Free Trade, the Corn Laws and The Economist

Posted by PITHOCRATES - September 8th, 2013

Week in Review

Today the political left attacks capitalism as being unfair.  And mean.  Whereas they laud government intervention into the free market.  To level the playing field.  And to redistribute income.  To help those who can’t be as successful as others.  They support unions.  And oppose free trade.  Because free trade lowers prices for consumers.  By breaking up monopolies.  And giving them choice.  Free trade is an essential element of capitalism.  But the fight to make people’s lives better with free trade wasn’t easy.  As people who got rich with government-protected high prices opposed free trade (see Why did The Economist favour free trade? by C.R. posted 9/6/2013 on The Economist).

IN NINETEENTH century Europe and America, debates over whether tariffs or free trade produced the most economic growth dominated the political scene. Up until the early 1840s, protection appeared to be winning the argument. In Britain, high tariffs were imposed on agricultural imports in 1819, by legislation known as the Corn Laws. The ideas of Friedrich List, a German economist who argued that tariffs boosted industrial development through the protection of infant industries, were gaining ground, particularly in the United States. One Pennsylvanian legislator even joked in 1833 that the dictionary definition of man should be changed to “an animal that makes tariff speeches” so frequently were they heard.

Against this atmosphere, James Wilson founded The Economist in 1843 to campaign for free trade. His first target was to repeal the Corns Laws in Britain. He argued:

They are, in fact, laws passed by the seller to compel the buyer to give him more for his article than it is worth. They are laws enacted by the noble shopkeepers who rule us, to compel the nation to deal at their shop alone.”

The UAW got very generous contracts with the Big Three during the Fifties and the Sixties.  Raising the price of cars.  Which wasn’t a problem when they were the only ones making cars.  But then came the imports.  Which told the people how much more they were paying than these articles were worth.  And started buying the imports.  As they did those generous pay and benefit packages became more difficult to pay.  So the Big Three lobbied for tariffs on those less costly imports.  And got them.  Raising the price of the imports.  Forcing Americans to deal with the Big Three alone.  And buy their more costly cars.

More people bought cars than made them, though.  And the people who made the cars were better paid than most Americans.  So these tariffs forced poorer people to spend more on a car leaving them less for their families.  So richer people could have more.  This is what tariffs do.  They allow fewer people to have more.  While more people have to do with less.  So fewer buy more.  While more buy less.  Because there are more people who buy cars than make them these tariffs, then, reduce economic activity.  And because the Big Three didn’t have to figure out how to give more for less to their customers they didn’t.  Giving their customers ‘rust buckets’ in the Seventies.  Something else that tariffs do.  Lead to inferior goods.  Because if the government forces people to buy from you then the quality of what you sell doesn’t matter.

Wilson believed that protectionism caused “war among the material interests of the world”, in other words, war between nations and classes. A high tariff regime was no longer economically “productive”; Britain was stuck in an economic depression in the early 1840s. In contrast, free trade produced “abundance and employment”. It was appropriate for Britain’s economy where “a large proportion of the population and property depended on commerce and industry alone”. On the other hand, List’s ideas about protection were dismissed as unnecessary “swaddling clothes” for a mature economy, such as Britain’s.

The Economist’s early views on free trade were strongly influenced by the classical economists Adam Smith and David Ricardo, as Ruth Dudley Edwards, a historian, has pointed out. Wilson, like Smith, realised that trade was a two way exchange. Countries needed to “increase imports to increase exports” to boost economic growth. Consumers, Smith argued in the Wealth of Nations, should buy products from where they were cheapest. All protection did was create monopolies, which were “a great enemy to good management”. Ricardo took Smith’s ideas further, arguing that all countries benefit from free trade by producing what they were best at relative to other countries.

That’s what the Big Three wanted.  A monopoly on cars sold in America.  And there is only one way to get one.  The government has to create them.  Hence the Big Three’s request for tariff protection.

