to their useful characteristics to better facilitate the exchange of goods in the market place.

And for almost all of recorded history, governments have attempted to gain control of the production and manipulation of money to serve their seemingly insatiable appetite to extract more and more of the wealth produced by the ordinary members of society. Ancient rulers would clip and debase the gold and silver coins of their subjects. More modern rulers -- whether despotically self-appointed through force or democratically elected by voting majorities -- have taken advantage of the monetary printing press to churn out paper money to fund their expenditures and redistributive largess in excess of the taxes they impose on the citizenry. Today the process has become even easier through the mere click of a "mouse" on a computer screen, which in the blink of an eye can create tens of billions of dollars out of thin air.

Thus, monetary debasement and the price inflation that normally accompanies it have served as a method for imposing a "hidden taxation" on the wealth of the citizenry. As John Maynard Keynes insightfully observed in 1919:

By a continuous process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method, they not only confiscate, but they confiscate arbitrarily; and while the process impoverishes many, it actually enriches some. The process engages all of the hidden forces of economic law on the side of destruction, and does it in a manner that not one man in a million can diagnose.

It is the corrosive, distortive, and destructive effects from monetary manipulation by governments that led virtually all of the leading economists of the nineteenth century to endorse the "anchoring" of the monetary system in a commodity such as gold, to prevent governments from using their powers over the creation of paper monies to cover their budgetary extravagance. John Stuart Mill's words from the middle of the nineteenth century are worth recalling:

No doctrine in political economy rests on more obvious grounds than the mischief of a paper currency not maintained at the same value with a metallic, either by convertibility, or by some principle of limitation equivalent to it . . . All variations in the value of the circulating medium are mischievous; they disturb existing contracts and expectations, and the liability to such changes renders every pecuniary engagement of long date entirely precarious . . .

Great as this evil would be if it [the supply of money] depended on [the] accident [of gold production], it is still greater when placed at the arbitrary disposal of an individual or a body of individuals; who may have any kind or degree of interest to be served by an artificial fluctuation in fortunes; and who have at any rate a strong interest in issuing as much [inconvertible paper money] as possible, each issue being itself a source of profit. Not to add, that the issuers have, and in the case of government paper, always have, a direct interest in lowering the value of the currency because it is the medium in which their own debts are computed . . . Such power, in whomsoever vested, is an intolerable evil.

Under a gold standard, it is gold that is the actual money. Paper currency and various forms of checking and other deposit accounts that may be used in market transactions in exchange for goods and services are money substitutes, representing a fixed quantity of the gold-money on deposit with a banking or other financial institution that are redeemable on demand.

Any net increases in the quantity of currency and checking and related deposits are dependent upon increases in the quantity of gold that depositors with banking and financial institutions add to their individual accounts. And any withdrawal of gold from their accounts through redemption requires that the quantity of currency notes and checking and related accounts in circulation be reduced by the same amount. Under a gold standard, a central bank is relieved of all authority and power to arbitrarily "manage" the monetary order.

Many critics of the gold standard consider this a rigid and inflexible "rule" about how the monetary system and the quantity of money in the society is to be determined and constrained. Yet, the advocates of the gold standard have long argued that this relative inflexibility is essential to discipline governments within the confines of a "hard budget."

Without the "escape hatch" of the monetary printing press, governments either must tax the citizenry or borrow a part of the savings of the private sector to cover its expenditures. Those proposing government spending must either justify it by explaining where the tax dollars will come from and upon whom the taxes will fall; or make the case for borrowing a part of the savings of the society to cover those expenditures -- but at market rates of interest that tell the truth about what it will cost to attract lenders to lend that sum to the government rather than to private sector borrowers, and therefore, at the social cost of private sector investment and future growth that will have to be foregone.

In other words, it prevents the government from "monetizing the debt" to cover all or part of its budget deficits. The borrowed sums cannot be created out of thin air through central bank monetary expansion. The government, under a gold standard, can no longer create the illusion that something can be had for nothing.