David Ricardo’s comparative advantage said nations should make what they can make best and trade for those things they can’t.  For example, if two countries can both make one thing but one can do so at lower costs they can make more of them for the same costs.  Giving them a larger surplus to trade for other things.  While the other nation will consume more resources to build the same quantity leaving less to make the other things they need.  While having fewer things available for export.  So if you try to make things you can’t make efficiently you end up consuming more resources to have less.  Whereas the nation that makes only what it can make best ends up consuming fewer resources that are then available to make other things.  And they have more things to trade.  Leading to a higher standard of living.  And if their trading partners do likewise they, too, experience a higher standard of living.

Free trade leads to greater economic activity.  Which made Britain wealthy.  Allowing them to extend their empire for another 70 years or so.  Despite the warnings of the rich landowners who said repealing the Corn Laws would cause harm.  Instead, repealing the Corn Laws led to greater economic activity.  And less costly food. Allowing people to feed their families more easily.  The only harm suffered was to the profits of the big landowners.  Who lost their monopoly.  And could no longer charge more than their food was worth.

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Greece, Rome, Western Civilization, Alexandria, Londinium, Enlightenment, Adam Smith, Free Market Capitalism and Gender Equality

Posted by PITHOCRATES - April 17th, 2012

History 101

Greece gave Western Civilization Math, Science, Engineering and Philosophy

History has been a political struggle over power.  Kings and emperors and priests and nobles had it.  While other kings and emperors and priests and nobles wanted it.  They fought wars.  They oppressed their people.  They’ve committed acts of genocide on their enemies.  And on their people.  To get that power.  To keep that power.  And that’s the way it was for a long time.  The ruling class at the top battling it out.  While the people suffer abject poverty, famine and genocide at the bottom.  Until something came along to change that.  An advanced civilization.  That could produce a food surplus.  Freeing up people to become artisans.  Specialists.  Who could invent and make things.  To make life better.  Especially for a large group of people called the middle class.

The Greeks and Romans took civilization to new heights.  When Edgar Allen Poe wrote To Helen (1845) he chose Greece and Rome to describe his most beautiful Helen.  Because Greece and Rome were that beautiful.

On desperate seas long wont to roam,
Thy hyacinth hair, thy classic face,
Thy Naiad airs have brought me home
To the glory that was Greece,
And the grandeur that was Rome.

Western Civilization began in Greece.  Food surpluses freed the great thinkers.  Math, science, engineering and philosophy took roots in Athens and spread through the Greek world.  The Hellenistic civilization.  That Alexander the Great spread east all the way to Iran and the Indus Valley.  And south into Egypt.  Where he founded the great city of Alexandria.  Repository of some of the greatest Greek books of knowledge.  When Rome conquered Greece they spread that great Hellenistic civilization east to Spain.  North to France and Germany.  Even to England.  London itself was once a Roman city.  Londinium.  And everywhere the Romans went they brought with them Greek math, science, engineering and philosophy.  Building engineering marvels.  And creating a very high standard of living.

Where the Romans went they also built roads.  Primarily to move their legions throughout their empire.  But they also used them for trade.  Where they traded the goods made by that rising middle class of artisans.  Economic activity was bustling.  Until the government grew.  To pay for an ever larger government bureaucracy and military they started taxing that economic activity.  And regulating it.  Rather harshly.  Restricting freedoms.  Eventually tying farm workers to the land.  Even their children.  Turning that once bustling economy into feudalism.  Serfdom.  Until the growth of government expenditures made the Western Empire so weak that the Germanic barbarians sacked Rome.

Enlightened Thinking and Adam Smith’s Wealth of Nations helped make Great Britain the Leading European Power

While Europe went through the Dark Ages the Eastern Roman Empire continued on.  Centered on Constantinople (modern day Istanbul) on the Bosporus, she was smack-dab in the middle of the trade crossroads between Europe and Asia.  And continued to prosper economically.  Until the Arabs began attacking her.  And the Christian Crusaders.  Who came down to reclaim the holy land for the Catholic Church.  Where they fought Muslim Arabs.  As well as Orthodox Christians.  While in the area they visited the sights.  Including that great repository of books in Alexandria.  Which they packed up and brought back to Europe.  And changed the world.