As Austrian economist, Ludwig von Mises, expressed it:

Why have a monetary system based on gold? Because, as conditions are today and for the time that can be foreseen today, the gold standard alone makes the determination of money's purchasing power independent of the ambitions and machinations of governments, of dictators, and political parties, and pressure groups. The gold standard alone is what the nineteenth-century freedom-loving leaders (who championed representative government, civil liberties, and prosperity for all) called "sound money."


Milton Friedman's "Second Thoughts" About the Benefits of Paper Money

It must be admitted that even some advocates of economic freedom and limited government have been advocates of paper money. The most notable one in the second half of the twentieth century was Milton Friedman. Over most of his professional career he argued that maintaining a gold standard was a waste of society's resources. Why squander the men, material and machinery digging gold out of the ground to then simply store it away in the vaults of banks? It is better to use those scarce resources to produce more of the ordinary goods and services that can enhance the standard and quality of people's lives. Control the potential arbitrary recklessness of central banks, Friedman proposed, by setting up a monetary "rule" that says: Increase the paper money supply by some small annual percent, with no discretion left in the hands of the monetary managers.

But it less well known is that in the years after Friedman won the Nobel Prize in Economics in 1976, he had second thoughts about this monetary prescription. In a 1986 article on, "The Resource Costs of Irredeemable Paper Money," he argued that when looking over the monetary mismanagement and mischief caused by governments and central banks during the twentieth century, it was "crystal clear" that the costs of mining, minting and storing gold as the basis of a monetary system would have been far less than the disruptive and destabilizing costs imposed on society due to paper money inflations and the booms and busts of the business cycle brought about by central bank manipulations of money and interest rates.

In his 1985 presidential address before the Western Economic Association on "Economists and Public Policy," he said that Public Choice theory had persuaded him that it would never be in the long-run self-interest of governments or central bankers to manage the monetary system according to some hypothetical "public interest." Those in government or holding the levers of the monetary printing press will always be susceptible to the temptations and pressures of short-run political gains that monetary expansion can fund. He admitted that it had been a "waste of time" on his part to try to get governments and central banks to follow his idea for a monetary rule.

And in another article in 1986 (co-authored with Anna Schwartz) on, "Has Government Any Role in Money?" Friedman said that while he was not ready at that time to advocate a return to the gold standard, he did conclude that "that leaving monetary and banking arrangements to the market would have produced a more satisfactory outcome than was actually achieved through government involvement."


Monetary Mismanagement versus Markets and Gold
But it is not only the political dangers arising from government mismanagement of paper money that justifies the establishment of a gold standard. It is also and equally the fact that monetary central planning is unworkable as a means to maintain economy-wide stability, full employment, and growth.

Especially since the 1930s, many economists and policy makers influenced by Keynes and the Keynesian Revolution have believed markets are potentially unstable and susceptible to wide and prolonged fluctuations in employment and output that only can be prevented or reduced in severity through "activist" monetary and fiscal policy.

But in reality, the causation runs the in the opposite direction. It is central bank manipulations of money, credit and interest rates that have generated the instability and periodic swings in economy-wide production and employment.

The fact is financial institutions and interest rates have important work to do in the market economy. Banks and other financial intermediaries are supposed to serve as the "middlemen" who bring together those who wish to save portions of their earned income with others who desire to borrow and invest that savings in profit-oriented productive ways that generate capital formation, technological improvements, and cost-efficient production of new, better and more goods and services to satisfy consumer demands in the future.

Market-determined interest rates are meant to bring those savings and investment plans into coordination with each other, so the amount of invested capital and the time-shape of the investment horizons undertaken are consistent with the available real savings to support them to maintainable completion.

Monetary expansion by central banks creates the illusion that there is more actual investable savings in the economy than really exists. And the false interest rate signals generated in the banking system by the monetary expansion not only misinforms potential investment borrowers about the amount of real savings available for capital projects, but creates an incorrect basis for determining the present value calculations that influence the time horizons for the investments undertaken.