As the Christian monks translated these books all of Europe read them.  Math, science, engineering and philosophy.  Kicking off the Enlightenment.  Advanced economies appeared in the Italian city-states as they controlled trade in the Mediterranean.  But with all that Greek knowledge Portugal, Spain and the Netherlands built bigger ships and learned to navigate across the oceans.  Moving the center of trade from the Mediterranean to northern Europe.  The Europeans established colonies in the Old World.  And the New World.  France and England soon followed.  Trade exploded.  And fortunes were made.  But something really special was happening in England. 

Thanks to all that enlightened thinking the English took the lead in Europe.  And the world.  Modern farming practices improved yields and created great food surpluses.  She had representative government in her Parliament.  The rule of law.  Banking institutions.  Joint-stock companies to raise large amounts of capital.  An insurance industry to manage the great risks of transoceanic trade.  And an economist up in Scotland who wrote a book about new ideas in economic thought.  Adam Smith.  Who wrote The Wealth of Nations.  Championing something he called the Invisible Hand in free market capitalism.  Taking away the economic decisions making from the kings and emperors and priests and nobles.  And giving it to the people.  Which Great Britain embraced.  Kicking off the Industrial Revolution.  Other European nations followed her lead.  As did one young upstart nation.  The United States.

Famine has been Rare in Western Civilization since the 18th Century

Western Civilization dominated the world in every measurable way.  Economic output.  Living standards.  Public health standards.  Gender equality.  You name it and the free market capitalism of Western Civilization made it better.  The general path of emigration of great minds traveled in one general direction.  From eastern/southern Europe to Germany, France and Great Britain.  Then on to the United States.  Or directly to the United States.  Where free market capitalism was the freest.  Making the Untied States the new world superpower.  Following the Industrial Revolution with even greater innovation.  Providing ever greater living standards.  And individual liberty.  For everyone.

The freedom in free market capitalism brought women into the workforce.  Take the automobile.  When Henry Ford first mass produced the car it was not people-friendly.  Men started our first cars by turning a hand crank.  Sometimes losing a finger or breaking a wrist in the process.  Once started he adjusted his goggles and gloves and took the wheel.  His face being the bug screen.  His muscles being his ‘powered’ steering.  Clutching through the gears.  Gearing down and stomping down on the breaks to stop.  It was man’s work driving our first cars.  Dirty, filthy man’s work.  The automatic starter, automatic transmission, power steering and breaks, though, changed all of that.  All American developments.  Allowing women in heels and a short dress to start and drive a car as well as any man without losing any of her dignity.  And she could sip a latte on her drive to work.  While listening to music.  And on those hot days she didn’t sweat through her clothes before getting to work.  Thanks to air conditioning.  Another American invention for the car.  And she’s able to enjoy this freedom because of some other inventions.  Two in particular that let her pursue a career.  And enjoy any activity whenever she chooses.  The birth control pill.  And the tampon.  Again, products of Western Civilization. 

Women in Western Civilization have it pretty good these days.  Where for the most part their standard of living has caught up to men.  There are some earning disparities.  But a lot of that is due to women leaving the workforce to raise children.  And then reentering at a later time.  Having to play catch-up with those who didn’t leave the workforce to raise a family.  Not too bad when you consider what women are going through where they don’t embrace free market capitalism.  For not only do they have none of these everyday comforts we take for granted but they often go without food.  Up until the 18th century famines were pretty common.  But with the advances we’ve made in farming and our other institutions we have that give us a modern and bustling economy (and our high living standards) there really haven’t been any famines in Western Civilization since the 18th century.  There may have been a few but they were very rare.  Unlike the famines in the 20th century that killed tens of millions in Russia, the Soviet Union, China, North Korea, Southwest Asia, Southeast Asia and Africa.  But famine is not the only thing killing people in these countries.  They have also suffered the greatest acts of genocides.  As rival groups battle each other for political power.  With the innocent masses stuck in the crossfire.  Something a prosperous middle class has put an end to in Western Civilization.

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The Invisible Hand

Posted by PITHOCRATES - April 16th, 2012

Economics 101

A Command Economy Reduces the Overall Economic Output because those Managing the Economy don’t Understand It

Command economy?  Or free market capitalism?  Which works better?  Well, let’s find out with a little experiment.  Let’s go back in time.  Say ancient Mesopotamia.  Just after they developed mass farming.  And produced some of the first food surpluses.  Allowing the rise of a middle class of artisans.  Now let’s look at what could have been the first two of these artisans.  A potter.  And a winemaker.  Who probably weren’t the first two artisans.  But will suffice for our little experiment.

The winemaker needs some pottery vessels to store and sell his wine in.  And the potter enjoys drinking wine.  They each have something the other wants.  And because we’re so far back in time there is no money yet.  We’re still only bartering at this time.  Trading the goods we make with each other.  But in our experiment the high priest of the civilization is also the economic planner.  This priest communicates to the civilization’s gods.  And guides the civilization in pleasing their gods.  Which he is very good at.  For he knows all of the old teachings and rituals.  But he doesn’t know a thing about pottery or winemaking.  But he looks at an empty pottery vessel and a pottery vessel full of wine and sees that the vessel volume equals the volume of wine.  And deems the price of one pottery vessel is the amount of wine one pottery vessel holds.

Well, the potter is quite happy with this price.  Because he is skilled.  And can dig up some clay.  Throw it on the potter’s wheel and knock out vessel after vessel.  Glaze them and fire them in the kiln.  Even working by himself he can achieve some economies of scale.  By repeating this process every day.  Something the winemaker isn’t quite able to.  For he makes wine by the batch.  Because each step in the process takes a lot of time.  Maintaining his grape vines.  Then picking the grapes.  Carrying them back to his winery.  Putting them into his winepress.  Squeezing the juice out of the grapes.  Putting the grape juice in large vats to ferment.  Monitoring the process.  When he determines the process is complete he fills the small pottery vessels with wine.  When it was finally ready for ‘sale’ and consumption.  Considering all the work it took him to make one vessel of wine the winemaker was not at all happy with the price the high priest set.  And instead builds his own potter’s wheel and kiln to make his own vessels.  Greatly increasing his workload.  And reducing his winemaking output.  While the potter loses a potentially large customer.  Thus reducing the amount pottery he makes.  Reducing overall economic output in the command economy.

The Invisible Hand makes sure we use our Limited Resources Efficiently to Make the Things People want Most

In this command economy the civilization suffered a deadweight loss.  Economic resources went unused.  They could have created more economic benefits with the available resources.  They could have made more pottery.  And made more wine.  Perhaps even creating some jobs to help with the economic output of efficiently using the available resources.  But they didn’t.  Because of the fixed prices economic resources went unused.  Thus creating a market equilibrium lower than where it could be.  Hence the deadweight loss.  Now let’s look at the same example with only one difference.  The high priest does NOT set prices.

In a barter economy people agree to trade the goods they make.  And now the potter and the winemaker are free to determine what they think is a fair trade.  That is, they set the price of pottery in wine.  And the price they agree on is one they find mutually acceptable.  Where the potter agrees to trade an amount of his pottery for an amount of wine.  And the winemaker agrees to trade an amount of his wine for an amount of pottery.  Everyone wins.  For the potter gets an amount of wine he values more than the pottery he traded for the wine.  The winemaker gets an amount of pottery he values more than the wine he traded for the pottery.  And the civilization wins because at this mutually agreed upon price both the potter and the winemaker increase their production.  Providing the civilization with more of their goods.  The potter and the winemaker may even hire people to help them produce more goods to meet this higher demand.  Thus increasing the level of happiness in the civilization.  By increasing the amount of economic activity.  Moving the market equilibrium to a higher level of economic output.  And thus reducing the deadweight loss.  By using the available resources in the most efficient manner.  As determined by these mutually agreed upon prices.