It is these false monetary and interest rate signals that induces the misdirection of resources, the mal-investment of capital, and the incorrect allocation of labor among employments in the economy that sets the stage for an inevitable and inescapable "correction" and readjustment that represents the recession stage of the business cycle that follows the collapse of the artificial boom.

The monetary central planners can never be more successful in determining a "optimal" quantity of money or the "right" interest rates to assure savings-investment coordination than all other socialist planners were when they tried to centrally plan agricultural production or investment output for an entire society. All such attempts at monetary planning and management by central bankers are instances of what Friedrich A. Hayek called in his Nobel Lecture a, "pretense of knowledge," that they can know better and do better than the outcomes generated by competitive interactions of the market participants, themselves. And as Adam Smith warned, nowhere is such regulatory power "so dangerous as in the hands of a man who had the folly and presumption enough to fancy himself fit to exercise it."

There is no way of knowing the optimal amount of money in the economy other than allowing market participants in the competitive exchange process to decide what they want to use as money -- which has historically been a commodity such as gold or silver. And there is no way of knowing what interest rates should be other than allowing the market forces of supply and demand for lending and borrowing to determine those interest rates through the process of private sector financial intermediation, without government or central bank interference or manipulation.


The Return to the Gold Standard as a Monetary Constitution

Finally, how do we return to a functioning and workable gold standard? Under the current government and central bank-controlled monetary system the simplest method might be for the monetary authority to stop creating and printing money and credit. Over a short period of time a fairly reasonable estimate could be made about the actual quantity of a nation's currency and checking and related deposits that are in existence and in circulation. A new legal redemption ratio could be established by dividing the estimated total quantity of all forms of these money-substitutes into the quantity of gold possessed by the government and the central bank.

A country following this procedure would then, once again, be on the gold standard. Its long-run maintainability, of course, would require the government and the central bank to follow those "rules of the game" that no increase in the quantity of money-substitutes may be created and brought into circulation unless there have been net deposits of gold in people's accounts with banking and other financial institutions.

Can we trust governments and central banks to abide by these rules of the game? The temptations to violate them will still remain strong in a political environment dominated by ideologies of wealth redistribution, special interest favoritism, and numerous "entitlement" demands.

It is why the real long-run goal of monetary reform should be the denationalization of money. That is, the separation of money from the state by ending of central banking, altogether. In its place would emerge private, competitive free banking -- a truly market-based money and banking system.

But nevertheless, in the meantime, a gold standard can serve as a form of a "monetary constitution" setting formal limits and imposing restraints on those in government who would want to abuse the monetary printing press, similar to the way political constitutions, however imperfectly, are meant to limit the abuses of power-lusting monarchs and the plundering majorities in functioning democracies.

If it fails, it should not be for want of trying. And a gold standard can be one of the positive institutional reforms in the attempt and on the way to a fully free market monetary system.

The $5 Million Tax Break

Congress has set sweet new terms for the gift tax, and families are tearing up their estate plans to take advantage. Here's what you need to know.

By Anne Tergesen and Laura Saunders (WSJ Online)

Largely lost amid all the political drama surrounding December's historic tax legislation was a sweet deal for families.

For the next two years, the gift-tax exemption jumps to $5 million from $1 million for individuals and to $10 million from $2 million for couples—meaning people can give away that much without paying a penny in taxes.

What's more, the tax rate on gifts above those amounts fell to 35% from a scheduled 55%, a boon to ultrawealthy people who want to give away even more money.

Washington's unexpected largess is prompting many taxpayers to throw away their estate plans and craft new ones before the favorable terms expire. But while anyone with significant assets should consider retooling their strategies, there are many important considerations, financial and emotional alike.

Click here to read the rest of the article on WSJ.com

Austrian Economics Gaining Ground

Fed-fighter Ron Paul thinks Paul Krugman
should debate an Austrian economist...

Big Government Fact & Fiction

Mises Institute Adjunct Scholar Robert Murphy
discusses whether big government under President Obama is a myth.

My Debate Challenge to Paul Krugman!

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

Purchase the Lara-Murphy Report

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!