This is the Invisible Hand in action.  An economic concept put forth by Scottish economist Adam Smith (1723-1790) in his The Wealth of Nations (1776).  In a competitive market place where traders set the price for their economic trade (not a command economy) two things happen.  First, resources flow to where we demand them most.  That is, to the buyers willing to pay the highest price.  Second, because of the competitive market place only those companies that sell at the low prices the market demands stay in business.  Which means that they have to use those resources as efficiently as possible.  Especially when they’re paying the highest prices for them.  And all of this happens because of the Invisible Hand. 

History has Proven that no Government Bureaucrat can do a Better Job than the Invisible Hand

Those who favor a command economy (or more government intervention into market forces) say the economy is too complex for us to leave it to its own devices.  That without a smart government bureaucrat managing this complex thing we cannot reach a market equilibrium that maximizes economic output.  Whereas Adam Smith says it is because the economy is so complex that no one is smart enough to manage it.  Just as a high priest doesn’t understand pottery or winemaking a smart government bureaucrat cannot hope to understand all the intricacies of a complex economy.  Nor can they ever hope to understand what millions upon millions of consumers want to buy most.  But the beautiful thing is we don’t have to.

The multitudes make individual decisions just like our potter and winemaker.  Where everyone is looking to maximize their own value.  And when they agree on a mutual acceptable price all parties in the trade win.  While making sure our resources flow to where they are demanded most.  And that we use these valuable and limited resources most efficiently.  Thus maximizing overall happiness in our country.  Reducing deadweight losses to a minimum.  And obtaining a market equilibrium that maximizes economic activity.  All of which happens with no one in charge.  As if an Invisible Hand guides us in the market place to make all the right decisions to maximize this economic output.  And our happiness.

So which is better?  Command economy or free market capitalism.  Well, if you’re being honest you have to choose Adam Smith’s Invisible Hand and free market capitalism.  For history has proven that no government bureaucrat can do a better job than the Invisible Hand.  Not the Soviets.  Not the Chinese Communist (under Chairman Mao).  Not the Cubans.  Not the North Koreans.  Even the Americans failed when their government actively intervened in the private economy.  Something that President Jimmy ‘one-term’ Carter knows only too well.  So based on our hypothetical Mesopotamian example, and history in general, free market capitalism is, and always has been, and always will be, better than a command economy.

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Republican (rĭ-pŭb’lĭ-kən), n., One who belongs to the Republican Party, the more conservative of the two major political parties in the United States.

Posted by PITHOCRATES - November 10th, 2011

Politics 101

Republicans can Trace their Lineage back to Abraham Lincoln, Edmund Burke, Adam Smith and John Locke

The Republican Party was born in the 19th century.  As the anti-slavery party.  Their motto was “free labor, free land, free men.”  They opposed concentrated wealth (i.e., land) in the hands of an aristocracy such as the planter elite in the South.  And the slavery that made that system work.  They were the party of the middle class.  Independent artisans.  Small farmers.  Entrepreneurs.  And businessmen.  In other words, free market capitalists.  To a point, at least.  They wanted to industrialize America.  But they wanted to protect these emerging industries with import tariffs.  And they wanted to pay for this industrialization with public money.  Neither of which is very capitalistic.

Republicans can trace their lineage back to the Whig Party.  Abraham Lincoln, our first Republican president, was a former Whig.  Whig political philosophy goes back to Great Britain.  Which built on the philosophy of some of the greats.  Edmund Burke.  Adam Smith.  And John Locke.  To name a few.  The Whigs formed the opposition to absolute monarchial rule.  Supporting constitutional monarchy.  With ultimate power lying in Parliament.  Not the Crown.  Or with the landed aristocracy allied to the Crown.  Which greatly influenced the American Founding Fathers.  Putting them on the path to independence from the Crown.

The Whigs supported the manufacturers and the merchants.  The thriving and prosperous middle class.  And the wealthy.  Which all threatened the power of the Crown.  Because it made the Crown less important.  The privileged class owed their privilege to the king.  The industrialists and merchants did not.  Their wealth was self-made.  And they further threatened the Crown by supporting free trade, the abolition of slavery and expanding the vote to more people.  Which gave people more individual liberty.  A say in their government.  And allowed them to be whatever they wanted to be.  Even wealthy.  If they worked hard to become wealthy.

The Republican Party is the Party of Conservatism in the U.S. but not all Republicans are Conservatives

The modern Republican Party shares much of the same philosophy.  They abolished slavery in the U.S.  Even deployed the Union Army to the South to protect the freed slaves during Reconstruction.  And went on later to fight Jim Crowe laws and the segregationist policies of the Southern Democrats.  Being instrumental in passing much civil rights legislation over Democrat opposition.

They believe in limited government.  And capitalism.  But they’re opposed to tariffs these days.  And favor true free trade.  As well as lower taxes.  Fewer regulations.  Less government spending.  And sound money.  They disapprove of loose monetary policy.  Playing with interest rates and/or printing money.  For an activist, tax and spend government.  Where the government picks winners and losers.  Instead they prefer that government stays out of things economic.  And let the private sector pick winners and losers.    Because the private sector has a record of success.  And government does not.

But some in the party have drifted from their philosophical roots.  Corrupted by power.  Enjoying the privilege of being part of the ruling elite.  They have earned the moniker RINO (Republican In Name Only).  And even though the Republican Party is the party of conservatism in the U.S., not all Republicans are conservatives.  There are a lot of moderates.  And a few downright liberals.  The heretofore mentioned RINOs.

Ronald Reagan got Social Moderates and Even Democrats to vote Republican

There is a schism in the modern Republican Party.  Between God and economics.  You probably have heard someone say that they are a fiscal conservative.  But they’re a social moderate.  This is someone turned off by the God stuff.

Christians tend to be conservative and vote Republican.  Those who aren’t so devout religiously and/or want to keep abortion legal have difficulty voting Republican.  Because of the God stuff.  Which explains why liberals often win elections over conservatives even though they’re outnumbered nearly 2 to 1.  Because the social issues win out over the fiscal issues and these fiscal conservatives vote Democrat.

At least during good economic times.  But when the economy is not doing well their fiscal side wins out.  Especially when you have a great presidential candidate.  Like Ronald Reagan.  Who not only got social moderates to vote Republican.  He even got Democrats to vote Republican.  So remarkable a phenomenon that we call them Reagan Democrats.

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LESSONS LEARNED #27: “Yes, it’s the economy, but the economy is not JUST monetary policy, stupid.” -Old Pithy

Posted by PITHOCRATES - August 19th, 2010

WHAT GAVE BIRTH to the Federal Reserve System and our current monetary policy?  The Panic of 1907.  Without going into the details, there was a liquidity crisis.  The Knickerbocker Trust tried to corner the market in copper.  But someone else dumped copper on the market which dropped the price.  The trust failed.  Because of the money involved, a lot of banks, too, failed.  Depositors, scared, created bank runs.  As banks failed, the money supply contracted.  Businesses failed.  The stock market crashed (losing 50% of its value).  And all of this happened during an economic recession.

So, in 1913, Congress passed the Federal Reserve Act, creating the Federal Reserve System (the Fed).  This was, basically, a central bank.  It was to be a bank to the banks.  A lender of last resort.  It would inject liquidity into the economy during a liquidity crisis.  Thus ending forever panics like that in 1907.  And making the business cycle (the boom – bust economic cycles) a thing of the past.

The Fed has three basic monetary tools.  How they use these either increases or decreases the money supply.  And increases or decreases interest rates.

They can change reserve requirements for banks.  The more reserves banks must hold the less they can lend.  The less they need to hold the more they can lend.  When they lend more, they increase the money supply.  When they lend less, they decrease the money supply.  The more they lend the easier it is to get a loan.  This decreases interest rates (i.e., lowers the ‘price’ of money).  The less they lend the harder it is to get a loan.  This increases interest rates (i.e., raises the ‘price’ of money). 

The Fed ‘manages’ the money supply and the interest rates in two other ways.  They buy and sell U.S. Treasury securities.  And they adjust the discount rate they charge member banks to borrow from them.  Each of these actions either increases or decreases the money supply and/or raises or lowers interest rates.  The idea is to make money easier to borrow when the economy is slow.  This is supposed to make it easier for businesses to expand production and hire people.  If the economy is overheating and there is a risk of inflation, they take the opposite action.  They make it more difficult to borrow money.  Which increases the cost of doing business.  Which slows the economy.  Lays people off.  Which avoids inflation.

The problem with this is the invisible hand that Adam Smith talked about.  In a laissez-faire economy, no one person or one group controls anything.  Instead, millions upon millions of people interact with each other.  They make millions upon millions of decisions.  These are informed decisions in a free market.  At the heart of each decision is a buyer and a seller.  And they mutually agree in this decision making process.  The buyer pays at least as much as the seller wants.  The seller sells for at least as little as the buyer wants.  If they didn’t, they would not conclude their sales transaction.  When we multiply this basic transaction by the millions upon millions of people in the market place, we arrive at that invisible hand.  Everyone looking out for their own self-interest guides the economy as a whole.  The bad decisions of a few have no affect on the economy as a whole.

Now replace the invisible hand with government and what do you get?  A managed economy.  And that’s what the Fed does.  It manages the economy.  It takes the power of those millions upon millions of decisions and places them into the hands of a very few.  And, there, a few bad decisions can have a devastating impact upon the economy.

TO PAY FOR World War I, Woodrow Wilson and his Progressives heavily taxed the American people.  The war left America with a huge debt.  And in a recession.  During the 1920 election, the Democrats ran on a platform of continued high taxation to pay down the debt.  Andrew Mellon, though, had done a study of the rich in relation to those high taxes.  He found the higher the tax, the more the rich invested outside the country.  Instead of building factories and employing people, they took their money to places less punishing to capital.

Warren G. Harding won the 1920 election.  And he appointed Andrew Mellon his Treasury secretary.  Never since Alexander Hamilton had a Treasury secretary understood capitalism as well.  The Harding administration cut tax rates and the amount of tax money paid by the ‘rich’ more than doubled.  Economic activity flourished.  Businesses expanded and added jobs.  The nation modernized with the latest technologies (electric power and appliances, radio, cars, aviation, etc.).  One of the best economies ever.  Until the Fed got involved.

The Fed looked at this economic activity and saw speculation.  So they contracted the money supply.  This made it hard for business to expand to meet the growing demand.  When money is less readily available, you begin to stockpile what you have.  You add to that pile by selling liquid securities to build a bigger cash cushion to get you through tight monetary times.

Of course, the economy is NOT just monetary policy.  Those businesses were looking at other things the government was doing.  The Smoot-Hartley tariff was in committee.  Across the board tariff increases and import restrictions create uncertainty.  Business does not like uncertainty.  So they increase their liquidity.  To prepare for the worse.  Then the stock market crashed.  Then it got worse. 

It is at this time that the liquidity crisis became critical.  Depositors lost faith.  Bank runs followed.  But there just was not enough money available.  Banks began to fail.  Time for the Fed to step in and take action.  Per the Federal Reserve Act of 1913.  But they did nothing.  For a long while.  Then they took action.  And made matters worse.  They raised interest rates.  In response to England going off the gold standard (to prop up the dollar).  Exactly the wrong thing to do in a deflationary spiral.  This took a bad recession to the Great Depression.  The 1930s would become a lost decade.

When FDR took office, he tried to fix things with some Keynesian spending.  But nothing worked.  High taxes along with high government spending sucked life out of the private sector.  This unprecedented growth in government filled business with uncertainty.  They had no idea what was coming next.  So they hunkered down.  And prepared to weather more bad times.  It took a world war to end the Great Depression.  And only because the government abandoned much of its controls and let business do what they do best.  Pure, unfettered capitalism.  American industry came to life.  It built the war material to first win World War II.  Then it rebuilt the war torn countries after the war.

DURING THE 1980s, in Japan, government was partnering with business.  It was mercantilism at its best.  Japan Inc.  The economy boomed.  And blew great big bubbles.  The Keynesians in America held up the Japanese model as the new direction for America.  An American presidential candidate said we must partner government with business, too.  For only a fool could not see the success of the Japanese example.  Japan was growing rich.  And buying up American landmarks (including Rockefeller Center in New York).  National Lampoon magazine welcomed us to the 90s with a picture of a Japanese CEO at his desk.  He was the CEO of the United States of America, a wholly owned subsidiary of the Honda Motor Company.  The Japanese were taking over the world.  And we were stupid not to follow their lead.

But there was no invisible hand in Japan.  It was the hand of Japan Inc.  It was Japan Inc. that pursued economic policies that it thought best.  Not the millions upon millions of ordinary Japanese citizens.  Well, Japan Inc. thought wrong. 

There was collusion between Japanese businesses.  And collusion between Japanese businesses and government.  And corruption.  This greatly inflated the Japanese stock market.  And those great big bubbles finally burst.  The powerful Japan Inc. of the 1980s that caused fear and trembling was gone.  Replaced by a Japan in a deflationary spiral in the 1990s.  Or, as the Japanese call it, their lost decade.  This once great Asian Tiger was now an older tiger with a bit of a limp.   And the economy limped along for a decade or two.  It was still number 3 in the world, but it wasn’t what it used to be.  You don’t see magazine covers talking about it owning other nations any more.  (In 2010, China took over that #3 spot.  But China is a managed economy.   Will it suffer Japan’s fate?  Time will tell.)

The Japanese monetary authorities tried to fix the economy.  Interest rates were zero for about a decade.  In other words, if you wanted to borrow, it was easy.  And free.  But it didn’t help.  That huge economic expansion wasn’t real.  Business and government, in collusion, inflated and propped it up.  It gave them inflated capacity.  And prices.  And you don’t solve that problem by making it easier for businesses to borrow money to expand capacity and create jobs.  That’s the last thing they need.  What they need to do is to get out of the business of managing business.  Create a business-friendly climate.  Based on free-market principles.  Not mercantilism.  And let that invisible hand work its wonders.

MONETARY POLICY CAN do a lot of things.  Most of them bad.  Because it concentrates far too much power in too few hands.  The consequences of the mistakes of those making policy can be devastating.  And too tempting to those who want to use those powers for political reasons.  As we can see by Keynesian ‘stimulus’ spending that ends up as pork barrel spending.  The empirical data for that spending has shown that it stimulates only those who are in good standing with the powers that be.  Never the economy.

Sound money is important.  The money supply needs to keep pace with economic expansion.  If it doesn’t, a tight money supply will slow or halt economic activity.  But we have to use monetary policy for that purpose only.  We cannot use it to offset bad fiscal policy that is anti-business.  For if the government creates an anti-business environment, no amount of cheap money will encourage risk takers to take risks in a highly risky and uncertain environment.  Decades were lost trying.

No, you don’t stimulate with monetary policy.  You stimulate with fiscal policy.  There is empirical evidence that this works.  The Mellon tax cuts of the Harding administration created nearly a decade of strong economic growth.  The tax cuts of JFK were on pace to create similar growth until his assassination.  LBJ’s policies were in the opposite direction, thus ending the economic recovery of the JFK administration.  Ronald Reagan’s tax cuts produced economic growth through two decades. 

THE EVIDENCE IS there.  If you look at it.  Of course, a good Keynesian won’t.  Because it’s about political power for them.  Always has been.  Always will be.  And we should never forget this.

www.PITHOCRATES.com

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